Facebook Blogging

Edward Hugh has a lively and enjoyable Facebook community where he publishes frequent breaking news economics links and short updates. If you would like to receive these updates on a regular basis and join the debate please invite Edward as a friend by clicking the Facebook link at the top of the right sidebar.

Sunday, June 19, 2011

India's Economy Hits What Has To Be A Very Welcome "Soft Patch"

“If you look at the world, it would inevitably appear India’s growth is preordained. The world needs working hands. The world needs back offices. India seems to be a natural fit…We are producing a workforce which is not only for India, but a global workforce.”
Sunil Bharti Mittal, founder and chairman of New Delhi-based Bharti Enterprises
As the European Central Bank moves steadily and earnestly forward with its ongoing rate hike cycle - in so doing sending one fragile economy after another along Europe's periphery drifting off towards recession - there is at least one prominent global central banker who must be feeling vindicated in the policy stance he has taken to try and bring the rampant inflation from which his country has been suffering back under control. Duvvuri Subbarao is Governor of the Reserve Bank of India, and under his stewardship the central bank has been hard at work over the last twelve months trying to credibly fight inflation. So far raised rates have been raised ten times, and the bank has managed to claw the annual rate of wholesale price inflation back from its peak of 10.9% to the current level of 9.06%. Hardly a level to be complacent about, but then Mr Subarrao seems far from complacent.

Obviously there is long way to go yet awhile before he can even reach his short term inflation target, which is why he warned again following last week's monetary policy meeting - when the benchmark repo rate was raised to 7.5% - that monetary tightening in India would continue even at the cost of further slowing economic growth. In so doing he underlined his determination to reach his inflation objective of 6 percent “with an upward bias” by March 31, 2012 and maintain the credibility of the bank as an independent entity. So, be warned, when this man says "strong vigilance" he means it, even though, as has to be recognised, central bank rates are still negative at this point.

As a result of this posture India’s economy may, he accepted, expand by only “around 8 percent” in the financial year through March, a reduction on the 8.6 percent he previously estimated, and significantly short of those double digit growth rates India must be aiming for in the near term. In fact most forecasters agree with Subarrao, and see India's growth dropping back from last years sweltering 10.3% pace, indeed the majority of commentators are agreed that in the very short term this would be no bad thing. India's inflation is structural, and needs containing so the economy can accelerate to its full growth potential, which I personally estimate to be well into the double digit zone. I have felt and been arguing so for some years (see me berating the Economist on this very topic of India's growth potential here in 2007 and here in 2006). It is highly likely India can easily fact break all those earlier Chinese records when she really gets going, such is the country's potential, but that potential can only be realised if the old phantoms which haunt the economy are hunted down and eliminated. High on the "hit list" here has to be the inflation curse.

Purging the endemic inflation out of the system is as much an attitude change as anything, and Duvurri Subbarao is hard at work trying to achieve it. People need to get used to the idea that they cannot simply solve their short term problems by raising prices and passing on their inefficiencies to customers, and that the reason they can't do this is that the central bank is there to make sure they don't.

As I say, India’s current inflation problem is largely a structural one, and is in large part due to supply side rigidities coupled with low capacity slack in some of the key sectors. Ultimately only government initiated reforms and substantial infrstructural investment can get to the heart of the problem, but the central bank has a key role to play in this, especially by demonstrating to would be investors that the financial and price environment is a stable one. The current bout of energy and food price inflation is a particular concern given the risks that the country's supply side deficiencies and rigidities could generate second round effects and feedback into core prices. This is important, since unlike in many developed economies, India’s inflation is, in part, a demand-driven phenomenon. And since it is demand driven, it is susceptible to the application of monetary policy.

In any event, more interest rate rises are certainly in the pipeline, and the markets are taking the central bank growth warnings seriously: stocks peaked in November, and they show no sign of reviving in the short term.

It's The Demography Silly!

Now, if we take a look at the way things worked out in the first decade of the present century, you might want to ask yourself how I can be so sure that India is destined to become one of the leading players in the global economy over the next decade or two. Surely up to now the Emerging Markets story has been very much a China one.

Well my answer would be, it's the demography silly! Now I am sure there will be no shortage of people lining up out there just waiting to tell me that I am wrong, that demography isn't destiny, and I don't know what else. So I am here to answer them, saying you are right, in economic terms demography may well not be everything, but it sure as hell is a big part of the picture, a much bigger one than many economists are willing to admit. This is the real problem, since mainstream neo-classical economics and structural-reform-oriented microeconomic analysis virtually screens demographic dynamics out of the picture.

And it is the underlying comparative demography of the two huge emerging "mega-countries" that suggests to me that while the global growth story at the present time is largely a China one, poll position could easily pass over to India at some point during the next decade. The principal reason I feel so confident in saying this is that India's demographic transition is a much more balanced one, producing a far more stable population pyramid than the one China is about to find itself landed with.

In The Long Run - We Are All OLD

Population ageing is a global phenomenon, one which has been affecting all societies and all countries since the start of the industrial revolution. The last 250 years have seen enormous and swift changes in the structure of our populations. During nearly roughly 10,000 years prior to the coming of modern society population median ages and structures varied very little, but since the the end of the 18th century, and driven by movements in fertility rates and life expectancy, populations all across the globe have been steadily ageing.

Put very simply this ageing comes in two waves, which could loosely be called the first and second demographic transitions. During the first transition fertility falls from very high levels to population replacement ones, the proportion of those in the working age groups rises constantly, while life expectancy increases such that the population in the 65 to 80 age group steadily increases. This is the time when pension Pay As You Go pension systems are introduced, since people still can believe they are sustainable.

During the second transition, fertility in many countries falls well below replacement level and stays there for several decades. Life expectancy rises such that the over 80 population becomes a significant part of the total population and the working age population goes into long-term permanent decline in both absolute terms and as a proportion of the total. As this happens, people start to worry about the sustainability of those very same pension systems they have just introduced, while financial markets begin to ask questions about the posibility of sovereign default.

Again simplifying, the developed societies are now well into the second ageing phase, while the so called emerging (or "growth" economies) are at some point or other along the first one. And the the big difference between India and China is the velocity with which they are passing through the first phase.

Quick-fixes Normally Don't Work

Back in the 1970s China opted for a short term solution to its perceived population problem by applying drastic social surgery in the form of the one child per family policy. Their problem was, of course, a very real one, since the underlying population explosion made it very hard to feed everyone, but as is often the case with such drastic remedies, in the longer run the cure may turn out to have been even worse than the ailment.

Fertility in India, on the other hand, has declined much more slowly (always accepting, naturally, that there are very large differences between North and South) and as a consequence the poulation ageing process is much slower. While the proportion of population in the under 14 age group declined from 41 per cent in 1961 to 35.3 per cent in 2001 (that is, by 5.7 percentage points), the proportion of population in the age group 15-59 increased from 53.3 per cent to 56.9 per cent (that is, by 3.6 percentage points). The proportion of those over 60 increased from 5.6 per cent to 7.4 per cent (that is, by 1.8 percentage points).

In strictly numerical terms the changes seem much larger. The increase in the 15-34 age-group population, for example; has been quite dramatic: from 174.26 million (31.79 per cent) in 1970 to 354.15 million (34.43 per cent) in 2000. This age group is currently projected to peak in 2030 at around 485 million.

According to UN Population Division projections even though the 15-34 age group will only start to decline in absolute terms in India post 2030, it started to fall as a proportion to the total population last year. But for the time being the rate of decline is marginal (being projected to drop from 35.4 per cent in 2010 to 34.5 per cent in 2020, to 32.4 per cent in 2030). After 2030, however, the rate of decline will accelerate (dropping to 29.7 per cent in 2040, and 26.6 per cent in 2050 according to the forecasts). Yet even given this there will still be a massive 441.1 million people in the age group by the time we reach 2050.

This demographic evolution will have important implications for the country's labour market. India's labour force, which was estimated at 472 million in 2006, is expected rise to around 526 million in 2011 and then grow steadily hitting 653 million in 2031. The labour force growth rate will remain higher than the rate of increase in total population until 2021. According to Indian government estimates, 300 million young people will enter the labour force between now and 2025, by which time approximately 25 per cent of the global labour force (or one worker in four) will be Indian.

Meanwhile, as can be seen in the accompanying charts, China's working age population is in the process of peaking both numerically and as a proportion of the total population.

China is getting old far too fast. By 2040, assuming current demographic trends continue, there will be 397 million Chinese over 65 - more than the total current population of France, Germany, Italy, Japan, and the United Kingdom combined.

The population pyramid is shifting fast (unusually fast for a country with China's income level), and the degree of ageing we should anticipate, in terms of both absolute numbers and velocity, is simply staggering. It is during the 2020’s that China’s age wave will arrive in full force. The elder share of China’s population seems set to rise steadily from 11 percent of the total in 2004 to 15 percent in 2015, and then leap to 24 percent in 2030 and 28 percent in 2040. Over the same period, China’s median age will climb from 32 to 44.

Thus China’s ageing is characterised by the unusual speed with which it is occurring, something which should not surprise us given that the outcome is the result of a massive social engineering experiment. To give an idea, while Europe's over 65 population crossed the 10 percent threshold back in the 1930s, it is not expected to reach the 30 percent of the population mark until the 2030s, a full century later. China, on the other hand, will traverse this same distance in a single generation. The magnitude of China’s coming age wave, is simply staggering. And if the economic consequences of the first (positive) part of China's demographic transition have already been large and significant, we should now be beginning to brace ourselves for the other part, the demographic downside.

So India has huge potential, including the potential to act as a sheet anchor for a global economy in a state of shock as China struggles with the enormous challenges which will face it. But will India really be able to realise the potential it has? To think about this. let's go back to the short term economic development of the Indian economy, and back to the world of Duvarri Subarrao and the battle he is fighting over at the Indian central bank.

India's Exports Are Growing Fast

Now first of all the good news: India's merchandise exports rose sharply in May, helped by a surge in shipments of engineering and electronic products. They jumped 56.9% year-on-year to reach $25.9 billion, and totalled $49.8 billion for the first two months of the fiscal year that started on April 1, an increase in 45.3% over the same period a year earlier.

But So Too Are Its Imports

In fact India runs a trade deficit (well, someone has to). May imports surged 54.1% to $40.9 billion, touching the highest level in four years and only adding to concerns about the widening trade deficit. India's goods trade deficit was $15 billion in May - the widest level since August 2008

Governance IS A Problem In India

So here we have the first sign beyond the inflation that all is not entirely well in the Indian economy. If India has a trade deficit, then this means that someone somewhere is borrowing money. And indeed they are, since while private sector indebtedness in India is low (despite rising consumer credit), government debt is high, indeed it is very high by emerging economy standards.

But when you have an economy expanding at 8% a year, and set to accelerate to over 10%, so much government debt is hard to understand, especially since all the evidence suggests that it is not being used to finance a massive, and much needed, infrastructure overhaul. And at the present time India's general government deficit is running at near to 10% of GDP. Part of the problem here are India's state governments, but even the performance of central government leaves a lot to be desired. Finance Minister Pranab Mukherjee has promised to marginally reduce the central government budget component to 4.6 percent of GDP in the current financial year, down from 4.7 percent in the previous 12 months, but even this minor correction now seems to be in some doubt, since Chakravarthy Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, told reporters in Mumbai recently that the target would be “difficult to achieve".

As A Result India Has Trouble In The Current Account Department

With a fiscal and a trade deficit it is hardly suprising that India's current account position has been deteriorating in recent years. India reported a current account deficit equivalent to $9.7 Billion in the fourth quarter of 2010, down from $16.8 billion in the third quarter, and the situation may have even improved again during the first quarter given the strong export performance, but the IMF are still forecasting a small increase for 2011, up to 3.7% of GDP from 3.2% in 2010.

At the present time the deficit is being financed by short term capital inflows - India's reserves stood at $313 billion at the start of June, up from $271 billion a year earlier (a rise of 15%).

Net private capital inflows to emerging market economies can be expected to keep growing this year (provided there is no financial accident in Europe) and could even reach $1.1 trillion in 2012 according to a recent estimate by the Washington-based Institute of International Finance. As the IIF says, “The strength of capital flows is still presenting policy challenges in a number of emerging economies, especially those already facing pressures from rising inflation, strong credit and asset price growth and rising exchange rates" - India's case precisely.

Just as importantly, many of the inflows are short term, and are primarily used to fund bank loans and equity purchases. The share going into infrastructural and other projects is comparatively small.The Bank For International Settlements (the central bank of the central banks) highlighted just this problem in their latest quarterly report, drawing attention to the extent to which the rapid growth in lending to emerging market economies might be “hot” money, subject to withdrawal at short notice. According to the bank, most of the growth in lending to EMs between the second quarter of 2009 and the end of 2010 was driven by short term lending, and an estimated $418bn, or 79 per cent, of the increase consists of loans with maturities of less than one year. This compares with the 49 per cent of lending to EMs falling into this category between the start of 2006 and the middle of 2008. And the bank also highlighted just how the trend of increasing reliance on short-term lending was highly concentrated among borrowers in the Asia-Pacific region which accounted for 84percent of the recent rise.

These proportions look horribly like what we were seeing entering emerging economies in Eastern Europe in the run up to the Lehman debacle, which means if we do have a sharp reversal in risk sentiment on the back of the Eurozone debt crisis, emerging Asia would look to be very exposed, a point which is not lost on central banker Subbarao, who warned on precisely this topic in a recent speech in Zurich.

After the U.S. announced its second round of quantitative easing in August 2010, “the prospect of easy liquidity in the U.S. seemed to prompt a large increase in capital flows to emerging market economies, threatening domestic price and financial stability,” he told his audience. Since the U.S. quantitative easing policy had also put pressure on global commodity prices, the "combination has put some emerging market economies in a policy bind, but higher interest rates will only intensify capital inflows, potentially putting more pressure on exchange rates and domestic stability. In India’s case, the concerns on this account currently are less acute since capital flows are needed to finance our current-account deficit.Yet even for us, the composition of the inflows remains an issue,” he said. “About three-quarters of the current-account deficit has been financed by volatile capital inflows.” And those inflows, in situations of stress could easily reverse, as he knows only too well.

We Should Never Forget India Is Still An Emerging Economy

Having said all this we should never forget that India is still an emerging economy, one which has made great strides forward in recent years. And despite many difficulties India has remained a democracy since independence. It is a country where human rights are by and large respected, and where institutional quality is gradually improving. As I am suggesting here, the central bank is becoming more and more independent. Corruption is still a BIG problem, but eventually this has solutions. At the same time India is a country of individuals, of creativity and strong entrepreneurial spririt and, to close with a professional bias: India produces economists of extraordinary quality.

And, as I said above, maybe demography isn't everything, but we should never forget that it is a large and important part of the picture.

This post first appeared on my Roubini Global Econmonitor Blog "Don't Shoot The Messenger".

Saturday, June 20, 2009

Facebook Links

Quietly clicking my way through Bloomberg last Sunday afternoon, I came across this:

Facebook Members Register Names at 550 a Second

Facebook Inc., the world’s largest social-networking site, said members registered new user names at a rate of more than 550 a second after the company offered people the chance to claim a personalized Web address.

Facebook started accepted registrations at midnight New York time on a first-come, first-served basis. Within the first seven minutes, 345,000 people had claimed user names, said Larry Yu, a spokesman for Palo Alto, California-based Facebook. Within 15 minutes, 500,000 users had grabbed a name.

Mein Gott, I thought to myself, if 550 people a second are doing something, they can't all be wrong. So I immediately signed up. Actually, this isn't my first experience with social networking since I did try Orkut out some years back, but somehow I didn't quite get the point. Either I was missing something, or Orkut was. Now I think I've finally got it. Perhaps the technology has improved, or perhaps I have. As I said in one of my first postings:

Ok. This is just what I've always wanted really. A quick'n dirty personal blog. Here we go. Boy am I going to enjoy this.
Daniel Dresner once broke bloggers down into two groups, the "thinkers" and the "linkers". I probably would be immodest enough to suggest that most of my material falls into the first category (my postings are lo-o-o-ng, horribly long), but since I don't fit any mould, and Iam hard to typecast, I also have that hidden "linker" part, struggling within and desperate to come out. Which is why Facebook is just great.

In addition, on blogs like this I can probably only manage to post something worthwhile perhaps once or twice a month, and there is news everyday.

So, if you want some of that up to the minute "breaking" stuff, and are willing to submit yourself to a good dose of link spam, why not come on in and subscribe to my new state-of-the-art blog? You can either send me a friend request via FB, or mail me direct (you can find the mail on my Roubini Global page). Let's all go and take a long hard look at the future, you never know, it might just work.

Saturday, May 23, 2009

Don't Get Carried Away Now!

As Paul Krugman recently pointed out, one of the central points they made in the latest IMF World Economic Outlook was that recessions caused by financial crises tend to get resolved on the back of export-lead booms, with countries normally emerging from the crisis with a positive trade balance of over 3 percent of GDP. The reason for this is simple, since consumers are so laden-down with debt from the boom period, they are naturally more obsessed with saving than borrowing during the initial crisis aftermath. So much then for the typical crisis, and the typical exit. But musing on this point lead Krugman to an additional, rather disturbing, conclusion: since the present financial crisis is truly global in its reach, the habitual exit route to recovery will only work after we are able to identify another planet to send all those exports to (shades of Startreck IV). The joke may seem a rather exaggerated one, in poor taste even, but behind it there lies a little bit more than a grain of truth.

But not everywhere is gloom and doom at the moment, and on the other side of the world they woke up reeling from different kind of bounce last Monday morning, on learning that India’s outgoing government had been not only been re-elected, but had been thrust back into power on a much more stable basis. And that was not the only pleasant surprise in store for those reading their morning newspapers in London, Madrid or New York, since India's main stock index - the Sensex - shot up as much as 17% during early trading on receiving the news, while the rupee also surged sharply. So just one more time we find ourselves faced with the prospect of living in a rather divided world, where on one side we have growing and deepening pessimism, while on the other we see a burst of optimism, with someone, somewhere, getting a massive dose of that "let a thousand green shoots bloom" kinda feeling. Perhaps we should ask ourselves whether there is any connection?

Well, and to cut the long story short, yes there is, and the connection has a name, and it's called sentiment. Indeed sentiment is precisely why the recent (and highly controversial) US bank stress tests were so important. Their real significance was not for any relevance they may have from a US banking point of view (which was, of course, highly contested), but for the reassurance they can give market participants that there will not be another financial explosion in the United States (as opposed to a protracted recession, and long slow recovery), or put another way, to show the days of "safe haven" investing are now over. Risk is about to make a comeback, and the only question is where?

Which brings us straight back to all that earlier talk of coupling, recoupling, decoupling, and uncoupling which we saw so much of a year or so ago (or to Decoupling 2.0, as the Economist calls it). And to the world as we knew it before the the demise of Lehmann brothers, where commodity prices were booming like there was no tomorrow on the one hand, while credit- and housing-markets markets were steadily melting down in the developed economies on the other, where growth was being clocked up in many emerging economies at ever accelerating rates, while the only "shoots" we could see on the horizon in the US, Europe and Japan were those of burgeoining recessions.

The point to note here is not just that a significant group of investors and their fund managers spent the better part of 2008 busily adapting their behaviour to changed conditions in the US, Europe and Japan, but rather that a very novel set of conditions began to emerge, as the credit crunch worked its way forward and property markets drifted off into stagnation in one OECD economy after another. Just as they were finally announcing closing time in the gardens of the West almost overnight it started "raining money" in one emerging economy after another - as foreign exchange came flooding in, and the really hard problem for governments and central banks to solve seemed to be not how to attract funding, but rather how to avoid receiving an excess of it. Thailand even attained a certain notoriety by imposing capital controls with the explicit objective of discouraging funds not from leaving but from entering the country.

Then suddenly things moved on, and day became night just as quickly as night had become day as one fund flow after another reversed course, and the money disappeared just as quickly as it had arrived. Behind this second credit crunch lay an ongoing wave of emerging-market central bank tightening (during which Banco Central do Brasil deservedly earned its spurs as the Bundesbank of Latin America) with the consequence that one emerging economy after another began to wilt under the twin strain of stringent monetary policy and sharply rising inflation. Thus the boom "peaked" in July (when oil prices were at their highest), and momentum was already disapearing when the hammer blow was finally dealt by the decision to let Lehman Brothers fall in late September. By November all those previous positive expectations were being sharply revised down, with the IMF making an initial cut in its global growth estimate for 2009 - to 2.2 percent from the 3.7 percent projected for 2008. The World Bank went even further, and by early December was projecting that world trade would fall in 2009 for the first time since 1982, with capital flows to developing countries being expected to plunge by around 50 percent. By March 2009 they were estimating that the volume of world trade, which had grown by 9.8 percent in 2006 and by 6.2 percent in 2007, was even likely to fall by 9 percent this year.

Having said this, and while fully recognising that the future is never an exact rerun of the past - and especially not the most recent past - given that emerging economies have been the key engines of global growth over the last five years, is there any really compelling reason for believing they won't continue to be over the next five? Could we not draw the conclusion that what was "unsustainable" was not the solid trend growth which we were observing between 2002 and 2007, but rather the excess pressure and overheating to which the key EM economies were subjected after the summer of 2007? And if that is the case, might it not be that the "planet" we need to find to do all that much needed exporting to isn't so far away after all, but right here on this earth, and directly under our noses, in the shape of a growing band of successful emerging economies.

According to IMF data, the so called BRIC countries actually accounted for nearly half of global growth in 2008 - China alone accounted for a quarter, and Brazil, India and Russia were responsible for another quarter. All-in-all, the emerging and developing countries combined accounted for about two-thirds of global growth (as measured using PPP adjusted exchange rates) . Furthermore, and most significantly, the IMF notes that these economies “account for more than 90 per cent of the rise in consumption of oil products and metals and 80 per cent of the rise in consumption of grains since 2002”.

But behind the recent emerging market phenomenon what we have is not only a newly emerging growth rate differential, since alongside this there is also alarge scale and ongoing currency re-alignment taking place, a realignment driven, as it happens, by those very same growth rate differentials. The consequential rapid and dramatic rise in dollar GDP values (produced by the combination of strong growth and a declining dollar) has meant that a slow but steady convergence in global living standards - at least in the cases of those economies who have been experiencing the strongest acceleration - has been taking place, and at a much more rapid pace than anyone could possibly have dreamed of back in the 1990s, even if the long term strategic importance of this has been masked by the recent collapse in commodity prices and the downward slide in emerging stocks and currencies associated with the post-Lehman risk appetite hangover. Which is why, yet one more time, that simple issue of sentiment is all important, or using the expession popularised by Keynes "animal spirits".

Carry On Trading

But now we have a new factor entering the scene. The US Federal Reserve, along with many of the world's key central banks, has so reduced interest rates that they are now running only marginally above the zero percent "lower bound", and the Fed is far more concerned with boosting money supply growth to fend of deflation than it is with restraining it to combat inflation. Not only that, Chairman Ben Bernanke looks set to commit the bank to maintain rates at the current level for a considerable period of time.

In this situation, and given the extremely limited rates of annual GDP growth we are likely to see in the US and other advanced economies in the coming years, all that liquidity provision is very likely to exit the first world looking for better yield prospects, and where better to go than to to look for it than those "high yield" emerging market economies.

The Federal Reserve could thus easily find itself in the rather unusual situation of underwriting the nascent recovery in emergent economies like India and Brazil , just as Japan pumped massive liquidity straight into countries like New Zealand and Australia during its experiment with quantitative easing between 2001 and 2006. And the mechanisms through which the money will arrive? Well, they are several, but perhaps the best known and easiest to understand of them is the so called carry trade, which basically works as follows.

Stimulus plans and near-zero interest rates in developed economies boost investor confidence in emerging markets and commodity-rich nations whose interest rates are often in double figures. Using dollars, euros and yen these investors then buy instruments denominated in currencies from countries like India, Brazil, Hungary, Indonesia, South Africa, Turkey, Chile and Peru - which collectively rose around 8% from March 20 to April 10, the biggest three-week gain for such trades since at least 1999 . A straightforward and simple carry-trade transaction would run like this: you borrow U.S. dollars at the three-month London interbank offered rate of (say) 1.13% and use the proceeds to simply buy Brazilian real, leaving the proceeds in a bank to earn Brazil’s three-month deposit rate of 10.51%. That would net anannualized 9.38% - under the assumption that the exchange rate between the two currencies remains stable, but the real, of course, is appreciating against the dollar.

Other options which immediately spring to mind are Turkey, where the key interest rate is currently 9.25 percent, Hungary (9.5 percent) or Russia (12 percent). And the cost of borrowing is steadily falling - overnight euro denominated inter-bank loans hit 0.56 percent last week, down from 3.05 percent six months ago after recent moves by the European Central Bank to cut interest rates and pump liquidity into the banking system. The London interbank offered rate, or Libor, for overnight loans in dollars is thus down to 0.22 percent from 0.4 percent in November. And while the ECB provides the liquidity, the EU Commission and the IMF provide the institutional guarantees which - in the cases of countries like Hungary or Romania - mean that even is such lending is not completely free from default risk, they are at least very well hedged.

Indeed Deustche Bank last week specifically recommended buying Hungarian forint denominated assets, and according to the bank the Russian ruble, the Hungarian forint and the Turkish lira are among the trades which offeri investors the best returns over the next two to three months. Deutsche Bank recommends investors sell the euro against the forint on bets the rate difference will help the Hungarian currency gain around 10 percent over the next three months (rising to 260 from around 285 to the euro when they wrote). Investors should also sell the dollar against the Turkish lira and buy the ruble against the dollar-euro basket, according to their recommendations.

And it isn't only Deutsche Bank who are actively promoting the trade at the moment, at the start of April Goldman Sachs also recommended investors to use euros, dollars and yen to buy Mexican pesos, real, rupiah, rand and Russia rubles. John Normand, head of global currency strategy at JPMorgan, is forecasting a strong surge in long term carry trading as the recovery gains traction. Long trading, he says, is decidedly "underweight" at this point. Long carry trade positions held by Japanese margin traders, betting on gains in the higher-yielding currencies, peaked at $60 billion last July, according to Normand. They were liquidated completely by February, and have subsequently increased to around one third of the previous value (or $20 billion). “Only Japanese margin traders and dedicated currency managers appear to have reinstated longs in carry,” Normand says. “Their exposures are only near long-term averages.”

And Barclays joined the pack this week stating that Brazil’s real, South Africa’s rand and Turkey’s lira offer the “largest upside” for investors returning to the carry trade. A global pickup in investor demand for higher-yielding assets and signs the worst of the global recession is over “bode very well for the comeback of the emerging-market carry trade,” according to analyst Anfrea Kiguel in a recent report from New York. In part as a result of the surge in carry activity the US dollar declined beyond $1.40 against the euro on Friday for the first time since January. Evidently the USD may now be headed down a path which is already well-trodden by the Japanese yen.

India on The Up and Up.

But some of these trades are much riskier than others. Many of the countries in Eastern Europe who currently offer the highest yields are also subject to IMF bailout programmes, so they are with good reason called "risky assets". But others look a lot safer. Take India for example. As Reserve Bank of Indian Governor Duvvuri Subbarao stressed only last week, India’s “modest” dependence on exports will certainly help the economy weather the current global recession and even stage a modest recovery later this year. Of course, "modest" is a relative term, since even during the depths of the crisis India managed to maintain a year on year growth rate of 5.3 percent (Q4 2008), and indeed as Duvvuri stresses, apart from the limited export dependence, India's financial system had virtually no exposure to any kind of "toxic asset".

As mentioned above, the rupee rose 4.9 percent this week to 47.125 per dollar in Mumbai, its biggest weekly advance since March 1996, while the Sensex index rallied 14 percent for its biggest weekly gain since 1992.

And, just to add to the collective joy, even as Indian Prime Minister Manmohan Singh began his second term, and stock markets soared, analysts were busy rubbing their hands with enthusiasm at the prospect that the new government might set a record for selling off state assets, and thus begin to address what everyone is agreed is now India's outsanding challenge: reducing the fiscal deficit.

Singh, it seems, could sell-off anything up to $20 billion of state assets over the next five years as he tries to reduce the central govenment budget shortfall which is currently running at more than double the government target - it reached 6 percent of gross domestic product in the year ended March 31, well beyond the 2.5 percent government target. The prospect of a wider budget gap prompted Standard & Poor’s to say in February that India’s spending plans were “not sustainable” and threaten that the country's credit rating could be cut again if finances worsen. But just by raising 100 billion rupees from share sales and initial public offerings in the current financial year would reduce the fiscal deficit by an estimated quarter-point, at the stroke of a pen, as it were. And there is evidently plenty more to come from this department.

As a result of the changed perception that the new Indian government will now - and especially with the elections and the worst of the global crisis behind it - seriously start to address the fiscal deficit situation, both S&P and Moody’s Investors Service, have busied themselves emphasising just how the outcome gives India's government a chance to improve its fiscal situation. The poll result gives the government more “political space” to sell stakes in state-run companies and improve revenue, according to Moody’s senior analyst Aninda Mitra, while S&P’s director of sovereign ratings Takahira Ogawa commented that the result means “there is a possibility for the government to implement various measures to reform for further expansion of the economy and for the fiscal consolidation.”

So off and up we go, towards that ever so virtuous circle of better credit ratings, lower interest rates, rising currency values, and ever higher headline GDP growth, which of course helps bring down the fiscal deficit, which helps improve the credit rateing outlook, which helps... oh, well, you know.

And it isn't only India which is exciting investors at the moment. Brazil's central bank President Henrique Meirelles went so far as to warn this week against an “excess of euphoria” in the currency market, implicitly suggesting the bank may engage in renewed dollar purchases to try to slow down the latest three-month rally in the real. The central bank began buying dollars on May 8, and Meirelles’s latest are evidently upping the level of verbal intervention. The real has now climbed 20.5 percent since March 2, the biggest advance among the six most-traded currencies in Latin America, as prices on the country’s commodity exports rebounded and investor demand for emerging-market assets has grown. The currency is up 14 percent this year, more than any other of the 16 major currencies except for South Africa’s rand, reversing the 33 percent drop in the last five months of 2008.

Carry Me Home

Despite a number of outsanding worries about the emerging economies in Eastern Europe, the general idea that countries like India, Brazil, Turkey, Chile, Peru etc are firmly at the top of the list of the economies where current growth conditions are generally favorable seems essentially sound. Additionally, if this sort of argument has any validity at all it is bound to have implications for what is sure to be one of the key problems we will face during the next global upturn: what to do with the financial architecture which we have inherited from the original Bretton Woods agreement (or Bretton Woods II as some like to call it).

The limitations of the current financial architecture have become only too apparent during the present recession, since with both the Eurozone and the US economies contracting at the same time, the currency see-saw between the dollar and the euro has failed to provide any adequate form of automatic stabiliser. And since Japan's economy is in an even more parlous state -deep in recession, and desperate for exports - having to live with a yen-dollar parity which is at levels not seen since the mid 1990s can hardly be fun. This has lead some analysts to start to talk of a new and enhanced role for China's currency, the yuan, in any architectural reform we may initiate. But obviously, beyond the yuan we should also be thinking about the real and the rupee. However,I would like to suggest the problem we now face is a much broader one than simply deciding which currencies should be in the central bank reserve basket, and it concerns the central issue of how to conduct monetary policy in an age of global capital flows. During the last boom, comparatively small open economies like Iceland and New Zealand were on this receiving end, but this time round we face the truly daunting prospect of having global giants thrust into the same position, while the USD gets pinned to the floor, just as the Japanese yen was previously.

The problem is evidenty a structural one. The euro hit 1:40 to the USD on Friday (at a time when Europe's economies are in deeper recession than the US one is), while - as I said - the Brazilian central bank President felt the need to come out and warn against an “excess of euphoria” in the local currency market following an 18% rise in the real over 3 months. Officially, the euro surged as a result of news that the US might receive a downgrade on its AAA credit rating, but this justification hardly bears examination, given that around half of the eurozone economies could be in the same situation. Obviously currency traders live in a world where the most important thing is to "best guess" what the guy next to you is liable to do next, and in this sense the rumour could have played its part, but the real underlying reason for the sudden shift in parities is the return in sentiment we have been seeing since early May, and the massive and cheap liquidity which is on offer in New York.

Of course, the impact spreads far beyond Delhi and Rio. Turkey’s lira is also well up - and has now advanced 10 percent over the last three months - while South Africa’s rand is up 22 percent, making it the best performing emerging-market currency during the same period.

All good "carry" punts these, with Turkey’s benchmark interest rate standing at 9.25 percent, and Brazil’s rate of 10.25 percent. Even the ruble is up sharply, just as Russia's economy struggles to handle the rapidly growing loan default rates. The currency climbed to a four-month high against the dollar on Friday, making for its longest run of weekly gains in almost two years, hitting 31.0887 per dollar at one point, its strongest level since Jan. 12. The ruble was up 3.2 percent on the week - closing with its sixth weekly advance and extending its longest rally since September 2007 - and has risen 16 percent since the end of January. Russia's central bank has cut base interest rates twice since April 24 in an attempt to revive the economy, but the refinancing rate is still 12 percent - well above rates in the EU, the U.S., Japan and even quite attractive in comparison with those on offer in other emerging markets. The basic point here is that carry trade players can leverage interest rate differentials and benefit from the changes in currency valuation that these very trades (along with those made by other participants) produce. So all of this is truly win-win for those who play the game, until, that is, it isn't.

Not all of this is preoccupying - far from it, since the issues arising are in many ways related to the problem I started this article with: namely, who it is who will run the trade and current account deficits and do the necessary consuming, to make all those export-lead recoveries (even in China, please note) possible. Evidently the core problem generated during the last business cycle was associated with the size of the imbalances it threw up, and the impact on liquidity and asset prices that these imbalances had. If I am right in the analysis presented here, then we are all on the point of generating a further, and certainly much larger, set of such imbalances as we let the process rip in the uncordinated and unrestrained fashion we are doing. As you set the problem up, so it will fall. Floating Brazil and India is a very attractive and very desireable proposition. Consumers in those countries can certainly take on and sustain more leveraging. The two countries can even to some extent support external deficits as they develop. But they need to do this in a balanced way, an they do not need distortions. The world does not need more Latvias, Estonias, Irelands or Spains (let alone Icelands, and let alone of the size of a Brazil or an India). So policy decisions are now urgently needed to impose measures and structures which help avoid a repeat of the same in what is now a very imminent future. And despite all the talk of reform, very little has been done in practice. Talk of "tax havens" and the like sounds nice, and is attractive to voters, but all this is on the margin of things. What we need is global architectural reform, and policy coordination at the central bank, and bank regulation level, not to stop the capital flows, but to find a more sophistocated way of managing them.

Monday, May 18, 2009

India's 2009 General Election Delivers A Surprise Outcome

Guest Post by Manuel Alvarez-Rivera, Electoral Resources On The Internet

Contrary to exit poll findings and widespread expectations of a closely fought race, India's ruling Congress Party - formally the Indian National Congress - and its allies won a clear victory in the general election held in April and May of this year, emerging well ahead of the right-wing, Hindu nationalist Bharatiya Janata Party (BJP). In all, the Congress-led United Progressive Alliance (UPA) won 261 of 543 seats in the Lok Sabha - the lower house of India's bicameral Parliament - and came within eleven seats of an absolute parliamentary majority, while the BJP-headed National Democratic Alliance (NDA) secured only 157 and the Third Front - composed of leftist and regional parties - captured 80 seats. Meanwhile, the new Fourth Front also fared poorly, obtaining just 27 seats, while the remaining 18 seats went to other parties.

The Election Commission of India has 2009 parliamentary election results available here.

Members of the Lok Sabha are elected in single-member constituencies by the first-past-the-post system used in parliamentary elections in the U.K., India's erstwhile colonial ruler. However, unlike in Britain, no single party has won an overall parliamentary majority in a general election in India since 1984, when Congress - which at the time had ruled India for all but three years since the attainment of independence in 1947 - won a record landslide victory, following the assassination of then-Prime Minister Indira Gandhi; since 1989, Congress has been in and out of office, while BJP has emerged as a formidable rival to the Congress Party. In the meantime, India, which previously had a multi-party system with one dominant party - namely Congress - developed a highly fractious party system characterized by a proliferation of regional parties, which stands in stark contrast with the two-party (or at least two-party dominant) systems of other countries with first-past-the-post electoral systems, such as the U.K., the U.S. and (to a lesser degree) Canada.

Nonetheless, the outcome of this year's election, in which Congress won 206 seats (up from 145 in 2004) constitutes the best showing of any party since 1991, when a wave of sympathy following the assassination of then-Congress leader Rajiv Gandhi (Indira's son) in the middle of a general election allowed the party to capture 232 seats in the Lok Sabha. Conversely, BJP had its worst result since 1991, although the party remains by far the second largest in India.

The election was also a major defeat for the Third Front: the Communist Party of India (Marxist; CPM) suffered a crushing defeat in its traditional stronghold of West Bengal, while the Bahujan Samaj Party (BSP) of Mayawati Kumari, the Chief Minister of Uttar Pradesh - India's most populous state - failed to make an impact outside its home base. Moreover, Congress made a major comeback in Uttar Pradesh, capturing 21 of the state's 80 Lok Sabha seats, up from just nine in 2004 and one more than the twenty won by BSP, which seeks to represent the lower-caste Dalits, previously known as the "untouchables;" Congress' gains in Uttar Pradesh came largely at the expense of the Samajwadi Party (SP) - the Fourth Front's largest party - which lost twelve of its thirty-five seats in the northern state.

The UPA has held power since 2004, when Congress narrowly prevailed over BJP, which had been in office since 1999. After Congress Party president Sonia Gandhi - the Italian-born widow of Rajiv Gandhi - declined an offer to become India's head of government, Manmohan Singh formed a minority coalition government with outside support from leftist parties. Singh had previously served as finance minister in the 1991-96 Congress Party government of P.V. Narasimha Rao, implementing a number of measures that liberalized India's economy (until then tightly controlled by the state) and paved the way for its subsequent rapid growth. Despite the global economic crisis, India has the world's second-fastest growing economy; however, widespread poverty remains a major problem.

Although UPA remains just short of an absolute majority in the Lok Sabha, it is expected that Congress and its allies will remain in office, in light of their unexpectedly strong election showing.