Japan goes back to bigger quantitative
easing; American recovery quickens; European and Chinese inflation also lower
and more stable. Competitiveness
concerns may finally force RBI’s hand to lower rates.
In the weekend
before Christmas, as the world’s financial markets sauntered into holiday-hibernation,
Shinzo Abe - Japan’s Prime Minister-Elect - bettered Santa Claus (or Attila the
Hun, depending on your perspective) by declaring that his coalition, which
holds an unassailable two-thirds majority in the lower house of the Japanese
Parliament, may change the law governing the coy Bank of Japan (BOJ) if it
refuses to accept a 2 per cent inflation target at its January meeting. In any
case, Masaaki Shirakawa, the relatively hawkish BOJ governor will be replaced
with a more dovish, pliable candidate by April 2013. At the December 20th meet,
he already declared to engage in more easing by expanding asset-buying and
lending program by a tenth to $1.2 trillion, and hinted at an upward review of
its 1 percent inflation target.
Japan following Europe in moving from
inflation targeting to dual targeting
The BOJ, like
the European Central Bank (ECB), is at least in theory an inflation-targeting
central bank but Abe wants it to have a dual target of inflation and employment
much like its American counterpart - the Federal Reserve (“Fed”). But a year
ago, of course, the ECB had de facto reneged
on or at least expanded its inflation-targeting mandate by launching its first
series of Long Term Refinancing Operations (LTRO) with 489 billion
freshly-created Euros, the full (bullish) effects of which took months to play
out. The Fed of course must itself be confused about its Quantitative Easing
(QE, a term first used in Japan) historiography, with its even larger and
multifarious rounds since late 2008 or early 2009 (depending on how QE is
defined).
Yet, Japan
has no real short-term alternative policy plan given its political economy.
October 2012 figures show that CPI or consumer price inflation was negative
0.4% (or deflation), inflation has been largely negative or zero for the last
few years and nominal interest rates cannot really go down any more. Differences
on monetary easing therefore is on the margins, and imaginative solutions are
politically locked as of now – immigrants a.k.a new tax payers are still
frowned upon, an aging population creates more fiscal dependents, free trade in
agriculture is taboo, and finally there is no political force that can resist
the asymmetrical Keynesian orthodoxy in Japan. “Bridges to nowhere” are still
being touted as an economic solution, whereas structural supply-side reforms
and targeted growth-supporting tax cuts are relatively frowned upon.
All this
combined with even slower growth rates since the financial crisis of 2008 has
ballooned Japan’s government debt to GDP ratio from 167% in 2008 to 212% in
2012. Yes, interest rates have fallen since 2008 and the flow of debt servicing
has been easier to manage. But this huge stock of debt will still be around,
when – not if – interest rates rise. Yes, even China’s economic size at market
exchange rates (as opposed to purchasing power parity rates which are more
favorable to poor per-capita countries like India and China) has now clearly
overtaken Japan’s and is almost half of America’s size, yet the Government of
Japan’s debt at around 12 trillion USD is comparable to the US Government’s 15
trillion (whereas the American economy is almost three times as large as
Japan’s).
The Yen depreciates, re-establishing
itself as a carry trade generator?
Moreover, the
situation is not radically different in the US or EU, and easing there – along
with the continuing slowdown - had forced the Yen up and weakened Japanese
exports (Japan posted a larger-than-expected trade deficit in November). While
a few large countries or economic blocks could sit together and theoretically
stop down competitive devaluation, this is unlikely to happen because
democratic governments come to appreciate seigniorage and inflation as hidden
taxes that also re-adjust the balance between labour and capital in favour of
the latter without having to force the former into nominal wage cuts.
Already, the
Yen has depreciated from 79.5 in mid-November 2012 to above 84 before Christmas
in anticipation of Abe’s victory and policies. That is a 5 percent short-term
competitive advantage for Japanese exporters and manufacturers and will help at
the margins. Such overall Yen structural
weakness might mean borrowing in yen and investing in foreign currencies, which
might be a boom for Indian and other emerging market (EM) equities, if not
commodities (where supply-side booms and demand-side drops due to technical
innovations continues apace)
Jump off fiscal cliffs or not,
American central bankers will still ease for now.
The current
fight over the “fiscal cliff” in the United States exemplifies the inability of
the political class the world over to lead its societies to defer more
consumption and gratification for the well being of their children and
grandchildren. American Democrats would not countenance any stricter criteria
for redistribution payments, and many congressional Republicans would not accept
any higher taxes on upper-middle class families. Ben Bernanke’s Fed, blessed
with America’s size and credit history, is in a unique position to further ease
and yet attract lower yields with every economic downturn (including a fiscal
tightening), despite the total government to debt ratio having breached 100%.
But signs of American solvency – any ratings downgrade hysteria notwithstanding
– are inaccurate and overly pessimistic: US GDP increased at an annualized
inflation-adjusted rate of 3.1 percent in the third quarter of 2012 (that is,
from the second quarter to the third quarter). In the second quarter on the
other hand, GDP had increased by “only” 1.3 percent –strengthening the recovery
thesis. The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.3
percent in November on a seasonally adjusted basis, hinting at perhaps more room
for easing at least in the short run. Over the last year, the overall price
index increased by just 1.8 percent.
The Fed therefore
said it will buy $45 billion a month of Treasuries (and 40 billion additional
dollars worth of mortgage securities) starting in January, expanding its
asset-purchase program indefinitely until 6.5% unemployment is not reached, and
so long as inflationary expectations one to two years in the future does not
breach 2.5%. Total nonfarm payroll employment rose by 146,000 in November, and
the unemployment rate went down to 7.7 percent. An additional drop of 1.2
percentage points in official unemployment rates will take at least two more
years by current estimates. But why is all this easing not leading to inflation
(yet)?
As the
financial economist Dr. Scott Grannis writes, the US public holds $6.5 trillion
of bank savings deposits (up 64% in the past four years) paying almost nothing
– 1.5 trillion of those could be diverted (as they are excess bank reserves) to
entrepreneurial activities or consumption. Therefore, while the monetary base
has exploded in recent years the M2 measure of money supply in the United
States has grown only slightly faster than its long-term average of 6%,
partially because the public does not see that many organic or structural
investment opportunities.
Moreover, the
American economy (and more specifically the housing market) continues to
“optimally” strengthen, as Ray Dalio of Bridgewater Capital might say - because
of moderate monetary policy led-leveraging (mortgage refinancing help, and
demographic expansion) with fiscal policy and private sector partial
deleveraging. 2011’s brisk revival was continued this year, with a 22 percent
increase in housing starts in the last 12 months.
Whither Europe?
Just like
politicians from India to US have not had the courage to pass many genuinely
short-term austerity and long-term liberalization measures, Mario Draghi’s ECB has
nudged Germany to repeatedly cave in to the demands of smaller, profligate countries
like Greece which refuse to fully accept painful restructuring.
The European
fiscal union – and indeed the single European nation-state – is being molded
and merged in the cauldron of its fiscal, economic and finally demographic
crisis; with this dream of the idealists of yore being suitably lubricated by
the ECB. In this pursuit, it is being helped by falling inflation (2.2% in
November, down from 2.5% in October; last year was around 3 percent)
Moreover, the
year-on-year Euro Area industrial production in October also fell by 3.6%
(seasonally adjusted) – calling for further creating/printing of new Euros.
While the ECB still remains more cautious and conservative than the Fed, it
will have to step in even more given the reality of at-best zero-growth-rate
economies. The election of Hollande’s socialist party in France has played out
as expected – discouraging entrepreneurs, and strengthening government unions.
Moreover, the resignation of the reformist, technocratic Prime Minister of
Italy, Mario Monti, has put a question mark on another too-big-to-fail European
nation. While a Greece and Portugal can be “bought off” for now, an Italy or
France or Spain faltering seriously will be the end of the Euro project, which
would not necessarily be cataclysmic if managed well (a big “if” that).
China – falling inflation point to
monetary easing here too
In November
2012, the Chinese consumer price index (CPI) went up by 2.0 percent
year-on-year. The food prices went up by 3.0 percent, while the non-food prices
increased by 1.6 percent. In the third quarter of 2012, Chinese GDP grew by 7.4
% year on year and almost 9 % annualized seasonally adjusted quarter on
quarter. Therefore, while the annual expansion was one of the slowest since
2009, the quarterly change has shown improvement. On the trade front, like the
growth front, also we have mixed signals – only inflation seems to be a
relatively clearly indicator.
Structurally,
the Chinese growth is chugging along well despite no new major government stimulus
and still weak global demand, which is a testament to the diligence of the
Chinese people. The property markets of free market havens, Hong Kong and
Singapore, have had to take unprecedented protectionist/stamp duty measures to
thwart rich Chinese buyers (so as to prevent bubbles) in the wake of Western
monetary easing washing up on Asian shares rather quickly. Yet, China has not
exactly turned corners. Also, the Chinese national bond regulator has temporarily stopped approving debt sales
by governments below provincial level, thereby sending out a signal,
however credible, against implicit federal guarantees and thereby strengthening
the stimulus reservoir strength at the national level in some future
contingency (sub-national Chinese insolvency was causing some prominent
investors a lot of jitters).
It seems that
while the Americans are expanding the monetary base, but not subsequent layers
of credit, the Chinese are to some extent accelerating investment credit
outflows through their banking systems while not necessarily focusing on the
monetary base per se. This latter plan of action is of course only possible in
more tightly controlled banking systems, and has its own downsides in
efficiency and corruption. The Chinese economic expert and “bear”, Dr. Michael
Pettis, remains pessimistic about China in the mid term noting that “of the
dozens of developing economies that have experienced investment-driven growth
miracles in the past 100 years, the only ones that have managed the transition
to developed country status are South Korea, Taiwan, and maybe Chile” and hence
China will have to face a painful transition from its mercantilist, centralized
model to a more market-finance based one.
Probable impact of all this on India -
short-term equity bullishness
Besides some
domestic reforms (FDI policy in retail being passed in both houses of the
parliament), the Indian markets have been buoyant for these external factors as
well, and this could be the beginning of another mini-rally with higher tops
and higher lows. But, India’s monetary policy remains cautious and fiscal
policies remain reckless – slowing growth have resulted in advance tax receipts
growing by just (annualized) 10.4% in December so far (collections grew even
slowly at 7.5% on year between April and December, with the nominal growth rate
all along being just shy of 15%, 6 percent growth plus 9 percent inflation
roughly speaking).
In a battle
of wills between politicians and central bankers, the latter are more likely to
blink first. Tax breaks to invest in Indian bonds were declared earlier to
attract foreign and/or privative investments, and this is already showing
results. Ennore Port in Tamil Nadu is
already issuing bonds worth Rs. 1000 cr within this scheme. On the other hand, there have been many
“deforms” as well. Life Insurance Corporation (LIC) and now even the Employees’
Provident Fund Organization (EPFO) are being raided by the Government of India
(GoI) for its fiscal purposes, destroying more necessary firewalls between various
quasi-arms of the state. The Food bill, like NREGA, is going to be high on
redistributive expenditure and low on allocative efficiency – there is no plan
to currently use private retail outlets (existing ration shops would be used)
Indian
foreign reserves have been stable at around 300 billion USD for many years even
as the economy continued to grow, showing that any dramatic appreciation of the
rupee is very improbable now. In fact, our overall macro policies are fairly
balanced with remittances providing a solid support that needs to be always
remembered given the sticker shock of our trade deficit numbers. India is the
only huge nation with a demographic surplus for the next few decades, and
emigration should be an “export” for our accounting purposes, just like “gold
purchases” need to be considered at least partially as investments. With rating
agencies likely to be even more involved because of the government’s gradual
and further opening up to foreign financial capital, invariably a fiscal-political
balance will also be found. The long term growth story of the capitalist
democracy of India is intact, despite the hysterical headlines every now and
then.
*A special contribution by Harsh Gupta....Economist from Dartmouth University
Best Regards
Paras Bothra
paras.bothra@ymail.com
+919831070777
