Skip to main content

Global Monetary Policy

Keeping it slack
A few weeks into the Trump Presidency, bond markets in America jumped with yields spiking from 1.7% in November 2016 to 2.5% a few weeks later. Markets anticipated a reversal of the interest rate cycle, with expectations of higher economic growth driven by a combination of tax cuts and a spending stimulus. This was based on promises during Mr Trump’s election campaign and subsequently reinforced by his new administration. With a rise in the payroll and falling unemployment, the United States Federal Reserve hiked interest rates by 50 basis points in two separate tranches, with prospects of further hikes during the course of the year. Economic output was expected to climb from 1.8% in 2016 to 2.9% this year.
Across the Atlantic, analysts began to convince themselves that the European Central Bank would taper its bond purchases with a fairly upbeat outlook within the Eurozone both on growth and price deflation. In Japan too, with a strong recovery in exports, economic output was expected to rise from 0.7% last year to 1.2% in 2017, accompanied by some hardening of prices. But in the months that followed a slightly different picture seems to have emerged, where underlying weaknesses of price deflation and fragility in the recovery process, remain entrenched.
Whilst the markets expect a hike in US dollar rates by the Fed in the coming weeks, they have no longer priced in sharper hardening in the rest of the year. The ECB too is moving cautiously with underlying inflation falling to 0.9% in May, far removed from a target of 2%. It must naturally be concerned as to the impact of a sudden rise in bond yields, especially on a wobbly economy like Italy, which is burdened with huge sovereign debt, a forbidding problem of bad loans in the banking system, high unemployment and puny growth. In Japan too, with inflation dropping to 0.2% in March, the Bank of Japan is unlikely to alter its tack on monetary easing in a hurry and bond purchases will continue for some time to come. With the collective balance sheets of large central banks on an expansion path, monetary policy will remain loose for a while yet or until 2019, as some analysts have now begun to believe.
In China, the world’s second largest economy, the primary risks stem from large amounts of debt which rose steadily from 150% of GDP in 2007 to over 280% now. With a slowing economy and falling exports, the People’s Bank of China is now increasingly cautious, clamping down on money supply to the shadow banking system, which is prone to risky exposures. Credit growth has slipped from 16% in 2016 to about 13% now with expectations of a further decline in the near term. The risks in China are heavily weighed on the downside and Fed officials together with their peers in the ECB must keep these considerations in mind before affecting radical changes in their stance.
As if in reflection of such beliefs, US bond markets have tempered their earlier flurry with yields moderating to 2.2%. Markets therefore anticipate short term interest rates to remain muted over the coming year. These developments will encourage money flows into emerging markets through the carry trade and we therefore expect greater liquidity and a marginal strengthening of currencies. The rupee, which gained 5.5% since January 2017, may rise further. This would provide some room to the Reserve Bank of India to reduce interest rates in the coming months.


Popular posts from this blog

Uday: a federalist success story

At our 21 st Annual CEO Roundtable in Thimphu last week, there was spirited debate over the performance of the current administration. A participant suggested that the Ujjwal Discom Assurance Yojana (Uday), a scheme to reform India’s downstream power sector, for all its fanfare was actually a failure of sorts and that India’s renewable energy programme, specifically on solar energy, was lacking on many counts. Whilst it was my intuitive belief that both claims were unsympathetic, I thought it would perhaps be in order to examine the facts in detail and subsequently provide an assessment. This paper, accordingly, presents an analysis of the first of the two issues – the Uday programme. The second will be addressed in a subsequent piece. The electricity distribution crisis: background Electricity distribution has been disastrously managed over the last three decades and in 2015 was on the verge of absolute collapse. Under-priced power, operational inefficiency, broken equip

The Employment Conundrum

Over the last three months, I have had the opportunity of engaging with our clients across various forums and cities. What provided a platform for this interaction was my briefing on four critical initiatives that we believe will, if properly implemented, serve as game changers with a palpable impact on economic output. The question that consistently came up almost everywhere was on the perception of jobless growth and consequently, rising unemployment within India. This has possibly been based on recent press reports and television debates that consistently cite certain headline statistics. These suggest a fall in employment levels between 2011-12 and 2015-16 compared to vigorous growth in earlier years, since 2004-05. Even on the surface, this conclusion does not gel fittingly with other statistics. For instance, indirect tax collections and consumption expenditure, which are both proxies of aggregate spending and wellbeing, do not corroborate falling employment. Tax collections

Farm Loan Waivers

Farming damage In 2008, when the Government of India announced a Rs 60,000 crore farm loan waiver, the decision horrified economists and the financial markets. The waiver, amounting to 1.3% of GDP, would cripple national finances and damage the credit culture. The moral hazard of penalising prudent borrowers would be systemic and enduring. However, its proponents argued that it would free farmers ‘from the suffocating clutches of endemic debt’ and, in the process, also provide a quick consumption stimulus to the economy. Subsequent events proved both assumptions awry and the folly of the decision was absorbed in a hard and painful way. Nevertheless, a lesson was learnt and federal Governments have since avoided a repeat. However, it would seem that it is now the turn of state Governments to blunder. In the last few months, Uttar Pradesh, Maharashtra, Karnataka and Punjab announced waivers of agricultural loans in their states to the tune of Rs 80,000 crore. Fortunately, the