Tag Archives: India

Central Bank Policy Rates – China cuts for first time since GFC

The Chinese authorities have cut interest rates for the time since the Global Financial Crisis (GFC). One year lending and deposit rates were cut by 0.25%.

Lending rate – 6.31%
Deposit rate – 3.25%

Although this should encourage spending with an increase in the money velocity in the circular flow some commentators are concerned that the Chinese authorities know something about their economy that the rest of world is in the dark about.

It is interesting to see the reaction of main central banks in the aftermath of the GFC and how aggressive they were in cutting rates – US, EU, UK – relative to the other countries on the graph, namely China, India and Australia. Furthermore notice that some economies seem to have been at a different part of the economic cycle namely Australia, India, and the EU as their central bank rates have risen in order to slow the economy down. This is especially in India as they have had strong contractionary measures in place but have now started to ease off on the cost of borrowing.

Indian growth has slowed to 5.3% this year and although this seems very healthy it is the lowest level in 7 years. A developing nation like this needs higher levels of growth to create the jobs for their vast working age population and without employment there could be a situation not unliike that of Spain where over 50% of those under 25 don’t have a job. The main cause of the slowdown seems to be from a lack of private investment.

Also look how low rates are in the US, UK, and EU. With little growth in these economies the policy instrument of lower interest rates has been ineffective and they are in a liquidity trap. Increases or decreases in the supply of money do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.

Asia’s energy source – bring on the negative externalities.

According to the International Energy Agency (IEA) coal accounts for 20% of the primary energy supply in OECD countries. If you consider world consumption, coal accounts for 50% of the increase in energy use between 2000-2010. Not surprisingly 66% of the growth in demand for energy has come from Asia with China leading the world in coal production and consumption – some interesting facts:

1. China mines over 3 billion tonnes of coal per year – that is x3 when compared to USA
2. 80% of China’s electricity comes from coal-fired power plants
3. Burning coal is the biggest cause of air pollution.
4. By 2030 China is likely to consume 4.4 billion tonnes of coal.
5. From 2005 – 2030 – Carbon emissions are expected to increase from 6.8bn – 15bn tonnes

India also uses significant amounts of coal – 70% of its electricity comes form coal. It has 5th largest coal reserves globally but cannot extract it quick enough to satisfy the demand. However its emissions will increase by 250% by 2030.

In the emerging Asian economies the drive for more coal-fired power continues to steam ahead. Unfortunately alternative forms of energy don’t offer affordable electricity on a large enough scale to satisfy the Asian economies insatiable demand for energy. Natural gas which emits less carbon could be an option, but it will not take over from coal. Look out for those negative externalities – see graph below from Tutor2u.net.

Ability to stimulate using Monetary and Fiscal Policy

With the stagnating growth levels in the developed world – USA, Europe, etc – the emerging economies are not immune from this environment. Lower export demand for goods and services impacts on average growth levels in those emerging countries. In order to get out this sluggish condition economies can employ both monetary and fiscal policy. However richer nations have tended to exhaust both these policy options by dropping interest rates to exteremely low levels (see interest rates below) and in their inability to exapand their borrowing because of the size of governmets deficits. Emerging economies average budget deficit 2% of GDP, against 8% in the G7 economies. And their general-government debt amounts on average to only 36% of GDP, compared with 119% of GDP in the rich world.

The Economist ranked 27 emerging economies according to their ability to utilise expansionary fiscal and monetary policy. They used 6 indicators to assess a country’s ability to use these policies. The first 1-5 focus on the ease of which countries can manipulate monetary policy interest rates. 6 concerns Fiscal Policy flexibility

1. Inflation – 2% in Taiwan to 20% or more in Argentina and Venezuela.
2. Excess Credit – measures the gap growth rate in bank credit and nominal GDP. Argentina, Brazil, Hong Kong and Turkey have seen credit grow vastly beyond GDP whilst Chinese bank lending is now rising mor slowly than GDP.
3. Real Interest Rates (interest rate – CPI) – tends to be negative in most economies. Over 2% in Brazil and China
4. Currency Movements (against US$ since mid-2011) – Nine countries, including Brazil, Hungary, India and Poland, have seen double-digit depreciations, with the risk that higher import prices could push up inflation.
5. Current-Account Balance – If global financial conditions tighten, it would be harder to finance a large current-account deficit, and so harder to cut interest rates.
6. Fiscal-Flexibility Index – combining government debt and the structural (ie, cyclically adjusted) budget deficit as a percentage of GDP.

From The Economist
The average of these monetary and fiscal measures produces our overall “wiggle-room index”. Countries are coloured in the chart according to our assessment of their ability to ease: “green” means it is safe to let out the throttle; “red” means the brakes need to stay on. The index offers a rough ranking of which economies are best placed to withstand another global downturn. It suggests that China, Indonesia and Saudi Arabia have the greatest capacity to use monetary and fiscal policies to support growth. Chile, Peru, Russia, Singapore and South Korea also get the green light.

Red alert
At the other extreme, Egypt, India and Poland have the least room for a stimulus. Argentina, Brazil, Hungary, Turkey, Pakistan and Vietnam are also in the red zone. Unfortunately, this suggests a mismatch. Some of the really big economies where growth has slowed quite sharply, such as Brazil and India, have less monetary and fiscal firepower than China, say, which has less urgent need to bolster growth. India’s Achilles heel is an overly lax fiscal policy and an uncomfortably high rate of inflation. The Reserve Bank of India has sensibly not yet reduced interest rates despite a weakening economy. In contrast, Brazil’s central bank has ignored the red light and reduced interest rates four times since last August. In its latest move on January 18th, the bank signalled more cuts ahead. That will support growth this year but at the risk of reigniting inflation in 2013. Desirable as it is to keep moving, ignoring red lights is risky.

World Income Inequality chart

Still on the inequality theme – here is a very worthwhile chart that looks at World Income Inequality. It is from the publication entitled “The Haves and the Have-Nots,” a new book by the World Bank economist Branko Milanovic about inequality around the world which was recently reviewed by New York Times columnist Catherine Rampbell. The graph below shows how inequality in Brazil, USA, China, and India ranks on a global scale. On the x axis the population of each country is divided into 20 equally-sized income groups, which is ranked by each country’s household income per person. These are referred to as ventiles and 1 ventile = 5% of the population. So that we are looking at purchasing power parity (PPP) the data is adjusted for the variance in the cost of living in different countries.

Now on the vertical axis, you can see where any given ventile from any country falls when compared to the entire population of the world.

Brazil
– poorest 5% are amongst the poorest in the world
– richest 5% are amongst the richest in the world

USA
– the bottom 5% are richer than 68% of the world’s population

India
– the bottom 5% = 4th poorest percentile worlwide.
– the richest 5% = 68th percentile worldwide which means that USA’s poorest = India’s richest.

Now you might be wondering: How can there be so many people in the world who make less than America’s poorest, many of whom make nothing each year? Remember that were looking at the entire bottom chunk of Americans, some of whom make as much as $6,700; that may be extremely poor by American standards, but that amounts to a relatively good standard of living in India, where about a quarter of the population lives on $1 a day.