Wednesday, May 27, 2009

Prices Fall In Germany

From the FT.

German price falls add to ECB fear
By Ralph Atkins in Frankfurt

Published: May 27 2009 22:18 | Last updated: May 27 2009 22:18

German inflation has turned negative for the first time in more than 20 years, fuelling fears of a fall in prices across the eurozone that will add to pressures facing the European Central Bank as it grapples with Europe’s severe recession.

Consumer prices in Germany fell 0.1 per cent this month from a year ago on a European harmonised basis, the country’s statistical office said yesterday. The unexpected drop was the first negative annual inflation rate since comparable records began in 1996 and since March 1987 on the previous basis.

The German data meant eurozone figures due tomorrow were expected to show annual inflation in the 16-country region at about zero in May with a dip into negative territory likely in June, economists said. Spain, Ireland and Portugal – three of the eurozone countries worst hit by the global downturn – have already reported negative annual inflation rates.

Inflation has tumbled on the back of steep falls in oil and commodity prices but also on weaker economic activity. “Energy is behind the wild swings, but core inflation is easing quite a lot and that is because we have the deepest recession since the 1930s,” said Dirk Schumacher at Goldman Sachs in Frankfurt.

The worry for the ECB, which has ensuring “price stability” as its main task, is that falling headline inflation rates fuel fears of a damaging deflation phase – in which generalised price falls wreak significant economic damage.

The ECB has warned that headline eurozone inflation rates are likely to turn negative for some months and thus undershoot by a large margin its definition of price stability – an annual inflation rate “below but close” to 2 per cent. It argues short-term inflation trends are irrelevant for monetary policy and sees inflation rising later this year. More importantly, it sees long-term expectations for inflation still in line with its goal. Core eurozone inflation, which excludes volatile energy and unprocessed food costs, has remained positive – except in Ireland.

However, Julian Callow, European economist at Barclays Capital, warned negative headline inflation would create “an important communication challenge” for the ECB. The risk was that a bout of “benign deflation” became malign, he said. The speed at which inflation had eased in Spain and Ireland, suggested that prices were proving more responsive to the crisis than might have been expected, Mr Callow argued.

Since last October, the ECB has slashed its main policy rate by 325 basis points to 1 per cent, the lowest ever. Jean-Claude Trichet, ECB president, has been careful not to rule out further cuts in interest rates or additional emergency measures. However, next week’s meeting is expected to see official interest rates left unchanged.

Tuesday, May 26, 2009

Three Charts

Monday, May 25, 2009

Spain Is Economically And Politically Bankrupt

Rajoy prescribes dose of Spanish austerity
By Victor Mallet in Madrid

Published: May 25 2009 17:45 | Last updated: May 25 2009 17:45

Spain’s opposition Popular party and Mariano Rajoy, its leader, have not had a good crisis.

Although Spain has plunged into its worst economic recession since the end of the Franco dictatorship in the 1970s, the right-wing PP has failed to capitalise on the Socialist government’s discomfiture over the country’s 4m unemployed and has only just begun to match the Socialists in the opinion polls.

Even business leaders who reflexively support the PP complain that Mr Rajoy, a former cabinet minister, lacks the drive and charisma to lead the opposition to victory in a national election due in 2012.

Mr Rajoy, however, has been reprieved by his party’s outright regional election win in Galicia – his home – in March. In an interview with the Financial Times, he launched a stinging attack on the government’s economic policies and predicted victory for the PP in the June 7 European elections.

“The government has presented 11 economic plans since March 2008. Every fortnight there are two or three measures announced. There’s no order or coherence,” said Mr Rajoy.

Mr Rajoy was scathing about the “untenable” rise of Spain’s indebtedness. “At the end of 2007, Spain had a budget surplus of something over 2 per cent [of gross domestic product]. At the end of 2008, the deficit was already 3.8 per cent and at the end of 2009 it could be at 10 per cent.”

The PP, Mr Rajoy said, believed in “austerity” and would aim for a budget deficit of about 3 per cent – the same as the now widely ignored limit set by the European Union.

For all Mr Rajoy’s optimism, it is not clear that Spanish voters are in the mood to support austerity or the PP’s plans for labour reform and lower taxes.

The PP crept ahead of the Socialists at the start of this year in the opinion polls but the latest survey shows them almost level with about 42 per cent support each.

The PP leader may gain more traction, at least in central Spain, with his complaint that the 17 autonomous regions have gone too far in imposing local languages at the expense of Spanish and in applying divergent commercial standards that cause headaches for investors.

In defence of his plan for a law on the unity of the Spanish market, he gave the example of the government’s plans to help the motor industry through the crisis with a €2,000 subsidy for the purchase for each new car, a measure that has run into bureaucratic obstacles in parts of Spain.

“Imagine that if you wanted to buy a car in Manchester, there would be a certain aid package, and in Liverpool there would be totally different regulations. This is what is happening in Spain,” Mr Rajoy said.

He admitted that the PP, like the Spanish Socialists, was campaigning in the European elections largely on domestic issues. “We will win the European elections. The Popular party will be the leading political force [in Spain] in the vote,” he predicted. As for his own performance, the self-effacing Mr Rajoy is not a populist – he smokes fat cigars and prefers modest local meetings to big crowds – but he insisted he was eager and ambitious enough to be Spain’s next prime minister.

“If not, I wouldn’t be here,” he said at his party headquarters in Madrid as he prepared to tour the country on the European election campaign trail. “I am going to join this battle because I think things could be done infinitely better, because I have the desire and lots of experience.”

The next test for Mr Rajoy, then, will be the results of the June 7 vote. If the PP does well, he should in theory be on track as a future Spanish prime minister after national elections. If not, he will be under more pressure than ever to step aside.

Sunday, May 24, 2009

Jo porto el Barça dins del meu cor

Visca El Barça! Visca Catalunya!

Friday, May 22, 2009

Don't Get Carried Away Now!

As Paul Krugman recently pointed out, one of the key points to be found 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 trade balance of more than 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 for the typical crisis then, and the typical exit. But musing on this point lead Krugamn to a rather the disturbing conclusion: given the truly global character of the present financial crisis, 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 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 another kind of bounce last Monday morning, the one they experienced on learning that India’s outgoing government had been not only been re-elected, but had come back into power on a much more stable basis. And that was not the only pleasant surprise in store for those reading the 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. 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 were busily adapting their behaviour to changed conditions in the US and Europe, 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 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) which lead one emerging economy after another to wilt under the twin strain of stringent monetary policy and sharply rising inflation. 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 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, alongside this we have also seen large 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 convergence in global living standards - at least in the cases of those economies who have been experiencing the strongest acceleration - has been taking place much more rapidly than anyone could possibly have dreamed back in the 1990s, even if the long term importance of this is currently being masked by the recent collapse in commodity values and the downward slide in emerging currencies associated with this and the wekening in risk appetite.

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 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, such liquidity provision is very likely to exit the first world looking for yield, and where better to go than to 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 did during the period of 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 who have interest rates which are often in double figures. Using dollars, euros and yen these investors then buy instruments denominated in currencies from countries like Brazil, Hungary,Indonesia, South Africa, New Zealand and Australia - 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 be to borrow U.S. dollars at the three-month London interbank offered rate of 1.13% and use the proceeds to buy Brazilian real and earn Brazil’s three-month deposit rate of 10.51%. That would net anannualized 9.38% - as long as both currencies remain stable, but the real, of course, is appreciating.

Other options are Turkey, where the key interest rate is currently 9.25 percent, Hungary (9.5 percent) and Russia’s (12 percent). The cost of borrowing in euros overnight between banks reached 0.56 percent last week from 3.05 percent six months ago as the European Central Bank cut interest rates while pledges of international aid reduced concern the global recession would worsen. The London interbank offered rate, or Libor, for overnight loans in dollars fell to 0.22 percent from 0.4 percent in November.

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 trades offering 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 10 percent to 260 per euro in two to three months from 286.55 today. Investors should also sell the dollar against the lira and buy the ruble against the dollar-euro basket, the bank said. And it isn't only Deutsche Bank, 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. And Barclays joined the pack this week saying Brazil’s real, South Africa’s rand and Turkey’s lira offer the “largest upside” as investors return 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 US 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, as if to add to the 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, may well 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. At the present time India's Congress party-led coalition faces a central government fiscal deficit which is 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 the nation’s credit rating may be cut again if finances worsen. But simply raising 100 billion rupees from share sales and initial public offerings in the financial year that began last April 1 would cut the fiscal deficit by an estimated quarter-point.

As a result of this perception that the new Indian government will seriously address the fiscal deficit situation, stocks rose sharply this week, with the benchmark index posting a 14 percent rise, its largest weekly gain in 17 years, on speculation the ruling party will accelerate economic reforms.

And it isn't only India which is exciting investors. 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 three-month rally in the real. The central bank began buying dollars on May 8, while Meirelles’s comments this week were seen as an additional measure to upgrade 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.


Despite a number of outsanding worries about the emerging economies in Eastern Europe, the general idea that countries like India, Brazil, Turkey, Chile, Peru are up towards the top of the list of economies where growth conditions are, relatively, the most favorable seems essentially sound. Additionally if this sort of argument has any validity at all, it is bound to have implications for one of the key problems which we will face in the context of 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 is in an even more parlous state, deep in recession, and desparate for exports, it is having to live with a yen-dollar parity which is at levels not seen since the mid 1990s. This has lead some analysts to start to talk of a new and enhanced role for China's currency, the yuan, and obviously beyond the yuan we could also consider the real and the rupee, but I would like to suggest the problem we now face is a much broader one, and it concerns how to conduct monetary policy in an age of global capital flows.

The euro hit 1:40 to the USD yesterday (at a time when Europe's economies are in deeper recession than the US one is), while Brazilian central bank President Henrique Meirelles 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. Turkey's lira was also up and has now advanced 10 percent in the last three months, while South Africa’s rand is up 22 percent, making it the best performing emerging-market currency over the past three months.

All good "carry" punts these, since Turkey’s benchmark interest rate stands at 9.25 percent, compared with a range for overnight loans between banks of zero to 0.25 percent in the U.S. Brazil’s benchmark interest rate is 10.25 percent. Even the ruble is up sharply, as Russia's economy struggles to handle growing default rates. The currency climbed to a four-month high against the dollar yesterday, 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 currency was up 3.2 percent on the week, thus closing its sixth weekly advance and extending its longest rally since September 2007. The ruble has in fact now climbed 16 percent since the end of January. Russia’s 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.

The issues presented by what is now happening are in many ways related to the one I started this article with: namely, who it is who will run the trade and current account deficits and do the necessary consuming which will make all those export lead recoveries possible. Evidently the main problem generated during the last business cycle were associated with the size of the imbalances which were generated. If I am right, we are just about to generate a further, and possibly even larger, set of such imbalances if we let the process rip in an uncordinated and unrestrained fashion. Floating Brazil and India is a very attractive and very desireable proposition. Consumers in those countries can take on more leveraging, and the countries can to some extent support external deficits as they develop. But they do not need distortions, and we do not need more Latvias, Estonias, Irelands or Spains. So policy decisions are now urgently needed to impose measures and structures which help avoid a repeat of the same in the near future.

Sunday, May 17, 2009

Is The Indian Economy Heading For Its Finest Hour?

"For what it’s worth, a key conclusion from the IMF’s new World Economic Outlook is that recessions caused by financial crisis typically end with export booms, with the trade balance improving,on average, by more than 3 percent of GDP. I find this a disturbing result: we’re now suffering from a global financial crisis, which means that the usual driver of recovery will only be available if we can find another planet to export to."
Paul Krugman

With results still coming in, projections show the United Progressive Alliance is likely to win about 250 seats, making it a shoo-in to form the next government and provide continuity, a stable administration and progress on key economic and corporate reforms.
Wall Street Journal, May 16 2009

Prime Minister Manmohan Singh’s electoral victory, the biggest any Indian politician has scored in two decades, may loosen political shackles that have restrained the country’s economic growth as it struggles to free half a billion people from poverty.....Political stability will make India a more attractive investment destination as Singh, 76, seeks the funds to stimulate Asia’s third largest economy.
Bloomberg, May 18 2009

Many are called, but few are chosen, as the saying goes. But could it just be that this time around, and on a one-off, never to be repeated basis, India might find itself right there in the midst of things, with a 50-50 opportunity to add its name to that select and noble band, the chosen few. After all, someone has to lead the next global charge. The majority of the developed economies are either weighted down with substantial quantities of debt that they desperately need to pay off, or weighted down with elderly populations which are weakening consumption growth and leading to export dependence (Germany, Japan...). And as Krugman humorously points out, someone will have to add the extra demand which will allow global trade to start to grow again, so why should India not supply a significant part of this new demand, after all we are more likely to find consumers in India than we are on Mars.

India's Sensitive index, or Sensex, surged 2,099.21 points to 14,272.63 on Monday morning, posting a record 17 percent gain, and prompting exchanges to halt trading at 9:55 am, initially for 2 hours and then for the rest of the day, the first time ever that this has happened.The rupee also jumped the most in two decades while bonds rose. The reason for the surge is not due to any deap seated admiration for the Singh government itself, but rather a sense of optimisim that it will give India the continuity and stability it needs to grasp the challenge before it with both hands.

From "Hindu Growth" To A Global Powerhouse

But why the enthusiasm now? Certainly India's post independence growth record has been notoriously uneven, with growth rates up to the 1980s low and extremely volatile. But then, in the 1980s and 1990s things started to change, economic reform started, tentatively at first, and more substantially later, while Inda's demographic profile started to improve, as the country faced the prospect of a steadily growing, healthier and better educated workforce. Post 2000 growth really started to take off - and has averaged around 7 percent since then. In 2007 the Indian economy maintained an impressive 9 per cent growth rate, despite the arrival of the sub-prime crisis (although not a few were talking of overheating, and "bubbles"), only then to drop back to a 7.3 percent rate in 2008, with the IMF are currently forecasting growth of 4.5 percent in 2009.

Evidence of the recent slowdown in the Indian economy is everywhere, but this, it should be stressed, is a "slowdown" and not an outright crisis of the kind we are seeing in many other countries. GDP growth slowed in Q4 2008 to 5.3 percent (from 7.6 percent in Q3), a serious development, but not an outright disaster.

Industrial output also fell year on year by about 1 percent during the first three months of 2009, which compared to the 8.7 percent rise in the first quarter of 2008 was disturbing, eespecially since this is the first time we have seen a quarterly contraction in many years. Money supply has remained rather more constant, and M3 growth to mid February 2009 was an annual 19.9 percent as compared to 21.6 percent growth last year, so the rate of increase has only eased marginally. And in the meantime the annual rate of wholesale price inflation has fallen back strongly, hitting an estimated 0.48 percent at the start of May. But then, since money supply growth hasn't slackened that much, there has evidently been a significant weakening in internal demand (alongside the obvious fall in commodity prices).

A number of fiscal stimulus packages have been put in place, and as a result the fiscal deficit from April 2008 to January 2009 was 174.3 per cent above that for the corresponding period a year earlier. The revenue deficit was up by 278 percent higher, indicating very strong pressures on the fiscal deficit and a significant departure from the The Fiscal Responsibility and Budget Management Act (FRBM). This surge in the fiscal deficit has been widely criticised, and Standard and Poor's reduced India’s rating outlook to negative from stable in February, citing the danger that “continued loose fiscal policy would result in a downgrade” in the country’s credit rating. In the meantime it affirmed India’s BBB- long-term credit rating, the lowest investment grade level.

But there are reasons for optimism. As Duvvuri Subbarao (Governor of the Reserve Bank of India) argued in a speech - ‘India, Managing the Impact of the Global Financial Crisis’ - delivered to the Conference of Indian Industries on 26 March this year, the Indian economy has been spared the worst of the blast from the present crisis for two reasons. The Indian economy is still not sufficiently "open" to take a direct hit - only 15 percent of the Indian economy is export oriented - and Indian banks and financial corporations were relatively free of contamination from "toxic" instruments.

Why Should We Expect A Ressurgence In Indian Growth?

In order to understand what may happen next, perhaps the most import thing to grasp is what it was that just happened. In some ways a quick look at look at the Reuters/Jeffries CRB commodities index (see chart below) says it all. The chart - which shows the evolution of this index from the mid 1990s to date - immediately makes a number of important details about what has been going on incredibly clear. In the first place we can see how, after long languising idly around some sort of mean, a secular rise in commodity prices starts up around 2002 and last for around four years, eventually flattening out from between 2006 to mid 2007. After this there was a further strong surge forward in the autumn of 2007 which lead to a sharp spike upwards. Basically, you could say (with the benefit of hindsight) that this period from August 2007 to July 2008 was the "overheating" period, as the growth crisis in the developed economies which followed the initial wave of "financial turbulence" in the US lead to massive inflows of funds into the BRIC and other emerging economies. This produced a sharp spike in commodity price inflation, and monetary tightening in one emerging economy after another. A desperate attempt to avoid the inevitable correction in the global economy which would follow the sub-prime "blow out" was "forcing" growth in the emerging economies at a rate they could not withstand (given global resource constraints), and the thing inevitably had to burst. Commodities peaked in July 2008, but the correction in the real economy only set in following the aftermath of the collapse of Lehman Brothers in October.

The Reuters Jeffries index hit an all-time series high of 473.518 on 2 July 2008, but was still stuck in the low 200s as we entered May 2009.

So the real point I would make a about the current slowdown is not the result of a problem inherent to the Indian economy as much as a reflection of more general problems at the global level, whereby the Indian economy was first accelerated and then half crashed. Which is why I personally think the recent (and highly controversial) US bank stress tests were so important, not because of their significance from a US banking point ofview (which is what all the fuss was about), but because of the reassurance they can give market participants that we are not going to see another financial explosion in the United States (as opposed to a protracted recession, and slow recovery). Uncle Ben is thus underwriting the recovery in emergent economies like India and Brazil by offering the reassurance that investors need that there will not be another violent bout of instability. What India and Brazil now most need is for Ben Benanke to commit to mainaining US interest rates near zero for a sustained period of time, so that people can practice "carry" with a certain degree of confidence that things won't unwind, then, I think, we are up, up and away. So, on behalf of everyone concerned, thank you Ben.

Here Come The Opportunities

India’s inflation rate stayed under one percent for a ninth consecutive week at the start of May, giving the central bank a much needed margin to keep the current record-low interest rates in place and offering the outlook of inflation free economic growth for some time to come. With so much slack in the global economy, a sudden surge in commodity prices like the one we saw in the autumn of 2008 is most unlikely, and so, as they say, while the cat is away the mice can well and truly play.

Wholesale prices rose a mere 0.48 percent year on year in the week to May 2 following a 0.70 percent increase in the previous week.

Not everyone is convinced the outlook is so benign, and Reserve Bank of India Governor Duvvuri Subbarao said only last week policy makers need to begin to think about when they will begin reversing their expansionary steps. The current RBI forecast is for inflation to climb back towards 4 percent by March 31 as the economy gradually revives. Some evidence to support Subbarao's fears can be garnered from the evolution of consumer prices paid by industrial workers, which rose 9.63 percent in February from a year earlier, after gaining 10.45 percent the previous month, according to government data. Consumer-price inflation for farm workers was 10.79 percent. India, in fact, has four consumer-price indices and as a result tends to rely on the wholesale price index as benchmark because since it is felt the consumer price indices don’t adequately capture the aggregate price. However, the disconnect between wholesale and consumer prices that we can see at this point can be more a reflection of the fall in commodity prices and the presence of excess capacity on the supply side, so the evolution of these indices needs to be carefully monitored.

The RBI has now slashed borrowing costs six times in the past seven months, with the reverse repurchase rate being cut by a quarter-point to 3.25 percent as recently as April 21.
This means the bank has now lowered the benchmark by 275 basis points since last October, while the repurchase rate has been reduced by 425 basis points over the same period to its current 4.75 percent level.

As I say governor Subbarao is rightly cautious about reducing interest rates further as Indian consumer price gains remain high, suggesting that local demand hasn’t been completely dented even as the rest of the world remains mired in a recession. Cheaper loans are helping stoke consumer spending. “The fiscal and monetary stimulus measures initiated coupled with lower commodity prices could cushion the downturn in the growth momentum” over 2009 to 2010, the central bank said recently. “Notwithstanding the contraction of global demand, growth prospects in India continue to remain favorable compared to most countries.”

And between now and September, the central bank is set to inject another 1.2 trillion rupees ($23.8 billion) into the banking system by purchasing government bonds via auctions and buying back market stabilization bonds, which were sold in the past four years to drain money from the economy. The injection is estimated to be the equivalent of a 3 percentage point reduction in the cash reserve ratio, according to the Reserve Bank.

Subbarao’s optimism is also based on forecasts for this year’s monsoon rains - which look set to be normal. If this expectation is confirmed it will help sustain the unprecedented 4.3 percent average annual farm production growth recorded since 2005, boosting incomes for the three-fifths of India’s 1.2 billion people who depend on agriculture for their livelihood while keeping price inflation modest to feed to consumption of India's urban workforce.

Sibbarao is also aware that India is much less vulnerable to the global economic slump than most of its neighbors since exports only constitute about a quarter of the economy, as compared with around a half for developing Asia as a whole. So India is less open, and while in general terms this would not be an advantage, during the current slump in world trade it is an evident plus.

Industrial Output Falls Sharply In Q1 2009

India’s industrial production fell the most in 16 years in March as the worst global recession since World War II hit demand for the country’s exports. Output at factories, utilities and mines declined 2.3 percent from a year earlier after a revised 0.7 percent drop in February. Production was dragged down in March by an 8.2 percent drop in capital-goods output (which does not bode well for short term investment), with all other categories showing improvement from February. Consumer durables production jumped 8.3 percent from a year earlier, the biggest increase in six months.

In fact the (non seasonally corrected) output index was up in March over February, and substantially up from the lows registered in the last quarter of 2008. This impression is confirmed by the purchasing managers index, which in April gave the highest reading for the Indian headline manufacturing PMI in seven months. In fact the output index registered 53.3, a level above the 50 critical one separating growth from contraction. In fact the index has now steadily risen after hitting a trough of 44.4 in December.

Just as encouraging, the new orders index rose to 54.9 from 49.5 in March. The return to growth was primarily driven by an improvement in domestic demand, according to the accompanying report. "Although the rise in new business came principally from the home market, there was also some, albeit slight, improvement in foreign demand for Indian manufactures," ABN Amro Bank said in the official release.

Interestingly, along with the expansion Indian manufacturers noted renewed input price inflationary pressures. A combination of increased prices for some commodities and unfavourable exchange rates led to a moderate rise in input costs during April. This is the first time that input price inflation has been recorded in India's manufacturing sector since October last year. However continuing competitive pressures meant that manufacturers did not pass on their cost pressures on to customers, and factory gate prices were cut for the sixth straight month. However, the latest drop in average prices was the weakest in the current period of falling output prices.

Employment levels across India’s manufacturing economy were little-changed during April with increased production requirements leading to recruitment on the one hand, while cost-cutting pressures produced job losses on the other.

"The April PMI gives a very clear indication that business conditions in the manufacturing sector have improved significantly after a period of sharp contraction and gradual stabilisation. The headline PMI at 53.3 has signaled expansion in activity for the first time since October 2008. Moreover, the April reading is the strongest since October 2008," according to Gaurav Kapur, Senior Economist, India, with ABN Amro. "Survey data suggests that production was ramped up during April in order to cater to a pick-up demand and to build inventories. The output index printed at 55.7 for April compared to 49.3 in March, as new incoming business expanded during the month. The domestic orientation of the improvement in demand is clearly visible from the new orders index rising well above 50, even though external demand also improved modestly. New orders index printed at 54.9 as against 49.5 in March. This is critical as it suggests that domestic demand conditions are now strong and supportive for growth in the sector,"

Car sales and the production of cement, electricity and refined petroleum are also showing signs of recovery. India’s passenger car sales increased 4.2 percent in April from a year earlier, after a 1 percent gain in March. Cement production jumped 10.1 percent in March and electricity output rose 5.9 percent from a year ago, according to government data. But exports still remain weak, with shipments declining 33 percent in March from a year earlier, the biggest fall since at least April 1995.Goods exports dropped 33 percent from a year earlier to $11.5 billion last month, the government said in New Delhi today. That was the biggest fall since at least April 1995. Exports slid 21.7 percent in February.

India’s exports, which account for about 15 percent of the economy, were up 3.4 percent (to $168.7 billion) in the fiscal year ended March 31, missing a $200 billion target set by the government before the September collapse of Lehman Brothers accelerated the world financial and economic slump. The government now expect exports to total $170 billion in the year that started April 1. The decline in exports is likely to continue until at least September, according to India’s Trade Secretary Gopal K. Pillai, while falling overseas sales may cost India about 10 million jobs, according to estimates from the Federation of Indian Export Organisations.

Imports were also down in March - by an annual 34 percent - and as a result the trade deficit narrowed to $4.04 billion from $6.3 billion in March 2008. Oil imports plunged 58 percent to $3.8 billion, while non-oil imports dropped 19 percent to $11.75 billion.

However, Subbarao argues, the Indian economy has globalized rapidly during the past few years. In terms of openness to international trade the ratio of exports plus imports to GDP increased from by more than 50 per cent in the 10 years from 1997–98 to 2007–08 (from 21.2 per cent of GDP to 34.7 per cent of GDP). Furthermore, the growth of financial integration has been even more rapid. During the same 10 year period (1997–98 to 2007–08) the ratio of total external transactions (gross current account flows plus gross capital account flows to GDP) increased by more than 100 per cent from 46.8 per cent in 1997–98 to 117.4 per cent in 2007–08. Furthermore, corporate borrowing from external sources has also increased significantly. In 2007–08, for example, India received capital inflows to the extent of 9 per cent of GDP as against a current account deficit of 1.5 per cent of GDP.

Twin Deficits?

India has been facing the so-called twin deficit problem for some time now, and the poor fiscal record, together with the continuing high deficit is the main reason why international credit rating agencies have brought the country’s debt close to junk status. The fiscal problem is not an easy one - apart from running a general government fiscal deficit of a estimated 9.9 percent of GDP, the debt to GDP ratio is stubbornly stuck round the 80% level - far, far too high.

On the other hand th current account deficit seems set to shrink despite the huge tumble in export earnings. Part of this steep fall is because of the recent drop in global oil prices. Meanwhile, capital flows continue to be vibrant despite the huge withdrawal of money from the domestic stock market by foreign financial institutions, or FIIs. But equally interesting is the change in the composition of these capital flows. FIIs pulled out an estimated $15.02 billion in 2008-09, according to data released this week by the Reserve Bank of India, or RBI. The scale and rapidity of this withdrawal after September did unsettle the money and foreign exchange markets—short-term interest rates crossed 20% and the rupee tumbled to an all-time low of 52 against the dollar. But other types of capital inflows have been strong, especially foreign direct investment, or FDI. RBI provisionally estimates that India got a net inflow of $33.61 billion through FDI. Overseas Indians, too, sent a lot more money back home, thanks to the financial near-collapse in the West and higher interest rates in India. Money from overseas Indians is volatile and can flow out very easily, as it did in 1990 and 1991 when India came close to defaulting on its global debts. But a greater dependence on FDI rather than FII money will make the financing of the current account deficit more stable.

Taken together, the measures put in place since mid-September 2008 have ensured that the Indian financial markets continue to function in an orderly manner. The cumulative amount of primary liquidity potentially available to the financial system through these measures is about Rs.390,000 crore (78 billion dollars) or 7 per cent of GDP. This sizeable easing has ensured a comfortable liquidity position starting mid-November 2008 as evidenced by a number of indicators such as the weighted average call money rate, the overnight money market rate and the yield on the 10-year benchmark government security. Commercial banks have responded to policy rate cuts by the Reserve Bank of India by reducing their benchmark prime lending rates. Bank credit has expanded too, but slower than last year. The RBI’s rough calculations show that, on balance, the overall flow of resources to the commercial sector is less than what it was last year indicating that even though bank credit has expanded, it has not fully offset the decline in non-bank flow of resources to the commercial sector.

Of course, the present level of fiscal deficit is easy enough to justify, given the need to put a platform under the economy, and a number of stimulus packages have been announced by the Indian Government in response to the global financial crisis.

Just one such measure - the decision of India's Sixth Pay Commission (which was not a stimulus measure as such, but rather the outcome of the routine policy process, and possibly highly political in view of the impending elections) was widely criticised, although the implementation in the short term may in fact have been timely.

The Commission recommended across the board increases in salary for central government employees, to be followed in due course by comparable salary increases for state government employees. The payment was to be made in two installments, 40 percent (an estimated Rs. 1.57 trillion or roughly $31.4 billion) during 2008–09, with the remaining 60 percent coming due in 2009–10. The decision is, I say, deeply controversial, given the size of the deficit and accumulated government debt, but under the circumstances may well have served to place some sort of platform under domestic demand during times of global financial crisis.

The first stimulus packages per se have also come in two installments, a first, announced in December 2008, was largely fiscal in its intent, and included additional expenditure of Rs.3 trillion ($60 billion) over four months, a cut of 4 percent in value-added tax, as well as a 2 percent export credit for labour intensive sectors and other export incentive schemes.

The second stimulus package - announced in January 2009 - was mainly montary and directed towards credit easing. Among the more important measures an SPV was to be created to provide liquidity support for investment grade paper to specific Non Banking Finance Companies (NBFCs). The scale of liquidity potentially available was Rs.25,000 crores/$50 billion. Public Sector Banks were to provide a line of credit to NBFCs specifically for purchase of commercial vehicles. Credit targets of Public Sector Banks were revised upward to reflect the needs of the economy. Government would monitor, on a fortnightly basis, the provision of sectoral credit by public sector banks. The guarantee cover under Credit Guarantee Scheme for micro and small enterprises on loans was increased from Rs 5 million to Rs 10 million with a guarantee cover of 50 per cent. In order to enhance flow of credit to micro enterprises, it was decided to increase the guarantee cover extended by Credit Guarantee Fund Trust to 85 per cent for credit facility upto Rs 0.5 million. This will benefit about 84 per cent of the total number of accounts accorded guarantee cover.

India Infrastructure Finance Company (IIFCL) was authorized to raise Rs 10,000 crores/$20 billion through tax free bonds by 31 March 2009 for refinancing bank lending of longer maturity to eligible infrastructure bid based PPP projects. This would enable the funding of mainly highways and port projects on hand of about Rs 25,000crore/$50 billion. To fund additional projects of about Rs 75,000 crore/$150 billion at competitive rates over the next 18 months, IIFCL would be allowed to access in tranches an additional Rs 30,000crores/$60 billion by way of tax free bonds once funds raised in the current year are effectively utilized.

This surge in the fiscal deficit has been widely criticised, and Standard and Poor's reduced India’s rating outlook to negative from stable in February, citing the danger that “continued loose fiscal policy would result in a downgrade” in the country’s credit rating. In the meantime it affirmed India’s BBB- long-term credit rating, the lowest investment grade level. S&P estimated that India’s national budget deficit, including off-budget items such as oil and fertilizer bonds and state government deficits, may increase to 11.4 percent in the year ending March 31 from 5.7 percent in the previous year. India regards bonds sold to subsidize fuel and fertilizer as “off-budget” items and doesn’t show them in state accounts.

Current Account Blues?

As suggested throughout this post, the tailwinds behind the Indian economy are now incredibly favourable. A new government has just been elected which should provide stability to the country, and continuity in the realm of economic policy. The changing age structure of India’s population means that the proportion of the Indian population in the working age group (15–64 age bracket) is set to rise from 60.9 per cent in 2000 , to one which will surpass that if a developed economy like Japan by 2012, and continue to climb steadily to 66 per cent by 2030. But it isn't only quantity which is important here. Quality also matters. The nutritional status of India's population is improving rapidly, with calorie and other macro and micro nutrient deficiency on the decline. According to the 2001 Census, the literacy rate of India's population climbed from 51.54 percent in 1991 to 65.38 per cent in 2001. India will thus, in the years to come, find itself with a younger, healthier, better educated and thus more productive workforce than ever before.

At the same time, the massive slack which exists in the global economy means that Indian now has a more-or-less unique opportunity to accelerate the development process at non-inflationary growth rates well above those which would have been envisaged only two or three years ago. At the same time, as the age structure has shifted, and the weight of child dependence has reduced, India's savings rate has risen steadily from 23.4 per cent of GDP in 2000–01 to 35.4 per cent in 2007–08. During the same period investment rose from 24 per cent of GDP to 36.3 per cent of GDP, suggesting the need for a slight current account deficit to cover the gap between savings and investment.

And to return to where we started, on where the demand is going to come from to support the current global recovery. The IMF currently forecast a 2.5% of GDP current account deficit for Indian. Given the extent of investment that is needed in capital goods, technology and infrastructure this is a small, even benign, number, and at the end of the day will mean that Indian is once more playing its part in the community of nations, by adding a little extra net demand to the global pot.

Wednesday, May 13, 2009

Fitch Cuts Greece Rating Outlook

ATHENS, May 12 (Reuters) - Fitch Ratings cut its outlook for Greece from stable to negative on Tuesday, saying it was sceptical the conservative government could manage public finances during difficult economic times.

Fitch kept its 'A' rating on Greek debt and will not rush a rating decision but it will keep a close watch on the heavily indebted country's deficit and debt ratio for any future move, Fitch analyst Chris Pryce told Reuters.

"The authorities consistently over-estimate revenue while slippages in expenditure reflect weak controls and a lack of political will," Pryce, a director in Fitch's sovereign team, said in a statement.

Fitch's outlook cut is the second outlook downgrade by a rating agency this year for Greece, the euro zone's most heavily indebted member after Italy as a percentage of GDP.

Greece's conservative government with a wafer-thin majority in parliament has struggled to impose painful economic reforms in the face of a series of scandals as well as recurrent street riots which followed the fatal shooting of a teenager by police last December.

"Fitch is sceptical of the authorities' ability to manage public finances in a more difficult global economic environment and forecasts that the deficit and public debt will rise to 6 percent and 106 percent of GDP respectively in 2009, significantly above official projections," Pryce added.

The move follows downgrades by rating agencies this year on other euro zone members Ireland, Spain and Portugal. Spreads of Greek government bonds over benchmarkb German bonds rose to 180 basis points from 176 after the outlook change.


In February, Moody's Investors Service cut its outlook for Greek government bonds to stable from positive but said at the time a rating downgrade was no more likely than an upgrade over the next 12-18 months.

Standard & Poor's cut Greece's sovereign rating one notch to A-/A-2 in January with a stable outlook, citing a loss in economic competitiveness due to high wage inflation and the persistently high budget deficit.

"The key is public finances," Pryce told Reuters. "There would also have to be a genuine reduction in debt; the Greek government must wean itself off resort to debt."

The European Commission expects Greece's debt to reach 103.4 percent of GDP this year and 108.0 percent next year.

The financial crisis has widened the premium Greece must pay on its bonds compared to higher-rated core European issuers like Germany at a time when a slowing economy and weak government revenues boost public borrowing needs.

Greece's conservatives cling to a one-seat majority and narrowly avoided being forced to call snap polls over a bribe scandal last week.

"I am sceptical as to whether the government can fix the state finances with such a narrow majority. They have no choice but to try, but the probability that they'll manage to do it is small," said Sebastian Wanke, an economist at DekaBank.

Analysts said the harsh Fitch statement was not a surprise, given Greece's deteriorating finances, and was not expected to have a major impact on spreads but a rating downgrade would affect the whole bloc.

"Any suggestion that the country's single-A rating could be cut would be more serious for the entire euro zone," said David Schnautz, a bond analyst at Commerzbank in Frankfurt.

Pryce said he did not expect Fitch to take a further step regarding Greece in the next six months. "We could do, if there were any further shocks from Greece," he added.

Tuesday, May 12, 2009

Sentimental Stuff

This was Angela Merkel's point wasn't it, if you remember, as she came out of the April EU summit she argued:

“Saying that the situation is the same for all central and eastern European states, I don’t see that……you cannot compare the dire situation in Hungary with that of other countries.”
Angela Merkel

The Economist made a similar point at the time:

“Most other countries in the region are faring much better, though….Like Slovenia, which joined two years ago, Slovakia can enjoy the full protection of rich Europe’s currency union, rather than just the indirect benefit of being due to join it some day.”

And basically, it is true, not all East Europe's economy are the same, though some of the differences between them might surprise you. There are, of course, many different ways in which to compare the economies of the East, but one very simple one, in terms of the present crisis is the reading they register on the EU monthly Economic Sentiment Indicator. This is a composite which measures sentiment in industry, servces, construction, retail and building, and does at least have the advantage of offering us a rule of thumb guide as to how a country is handling the crisis.

Not surprisingly Hungary is the worst performer at the present time, while Poland still hangs on to poll position. But in between there are some surprises, like the fact that the two recent members of the Eurozone - Slovenia and Slovakia - are doing worse than any one else than Hungary, or if you prefer, a crisis racked economy like Latvia (whose economy is contracting at an 18% annual rate, and whose bankers and politicians are moving heaven and earth to try to scrape through the qualifying hurdle for eurozone membership) is still feeling better than many economic agents in the two countries who have managed to access the zone.

On the upside it is perhaps surprising to find that Bulgaria still registers as the second best performer, since evidently a sharp downturn is underway, but perhaps there is still a time lag at work, and sentiment is about to take a big knock. It is hard to say at this point, but since we will now try and follow this indicator, it will be interesting to watch how the different countries evolve over time. After all, Hungary can only move up the classification, can't it.

Friday, May 8, 2009

Wednesday, May 6, 2009

The Global Services Contraction Also Stabilises in April

The JPMorgan Global Services Business Activity Index rose for the second month running in April, registering at 43.8 its highest level since last September. At the same time the headline index remained well below the critical dividing line of 50 which separates growth from contraction and thus still firmly within recession territory.

The JPMorgan Global Serices Report is based on the results of surveys covering around 3,500 executives in countries which taken together account for an estimated 60% of global service sector output.

Measured overall, worldwide services activity fell for the eleventh month running. Lower levels of activity were reported across all of the nations for which April PMI data were available. Rates of decline did however ease to their weakest in the current seven month period of decline in the US, to a six-month low in the Eurozone and to their weakest for seven and eight-months respectively in Japan and the UK. Only Ireland reported a faster drop in activity than during March.

Global services employment however continued to give cause for concern and declined for the twelfth month running in April. The US saw a severe reduction, albeit at a noticeably slower pace than in March. Japan cut jobs at the weakest rate of all the nations covered. The UK, Russia and Australia reported slower declines, whereas the rate of job loss in the euro area hit a series record. Deflationary pressures were evident, and average input costs declined for the sixth successive month in April. The sharpest reductions in costs were signalled for Ireland and the US. Input prices in the Eurozone fell at the fastest pace in the series history, but slower than the global average. The UK and Russia reported higher costs in April.


The Eurozone services PMI staged its biggest one-month rise since December 2001 as Markit unexpectedly revised up its services business activity index to 43.8 following the earlier flash reading of 43.1. Activity thus registered its slowest pace of contraction in six months in a sector which covers everything from financial services to airlines. The figure was well above the 40.9 registered in March, but still heavily in contraction territory. The rate of contraction did, however, slow in all four of the biggest euro zone countries even reaching the slowest rate of contraction in nearly a year in Spain.

The eurozone composite PMI, which includes both manufacturing and services, was also up strongly - to 41.1 from 38.3 in March. This was again the highest level since October, and suggested the rate of economic contraction in the second quarter of the year may be rather better than the 1.9 percent contraction rate expected by consensus estimates for the first three months of the year. The eurozone economy contracted at a 1.6 percent in the final months of 2008 and we may well be in for something similar in Q2.

The movement in the reading for services business expectations to 54.4 from 48.6 in March was the biggest one-month rise in this index since January 2002, and this is likely to further encourage optimists who expect the eurozone economy to start to grow again before the year is out, but really it would be very premature to draw any longer term forward looking projections at this point, especially given sensitivity in the index to seasonal factors like Easter and the weather.

Business expectations were generally up, and were the best in 15 months for Spain, and in 10 months in both Germany and France, while in Italy they hit an eight-month high. The report, however, did suggest that unemployment, which is already at 8.9 percent for the euro area as a whole (and 17.4 percent in Spain), is set to rise even further, with record rates of job cutting being reported across the entire euro area service sector.


Spanish service sector activity continued to decline in April although as elsewhere the rate was much slower than in previous months. The headline activity index stood at 42.5, still well below the critical 50 level indicating growth, but way above 34.1 in March and November's record low of 28.2. April's figure was in fact the highest recorded since May 2008 but nevertheless marked the 16th consecutive month of contraction as the deep recession weighed on new orders and jobs. According to Andrew Harker ,economist at Markit Economics, "Jobs continued to be lost at a fast pace, indicating that the labour market remains a key source of weakness."

The survey showed staffing levels declined in April for the 14th month running as service providers cut jobs due to lower activity and to keep costs down. Hotel and restaurant firms were the hardest hit. However despite Spain's deep and ongoing economic crisis, April's survey was marked by confidence levels not seen in 15 months. Many of those surveyed by Markit said they believed the crisis would end within a year, with two-fifths of panellists expecting activity to be higher in 12 months and just 22 percent forecasting lower activity. However, companies remained relatively cautious about short term economic prospects.

The service sector thus is showing a significantly sharper rebound from the record declines of the last few months than is to be seen in the manufacturing sector, which continued to contract at a rapid pace in April.

Prices continue to fall, and services output prices registered the third-fastest decline in the survey's history, second only to February and March this year, with those surveyed citing increased competition for new business and pressure from clients. Service providers also reported falls in input costs due to reduced labour costs and lower prices from suppliers, but, according to Markit, the decrease here was less marked than that for output prices.


Italian service sector activity contracted for the 17th consecutive month in April although at the slowest rate for six months. The Markit/ADACI Purchasing Managers' Index rose to 42.0 from 39.1 in March, but still is not that far above the record low of 37.9 recorded in February. Activity has now been stick below the 50 mark that separates growth from contraction since November 2007.

The survey showed new business shrinking for the eighteenth straight month in April, though the rate of decline eased for the second month running, while expectations of business in a year's time rose to an eight-month high. As elsewhere, while optimism is rising Markit did point to record job losses as a likely on consumer spending looking ahead, making hopes of a swift recovery extremely premature. The employment sub-index fell to 44.0 from 44.6, as firms cut jobs at a survey record rate in response to the ongoing loss of business. The survey is thus consistent with other recent indicators that have pointed to an economy still mired in the deep recession that began in spring of last year, but with some grounds for thinking that the lowest point may now have been passed. Consumer and business sentiment as measured by the ISAE institute both rose in April, and the manufacturing PMI showed activity shrinking at its slowest rate for six months after the index hit a record low in March.

Deflationary pressure remained evident with service firms cutting their prices for the seventh month running and at the fastest rate in the survey's history in response to weak demand, while input prices showed no monthly increase for the first time since the survey began. The Italian government slashed its economic forecasts last week, and now project gross domestic product to fall by 4.2 percent this year following last year's 1.0 percent decline. The International Monetary Fund is more pessimistic, forecasting a 4.4 percent fall this year and a further drop of 0.4 percent in 2010. Italy thus now possibly faces three years of economic contraction one after the other although previously the country had not posted two consecutive years of falling GDP in its entire post-war history.


Activity in Germany's private sector shrank for the eighth month running in April, though as elsewhere the pace of the contraction eased, in the German case to the slowest rate since last October. The services sector PMI edged up to 43.8 from 42.3 in March, while the business expectations sub index jumped to 44.4 from 39.0, and the headline composite PMI reading rose to 40.1 from 38.3 in March.

Markit reported that "Pessimism about the year ahead outlook for activity was the least marked since June 2008. This partly reflected the support given to business sentiment from the government's economic stimulus plans, as well as hopes that overall market conditions will begin to stabilise". These firmer expectations are consistent with the rise in the April Ifo reading for German corporate sentiment, which hit its strongest level in five months.

However, despite the more positive business expectations, the German government has slashed its forecast for the economy, projecting a record 6-percent contraction this year. Previously it had not shrunk by more than 1 percent in any year since the second world war.

In harmony with this more sober assessment, the sub-index on employment fell to 40.6 from 42.3 in March. "We are now seeing the labour market feel the full force of the economic downturn, with the latest wave of private sector job losses the steepest for at least 11 years," according to Tim Moore, economist at Markit Economics. "This provides advance warning that April's spike in official unemployment numbers will be repeated during the months ahead ... firms are likely to make further substantial job cuts even after the worst of the recession has passed," he added. German unemployment rose for the sixth month running in April to hit its highest level since late 2007 despite government subsidies designed to prevent mass layoffs.


The contraction also eased in the French services sector in April, this time for a second successive month in April, and the Markit/CDAF final services PMI reached its highest level in six months at 46.5, up from 43.6 in March. The composite PMI also rose to 43.8 for the month, from a revised figure of 40.2 in March.

According to Markit panellists continued to report that overall operating conditions remained unfavourable and that falling new business had again negatively impacted on activity. New orders to service providers fell for the seventh consecutive month, with hotels and restaurants bearing the brunt of the downturn as customers cut back on discretionary spending. The business expectations index on the other hand climbed to 58.3 in April from 51.9 in March, and responses were more optimistic, with Markit reporting that 37 percent of respondents expected output to be higher in twelve months' time.

In the short term, however, the picture was pretty similar to that seen elsewhere , with firms continuing to make painful adjustments to cope with a harsh economic environment, slashing prices to boost sales, and making further sweeping cuts to staffing levels. April's output prices index showed prices falling for the eighth straight month, hitting a record low of 38.1, compared with the March reading of 38.4. The services employment index rose slightly to 41.0 from 40.8 in March, but still remained close to February's survey record low of 40.6, indicating a further steep contraction in the service sector workforce, according to the Markit report.


Russia's service industries contracted at the slowest pace in six months in April as business confidence improved, according to the monthly report from VTB Capital, with the PMI coming in at 44.4, compared with 43.9 in March.

While Russian services activity fell for the seventh consecutive month, it continued to rebound from December’s record fall of 36.4. The rate of decline in new orders also eased for the third month in succession after registering a record contraction in January. Prices charged by companies declined for the first time since VTB started compiling the survey as providers competed by offering lower prices and discounts, according to the report. Input prices advanced at the slowest pace on record.

Russia’s inflation rate fell slightly in April, dropping to 13.2 percent after rising to 14 percent in March, with consumer-price growth slowing to 0.7 percent month on month, according to the Federal Statistics Service. Retail sales were down an annual 4 percent in March, the biggest decrease since September 1999, as frozen credit markets and falling incomes forced Russians to curb spending, while GDP is now thought to have fallen 9.5% year on year in the first quarter of 2009.

United States

U.S. service-producing industries contracted again in April for the seventh straight month, but again the pace was slower than in March, according to the US Institute for Supply Management.

The ISM non-manufacturing index improved to 43.7% from 40.8% in March. This was the first increase since January. The index has now been below 50% since October, and touched its lowest level of 37.4% in November. Seven of 18 industries surveyed actually showed frowth in April, including real estate, entertainment, retail, and finance. The new orders index improved to 47.0% from 38.8%.

The employment index improved to 37% from 32.3%, indicating a slackening in the pace of job destruction.

No New Stimulus In Europe

Bloomberg yesterday:

EU Finance Chiefs Plan No New Stimulus Even in ‘Social Crisis’

By Simon Kennedy and Meera Louis

May 5 (Bloomberg) -- European finance ministers said they have no plans to bolster their fiscal stimulus packages even as they warned that rising unemployment risked triggering a “social crisis.”

“We’re heading toward a social crisis; there will be an unemployment crisis,” Luxembourg Finance Minister Jean-Claude Juncker told reporters in Brussels late yesterday after leading talks of counterparts from the 16-nation euro region. “Even so, we do not believe euro-zone states should be adding to the economic programs they have decided upon.”

The ministers gathered hours after the European Commission, the European Union’s executive body, warned that the euro area will suffer its deepest recession since World War II this year and predicted the unemployment rate will reach the highest on record in 2010.

Companies across the continent including Germany’s BASF SE are cutting production and firing workers to survive the slump. Limiting the scope for governments to help are rising budget deficits following previous tax cuts and spending increases and the suspicion that more aid would fail so long as banks are plagued by toxic assets.

“We need to make sure the planned stimulus packages will really take effect,” said Dutch Finance Minister Wouter Bos. “A second round of stimulus packages -- that will cost more tax money and with dubious effects.”

Budget Deficit

The commission projected the euro-area economy will shrink 4 percent in 2009 and 0.1 percent in 2010. The region’s average budget deficit will widen to 6.5 percent of output next year, when unemployment will rise to 11.5 percent from 8.9 percent in March, it said.

Juncker called on employers not to shed staff prematurely and said policy makers should focus on finding ways to help those out of work to secure new jobs through retraining.

Finnish Finance Minister Jyrki Katainen urged his counterparts to follow the U.S. by subjecting banks to stress tests in order to restore trust in the financial industry and growth to the economy. The International Monetary Fund, the Washington-based lender with 185 member nations, last month warned Europe that its banks will have to write down $750 billion through next year.

“The name of the economic disease is banking crisis,” Katainen told Bloomberg Television. “We need to recover the trust within the banking sector and I don’t see any other way.”

Speaking separately in Brussels, European Central Bank Executive Board member Lucas Papademos said “there will not be strong and sustained recovery before balance sheets are strengthened and repaired.”

Automatic Stabilizers

Around 5 percent of EU gross domestic product already has been committed to reversing the recession in the form of recovery plans and so-called automatic stabilizers such as jobless benefits, the commission said yesterday.

Signs are emerging that may be paying off. A gauge of manufacturing activity rose to a six-month high in April, according to a survey of purchasing managers by Markit Economics published yesterday.

“Everybody agrees we are now in the worst moments of recession,” EU Monetary Affairs Commissioner Joaquin Almunia said at the press conference. “At the same time we observe positive signals.”

ECB - The Moment Of Truth?

From the FT today:

Moment of truth
By Ralph Atkins

Published: May 5 2009 19:51 | Last updated: May 5 2009 19:51

The global financial crisis is making and breaking reputations – of central bankers as well as the big names in private finance.

On Thursday the European Central Bank reaches what could be a defining moment in its 10-year history. With another quarter percentage point cut expected in its main interest rate – from 1.25 to 1 per cent – the ECB will, later than other central banks, have reduced official borrowing costs to what might turn out to be a floor. The big question then is: what next?

When financial market tensions erupted in August 2007, the Frankfurt-based central bank that sets interest rates for 329m Europeans in 16 countries cast off its reputation as a sluggish, timid institution by swiftly announcing large-scale injections of emergency liquidity. By contrast, the US Federal Reserve and Bank of England appeared slow in their response.

But as the crisis turned into a deep economic slowdown, others took up the running. The Fed cut interest rates much earlier and found other ways to help the economy. The Bank of England also performed policy pirouettes.

Jean-Claude Trichet, ECB president, has announced that on Thursday the 22-strong governing council will decide whether it, too, should move further into “non-conventional” policies. On the table are options such as asset purchases, being deployed in the US and elsewhere in a bid to unblock bottlenecks in the financial system – as in the market for corporate debt, for ex­ample, where banks are holding back.

Mr Trichet knows the stakes are high. Eurozone leaders who initially saw the crisis as a problem mainly for the US have been badly caught out. The eurozone will contract by 4 per cent this year – significantly faster than the US – according to European Commission forecasts this week, with a recovery not expected until next year.

Unemployment is rising sharply and eurozone governments fear a summer of social unrest; its policymakers, including Mr Trichet, have been noticeably more reluctant than their US or UK counterparts to talk of the “green shoots” of economic recovery.

A common criticism is that the eurozone governments have been too cautious in expanding public spending and the ECB too timid in seeking new ways of helping a return to growth. “The big risk,” says Erik Nielsen of Goldman Sachs, “is that [the ECB] will sort of say that ‘this is the finale, we have run out of bullets’. I think that would be terrible – because it is not true.”

Will the ECB rise to the challenge? According to one view, it is already too late. The Fed cut interest rates in late 2007. The ECB, however, was distracted by last year’s inflation spurt fuelled by the oil price – and even raised its main policy rate last July. “With hindsight, lowering interest rates at the beginning was the right thing to do because inflation was going to come down and growth would be declining a year later – and monetary policy works with a lag of about a year,” says Charles Wyplosz of Geneva’s Graduate Institute. He accepts, however, that “it was bad luck – it was a close call”.

After the collapse of Lehman Brothers in September last year, the ECB slashed interest rates – but not fast enough for everyone. “They did the usual striptease, one shoe dropping at a time. I would have gone much faster – quickly down to the zero bound and quickly talking about non-conventional measures,” says Professor Wyplosz.

Adding to the eurozone’s woes, the ECB allowed the euro to remain strong and act as a further brake on activity, while the UK benefited from a weakening currency.

Unsurprisingly, that is not how it looks from the Eurotower, the bank’s low-key glass and steel headquarters in Germany’s financial capital. There, they blame the scale of the eurozone’s downturn on the openness of its economy – especially export-dependent Germany, its largest member. A rule of thumb is that the region was hit twice as badly as the US by the slump in global demand triggered by the near collapse of the world’s financial systems that followed the failure of Lehman. Deflation has been seen as a threat in the US but not in the eurozone.

When it comes to comparing policy responses, the ECB believes insufficient account has been taken of “automatic stabilisers” – the natural increase in government spending and fall in revenues caused by an economic slowdown. Add those effects to the discretionary boost in public spending, and Europe is on a par with the US, runs a popular Frankfurt argument.

The ECB also believes more attention should be being paid to steps it has taken to pump unlimited liquidity into the banking system, which it says will make a decisive contribution to eurozone performance in coming months.

Explaining the significance of that policy to sceptical financial markets has been hard. Mr Trichet calls it “enhanced credit support”. Some of his colleagues reach for the even less media-friendly “endogenous credit easing”. Combined with cuts in the main ECB rate, the effects on market interest rates have been significant. Though official rates are still higher in the eurozone, six-month and 12-month rates have fallen lower in the eurozone than in the US. One-year interest rates are of particular significance because they form the basis for many eurozone mortgages.

The firepower being deployed is shown by the massive expansion in the ECB’s balance sheet, reflecting its dramatic increase in lending. Between June 2007 and the end of last month this rose by €600bn to €1,500bn ($1,997bn, £1,337bn) – equal to 16 per cent of eurozone gross domestic product. By comparison, the Fed’s balance sheet has expanded faster but, at just over 14 per cent at the end of last year, still accounted for a smaller share of US GDP.

Still, nobody pretends the ECB is a hot-bed of revolutionaries. Julian Callow of Barclays Capital says it was fortunate at the start of the crisis because it had the policy tools to provide liquidity to a large number of banks, secured against a broad range of assets eligible as collateral. Subsequently, Fed and Bank of England innovations “showed a determination to do something to counter the recession and return the economy to growth. It was a way of saying: ‘We’re doing all we can – nothing is off limits.’ At a time when things were so weak, that was quite a help in itself. We have not really seen anything like that from the ECB.”

One reason has been Frankfurt’s focus on combating inflation – the main task assigned to it under European Union treaties. To outsiders this can appear obsessive. Eurozone inflation is just 0.6 per cent – compared with the bank’s target of an annual rate “below but close” to 2 per cent. In coming months, inflation will almost certainly fall below zero. But the ECB fears that, if it is seen to drop its guard, there will be an outbreak of the kind of discussion taking place in the US about the long-run inflation dangers posed by policy actions. Germany, with its folk memories of hyper-inflation, has issued warnings that today’s excessively loose fiscal and monetary policies will be tomorrow’s regrets.

The ECB also fusses about its independence, which explains why it has all but ruled out buying government debt, arguing that such a step would blur the boundary between fiscal and monetary policy. Paul De Grauwe of Belgium’s Leuven university says its fears are surprising given that the ECB faces not one finance ministry but 16. “It shouldn’t really be afraid of being taken over by the Treasury – that is something an independent central bank in the US or UK could fear ... yet it acts as if buying the smallest government bond will destroy its independence. It is a kind of phobia.”

There is another reason for the ECB’s policy conservatism, he argues – its committee-based decision-making. The governing council comprises the central bank governors of the 16 member states, plus six executive board members. “We have not seen much creativity on the part of the ECB, and this has probably got to do with the fact that the governing council is too big,” says Prof De Grauwe.

For a gathering of central bankers, it is an eclectic bunch. Besides the odd former politician, some – such as Mr Trichet, previously head of the French Treasury – are career technocrats; others come from academia (Lucas Papademos, the vice-president), investment banking (Mario Draghi of Italy) or even, in the case of Athanasios Orphanides of Cyprus, from the US Fed. It includes nine economics professors. The mix almost guarantees tensions when members jostle for space at the cramped round table in the meeting room at the top of the ECB skyscraper.

In recent weeks, the discord has leaked into the public sphere. Council members have argued, for example, over whether 1 per cent is really the lowest possible level for the main interest rate; Mr Trichet has said zero rates are not desirable, but has carefully avoided saying where he sees the floor.

Those familiar with the workings of the council say it functions efficiently under Mr Trichet’s stewardship. The problem is that the issues involved in embarking on “non-conventional steps” are complex, especially given the eurozone’s fragmented capital markets and political system. The region faced “intricate challenges, due to its unique institutional framework”, Lorenzo Bini Smaghi, an ECB executive board member, argued in a speech last week.

But it is also true that under Mr Trichet’s leadership the ECB has sought to act as a source of stability in turbulent economic times, worrying for example about how it will exit from the measures it has taken once the crisis is over. Prof Wyplosz sees “valid trade-offs” between a US approach that could result in its economy escaping the recession earlier but at the cost of inflation and the ECB’s strategy – “very much in the tradition of prudent central banking, which is a very distinguished tradition”.

Thursday's governing council meeting will not be the last word. In June, the ECB will update its economic forecasts – a process that in the past has spurred it into policy action. As the eurozone economic deterioration continues, some economists believe the ECB will come under pressure to escalate its response. The ECB will know that its reputation is on the line.


European Central Bank action to combat financial market tensions and the economic recession has so far focused on pumping unlimited liquidity into the banking system, but success depends on banks’ willingness to pass on credit to businesses and consumers . The bank’s possible next moves to improve the effectiveness of its actions include:

Buying government bonds

For- This would indicate determination to take bold action and help inject demand into the economy.
Against - The ECB’s biggest objection is that this would blur fiscal policy with monetary policy. Deciding which governments’ bonds to buy would be hard. It would also add to the difficulties of creating an exit strategy.
Likelihood Extremely unlikely.

Buying private sector assets

For- Buying corporate debt, for example, could help ease specific problems in lending markets.
Against - Technical problems could arise in a monetary union of 16 countries. The ECB might fear it was developing an “industrial policy” favouring particular sectors or members. Relevant markets are negligible in some countries. And how would the bank pay for this?
Likelihood Reasonable, but could be small scale.

Pledging to keep policy interest rates low for an extended period

For- A commitment, for instance, to keep rates low for “as long as needed” would send a helpful signal and reduce long-term market interest rates.
Against - Such verbal reassurances would reverse the ECB’s strategy of never “pre-committing” to a particular interest rate path. There is a danger that markets would not believe it.
Likelihood Reasonable.

Further cuts in the main policy rate

For - A quarter-point cut to 1 per cent is all but certain on Thursday, but going lower would inject further stimulus into the economy.
Against - Though Jean-Claude Trichet, the bank’s president, has not specified the lower limit, any new cuts could bring the rate too close to zero – which he has declared forbidden because of the economic distortions the ECB believes it would create.
Likelihood Low at this stage.

Providing unlimited liquidity for longer terms

For - Extending to 12 months the period over which the ECB lends funds to banks at fixed interest rates would fit squarely with current strategy and enable banks to plan with greater certainty.
Against - Would banks pass on the funds to the real economy? Such a move would tie the ECB’s hands by forcing it to keep interest rates low for longer than it might wish.
Likelihood High.

Loosening collateral requirements

For - Relaxing the rules on what assets banks can put up as security, or smoothing out operational difficulties when borrowing from the ECB, would allow them to borrow even larger sums.
Against - It is not clear that a lack of adequate collateral is currently much of a constraint. Looser rules would involve the ECB carrying greater risks.
Likelihood Reasonable.

Foreign exchange intervention

For -Lowering the value of the euro could help boost eurozone exports.
Against - Intervention is considered dangerous and possibly inflationary by central bankers and would risk “beggar-thy-neighbour” responses elsewhere in the world. It would not necessarily boost demand for eurozone products.
Likelihood Extremely unlikely.

Sitting on hands doing nothing

For - Cool insouciance might appear to be a sign of confidence and prudence.
Against - More likely to be seen as an act of negligence, undermining confidence.
Likelihood Not insignificant.