Third Quarter Review of Indian Economy

This morning (25.01.2011), the Reserve Bank of India (RBI) released its Third Quarter Review of Monetary Policy for 2010-11. In its Third Quarter Review the RBI has stated that "Inflation is clearly the dominant concern. Even as the rate itself remains unacceptably high, the reversal in the direction of inflation is striking."  Keeping in view to curtile raising inflation, it had increased the repo and reverse repo rates by 25 basis points (bps) each. Therefore the curremt repo rate stands at 6.5 per cent and the reverse repo rate at 5.5 per cent; whereas, it had retained the cash reserve ratio (CRR) at 6 per cent of net demand and time liabilities (NDTL) of banks.

With the increases announced today, since mid-March 2010, the Reserve Bank has cumulatively increased the repo rate by 175 bps and the reverse repo rate by 225 bps. Additionally, the CRR was increased by 100 bps. In addition to changes in the policy rates, it had made some decisions to manage the current liquidity situation. It had decided that the additional liquidity support to scheduled commercial banks under the Liquidity Adjustment Facility (LAF) to the extent of up to one per cent of their NDTL; and a daily second LAF up to April 8, 2011.

RBI has revised the baseline projection of Inflation (WPI) rate from 5.5% to 7% for March 2011-12. It also stated that there was a rapid credit growth without commensurate increase in deposits is not sustainable. It also expects that the Current Account Deficit for the whole year (2010-11) would be around 3.5% of the GDP, which is not sustainable.

(Source: RBI website)

Interestingly, Finance Minster of India said that, "There are inflationary pressures in India and the government will have to begin supply-side management to tackle food inflation" He also stated that "Central bank rate hike is in line with the government's thinking and policy." 

If we look at the policy, then we can understand one thing in general; that is Food Inflation is really a greater concern for both RBI and Finance Ministry. In my view, the RBI move of hiking the repo and reverse repo rate will not have much impact on Inflation. The Government has to find out the exact reason for rising food prices and should take necessary step to curtail it.

Now, there are few other worrying scenario like Credit Deposit ratio, Current Account Deficit which are rightly mentioned in the Third Quarter Review. Another greater concern is India's External Debt. The ratio of short-term to total external debt stood at 22.3 % at end-September 2010 against 20.0% at end-March 2010. The ratio of short-term external debt to foreign exchange reserves was 22.5 % at end-September 2010 as compared to 18.8 per cent at end-March 2010.

It is very early to say that the increase in Repo and Reverse Repo Rate will have impact on Inflation. Finance Minister rightly said that there should be supply-side management for controlling Inflation. But, we need to wait and watch how the current monetary policy will help to control Inflation and stabilise the growing credit.

Debt Ceiling: A Brief Note

Nowadays, we often hear the term “Debt Ceiling” in many newspapers when they try to describe about the Government policy. What is debt ceiling? A "debt ceiling" is the maximum amount of debt that a government can take. In simple term, there is a limit, where government freezes their debt.

Why there should be a Debt Limit? The Main purpose of the debt ceiling is to try to limit out-of-control spending of the Government. In other words, debt ceiling is required to encourage more thrift and to have economically sound fiscal management.


Debt Ceiling and India: After almost a two decade of large fiscal deficits, India has adopted a rules-based fiscal framework in 2003 called the Fiscal Responsibility and Budget Management Act (FRBMA), with the objective to ensure intergenerational equity in fiscal management and the fiscal sustainability necessary.


According to FRBM ACT 2003 there are 4 Annual targets:


1. By 31st March 2008, the Central government shall reduce revenue deficit by an amount equivalent of 0.5 per cent or more of the GDP at the end of each financial year, beginning with 2004-05.


2. The Central Government shall reduce the fiscal deficit by an amount equivalent of 0.3 per cent or more of the GDP at the end of each financial year, beginning with 2004-05, so that, the fiscal deficit is brought down to not more than 3% of GDP at the end of March 2008.


3. The Central Government shall not give guarantees aggregating to an amount exceeding 0.5 per cent of GDP in any financial year beginning with 2004-05.


4. The Central Government shall not assume additional liabilities (including external debt at current exchange rate) in excess of 9 % of GDP for the Financial Year 2004-05 and in each subsequent financial year, the limit 9% of GDP shall be reduced by at least 1 percentage point of GDP.

(Source: FRBM ACT, Ministry of Finance)


          India’s fiscal deficit for 2009-10 had increased to 6.6 per cent of the GDP due to Stimulus Package made by Government for recovery from Global Meltdown. The Government has projected that the fiscal deficit would come down to 5.5 per cent of GDP in 2010-11.

European Economy - An Overview

           Today while I was browsing over the net on European Economy; I found a document titled “European Economic Forecast”. This report gives us a detailed study about status of European economy and International Environment. I also browsed some other materials where I found some information on EU and Euro Economy. The GDP growth rate have been forecasted to 1.7% and 2% for 2011 and 2012 respectively within EU and 1.5% and 1.8% for 2011 and 2012 in Euro Area.

       

          Inflation is projected to average 2% in the EU this year and next, easing to around 1.75% in 2012. For the euro area, a rate of 1.75% is expected in both 2011 and 2012. In forecast a modest improvement is expected with employment growth of almost 0.50% and around 0.75% is in 2011 and 2012, respectively. The unemployment rate is projected to gradually fall, from some 9.50% this year to about 9% by 2012.

         It is expected that (EU as a whole) a deficit of slightly above 5% of GDP in 2011 and 1 percentage point in 2012 as the recovery gains ground.

Is Europe Following India's Footstep?

The term "Flagship" normally denotes a lead ship.  The term has originated from the custom of the commanding officer in Naval who have right to fly a distinguished flag. The term Flagship scheme means the schemes which drive the economy towards faster growth. India is the first country to have flagship schemes. In India, (whoever follows the budget will know that) we have 8 flagship schemes. They are 1. Sarva Shiksha Abhiyan (SSA) 2. Mid-Day Meal (MDM) 3. National Rural Health Mission (NRHM) 4. Integrated Child Development Scheme (ICDS) 5. National Rural Employment Guarantee Scheme (NREGS) 6. Jawaharlal Nehru National Urban Renewal Mission (JNNURM) 7. National Rural Drinking Water programme(NRDWP) 8. Total Sanitation Campaign (TSC).

Now, the Europe has announced an initiative called “Europe 2020 flagship initiative”. They have seven flagship initiatives and they are:

1. Innovation Union: to improve framework conditions and access to finance for research and innovation so as to ensure that innovative ideas can be turned into products and services that create growth and jobs.

2. Youth on the move: to enhance the performance of education systems and to facilitate the entry of young people to the labour market.

3. A digital agenda for Europe: to speed up the roll-out of high-speed internet and reap the benefits of a digital single market for households and firms.

4. Resource efficient Europe: to help decouple economic growth from the use of resources, support the shift towards a low carbon economy, increase the use of renewable energy sources, modernise our transport sector and promote energy efficiency.

5. An industrial policy for the globalisation era: to improve the business environment, notably for SMEs, and to support the development of a strong and sustainable industrial base able to compete globally.

6. An agenda for new skills and jobs: to modernise labour markets and empower people by developing their of skills throughout the lifecycle with a view to increase labour participation and better match labour supply and demand, including through labour mobility.

7. European platform against poverty: to ensure social and territorial cohesion such that the benefits of growth and jobs are widely shared and people experiencing poverty and social exclusion are enabled to live in dignity and take an active part in society. (Source: Europe Commission website)

These seven flagship initiatives will commit both the EU and the Member States. In order to achieve the goals of Seven Flagship Initiatives within the stipulated timeframe i.e. 2020, the Europe Union and Member countries need stronger governance and also need to strengthen the coordination within economic and monetary union. No doubt, Europe is following India’s footstep on flagship schemes/ initiative. But, the success of their Flagship initiative mostly depends on the effectiveness of the governance and coordination within the union.

Should World be Open to do Business with China?

Yesterday, I have read an article from Economist titled "China buys up the world - And the world should stay open for business" Here are few excerpts from it "Chinese buyers—mostly opaque, often run by the Communist Party and sometimes driven by politics as well as profit—have accounted for a tenth of cross-border deals by value this year, bidding for everything from American gas and Brazilian electricity grids to a Swedish car company, Volvo"


The article says that there is opposition for this trend; it states that "The notion that capitalists should allow communists to buy their companies is, some argue, taking economic liberalism to an absurd extreme. But that is just what they should do, for the spread of Chinese capital should bring benefits to its recipients, and the world as a whole."


The article also talks about the rise of mercantalist, it states that "

The rich world has tolerated the rise of mercantilist economies before: think of South Korea’s state-led development or Singapore’s state-controlled firms, which are active acquirers abroad. Yet China is different. It is already the world’s second-biggest economy, and in time is likely to overtake America. Its firms are giants that until now have been inward-looking but are starting to use their vast resources abroad."

It also talks about the investment made by the chinese firms "

Chinese firms own just 6% of global investment in international business. Historically, top dogs have had a far bigger share than that. Both Britain and America peaked with a share of about 50%, in 1914 and 1967 respectively. China’s natural rise could be turbocharged by its vast pool of savings. Today this is largely invested in rich countries’ government bonds; tomorrow it could be used to buy companies and protect China against rich countries’ devaluations and possible defaults. "

The article questions about the domination of china over global capitalism, it further states that "Chinese firms are going global for the usual reasons: to acquire raw materials, get technical know-how and gain access to foreign markets. But they are under the guidance of a state that many countries consider a strategic competitor, not an ally................." 

"The idea that an opaque government might come to dominate global capitalism is unappealing. Resources would be allocated by officials, not the market. Politics, not profit, might drive decisions. Such concerns are being voiced with increasing fervour. Australia and Canada, once open markets for takeovers, are creating hurdles for China’s state-backed firms, particularly in natural resources, and it is easy to see other countries becoming less welcoming too."

The article further states that "That would be a Mistake. China is miles away from posing this kind of threat: most of its firms are only just finding their feet abroad. Even in natural resources, where it has been most active in dealmaking, it is not close to controlling enough supply to rig the market for most commodities."

"Nor is China’s system as monolithic as foreigners often assume. State companies compete at home and their decision-making is consensual rather than dictatorial. When abroad they may have mixed motives, and some sectors—defence and strategic infrastructure, for instance—are too sensitive to allow them in. But such areas are relatively few."


The article takes a stance that "China’s advance may bring benefits beyond the narrowly commercial. As it invests in the global economy, so its interests will become increasingly aligned with the rest of the world’s; and as that happens its enthusiasm for international co-operation may grow. To reject China’s advances would thus be a disservice to future generations, as well as a deeply pessimistic statement about capitalism’s confidence in itself."


I felt this a worth article to read; so I thought of sharing it here.

What is a Currency War?

Recently in many newspaper/ channels we would have come across the term Currency War. What (exactly) is a Currency War? It is a writers term (Currency war),  for economist it is well known as competitive devaluation. It  is a condition in international market's where countries compete against each other in order to achieve a relatively low exchange rate for their home currency, which will help their domestic industry to perish.

Normally at a certain period or given time, any given currency exists in a global markets is determined by supply (how much of a currency exists) and demand (how much investors want to buy goods and assets denominated in that currency).  A country can make its goods and services more "cheaper" (some may say more competitive, because its cheaper) in the global market by devaluing its currency. 


The devaluation of a currency can be made in number of ways, say, from Quantitative Easing (QE) (printing more money - by doing so there will be greater the supply of its own currency, which, would result in the less value it tends to be) to Buying of another Country's Debt (more the demand for another country's currency, the more valuable it tends to be).

QE is a practice, when a central bank tries to mitigate a potential or actual recession by creating money and injecting it into the domestic economy (so that they can avoid inflation once the economy improves). 

QE to devalue a country's currency indirectly in two ways. First, it will encourage the speculators to bet that the currency will decline in value. Secondly, the large increase in the domestic money supply will lower the domestic interest rates, which will become much lower than the prevailing interest rates compared to the countries which are not practicing quantitative easing.

When a country's currency falls in value, its exports usually grow, because its goods and services becomes much cheaper on the global market. Which will benefit the export of the country and boost the domestic as well as the global market and thus achieving economic stability.

(For More info:  click here and for History of Currency War)

(Refernces: Wikipedia and Investopedia)

Quantitative Easing and Developed Countries

        I have read 2 interesting articles today (11th October 2010) in Economist regarding the Quantitative Easing, they are - 1. The magic bullet - How the bulls believe quantitative easing will boost asset prices (Oct 7th 2010) and 2. The Japanese economy - Easy does it - Symbolic moves by the Bank of Japan (Oct 7th 2010) 

      Before going further on these 2 articles let me give definition for quantitative easing. What is quantitative easing? Usually, central banks try to raise the amount of lending and activity in the economy indirectly, by cutting interest rates. Lower interest rates encourage people to spend, not save. But when interest rates cannot be lowered no longer then central bank's only option is to pump money into the economy directly. This is called Quantitative easing (QE).

      The way the central bank does this through buying assets - usually financial assets, say government and corporate bonds. The institutions which sells the assets (either commercial banks or other financial businesses such as insurance companies) will have "new" money in their accounts, which will then boosts the money supply in the economy. Sometimes, the Quantitative Easing literally means printing money, but, nowadays the Bank don't have to literally print the money, because, it is all done electronically. However, few economists would still argue that QE is the same principle as printing money as it is a deliberate expansion of the central bank's in the monetary base. 

        Now coming back to those 2 articles, the First article says that the quantitative easing will boost asset prices. It states that "............ quantitative easing (QE), or creating more money to purchase assets. This is largely presented as a tactic to stimulate the domestic economy by lowering the cost of finance and putting more money into the banking system." 

         The article provides further information that "Over the past two years much of the developed world has attempted some form of QE. (The European Central Bank has done less than its rivals, which may help explain the euro’s relative strength.) Some see this as competitive QE, a game of “I can print more money than you can”. Many investors believe the Federal Reserve will be forced into another round of QE, perhaps as soon as November." It stresses that ".... QE is a kind of magic bullet, helping all asset prices to rise." It concludes that "Although asset prices may be buoyant at the moment, there are other risks ahead. Competitive devaluation is an inherently unstable system. Someone must lose their share of world trade. And a policy of boosting exports can all too easily turn into a policy of blocking imports."

         The Second article talks about Quantitative easing and Japan. It provides the information about how japan is currently facing problem with their monetary policy and how they are trying to adopt quantitative easing in order to get out from the Economic Crunch. The article states that "The effect would be to restart the policy of quantitative easing that Japan used to claw out of its banking crisis between 2001 and 2006. The initial amount under consideration is about ¥5 trillion ($60 billion), ¥3.5 trillion of which is for public-sector debt. That is on top of a sum of ¥30 trillion already budgeted for BoJ loans to banks."
          
         After I have read these 2 articles few thoughts arises in my mind, 1. Is QE is really a solution for the Economic Crisis and failure of Monetary Policy? 2. Whether QE will really boosts the asset's price? 3. If QE is used by an economy, then whether it's impact in the Exchange rate will be higher or lower? I am still looking for the answers for these questions.