Friday, November 12, 2010

Tiding over some Crisis Induced Weaknesses

Fiscal risks remain elevated in advanced economies where public debt ratios as percentage of GDP are still rising rapidly, the International Monetary Fund (IMF) said in its latest edition of the Fiscal Monitor. Market views on fiscal developments are being reflected in bond yields and spreads becoming more polarized; yields have declined in countries regarded as safe, or at least safer, havens, while they have increased (and spreads have widened) for a few countries that are considered to be more at risk. Developments in Europe also seem to have favored a portfolio reallocation toward emerging markets, particularly emerging Asia. EMEs are seeing historically low spreads, reflecting large capital inflows spurred by their relatively strong growth and fiscal positions and prospects. An analysis of the determinants of polarization of some specific type of spreads reveals that, although cross-country variation in spreads reflects country-specific fiscal fundamentals and other variables affecting solvency (growth prospects and banks balance sheet fragilities), global variables—such as risk aversion and global growth—have recently played an important role.

The Monitor, drawing on projections from the October 2010 World Economic Outlook (WEO), shows that: global fiscal deficit is projected to fall from 6.75 percent of GDP in 2009 to 6 percent this year, in line with earlier projections. Deficit declines are mostly due to improved economic conditions and to lower support to the financial sector. Further, in 2011, the global fiscal deficit will fall further, to about 5 percent of GDP. About 90 percent of countries are projected to record smaller deficits in 2011 (relative to 2010), with most of the deficit decline due to policy tightening. The advanced G-20 economies on average plan to improve their CAB by 1.25 percentage point annually during 2011–13, including through the unwinding of the 2009–10 stimulus. In the United States, the largest adjustment is expected to come in 2012. Fiscal consolidation plans of most economies are tilted toward expenditure cuts and spending cuts are more tilted toward the wage bill, size of civil service, and social transfers rather than public investment. On the revenue side, measures affecting direct taxation dominate, which may raise concerns for the impact on growth. Of the announced and already implemented revenue measures, personal income tax , corporate income tax, and social security contributions accounted for nearly half of all revenue measures, while increases in the value-added tax (VAT) (ranging from 1 to 4 percentage points in Europe) and excise taxes represent some additional revenue generating measures.


India faces a dilemma similar to some other emerging markets; on the one hand the return to fiscal sustainablility has led to cut back in government expenditures and stimuli once growth revived, on the other hand private sector demand is being pushed back through rate hikes in the fear of stoking inflation. The Reserve Bank of India recently increased both its policy rates by a quarter of a percentage point; the rate at which the central bank lends to banks was raised to 6.25%, and the rate at which it borrows from them was increased to 5.25%. The tightening was India’s sixth this year, mainly driven by the need to tame inflationary expectations. However, food price inflation the main cause for concern seems very unlikely to soften significantly as the spectre of inflation looms larger over global agricultural markets after the US slashed key crop forecasts and warned of shortfalls in grains, adding to problems raised by a massive drought in Russia; the UN’s Food and Agriculture Organisation noted the inevitable tightening of the overall food price situation as we go into 2011. On the other hand, successive rate hikes By RBI is now accompanied by a certain renewed sluggishness in industrial growth borne out by the vertiginous fall in IIP number to 5.6% (6.9 revised) in August and 4.4% in September predicted by the 18 month low September growth figures of 2.5% for the 6 infrastructure industries which account for over a quarter of IIP.

Despite being delinked with the global financial sector, the Indian banking sector has witnessed a relatively sluggish performance in the year 2009-10 with some emerging concerns with respect to asset quality and slow deposit growth. Bank deposits, which constituted around 78 per cent of the total liabilities of SCBs, registered a decelerated growth for the third consecutive year since 2007- 08. One of the factors responsible for a decline in the deposits growth in 2009-10 was the prevalence of low interest rates for a major part of the year. The other emerging concern was with respect to asset quality of banks. The gross Non-Performing Assets (NPAs) ratio showed an increase from 2.25 per cent in 2008-09 to 2.39 per cent in 2009-10. Moreover, there was an increase in the proportion of doubtful and loss assets in 2009-10. The increase in gross NPA ratio coupled with a decline in the (outstanding) provisions to gross NPA ratio in 2009-10 at the aggregate level, underlined the need for further strengthening of provisions by banks, though, notwithstanding the weakening asset quality, the Capital to Risk-Weighted Assets Ratio (CRAR) of Indian banks remained strong at 14.5 per cent, way above the regulatory minimum of 9 per cent after migration to the Basel II framework, providing banks with adequate cushion for emerging losses. In 2009-10, the profitability of Indian banks captured by the Return on Assets (RoA) was a notch lower at 1.05 per cent than 1.13 per cent during the previous year. Low levels of financial penetration and inclusion in the global comparison continued to be an area of concern for the Indian banking sector. However, data on sectoral deployment of gross bank credit does show significant improvement in credit flow to industry, services and personal loans during the current financial year, while credit to agriculture has declined further. Overall flow of resources from the financial sector to the commercial sector increased significantly in the first half of 2010-11 relative to the flows in the corresponding period of last year, though domestic non-bank sources of funds have declined.

Thus looking ahead, given the unstable global scenario, as the balancing act continues considerable volatility in all indicators of the Indian economy could be expected for some time to come. Track the global and Indian economy with our monthly statistical bulletin E-UpDates with monthly as well as daily data on the Indian and global economy for over 20 indicators.

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Tuesday, September 28, 2010

India Part of the IMF’s Surveillance for the World’s Top 25 Financial Sectors

According to the IMF Executive Board the recent crisis has made clear the need for mandatory and regular assessments of financial stability for countries with large and interconnected financial systems. Economies with financial sectors that have the greatest impact on global financial stability are now required to undergo in-depth reviews of their financial health by the International Monetary Fund every five years. All of the IMF’s 187 member countries are already required to undergo an annual economic health check-up, known as an Article IV consultation. In addition, Financial Sector Assessment Program (FSAP) offers the opportunity to all member countries to undergo, on a voluntary basis, a comprehensive financial sector assessment. The financial stability component of the voluntary FSAP will now be a mandatory part of the IMF’s surveillance for the world’s top 25 financial sectors. Under the Fund’s existing legal framework, it is open to the Fund to require members with systemically important financial sectors to engage in regular mandatory financial stability assessments under Article IV while not requiring such assessments of other members. The mandatory financial stability assessments will comprise three elements: 1) An evaluation of the source, probability, and potential impact of the main risks to macro-financial stability in the near term, based on an analysis of the structure and soundness of the financial system and its interlinkages with the rest of the economy; 2) An assessment of each countries’ financial stability policy framework, involving an evaluation of the effectiveness of financial sector supervision against international standards; and 3) An assessment of the authorities’ capacity to manage and resolve a financial crisis should the risks materialize, looking at the country’s liquidity management framework, financial safety nets, crisis preparedness and crisis resolution frameworks.

For defining systemic importance for this exercise a conceptual framework was developed by the IMF, BIS, and FSB. This framework approaches systemic importance from both a domestic and a global point of view. It identifies the following three key concepts: (i) size, i.e., the volume of financial services provided by an individual financial institution or market; (ii) interconnectedness, i.e., the extent of linkages with other financial institutions or markets; and (iii) substitutability, i.e., the extent to which other institutions or markets can provide the same services in the event of the failure of part of the system. The methodology for identifying jurisdictions with systemically important financial sectors is a three-stage process that uses available financial data for the entire Fund membership. The results identify 25 jurisdictions with the most systemically important financial sectors, which cover almost 90 percent of the global financial system and represent almost 80 percent of global economic output. At present the countries, in order of ranking, are: United Kingdom, Germany, United States, France, Japan, Italy, Netherlands, Spain, Canada, Switzerland, China, Belgium, Australia, India, Ireland, Hong Kong, Brazil, Russian Federation, Korea, Austria, Luxembourg, Sweden, Singapore, Turkey and Mexico.

Saturday, September 4, 2010

Cause Enough for RBI to Pause?

RBI’s tightening cycle was almost unanimously presumed to continue in its September policy review, however, the global economic scenario has clouded considerably recently and though the Indian economy seems to be steaming on there are a few warning signs which ought to be heeded before it is too late.

Growth in the world's largest economy decelerated to a pace of 1.6 percent, signaling a more pronounced slowdown in the recovery from recession. July consumer spending a key driver of US economic growth, usually accounting for two-thirds of output rose 0.4% and incomes rose a mere 0.2%, with spending outpacing income. The US Unemployment rate for August came in higher as forecasted at 9.6%, while the Change in Nonfarm Payrolls for the same period showed a better than predicted shed of 54 thousand jobs. However, the Change in Manufacturing Payrolls showed a shed of 27 thousand jobs, which is actually worse than the predicted outcome, and also Change in Private Payrolls showed that jobs added were lower than expected. Europe looked better; economic confidence in the 16 countries that use the euro rose to its highest level in nearly two-and-a-half years during August, as unemployment concerns eased somewhat. The UK economy expanded at 1.6% year-on-year, faster than previously estimated in the second quarter in the biggest growth spurt since 2001 as companies rebuilt stocks and construction work surged.

Japan's government and the central bank had to throw the economy a double lifeline; accompanied by an unanimous vote to keep its key interest rate at a 0.1 percent the central bank unveiled a new six-month low-interest loan program to financial institutions to boost liquidity, combined with an existing three-month funds-supplying operation worth 20 trillion yen ($236 billion) so that banks would have access to a total of 30 trillion yen ($355 billion).

India's economy grew 8.8 percent in the first quarter of the current fiscal, its best performance since 2007, led by a 12.4 percent year-on-year surge in manufacturing, a 9.7 percent leap in services and an 8.9 percent jump in construction and was also boosted by agricultural output expansion of 2.8 percent. Yet many economists suggest that the central bank, which has hiked rates four times since the start of the year to curb inflation, should pause its monetary tightening — the most aggressive in the Asia-Pacific region — in the face of the shaky global outlook. If that is not cause enough RBI should possibly heed the warning signals emitted from the slowdown in domestic investment; not only has manufacturing growth slowed from 16.3% in the previous quarter to 12.4%, essential supplies and construction outputs have also shrunk as compared to the previous quarter, while services growth in important sectors have not really picked up. More concerning is the fact that gross fixed capital formation has decelerated compared to the last 2 quarters at a time that it ought to be rising with a need for vast infrastructure spending both for physical and human resources development. Should inflation control measures delinked from monetary policy and targeted at select necessary commodities now be evaluated instead?

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Monday, August 2, 2010

RBI Move Caught between Hawks and Doves

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In line with policy normalization to pre-crisis levels and to fight continuing inflation pressures the Reserve Bank of India was expected to raise policy rates yet again in its First quarter Review of Monetary policy for fiscal 2010-11, however, the exact amount of tightening seems to have displeased both the Hawks and Doves. The RBI’s July review of monetary policy had three focal points — the central bank raised short term lending or the repo rate by 0.25 percentage points to 5.75 per cent; the short-term borrowing or reverse repo rate has been hiked by 0.50 percentage point to 4.50 per cent; and the cash reserve ratio or CRR and bank rate have been kept unchanged at 6.0 per cent. RBI has apprehended inflation and growth concerns and tried to balance them out and raised the repo rate to signal its hawkish bias to tame inflationary expectations, while it switches to a liquidity injection mode whenever there is a pressure on overnight rates. The asymmetric hikes in rates which leads to a narrowing of the corridor between the borrowing and lending rates is to signal the central bank’s desire to cut down volatility in short-term rates. The CRR has understandably been kept unchanged as bank deposits have not grown sufficiently in the low interest rate scenario and thus it may not be sensible to further reduce the lending ability of banks. The increase in bank deposit rates is expected to raise banks’ deposit accumulation and help to transmit monetary policy with a lag when they start raising lending rates thus moderating fund flows to particular sectors which are in danger of over-heating.

However, the Hawks blamed RBI for not doing enough to tackle inflation — especially given the fact that growth expectations are now higher along with emergence of clear demand side pressures on inflation — a 25 bps hike was clearly thought to be inadequate. Combined with an existing scenario of negative real interest rates RBI’s stance was not considered to be at par with a central bank dedicated to maintaining an inflation target. Doves on the other hand feel that given the uncertainty of global economic recovery and the infrastructure bottlenecks faced by the Indian economy, the cumulative 50 bps repo rate hike in the month was a bit steep and could destabilse the growth momentum, an apprehension not entirely unjustified, given that May IIP growth was significantly lower than preceding months, followed by June Core sector figures which were also lowest in a number of months. Not to forget the main supply side pressures on inflation created by tremendous amount of infrastructure investments still needed to strengthen agriculture and distribution mechanisms within the country. In fact the RBI brought a deluge on to itself as it said that the rains would impact inflation; however, we forget two things— it is not entirely the central bank’s fault that we still do not have enough infrastructure in place so as to not allow Rain Gods to set our inflation trajectory and also international commodity (say fuel) prices are still very much dependent on the amount of snowfall the West receives.

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Monday, May 17, 2010

Current Account Transactions – Further Liberalisation

In terms of (Rule 4) of the Foreign Exchange Management (Current Account Transactions) Rules 2000, prior approval of the Ministry of Commerce and Industry, Government of India, is required for drawing foreign exchange for remittances under technical collaboration agreements where payment of royalty exceeds 5% on local sales and 8% on exports and lump-sum payment exceeds USD 2 million [item 8 of Schedule II to the Foreign Exchange Management (Current Account Transactions) Rules, 2000].The Government of India reviewed the extant policy with regard to liberalization of foreign technology agreement and decided to omit item number 8. It was decided to permit, with immediate effect, payments for royalty, lump sum fee for transfer of technology and payments for use of trademark/brand name on the automatic route without the approval of Ministry of Commerce and Industry, Government of India. These new rules will be called the Foreign Exchange Management (Current Account Transactions) (Amendment) Rules, 2010, and shall be deemed to have come into force with effect from the 16th of December, 2009. The Ministry of Commerce and Industry (Government of India) issued a press release on 17 December, 2009 stating that it has removed certain requirements to obtain prior government approval for the transfer of technology into India with immediate effect.

Under the earlier policy, government approvals were required for foreign technology transfers into India involving lump-sum payments of over US$2 million, and payments of royalty of over 5% on domestic sales and 8% on exports. Even if no technology transfer was involved and the foreign collaboration was limited to licensing of trade marks, prior government approvals were required if the royalty payments were over the prescribed limits of up to 2% for exports and 1% for domestic sales. In December 2009 a new policy removed any such restrictions, however, all such payments were subject to Foreign Exchange Management (Current Account Transactions) Rules, 2000 (FEMA Rules), which has now been amended further easing foreign collaborations in the field of technology.

Thursday, April 22, 2010

RBI Balances Inflation and Financing Needs for Sustained Growth

The Reserve Bank of India tightened monetary policy another notch in its Annual Policy Statement for the new fiscal , hiking the short-term indicative borrowing and lending rates — repo and reverse repo — and the mandatory Cash Reserve Ratio (CRR) of banks by 25 basis points each. As a result of the increase in the CRR, about Rs.12,500 crore of excess liquidity will be absorbed from the system. This move was expected given the high inflation numbers which are now not solely supply driven — with inflation at 9.90% in March and spreading from food prices to manufactured goods. The tightening builds on a surprise inter-meeting rate hike in March. While, not ruling out mid-cycle action, the RBI referred to the fact that growth is coming from sectors which are interest-rate sensitive, and the need to step cautiously so as not to derail growth at this juncture. Lenders have indicated that this move is unlikely to result in an immediate increase in cost of borrowing even though the interest rate bias is clear. Real interest rates are still mostly negative.

The monetary policy stance was formulated in the backdrop of the need to continue steadily with tightening, while attempting to ensure, among other things, minimal disruptions in fund flows, both to the government’s already stretched market borrowing programme and to private corporations, and also to ensure a pick up in private consumption. RBI also mentioned measures designed to deepen financial markets and augment policy transmission channels in future which should gain clarity by its first policy review in July.

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Monday, March 22, 2010

Inflation Drives Exit-from-Stimulus Strategies

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The US FOMC continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period and will maintain the target range for the federal funds rate at 0 to 1/4 percent. However, in light of improved functioning of financial markets, the Fed has been closing the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities and on March 31 for loans backed by all other types of collateral. To provide support to mortgage lending and housing markets the Fed has been purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those purchases are likely to be executed by the end of this month.

ECB decided to leave the key interest rates unchanged as Euro zone inflation in February is at 0.9% and monetary analysis confirms the assessment of low inflationary pressures over the medium term, with money and credit growth remaining weak. But ECB announced the gradual phasing-out of our non-standard operational measures which includes return to variable rate tender procedures in the regular three-month longer-term refinancing operations (LTROs), starting with the operation to be allotted on 28 April 2010, further allotment amounts in these operations will be set with the aim of ensuring smooth conditions in money markets and avoiding any significant spreads between bid rates and the prevailing MRO (main refinancing operations) rate.

Policy makers in UK on the other hand had to acknowledge emerging evidence on the upside risks to inflation, though at the moment Bank Rate would be maintained at 0.5% despite the fact that UK inflation has increased to 3.5%, above the government's target. BoE would also maintain the stock of asset purchases financed by the issuance of central bank reserves at £200 billion as lending growth to households and businesses had remained weak, reflecting both demand and supply factors and was likely to remain constrained until the banking sector had completed the process of balance sheet restructuring and the refinancing of its own funding maturing over the coming years.

RBI of course decided to act prior to its annual policy review and has increased its key rates by 25 bps citing that containing overall inflation and anchoring inflation expectations have become imperative as inflationary pressures have intensified beyond RBI’s baseline projection and heighten the risks of supply-side pressures translating into a generalised inflationary process. After revision, the reverse repo rate — the rate of interest that the RBI offers banks when they leave their funds with the central bank — is 3.50%, nearly 42% lower than the pre-crisis level of 6%. The repo rate, at which banks can borrow from the central bank, is now 5%, 44% lower than the pre-crisis peak of 9% leaving enough scope for further hawkish measures probably again before its annual review, as headline WPI inflation which on a year-on-year basis stands at 9.9 per cent in February is expected to reach double digits in March 2010.

Wednesday, March 3, 2010

Focal Points of Indian Union Budget 2010-11

India's recent GDP numbers show that the economy grew 6 percent in the December quarter, as farm output fell 2.8 percent after a drought. The core sector, comprising six key infrastructure industries, grew 9.4 per cent in January 2010, compared with 2.2 per cent in January 2009 and pushes up hopes of a robust rcovery. The prime concern remains inflationary pressures which have built up by 8.9% (WPI based) in this fiscal so far, as compared to 1.51% in the last fiscal, pushed by food price inflation which has built up by a massive 14.7% during thi sfiscal compared to a 5.4% build up in the last fiscal. The Union Budget for the FY2010-11 addressed concerns on fiscal discipline with a plan to reduce the fiscal deficit to 5.5 percent of GDP in the new FY from 6.9 percent this fiscal, and further declines in coming years. Additional borrowing of 1.3% was proposed and given that the fiscal stimulus withdrawal was not aggressive so as to not choke wavering recovery, the case for policy tightening by RBI seems to be stronger. The budget lacked any direct measures to curb rising food prices, further the duty rollback on petroleum could contribute somewhat to inflationary pressures, however, reigning in of the fiscal deficit despite difficult circumstances should help cool long term inflation expectations.

Infrastructure, agriculture and social sector have been the key focus areas of budget 2010-11. From the infrastructure sector perspective, the positives are increased allocation for infrastructure by providing 46% of the total plan allocations, especially with respect to roads and the power sector and clean energy initiatives. The proposed tax relief for investment in long-term infrastructure bonds will further boost investment in infrastructure, while increased refinancing through IIFCL would help bank lending to infrastructure. Bank recapitalisation plans and the farm loan waiver are expected to benefit the banking sector. Much needed measures to boost farm spending and research and lift agriculture sector growth to 4 percent in the medium term were taken. With the key focus on inclusive growth social sector by allocation is around 37% of the total plan outlay, while urban development allocation has been increased by more than 75%.The budget has extended the interest subvention on pre-shipment credit for key export-oriented sectors and similarly extended the housing-loan interest subsidy scheme for another year, thus indicating that the fiscal stimulus would continue to sensitive sectors affected by the global slowdown. The expansion of direct personal tax slabs would help stabilise the nascent demand recovery.

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Wednesday, January 20, 2010

Into 2010 —Views on Sustainability of Recovery

Into the new decade beginning 2010 much of the Global economy is technically out of recession, thanks to the unprecedented synchronized monetary and fiscal stimulus provided by governments across the globe, even though major economic indicators continue to see-saw. The combination of improvement in the functioning of financial markets, higher prices for risky assets and the recent slower pace of tightening bank lending standards are expected to increase the chances for sustainable recovery according to the Global Economic Forum of Morgan Stanley. A slower pace of inventory liquidation and a gradual shift to inventory accumulation should add to growth. Past aggressive payroll cuts may now give rise to an increase in demand for labour and help to strengthen recovery. GEF points out that inflation risk will be a crucial factor for markets henceforth; as (particularly due to rising commodity price inflation) market-based inflation expectations are gradually rising. The end of easing and beginning of exit can be expected to cause wobbles in financial markets pushing inflation premia and thus bond yields significantly higher. The aggressive provision of stimulus has also theoretically led to significant increase in sovereign fiscal balances and default risks, which also pushes up bond yields.
Another threat to the nascent recovery in the form of existing global imbalances of distortionary /risky nature has been discussed in an IMF policy note, which points out that crisis induced changes in saving and investment patterns across the world have narrowed previously rising imbalances considerably. However, policy measures are required to correct for distortionary effects of — large current account deficit in the US, high oil prices and the large savings of oil exporters, high and rising saving rates in China, the investment boom driven by asset prices in peripheral Europe, the collapse in investment in emerging Asia (excluding China) and in Japan. An increase private and public US saving, an increase in social insurance, strengthening corporate governance, and implementation of reforms to increase access to credit for households and SMEs in China, a move from export-led towards more domestic-demand led growth in a number of emerging market countries, room for higher domestic demand and more spending on social infrastructure needs in some oil-exporting countries would help global rebalancing and ensure sustainability of recovery.
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Sunday, January 3, 2010

Happy New Year 2010

The SurgeRS (Surge Research Support) wishes all friends and visitors a very Happy New Year.

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