Tuesday, December 25, 2007
Credit crunch, did someone use the expression credit crunch?
Monday, December 24, 2007
None of the writers here at Japan Economy Watch are professional forecasters and analysts per se. Yet, with what seems to be happening 'next' in Japan I can not help but think that you have been extraordinarily well served here at JEW during the past year. As such, let us have a look at what I said on Japan (and indeed the global economy) about a year ago as we stood on the brink of 2007.
(...) we have the Top 10 of economic predictions for 2007 by Global Insight where the chief economist Nariman Behavesh argues that the BOJ is likely to have raised to 1% by the end of 2007; this would then imply three 0.25% steps from the current level 0.25%. As you will see this is a part of a broad discourse concerning how global interest rates differentials will narrow as the Fed is going to cut while the BOJ and the ECB are going to raise; for the record I do not see this happening at all!
Now, the ever perceptive readers of this blog will immediately notice the apparent rather peculiar reason as to why I am feeling so smug in my introduction. In this way and apart, of course from the BOJ raising to 1%, isn't this thing of 'narrowing' of global interest rate differentials exactly what we have seen? It could indeed seem so as the Fed's aggressive easing have coincided with a fixed stance in Japan and increases moving over to holding operations at the ECB. However, this is also where I would like to start the whole 'what will happen in 2008' debate since how sustainable is this current state of affairs amongst the three G3 economies? Well, as for the US they have already bitten the bullit. The subprime mess is still pounding away with the recent victims being Morgan Stanley and Bear Sterns having to push the big delete button on a slew of internal balance sheets as it became clear that the subprime debacle had claimed yet another score of assets. But the US economy in general and while certainly still on the ropes is on its way to get to grips with its new situation and get on with the fight. I won't even begin to rant on the Eurozone here where I fear that 2008 will be a year of many a camel swallowing (or was that cold pouridge?) by those who have been pushing the Goldilocks narrative the hardest. Let me move swiftly over to Japan where as can readily be seen the BOJ has not managed to raise the short term interest rate to 1%, far from it actually. I should note in this context that I am not trying to pound excessively on Global Insight and its chief economist who I am sure is a very able and smart analyst. I am simply trying to hammer down that the consensus on Japan as it emerged from 2006 has not exactly materialised and what we now need to do is to understand why as well as we need to look forward as to what will happen next. I will begin with the latter question as Bloomberg today carries a piece on Japan where it is actually suggested that the BOJ will have to lower rates which effectively would take them back into ZIRP ...
Toshihiko Fukui's final act as governor of the Bank of Japan may be to cut borrowing costs for the first time in more than six years. Economists began predicting Fukui, 72, will have to lower rates after the Bank of Japan yesterday downgraded its assessment of the economy for the first time in three years. The bank has raised rates twice since July 2006, when it ended a policy of keeping borrowing costs near zero to beat a decade of deflation. ``They may have to cut,'' said Robert Feldman, head of economic research at Morgan Stanley in Tokyo. ``As Fukui said yesterday, the economy is getting worse.''
This is of course far from being a done deal but it is interesting to see how the discourse kicked off in 2006 with sustainable recovery stories flying all over the place to now where it seems as if we have come full circle. What I particularly want to emphasise here is that this Felman talking and when he says something on Japan people all over the place are bound to listen carefully. Whether the BOJ will actually go ahead with a return into ZIRP is difficult to say indeed. The point is that while economic factors will indeed be importants determinants so will political. The BOJ stands before a change in leadership in Spring 2008 and given the current spout of political uncertainty lingering in Japan combined with fierce debate over potential future 'un-popular' political measures (e.g. a consumption tax perhaps?) any decision and especially one downwards in the interest rate is bound to be surrounded by much commotion not least from the external environment where the G7 is sure to be jumping and dancing all over the place in the event of a cut. This brings me to the other question raised above and one which is far more fundamental and important. As such, why is it that Japan did not see that sustainable recovery? The first thing to bear in mind is clearly the fact that the financial turmoil which was brewing in the beginning of 2007 reared its head with much more force than most had anticipated. There is no doubt that this has not exactly been accomodative to the Japanese economy. However, what I really want to home in on is the narrative which has emerged here in the twilight of 2007 as it has become clear that Japan will probably be flirting with a recession. In this way, it seems that whatever happens next in Japan with respect to the inevitable slowdown of economic momentum is bound to shore up exclusively at the politicians' door. Now, this is an extremely dangerous path to go by I think as I also noted recently (for good measure, Takehiro Sato's 'Buckle Up' analysis can be found here). Edward also treats this point in one of the post which immediately preceedes this one where the following point is worth pondering ...
For anything to work for you in life you need a certain amount of good luck, and when your luck is down, and the level of adversity you face mounts, then the problems only seem to pile up. This perfectly describes Japan present problem set I think (I mean don't forget the famous pensions-records scandal, which seems to have been all but forgotten at the moment, except by the people who had their records lost, of course). If you really could live without a spanner showing up in the works, then it never fails to show up. That's what we mean by being "down on your luck". As Jefferson said, when I find myself being lucky I am normally sitting here, hard at work at my desk. That is, we make our own luck, using foresight and sound policy.
In this way and to paraphrase one of pre-modern history's most vexing questions on whose altar many a head has been severed from its body we need to ask whether the sun revolves around the earth or whether in fact it is not the other way around? Of course, no heads will be severed this time around which serves to indicate the strides human intelligence and community have made after all. So, leaving you with these arcane matters I might risk coming off as a scrooge here just before Christmas. This was not my attention but I do think that we need to think long and hard about what cause and effect are in terms of analysing the Japanese economy.
I will have more later on the actual market implications of all this and do have a Merry Christmas come next week.
I think here that perhaps three charts tell it all. First we have the capital inflows themselves:
And then secondly we have the changing relative dollar values of global GDP, which is a topic that takes us straight into the whole debate about "decoupling" and "recoupling". Basically there seem to be two versions of the "decoupling" thesis knocking about. The first of these (which is now very definitely going out of fashion very fast) was based on the idea that the global economy was finally decoupling itself from the US one due to the fact that key global engines among the G7-type economies - and in particular Germany and Japan (and following in both cases lengthy periods of structural reforms) - were finally coming out of a long period of sub-par economic growth and achieving "home grown", domestic-demand-driven, sustainable recoveries in a way which would enable them to take more of the global strain
But there is another sense of "decoupling" (which is the one Claus Vistesen and I prefer to call "recoupling" - although this is not, it should be noted - recoupling in the way in which Nouriel Roubini (for example) uses the expression, which seems to refer to some form of renewed coupling to a US economy which is basically on its way down, not in GDP growth terms - although there may of course be a recession - but in dollar share of world GDP terms) and this is to do with the way in which certain emerging market economies (the EU 10, Ukraine, Russia, China, India, Turkey, Brazil, Argentina, Chile etc) are now accounting for a very substantial proportion of global growth (Claus and I have yet to do the detailed numbers on this, but suffice it to say that India, China and Russia alone will account for over 30 % of the growth in the global economy in 2007). This is a far cry from the central role which the US economy was playing in global growth in the late 1990s. So in this sense something fundamental has changed, and this is what Claus and I are calling "recoupling".
This situation can be observed quite clearly in the two charts which follow, which are based on calculations made from data available in the IMF October 2007 World Economic Outlook database. Now, as can be seen in the first chart the weight of the US economy in the entire global economy has been declining since 2001 (and that of Japan since the early 1990s). At the same time - and again particularly since 2001 - the weight of the soc called BRIC economies (Brazil, Russia, China and India) has been rising steadily. This is just one example - and a very crude one at that - of why Claus and I consider that demographics is so important, since it is precisely the population volume of the BRIC countries (and the fact that they start their development process from a very low base, ie they were allowed to become very poor comparatively, for whatever reason) that makes this transformation so significant.
Again, if we come to look at shares in world GDP growth we can see the steadily rising importance of these economies in recent years and the significantly weaker role of "home grown" US growth. The impact of the collapse of the Tech stocks/internet boom in 2001 is clear enough in the chart, as is the fact that everyone went down at the same time, and this is the old form of "coupling" wherein the US economy due, to its size (and hence specific weight) and "above-par" growth potential played a key role, and, as can be seen, when the US went down, then god save the rest. The present debate is really about what will happen if the rising dollar cost of oil and the ongoing difficulties in the financial sector caused by the sub-prime problem leads the US into recession in 2008. Will everyone else follow this time? In 1999 the US economy represented 30.91% of world GDP, and in 2007 this percentage will be down to 22.4% (on my calculations based on the forceast made by the IMF in October 2007). In 200 the US economy accounted for a staggering 40.71% of global growth, and by 2007 this share is expected to be down to 6.43%. So there are prima-facie reasons for thinking that this time round the impact of any US slowdown will not be as acutely felt in some parts of the globe as was the case in 2000, but which parts of the globe will be more affected and which less so?
So now back to those capital flows. As Arpitha Bykere points out, the rupee rose by around 15.5% against the dollar between Sep 2006 and Oct 2007. The RBI and Indian government have been busying themselves trying to use the various tools they have at their disposal to try to manage the inflows and their potential impact on liquidity and inflation with a variety of forms of FX intervention and sterilization.
Bank reserve requirements have been raised eight times this year, from 5% in December 2006 to 7.5% in October 2007.
The repo rate been raised seven times from 6% in April 2005 to 7.75% in March 2007 while the reverse repo rate has been increased five times from 4.75% in March 2004 to 6% in July 2006.
The increase in reserve requirement acts as a kind of tax on banks (and this makes their work even more difficult for them to increase their deposit base given the pressures for funds which exist in the consumer market and the attractive returns available elsewhere. Further, RBI rules that effectively force them to hold a quarter of their deposits in govt bonds and to purchase the low return sterilization bonds make for added pressures in the conventional banking sector).
India's central bank on December 14 also curbed bank loans to mutual funds by mandating that these loans will be treated as lenders' direct investments in stock and bond markets. The central bank has also accelerated the pace of the sterilization via issuance of market stabilization scheme (MSS) bonds. Using such techniques the RBI has managed to sterilize about 58% of the foreign inflows, according to estmates by Chetan Ayha. The sterilized liquidity (excess liquidity) stock - which includes reverse repo less repo balances, MSS bonds, government balances with the RBI and the increase in the cash reserve ratio - has shot up to US$77 billion as of end-October 2007 from US$19 as of end-October 2006, according to the same estimates.
Banks are currently required to limit investments in capital markets to less than 40 percent of their net worth, while funds may borrow from banks only to meet ``temporary liquidity needs'' and as per the capital market regulator's guidelines.
This move was a response to the discovery by an apparently astonished RBI that the financial records of some banks showed they had extended "large loans to various mutual funds and also issued irrevocable payment commitments to stock exchanges on behalf of mutual funds and foreign institutional investors". Such transactions were found to have been widespread, but were not included by the banks as part of their declaration of capital market investments.
As a result the Securities and Exchange of India has ruled that a mutual fund may borrow only up to 20 percent of its net assets and for periods of not more than six months.Also the RBI has ruled that banks must not give loans or other forms of financial assistance, such as payment guarantees, to foreign institutional investors. Domestic banks have now been given six months to comply with the instructions.
RBI’s control over monetary policy has evidently been gradually weakening. Initially RBI followed an independent monetary policy of targeting the interest rate while maintaining a competitive exchange rate with partial capital controls. But as the economy has gradually accelerated to around a 9% average over the last three quarters, and as the sub-prime blow out has added to the attraction of strongly growing emerging economies with relatively higher interest rates and the prospect of strong relative currency apprecaiation, the consequent ineviatable arrival of large capital inflows has lead to RBI to acquiesce its ongoing appreciation, and control over the value of the rupee has to some extent been sacrificed in an atempt to keep control over the interest rate. But as the rupee has steadily approached the 40 USD pain threshold level the RBI has shifted its efforts towards control over the capital account, imposing soft controls on inflows and easing outflows. Moreover, the use of interest rate is constrained by concerns about unnecessarily slowing growth in one direction, and accumulating inflationary pressure (including food, manufacturing, asset inflation) in the other.
In theory the RBI could allow exchange rate appreciation to offset the liquidity injection (buying dollars and selling rupees, for example). But a case can well be made that the Indian exchange rate is already somewhat over-valued. The 36-country real effective exchange rate was about 8.5% above the ten-year mean as of September 2007.
More importantly, the 12-month trailing trade deficit has shot up to 6.7% of GDP as of September 2007, resulting in an adverse impact on job creation in the manufacturing sector. Total goods exports growth has decelerated to 4.3% in rupee terms as of September 2007. In our view, small and medium enterprises would have been growing at an even slower rate, as the large companies would have been able to maintain their growth better.
Even if one were to consider the services sector exports, the trailing four-quarter sum of the current account deficit (excluding remittances) is at 4.2% of GDP as of June 2007. The headline current account deficit, however, is at a manageable level of 1%, primarily on account of the rising remittances from non-residents. The four-quarter trailing sum of non-residents’ remittances has shot up to US$30 billion (3.2% of GDP) as of June 2007. For assessing the impact of the exchange rate on the domestic output balance, we believe that we should exclude remittances, which represents transfer of income generated in foreign countries. Having to stand back and watch any further appreciation of the exchange rate will be a testing moment for policy makers considering the potential adverse impact on domestic growth and job creation.
Another important source of capital inflows has been Portfolio Investment which rose from $2.8 b in FY2000 and $12.5 b in FY2005 to $18.5 b Apr-Sep 2007. According to the IMF Foreign Institutional Investment (FII) has risen from $1.8 b in FY2000 to $8.7 b in FY2004 and to $15.5 b during Apr-Sep 2007. Moreover, the number of FIIs registered in India doubled to 1,050 between Mar 2001 and Jun 2007, and there are now around 3,336 FII sub-accounts. FII equity inflows have increased from $9.8 b in 2004, to $11 b in 2005, and now to over $16 b in the year so far of 2007.
India's stock market - buoyed by strong corporate performance and the aforementioned inflows - has risen 43% to date in 2007. According to Citigroup, FIIs holdings in the Bombay Stock Exchange 500 companies rose from 12% in March 2001 to around 22% in June 2007, which is greater than the holdings of domestic mutual funds.
In mid-October, the RBI reacted to some of this by banning foreign investment in the stock market via off-shore derivatives in the form of Participatory Notes (PN). Such derivatives had been habitually used by foreign investors who were not officially registered in India (say hedge funds) to indirectly invest through registered investors. Between Mar 2004-Aug 2007, the number of FIIs/Sub Accounts that issued PNs rose from 14 to 34. The share of PNs in total foreign portfolio flows is believed to have increased from 32% during 2006 to about 55% by Oct 2007, with hedge funds accounting for around 50% of the PNs. It has, however, been suggested that the real motive behind the October RBI measure was not so much to restrict investment as to improve the transparency of capital inflows and that restricting inflows via PNs is likely to have little or no impact on the overall inflows entering India in the medium term.
Hedge and mutual and pension funds activity have all been growing in India. Hedge fund investment in India has risen 400% from $2.8 b in Sep 2005 to $13.97 b as of July 2007 with over 90% of these investments in equities accruing high returns. According to the Financial Times, private equity deals have surged from $3.9 b in 2006 to around $ 5.9 b ytd in 2007.
FDI has also risen significantly from the low level of $3.8b in FY2004 to $16 b in FY2006. In addition, cross border M&A deals increased to 226 deals worth $15.3 b in 2006 from 192 deals worth $9.5 b in 2005. More importantly, investment by non-resident Indians in foreign currency deposits and rupee accounts has risen over the years from $21.7 b in FY2000, $33 b in FY2004 to $41.2 b in FY2006, leading the RBI to cap interest rates on the latter. Moreover, remittances have increased from $12.9 b in FY2000 to $20.5 b in FY 2004 and $27.2 b in FY 2006.
According to the IMF India's external debt rose 22.6% to $155 b in FY 2006 (with the appreciating rupee contributing to 10% of this increase) and now is equivalent to 16.4% of GDP. Around 56% of the increase in external debt was due to ECBs and 16% of the increase was due to NRI deposits. India's Net International Investment Position has improved somewhat in the recent years due to increase in assets (rising outward FDI), even as liabilities have continued to grow. Rising FDI and equity portfolio inflows have helped non-debt creating inflows to rise from 27% in FY2000 to 47% in FY2006, but FDI inflows are only up from 14.7% in FY2000 to 25% in FY2006.
As we never tire of pointing out here at this space the analysis and proper understanding of the global economy and more specifically her markets demand a vigorous interaction and -play between the overall broad conceptual analysis and the more nitty-gritty country analysis. Today, and as most people, in the Western World at least, rev up for some of that most scarce and precious quality time with friends and family I feel inclined to wander off over to Thailand for one last spout of economic analysis before closing down for the holidays. Before I start I think it would be only fair to point out that I am not exactly an expert when it comes to Thailand's economy but rather I shall progress in the spirit of traditional writings here at GEM where authors attempt to aspire to the ideal and tradition of the polymath rather than towards the profile of the 'genius savant' in one specialist area.
Yet, and despite my denial of expertise in the area of Thai economics I think it is safe to say that Thailand commands a rather special place in the whole global economic framework for two main reasons. The first is strictly endogeous to political life in Thailand, where the frequency with which governments are toppled by the military only to be subsequently re-inserted (with a quick change of label), is rather high when compared with most other members of the emerging economies leading group.
The lastest example of this tendency was handed to us a little over a year ago when General Sonthi Boonyaratglin ousted prime minister Thaksin Shinawatra and declared that a military junta would stay in power for a year. Such abrupt changes of government (and of course the way of changing them) have a tendency not to go down too well with foreign investors and naturally have tended to affect the ability of Thailand to attract foreign capital inflows, as well as to act as a source of outflows. Of course, many would, at this point in time, simply exclaim that since these things are now a natural part of the political cycle in Thailand they are already well priced-in to current market premiums. I will leave this issue here and simply note that whatever importance we ascribe to the political situation in Thailand, an interventionist military is certainly part of the picture and needs to be taken into account.
The second reason for Thailand's rather special position in the international economic environment is to be found by going back to 1997 and the Asian currency and financial crisis. As I am sure many of our readers remember Thailand acted was one of the principle centres of attention during the boom phase and then one of the victims of the sudden and abrupt retrenchment of private inflows to emerging markets which occured during the Spring and Summer of 1997. This would then translate into a modern day 'once bitten twice shy' mantle and although I am unsure whether this actually applies for Thailand it serves us well always to remember that debating capital flows in the context of Thailand always will tend to have that historical glow around it.
Where now for Thailand?
In order to deliver a reasonable crack at answering this after all very general question I need to invoke the headline of this note. In my opinion and as I will try to argue below Thailand is now at a crossroads. On the one hand Thailand finds itself right smack in the middle of the sweet spot relative to the ongoing demographic transition known as the demographic dividend. As we know this does not by any means constitute free lunches - of which, of course, there are very few, if any - but rather a golden opportunity for Thailand to move now in order to make sure that it does not go down the road of other rapidly ageing emerging economies of which China is perhaps the most important and best known example. However, if Thailand is to get rich before she actually gets old the window is closing fast.
By inspecting the graphs over at the Thailand Economy Watch we can readily see that Thailand with respect to its demographic position is now borderline between two extremes. The fertility rate has been stable at about 1.6 for the past 8 years and coupled with a rapid increase in life expectancy (which of course is a good thing) Thailand is now set to age rather rapidly. However, the effects of the ageing process are likely to be subdued in the interim as Thailand will enjoy something like 15 years of demographic headwind before reaching that ever so important 40 year median age threshold. Now, and although I realize that I have not yet fielded one single economic chart let me be very clear. A great deal of Thailand's economic future rests upon whether the economic growth which is now set to come and continue all things equal will bring Thailand a further notch into the demographic transition bringing TFR below the 1.5 mark. I really hope not and if there ever was an important objective for policy makers in Thailand it would be to make sure that what comes next is accompanied by an effort to keep the fertility rate from falling further, and preferrably, to find ways to nudge it back up to a slightly higher level. This would then bring me back to the present, which is what indeed is set to happen next in the context of the global and thus the Thailand economy?
Let us begin with a kind of overview of the Thailand economy such as it. As we can see from the two graphs fielded below, Thailand's prosperity has done been on the rise over the past 15-20 years, - a much more modest rise following 1998, but a rise nonetheless - and there is really no reason to believe that this will not continue to be the case in the immediate future. The Asian Crisis as it occured in the 1997-1998 is certainly not absent from the charts and you could even, if you are into such matters, debate whether in fact Thailand suffered an irreversible blow to its growth trend back in 1997? For more on this topic go here.
As for the short term economic data on Thailand, the most recent central bank inflation report (PDF) provides us with ample ammunition to get a more solid grip on the immediate outlook. If we scrutinize the data a bit more closely we see that growth in Thailand seems to have moderated somewhat when it comes to the evolution of headline GDP. This slowdown which must be considered in relative terms has coincided with a subtle but important change with respect to the engine of headline GDP growth. As can readily be seen from the chart the central bank provide (reproduced below) as private consumption and fixed capital formation have waned net exports of goods and services have slowly but surely been taking over as the main engine of economic growth in Thailand.
This is of course an important trend to take into account since it does mean that Thailand is subject to the whims of global markets to a higher degree than had been the case if private consumption had been doing the heavy lifting. Clearly, at this point we should remember that the time-span in question (i.e. Q2 2006 to Q3 2007) is exactly the period where domestic political uncertainty took a hefty leap upwards. So, it is really difficult to discern a notable trend in all this. However if we look at the central bank's private consumption index we can see after a slowdown at the end of 2006 (which would be associated with the political uncertainty) things do now seem to be turning back up again, so we may well be in a recovery phase.
Another notable feature of the recent trends in the Thai economy is the rather subdued rate of inflation which has come down over the course of 2006 and now into 2007/2008 as well. This seems somewhat odd when you look at the figures on the labour market where it quickly becomes clear that Thailand is firing on all cylinders at the moment with a monthly registred unemployment rate below 2% and somthing like 35 million people in work out of 64 million inhabitants. Indeed between the summer of 2005 the summer of 2007, Thailand added the best part of a million new jobs. This is really what the demographic dividend is all about, enabling rapid employment growth without provoking inflation. The demographic dividend isn't a policy, but it does produce an environment which is more favourable to the application of good policy.
This then serves us to move further into the argument in this note and as such to the more specific point on capital flows which are central for the understanding of the current changes in the global economy and thus also Thailand.
Capital Flows and Thailand - To Receive or to Send?
Starting out with capital flows in the global economy I recently narrated the current economic climate as fairing in uncharted waters given the delicate situation in which we are now finding ourselves. This uncharted waters theme should not however be misinterpreted as lack of oversight which I feel we at GEM have plenty of. Rather, we are simply noting that what happens next will be an important test for many of our theses and arguments. In this way and homing in on what is especially important in the context of Thailand we have the mounting signs and evidence that the structures and chains of Bretton Woods II are slowly but surely being worn thin. These changes however do not seem supportive of those who have spent their time arguing for a process of de-coupling in the traditional sense whereby the US hands over the baton to a train being run by a joint tag-team consisting of Europe and Japan.
Moreso, what we are seeing is a historic process of re-coupling by which the engine locomotive of the global economy is changing from being driven exclusively by the US towards a more diverse crowd of leaders. How far this process will go on is yet to be seen. I for one don't envision for example that the US will revert entirely to growth path where a substantial external deficit is not part of the overall picture. But the main point is that the relative weight will change and perhaps more importantly that the changes we are now seeing are happening at a pace which is quite unprecented. Of course, as Brad Setser is set on hammering home a lot lately, the recent retreat of financing from the external US balance is largely due to an almost effective stoppage of private inflows which of course has the nasty side effect that the US is now ever more so dependant on official foreign government inflows in order to keep the boat floating. As for the general situation, the following wonderful quote from Setser quite eloquently sums up how we are now situated in somewhat of an interim position
Private investors want to finance deficits in countries that don’t want to run deficits. The countries now accumulating reserves the fastest have the least need for reserves. The country with the largest deficit is struggling to attract enough private inflows to match the increased desire of its private sector to buy foreign assets – let alone both the deficit and those outflows. And the country with the strongest traditional aversion to state-ownership is now the country most-reliant on government inflows.
As I mentioned above Brad Setser seems to be focusing quite a lot on the apparent disconnect between private and government/official flows with respect to the financing of the US CA deficit. This rather specific topic should be the center of another note and here we should rather move on to the obvious question. Given that changes are taking place of almost tectonic proportions in the structure of global capital flows what will this mean for Thailand? To deliver a reasonable attempt to answer that question I will need to field some grahps of which some, I am afraid, will be plotting some rather technical stuff. But I will explain as I go along. Let us first inspect the basic graphs plotting the CA balance and financial account as it has evolved on a quarterly basis since 1995. Note that these two are inversely correlated as the former measures the headline balance between flows of funds, goods, and services whereas the latter plots the net change in foreign ownership of domestic financial assets. This basically means that if the financial account is in surplus foreigners are buying domestic financial assets more quickly than domestic agents are buying foreign assets and vice versa of course if we are talking about 'selling.'
Once again, we can easily see when the Asian Crisis occured in the beginning of 1997. Other things to note is the fact that volatility seems to have returned to the overall CA balance in the recent years which is something I will talk a bit further about below. Secondly, and following from this point we see that foreign investors seems to have once more become rather fond of putting their funds in Thailand over the last couple of years as compared with the relative stagnation in the years following the currency crisis. This is can be further substantiated by a chart showing the flows of net portfolio investments.
As can be seen particularly well on this graph volatility has indeed returned with a venegance since 2004 and as I hinted this is bound to bring forth that 'once bitten twice shy' mantle. However, and as a testament to the new situation in the global economy the Thailand response to all this was essentially turned upside down when it came the 18th of December 2006. As Edward wrote just as the news was coming in off the wire, the measures to control capital were not designed to stem a potential rapid fall in the value of the Bhat as was the case in 1997. Quite the contrary;
So now we have capital controls, not to stem an outflow of foreign exchange, but to stop an outflow of domestic currency. Oh how the world has changed. Of course, it should escape no-one's notice that with fertility now well below replacement (somewhere in the 1.6 tfr range) Thailand is now right in the middle of that Demographic Dividend/Demographic Transition process I keep talking about.
Indeed, the world seems to have changed and Thailand now must decide how to position itself in this new situation. And this my dear reader brings me back to where I started and how Thailand now seems to be set a crossroads and while it may not be a question of losing your horse or your head, it does seem as if whatever road Thailand chooses it is a choice of some importance. In this way, Thailand seems to be faced with, at least, two interconnected choices moving forward from here. The first issue as I have hinted above is whether Thailand will be able to get the demographic house in order or not. There are of course many unknowns here either way but one thing seems fairly certain at this point. With life expectancy shooting upwards and fertility lingering at a TFR of 1.6 the next 12-15 years of economic development will be very important. If evidence from other countries is something to go by Thailand faces the imminent risk of tumbling down into the sub 1.5 TFR region which essentially constitutes something of a fertility trap. I strongly advise policy makers and others to strive so that this does not come to pass.
The second challenge which stands before Thailand relates to the whole changing structure of the international economic system and essentially the point that what we considered yesterday to be a distinction between developing and developed countries today is nothing but another anachronism ready for the big historical bin. In short, which strategy should Thailand deploy in an environment where liquidity is aflush and where the global search for yield is on? There is no straightforward question to this answer and in particular when we are talking about Thailand you cannot but expect that the old 'once bitten twice shy' dictum to be high on agenda. However, as I have also tried to argue above the times have changed immensely from 1997 and now Thailand is busy keeping money from pouring instead of pouring out. Consequently, it was only back in the beginning of December that we learned how authorities in Thailand were considering lifting capital control following today's elections (23rd of December). This then trickled down onto the jungle drums where echoes of double digit % Bhat appreciation were flying all over the place. Indeed, the Bhat has been on an upwards path as of late against the USD and now as the new government readies itself to take office we shall see what happens.
However, what would my view be on this then? Well, I certainly don't want to come off as being complacent towards allowing money to come in too quickly since when this happens there is always the risk that those very same funds may leave just as swiftly again. Nobody would know this better than those interested in Thailand's economy. However, perhaps we should also take heart of the fact, and as Edward so eloquently emphasised in the context of India recently, that the sands and seeds of time cannot be made to run backwards. At the end of the day you could then ask the most prominent question of whether in fact Thailand has a choice or not? Of course it does, Thailand like India, Brazil, and Turkey cannot just with a simple stroke of a magic wand absorb the procedes of a full scale of re-balancing/re-coupling of the global train. However, trying to stem the tide by building barriers is not likely to do any good either.
Conclusively, I want to finish off by adding that I see a whole lot of potential for Thailand's economy going forward. It is going to be a bumpy ride for sure and wills and wit will be tested but so it is with history and the future. Both of them are very much with us in the present. The last thing I would like to emphasise is the danger that Thailand follows the path of China not, of course, with the one-child policy per se but rather with respect to the path of growth where I clearly see an important link between the two; demographics and growth path that is. Export dependancy it seems, and not as per usual like all good things, will come to those who wait. Let that be a subtle reminder for Thailand as the country equips itself for a new year with new challenges.
The demographic transition is - in simple language - a movement upwards in population median ages. Societies (one after another) move steadily from being high fertility, low life expectancy, low median age ones (think Niger, or Mali, or Uganda right now), to low fertility, high life expectancy, high median age ones (think Germany, Japan and Italy) in a more or less steady and ongoing fashion. We know of course what the starting point of this transition is (the above mentioned high fertility societies have a median age in the 17/18 range) but we don't know where the end point is, since while Germany, Japan and Italy currently have a median age of 43 things clearly are not set to stop at this point, and we won't really know what the ceiling is in this process till we reach it. So on this count we have to watch and wait. But observing the evolution of these three "elderly" societies we can identify some of the processes which are at work as population median ages rise, so while we are waiting for the final readout there is still plenty of work to be done - in terms of policy measures to be adopted - in the meantime. Thailand is one of those fortunate countries who, having arrived on the developing economy scene rather later than others, can learn somewhat from those who have gone before. If she is ready willing and able to listen that is.
Now Claus and I do put quite a lot of store by the median age reading of a society, and we do this for all sorts of reasons. Basically median ages serve as a very convenient proxy for all kinds of economically important phenomena like saving and borrowing, fixed capital formation, construction activity and export dependence, productivity, and ultimately labour and consumer supply.
The movement up through the various median age levels involves a constant change in population structure, and at one point these changes are very favourable to economic development. These positive changes provide the background to what is known as the demographic dividend process. At the end of the day the transition from being a very low median age to being a very high one involves a shift in the dependent population, from having a very high proportion of young dependent population to having a very high proportion of elderly dependent. In the middle lie the most favourable years, which come in two stages. In the first stage there is simply an increase in the volume of people available for the transition to work in an expanding market economy. This could be thought of as the accumulation of inputs phase - during which time, as we can see in the chart below, the rate of population inctrease continues to be large - and at this point a societies ability to incorporate ever more people into relatively low-value economic activities at a rapid rate produces a growth spurt - like the one we are seeing now in many of the emerging economies. This is why, for example, Thailand can easily contemplate annual growth rates of 7 or 8 percent at this point without setting off the inflation alarms, something which, unfortunately, is not possible in Eastern Europe.
But the dividend doesn't end just when the steady downward movement in fertility starts to make itself felt by reducing the inflow of young workers at the labour market entry point, since there is a second dividend phase were the accumulation of quantity is followed by the accumulation of quality, and this is made possible by the steadily growing share of workers in the 25 to 50 age group, and by the rising human capital quality of the new young labour market entrants. This is when you could expect a productivity driven "TFP revolution" and a steady shift through the value sectors towards the more productive and higher value ones.
Of course there is nothing automatic about any of this, demography just provides an environment, then it is down to policy to benefit from or fritter the potential which exists.
Thailand at this precise point in time is, as Claus indicates, at the crossroads. Labour supply means it is possible to obtain quite strong GDP growth simply by increasing employment, without necessarily achieving large scale productivity gains. But Thailand now needs to move on to the second stage, and rapidly so, since the low fertility environment means that this flow of labour is steadily going to dry up (of course migration from Malaysia and Myanmar can help offset this to some extent) and that growth will now need to become more productivity "intensive" if living standards are to continue to rise.
Why is this such an important moment. Well let's look at Thailand's median age.
As we can see, Thailand's median age has been rising quite rapidly since 1990. It is now in the early 30s - which is definitely a very favourable point - but by 2020 (according to the UN median forecast) it can have risen to 37. And this estimate is very likely rather conservative, since it anticipates a rebound in fertility from the current, below replacement level, of 1.6 TFR.
This forecast may well be overly optimistic when you think of what has happened in other developed Asian societies like Japan, Singapore, South Korea, Hong Kong, Taiwan, where fertility has fallen to the 1.2-1.3 range (and of China, where things may well be heading rapidly in this direction). Increasing education among women and rising living standards may well lead to increasing birth postponement (women having children at later ages) and we already have extensive evidence of the impact of this process on the TFR readout over extended periods of time.
Also life expectancy has been rising, and may well continue to rise more rapidly than the median forecast anticipates.
What all of this means is that if the upside risk to the Thai median age forecast turns out to be the case, then Thai median age could easily be brushing up against the watershed median age of 40 by the time we get to 2020. This age is important, since it seems to mark the frontier between an internal consumption driven society to an export dependent one. If Thailand hasn't made the leap from being a developing to a developed economy by this point her future could become very complicated. So the years to come are critical, which is why we are speaking of "crossroads".
Nowhere is this situation clearer than in the evolution of the 15 to 19 age group (see chart below). Thailand has a "loval peak" in this population around 2012. So during the next few years there will be a growing number of young people entering the labour market. So this is a very good time to get the labour intensive part of the development operation done. Post 2012 Thailand can move progressively towards greater dependence on productivity and TFP (if all goes well that is).
Fortunately, as I indicate in this post on India here, the global environment is likely to be very favourable. In addition Thailand's more recent and measured entry into the low fertility club (unlike, for example, Eastern Europe) means that she is capable (as Claus noted) to run quite rapid growth rates without hitting the solid wall of substantial wage inflation. So she has the wind behind her. Much more than she did in 1998. If we just briefly look at the chart for gross fixed capital formation for a moment.
Now it is very easy to see the massive distortion in investment which took place during the boom of the mid 1990s, how the correction was more or less inevitable, and how Thai Gross Fixed Capital Formation is now on a much lower and more sustainable level. So to some extent the "correction" worked. Also it should be noted that in the mid 1990s Thai median age was somewhere in the mid 20s (like Venezuela, or Ecuador right now, and these are hardly shining examples of political and economic stability). So Thailand was the victim of the Asian financial markets telling themselves the wrong story. Ideas and perpsectives do matter, since they serve to orient behaviour and expectations (those famous compasses and charts that Claus goes on about). Our apparent obsession with median ages isn't simply an obsession, and it isn't all rigmarole and obfuscation, it is part of a search for the "grail" of growth theory, then underlying mechanism.
Finally, just to illustrate what we are talking about, I present my habitual "exhibit A", Thailands population pyramids. These show the age structure transition which is taking place before our eyes clearly enough I think.
OK, that's it. Have a nice xmas everyone, and good luck Thailand, you will need it.
Here are some links to economic literature on the demographic dividend.
The Economics of Demographics, special issue of the IMF's Finance and Development Magazine, September 2006.
Especially Booms Busts and Echoes, by David E. Bloom and David Canning
Bloom, David E., and David Canning, 2004, "Global Demographic Change: Dimensions and Economic Significance," in Global Demographic Change: Economic Impacts and Policy Challenges, proceedings of a symposium, sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 26–28, pp. 9–56.
Lee, Ronald, 2003, "The Demographic Transition: Three Centuries of Fundamental Change," Journal of Economic Perspectives, Vol. 17 (Fall), pp. 167–90.
National Research Council, 1986, Population Growth and Economic Development: Policy Questions (Washington: National Academies Press).
Bloom, David E., David Canning, and Bryan Graham, 2003, "Longevity and Life-Cycle Savings," Scandinavian Journal of Economics 105, pp. 319–38.
Bloom, David E., David Canning, and Pia Malaney, 2000, "Demographic Change and Economic Growth in Asia," Population and Development Review, 26, pp. 257–90
Bloom, David E., David Canning, and Jaypee Sevilla, 2002, The Demographic Dividend: A New Perspective on the Economic Consequences of Population Change (Santa Monica, California: RAND).
Bloom, David E., and Jeffrey G. Williamson, 1998, "Demographic Transitions and Economic Miracles in Emerging Asia," World Bank Economic Review, 12, pp. 419–56.
Mason, Andrew, 2001, Population Change and Economic Development in East Asia: Challenges Met, Opportunities Seized (California: Stanford University Press).
Mason, Andrew, 2005, Demographic Dividends: The Past, the Present, and the Future, Working Paper, Department of Economics, Population Studies Program, University of Hawaii at Manoa
Saturday, December 22, 2007
As he says, in a post whose title I have ironically cited in this one:
The rupee's rise may be less dramatic than that of the Philippine peso, Brazilian real or Turkish lira. But it is uncomfortable nonetheless.Quite so, just like a strong vindaloo without the obligatory mango lassi as accompaniment it a rising currency produces its own kind of dispeptic discomfort. But hold on a second, mightn't a rising currency in India actually be good news, and in any event inevitable. Nothing it seems is ever good news where India is concerned for our valiant correspondant, and everything needs to be tinged with it's due dose of schadenfreund.
So what then is all the fuss about? Well the rupee certainly is rising. Here is a chart showing how it has risen vis-a-vis the US dollar over the last 2 years.
As the Economist India corresponent points out, India's currency has strengthened by about 15% against the dollar in the last year alone, and by over 10%, on an inflation-adjusted, trade-weighted basis, since August 2006. And why is this. Again our correspondent is pretty much to the point:
This vigour is due to a strong inflow of foreign capital, some of it enticed by India's promise, the rest disillusioned by the rich world's financial troubles. The net inflow amounted to almost $45 billion in the year to March, compared with $23.4 billion a year earlier.
Although I can't for the life of me understand why the latest data he has is from back in March. Can't this guy ever do a professional job? Data up to the start of December is readily available here, and fascinating reading it is, as you can see it in the chart below.
As we can see, while the net inflow of external funds in the year to March - as proxied by the level of foreign exchange reserves held at the Reserve Bank of India -was $45 billion, the net inflow between 31st March 2007 and the start of December has been $74.4 billion, or not that far from double the whole amount that entered in whole fiscal 2007/2008 in just 9 months (and $41 billion of this since 15 August). This is, of course staggering, but unfortunately, it seems, you aren't going to read about just how staggering it is in the pages of the Economist since over there we are still looking at last years data (the last time I cricised them they said I was cross, this time I am angry aren't I, does it show?). As can be seen directly from the chart, the money really started to flow in from mid-September and the very fast rate of inflow continued till mid November.
Now the locus classicus on all this is certainly Morgan Stanley's Chetan Ahya, really it was this post of his which alerted me to the extent and significance of what was happening.
Over the seven weeks ending November 2, 2007, India’s foreign exchange reserves have increased by US$34 billion (annualized inflow of US$250 billion). Indeed, the trailing 12-month sum of FX reserves has increased to US$100 billion. This compares with the average annual increase of US$38 billion over three years prior to these seven weeks. With the current account still in deficit, the increase in reserves is being driven largely by a spike in capital inflows and to a very small extent because of conversion of non-dollar reserves into dollars. During the last seven weeks in which FX reserves have shot up, we believe that capital inflows would have been US$35 billion. Out of this, not more than 10% has been on account of FDI inflows. Non-FDI inflows including portfolio equity and external debt inflows form a major part of these inflows.
While the inflows are pouring in at the annualized run rate of US$250 billion, in our view, currently the country can absorb only about US$40-50 billion of capital inflows annually without causing any concern on attended risks of overheating. The key question policy makers are grappling with is how to manage these large capital inflows. As the strong growth in domestic demand has resulted in overheating of the economy recently, the central bank does not want to leave such large capital inflows fueling the domestic liquidity. Not surprisingly, the central bank has accelerated the pace of the sterilization by way of issuance of market stabilization scheme (MSS) bonds and an increase in the cash reserve ratio (CRR). Over the last 12 months, the RBI has sterilized about 58% of the foreign inflows. The sterilized liquidity (excess liquidity) stock including reverse repo less repo balances, MSS bonds, government balances with the RBI and the increase in the cash reserve ratio has shot up to US$77 billion as of end-October 2007 from US$19 as of end-October 2006.
Now while the issue of whether or not India is overheating raises its head again here, the context is quite different, and it is clear that the Reserve Bank of India is now struggling with the problems that may arise in the wake of such a massive influx, especially if it continues, as it may well do if the problems in the developed economies experience in 2008 turn out to be greater than may appear to be the case at present, and again if not all the emerging economies are as sound as they appear to be. Also, India is hardly to blame for this state of affairs, since the money is leaving one place (the developed economies following the sub-prime bust, rather than intentionally going somewhere. It is just that, amongst all that growing risk you can see out there, India looks to be as good a safe haven as you can find these days.
But this is not the moment to take all this into those still uncharted waters. If you want to read more on this aspect of things, then I cannot recommend a better source than Claus Vistesen's Compass and Charts Needed. For my part, I think all I want to register here is that something profound and important is taking place, and not simply a tepid repeat of events we have seen all to often in the past. Starting from this recognition, let the debate as to where we go next, and what to do about it, commence!
Thursday, December 20, 2007
Surging food and fuel costs and a record $238 billion surplus in the first 11 months have prompted the government to name inflation and overheating as the biggest threats to growth. U.S. Treasury Secretary Henry Paulson is in Beijing to press for yuan gains that would narrow the trade gap and staunch the flow of money into the world's fastest-growing major economy.
The yuan gained by the most in a month against the dollar. The currency, which has climbed 12 percent since a fixed exchange rate was scrapped in July 2005, rose 0.22 percent to 7.3792 per dollar as of 4:46 p.m. in Shanghai from 7.3952 late yesterday. It touched 7.3770, the highest since the end of the dollar link.
The People's Bank of China last week ordered lenders to set aside 14.5 percent of deposits as reserves, up from 13.5 percent. China's one-year lending rate is at a nine-year high of 7.29 percent after five increases this year.
The trade surplus climbed 14.7 percent to $26.3 billion in November from a year earlier, the third-biggest monthly total, the customs bureau said today. The $15.2 billion trade surplus with the U.S. pushed the 11-month total with that country to $149.2 billion.
China's money-supply growth exceeded the central bank's annual target for a 10th straight month as a ballooning trade surplus pumped cash into the world's fastest- growing major economy.
M2, the broadest measure of money supply, rose 18.5 percent to 40 trillion yuan ($5.4 trillion) in November from a year earlier, the People's Bank of China said today on its Web site.
Wednesday, December 19, 2007
Here I just want to repost part of a reply I gave to the Economist when they had the kindness to try to answer some points I had raised about the general quality of their economic coverage, and about what I take to be their obsession with ignoring the demographic component in economic growth. For the Economist, it seems, growth and development is a single issue item, and is all about insitutions, and institutional quality. Which makes it kind of funny that Argentina, which must be among the worst of the emerging economy pack in institutional quality is still powering away, despite more or less openly manipulating the economic data.
Obviously institutions matter, but so does demography. This is not a one horse race, or if you prefer, this particular horse doesn't only run on one leg.
The topic in question here is India's potential growth rate. Recent GDP performance at just under 9% must have been astounding many of India's critics, especially given the way inflation, despite all that growth, has been kept pretty much under control.
Wholesale price inflation has been preforming even better:
So to go to the start of our story, back in September 2006, I post a piece on the India Economy Blog entitled "Uncharted Water" where I argued precisely the following:
What is clear is that the Indian economy is currently gathering steam,
and this at a time when there is a general consensus that the political will for
reform isn’t what it used to be. Strange isn’t it?
My meaning here isn’t that reforms aren’t necessary, but that there are other
factors at work, and in particular demographic ones. The importance of these
demographic factors generally can be seen from the fact that it is now the newly
developing countries (China, India, Brazil, Chile, Thailand, Turkey) who are
pulling the global economy (and in the process pushing up energy and commodity
prices). The developed world - which makes up say 50% of global GDP is growing
much more slowly than the developing world - and some of this for ageing related
demographic reasons. Global GDP is forecast to grow at a 5% annual rate this
year, yet the US is growing at around 3.5%, Japan 2.5% and the eurozone around
2%. So you tell me, who is pulling who here?
And this is why I say we are moving into uncharted territory. Economists
used to have a little model which worked on the assumption of each economy
having a certain growth capacity in any given moment. But could any one tell me,
what *is* the growth capacity of China or India? I certainly have no idea, and I
haven’t seen anyone else make a convincing case on this topic. The magnitude of
the growth we are now seeing in the developing world is beyond all historical
Doesn't look to bad at all does it, in the light of what has been happening during the second half of this year. And remember this was written in the Autumn of 2006, not Autumn 2007 when just about everyone and their auntie is saying something like this. Of course this whole debate is ongoing. Nandan Desai had an excellent piece on IEB which put things pretty much in perspective and in October 2006 I had another piece in the IEB, basically in response to the Sizzling India article in the Economist. I said this:
I am even brazen enough to believe that trend growth may well
have moved up beyond 8.5% going forward, and that indeed within 5 years we may
well see India overtaking China in terms of average quarterly growth rates (of
course this may well vary from one quarter to another, a phenomenon known as
volatility, and of course 5 years from now the Chinese economy may not still be
sustaining the very high growth rates we see today).
Again, I am really comfortable standing by this, and even the point about China, since the inflation problem really does seem now to be getting a grip (remember they have had nearly 30 years now of the one child per family policy, and at some point soon their labour market is going to tighten and tighten, for what may well happen next see my recent article on the growing problem we now have in Russia: "Russian Inflation, Too Much Money Chasing Too Few People" (not too much danger of this getting to be a problem in India in the near future, now is there?).
Since this time of course, the whole recoupling/decoupling issue has really taken off as a live debate. My latest thoughts on this can be found here, and Claus Vistesen's post - The Global Economy, Compass and Charts Needed - follows up on and continues the "uncharted waters" theme.
Now for the Economist. What I said in my response to them was as follows:
To The Economist
Well, at the risk of having to assume some kind of modern "j'accuse" mantle (for which of course there are ample precedents in the early origins of your own magazine) I am going to put up yet another comment. Maybe this is because I would like to participate in that "severe contest between intelligence, which presses forward, and an unworthy, timid ignorance obstructing our progress" which your contents page so boldly announces.
Maybe it is also because I want to pin down quite clearly for future reference just what the issues are, and just why it isn't "absurd" to suggest that the Economist currently systematically fails to factor-in the demographic components in economic growth (or the lack of it). Well, saving the best (or should that be the worst) to the last, I would like now to come to the case of your India correspondent. This gentleman (and I sincerely hope that despite his evident predilection for strong Vindaloo curry he is one of these) has been systematically re-adjusting upwards India's potential trend growth rate in recent months. In fact his estimate seems to have shot up from 6.5% in November 2006 to 7% in February 2007, to 8% in June 2007. Now that's an upward adjustment of around 25% in trend growth in roughly 8 months. Quite an achievement, especially since he offers absolutely no explanation whatever for these adjustments, but what he does not fail to tell us - oh, he never lets a moment rest without beating this drum - is that: "India's economy, like Delhi this week (or Vindaloo curry perhaps, EH), remains far too hot."
Now just in case what I am suggesting here is questioned I would like to quote chapter and verse, since the issue is an important one.
In November 2006 the Economist's India correspondent estimated capacited growth for India at around 6.5%.
23 November 2006 Too Hot To Handle
INDIA'S curries can be even hotter than the fieriest of Chinese hotpots; likewise the temperature of the two economies. Despite widespread claims that China's economy is overheating, actually India's shows more signs of boiling over.By February 2007 the estimate had risen to "not much above" 7%.
In the year to the second quarter, India's GDP grew by an impressive 8.9%, while China's more up-to-date figures show even more breathtaking growth of 10.4% in the year to the third quarter. But to judge whether an economy is too hot, one needs to compare this expansion in actual demand with potential supply, ie, the sustainable rate of growth. Despite India's growth spurt in recent years, its sustainable pace is still much lower than China's, which puts its economy more at risk of overheating and rising inflation.
India's trend growth rate has almost certainly increased but it is still
nowhere near as high as China's. Mr Prior-Wandesforde estimates that it is now
around 6.5%, up from 5% in the late 1980s. But India's recent acceleration
largely reflects a cyclical boom, thanks to loose monetary and fiscal policy.
The Reserve Bank of India has raised one of its key interest rates by one and a
half percentage points to 6% over the past two years, but inflation has risen by
more, so real interest rates have fallen and are historically low. This makes
the economy more vulnerable to a hard landing.
1st February 2007 India overheats
"But the problem is that this new speed limit is almost certainly lower than the government's one. Historic data would suggest a figure not much above 7% - well below China's 9-10%......If something is not done, then a hard landing will
and by June 2007 it had been revised up nearer to 8%.
June 7th 2007 Waiting For The Monsoon
"This is not to deny that India's economic speed limit has increased, to perhaps 7-8%, thanks to stronger investment and economic reforms. But growth has
exceeded that limit. The economy still shows alarming symptoms of overheating"
And depispite all this, we are now in December 2007, the Indian economy has been growing at around 9% for the last three quarters, and inflation has been kept remarkably under control.
So actually what we are all really waiting for here is not the arrival of the monsoon, but some explanation from the Economist's India correspondent about how he is calibrating all these estimates. There is nothing particularly to be embarassed about in getting this one wrong, since it is pretty difficult to put a number on where Indian growth is going, but it does seem hard to maintain the credibility of your calls if you conveniently keep ignoring what you were saying only yesterday, and more importantly fail to diagnose exactly why it is that India has been able to grow so much faster than you expected. And of course one day India may overheat, and stopped clocks do give the right time twice a day, but this doesn't make them especially useful measuring instruments.
Back in the autumn of 2006, on the India Economy Blog, I argued that we were now entering "uncharted waters" and that no-one really had any accurate idea of what India's true mid-term trend growth rate actually was. I also asserted that it was in all probability way above the more conservative and conventional estimates. I was guessing really, but behind my guesswork was a long hard look at India's underlying demography, and it is just this kind of approach that your India correspondent discounts. Again, chapter and verse:
1st February 2007 India On Fire
Many Indian economic commentators say that further structural reforms, though desirable, are not essential to keep the economy growing at 8% or more because
of the "demographic dividend". A fast-growing working population and a falling
dependency rate (thanks to a lower birth rate) will ensure more workers, more
saving and hence more investment." "India's demographic structure is indeed
starting to look more like that in East Asia when its growth took off. But this
mechanistic view of growth assumes that demography is destiny and that economic
policies do not matter. In fact, open markets, education and investment,
especially in infrastructure, were the three chief ingredients of East Asia's
success. Population growth by itself does not add to prosperity, unless young
people are educated and new jobs are created. India needs to reform its absurdly
restrictive labour laws which hold back the expansion of manufacturing
Basically I find myself in agreement with the Indian economists he doesn't like. It isn't that these reforms aren't desireable, as he admits, we all agree on this. But the point is, even ex-reforms (and of course there have been reforms and global opening) demographic momentum would indicate that substantial growth is now going to occur. How substantial? Hard to say, but I think it is quite probable that 5 years from now India will be growing faster than China, and may even peak out at the highest annual growth rates yet seen for a significant economy over the 5 to 10 year window. I can justify why I think this with some sort of coherent argument if anyone wants. I think the big danger for the sort of view you are advancing here at the Economist is that you imagine virtually nothing is possible with institutional reform, and this is just as big a mistake as saying demography is everything. You need to systematically take the two components into account. If you don't do this you risk getting into the ridiculous position the World Bank found itself in this week, when countries like Argentina and Thailand complained that since their countries were registered as going backwards on the global governance index, while both countries were growing quite nicely, then logically the methodology used to construct the index must be wrong. IMHO the World Bank has been totally mechanistic about institutions and thoroughly deserves all the problems it creates for itself on this count. OK, so that's it. I finally rest my case. The dialogue will continue.
And it is, undaunted by the failure of all that vindaloo curry to overheat more than his own digestive tracts our dear correspondent is now worrying about, guess what, the rise of the rupee. Continued in this post here.
Wednesday, December 12, 2007
During 2007, myself and especially Feldman and Takehiro Sato from Morgan Stanley have tended to move pretty much in unison when it comes to the economic analysis on Japan (non colluding!). Of course, this is very much due to the fact that I always make sure to read, at least, what the MS' Japan analysts have to say before saying anything myself on Japan. In this way, it is one thing to actually follow other analysts whereas an entirely different thing is to agree with them. However, it just so happens that I have largely agreed with the way Sato in particular covering the day-to-day analysis and Feldman have narrated the Japanese economy in 2007. This time around however it seems that Morgan Stanley might just be trailing me and my colleagues at JEW a little bit. At least, the following sounds very much as the tone which has been banging from the pages of Alpha.Sources' Japan pages as well as of course Japan.Economy.Watch' (JEW link above) day-to-day coverage and analysis for some time now.
Japan's economy is headed for a ``mild recession'' that could be worsened should a bigger-than- expected U.S. slowdown halt the nation's export-led expansion, Morgan Stanley said.
``It's time to buckle up,'' Takehiro Sato, chief Japan economist at the investment bank, said in a report yesterday. Sato cut next year's growth estimate for Japan in half, saying ``errant'' government policy has hurt consumers and the building industry at home, and credit problems stemming from the subprime- mortgage crisis will stifle demand from abroad. The world's second-largest economy is becoming more dependent on overseas markets just as world growth looks set to slow. Policies meant to protect homeowners from building fraud and borrowers from predatory lenders have hurt an economy that's already struggling with falling wages and record gas prices. ``The foreign-demand growth scenario for Japan's economy appears to be approaching a tipping point,'' Sato said. ``Coming on top of high energy prices, the fallout from the subprime crisis and errant policies will likely cause economic activity to stagnate.'' Sato slashed his 2008 growth estimate to 0.9 percent from 1.9 percent a month ago. He considers growth of less than 1 percent ``for an extended period,'' to constitute a ``mild recession.''
Of course, you would be well entitled at this point to ask just what this idea of a mild recession actually means. According to Sato it is defined by growth in the sub 1 % category for an extended period as you can confirm above. The question would then seem to be whether in fact not Japan might be heading for negative growth rates too? Difficult to say but the risk is definitely there I think. Also, I really want to warn against the discourse which is emerging about all this being the result of errant government policy. Institutions matter for sure but Japan's economy is faced with a far more potent driving force in its population structure and the last thing we need here is really that this is neglected while politicians are taking the heat even if those very same have not exactly put in a stellar performance. The thing is, people need to get their economic reasoning straight. Back in the beginning of 2006 and as we moved onwards from the ending of ZIRP in Japan myself and my colleague Edward Hugh were literally amazed to how the majority of the economic punditry came out exclaiming that now Japan was back amongst the leaders to paraphrase the FT's otherwise excellent Martin Wolf. And now suddenly it is the blame the politicians for the fact that it did not came to pass and not by a long-shot too. Something does not smell right here and I would be very discomforted to see if all this shored up yet again on the shoulders' of the 'institutions matter' paradigm since can these shoulders really take on more load as it is? You know, there is another side to this story too and far from being mutually exclusive we need both of them; institutions, policy and governance ... oh yes and demographics? Yes please!
Ok, sorry to be a rant here in the month of Christmas but I do feel rather strongly about this I am afraid.
Sunday, November 4, 2007
[This is a big one and if you are not in the mood I recommend that you just skip down to my summary which should give you the main thrust of my argument and analysis. This note also features over at my personal weblog Alpha.Sources.]
I would imagine that the answer to the question above remains quite at the forefront of many an investor's and economic analyst's mind. In this entry I will try to most modestly give interpretation of the road which lies immediately ahead for Japan's economy as we are about to receive Q3 GDP numbers on the 13th November. As per usual I am basing my analysis on the firmly established principle of standing on the shoulders of giants as well as I will field my traditional array of monthly charts updating the evolution of prices and household spending. Moreover, I will also, in the light of comments received outside the walls of the JEW and Alpha.Sources as well as the general interest in the subject, give my interpretation of where the Yen is going to be positioned in the months and quarters to come. Lastly, I will note the rather large and ugly downside which has emerged in the realm of the housing market and residential investment since this might just be the push which shoves Japan into a near recession path as we get to Q4 2007. I will finish off with a summary including remarks on the future course of policy at the BOJ as well as some brief comments on what seems to be clear signs of reform fatigue in Japan as well as the potential of uncertain times at the BOJ with respect to governance.
As you will see, Edward already has some snippets up (on JEW) on September exports, industrial production, and retail sales as well as the labour market. If we take a brief look at what these data releases have to say we can see that the outlook is steadily beginning to look ever so wobbly for Japan although, as I will also show below, household spending seems to be making a most welcome comeback. In terms of the external position we had one of the most negative news points as exports slowed quite significantly. Yet, we must always remember that there are two sides to the trade balance and an offsetting decline in imports helped to keep the trade balance to a record surplus. Yet, this does confirm the general outlook that the external environment just might be cooling off into the rest of 2007 from what has also been a red hot frantic pace. What remains is clearly that since external demand constitutes the main driver for Japan's economy any faltering on this account will translate swiftly into growth rates. On industrial production the picture is still somewhat clouded by the earthquake a few months back and as such the decline in September's IP comes on the back of a surge in August and should really be read accordingly. What should be noted however, as you can also see by the graph Edward fields is that IP still remains high relative to the beginning of the year which suggests that the readings should be taken with a pinch of salt. In this way I would not be surprised to see a further drop in October which would pair the surge seen in August and bring us back to a point below the high levels of Q4 2006. Finally, on retail sales Edward reported that they managed to push up a small 0.5% increase y-o-y thus showing some very welcome numbers outside the red for the first time in 2007. Yet, two things need to be remembered here. Firstly, as Edward notes there is a low base effect here since sales in September 2006 were comparatively low; this will become even clearer below. Secondly, the m-o-m evolution showed that retail sales extended a four month decline which goes to show the dynamics restricted on 2007.
Thus enlightened on what has already been noted at JEW why don't we move on to the new stuff. In tradition with my previous notes let us begin with the evolution of prices. Before I show you the chart we should dispense with the non-event that the BOJ chose to hold rates steady the day before yesterday. The statement from the BOJ as well as the recently published Outlook Report (Takehiro Sato has a round-up over at MS' GEF) did not really reveal much as to where we are going in terms of a rate outlook but did explicitly and quite as expected cite the global economic trend in credit markets as a source of uncertainty. In reality, a recent small but concise article from The Economist pretty much sums up the situation in its title sentence; The Bank of Japan would like to raise interest rates, the economy won't let it. And one of the obvious reasons can be seen below ...
As can readily be observed Japan remains mired in deflation with all three indices tugged firmly in negative territory. Regarding the officially deployed price index (core CPI) which is the CPI excluding fresh food (green line) we can see that this is virtually flat at -0.1%. In this respect, do also note that you, my dear reader, are getting a special treat here at Alpha.Sources (and JEW) with the inclusion of the index stripped of energy and fresh food. In this way we should be especially focused on this measure in the light of the fact that oil and gas are trading at very high levels at the moment. This of course does not mean that this can be used to anything as regards to economic/financial position making but it does go to show the 'real' price dynamics in Japan in the sense that it tends to be biased toward the effects of internal demand and activity in Japan. In general and on the probability of a positive yearly inflation reading in 2007 this has been somewhat of a mute point and as such a virtual improbability since the figures for the summer months came in. Regarding the official forecast, the just published Outlook Report sliced the previous F3/2008 forecast from 0.4% as it was made in April to 0.0%. If you are in to the more arcane matters of inflation forecasting the Outlook Report also fields projections for inflation readings in 2009 based on estimates of the output gap. Morgan Stanley's Takehiro Sato also ventures the official in house projections from the US investment bank. The bottom line seems to be that we are going to see a 0.4% inflation rate by F3/2009. In my honest opinion, I believe that such forecasts are complete word salad since no-one can say what will happen during 2008 let alone as far ahead as 2009, yet this is the forecasts as they are and we should keep them in mind. On balance, I don't see Japan escaping deflation anytime soon and this most emphatically goes if we home in on the core-of-core index (i.e. excluding fresh food and energy). An upside to this call would a be a pass through of high energy and base commodity prices but so far such effects have been muted, the anecdotal evidence on Tokyo's mayonnaise prices notwithstanding.
If we move on to indicators for domestic demand (living expenditures) the figures noted above on retail sales promise to bring some good news relative to what we are accustomed to in this area. Below I field the traditional three charts; one of the bread-and-butter y-o-y figure reported by the media, one of the seasonally adjusted m-o-m evolution, and finally a real monthly index (100=2005) to give the big picture.
If we look initially at the first figure which displays the headline number from the official statistical sources we note that the last two months have shot up significantly (although commentators seem to be attributing this to the illusive 'weather' effect). More importantly however, at this point we need to go back and consider what Edward said about a low base effect regarding the retail sales. In this way, the September reading on living expenditure has 'low base effect' written all over it but nevertheless we should not deny that it was an overall positive reading which as I said is most welcome reading. If we turn to the m-o-m figures however which are furthermore seasonally adjusted we indeed note a positive reading which extends a two month consecutive positive reading after three negative readings. Also do note that the recent two months' positive readings are below 1% which should not be interpreted as bad in itself but merely a reflection of the relative measures here. Finally, we need the big picture I think to finish off and in this way we can see that the long term index edged up but is still below the levels of Q4 2006 and the first months of 2007. As a very final data point Ken Worsley also informed us that auto sales rose in October by 2.0% which is the first gain in a very long time. In summary, on domestic demand and although the figures above form a clear basis for, at least a slight, optimistic sentiment household spending in Japan is still, by all measures, sluggish. The point is quite clearly that given the nature of Japan's demographic profile we are unlikely to see domestic demand be the main driver of growth which is then to say that on the margin the Japananese GDP account is not going to be carried by households spending. Regarding actual forecasts I put forward the notion a while back that I didn't think the official and widely reported figure for living expenditures would exceed 1% on a y-o-y basis. So far we are looking at a rolling average of 0.92% which of course includes the last two months' rather above par performance. I am consequently sticking to my prediction.
Before moving on to an analysis of the Yen and where it might be heading I want to touch upon another aspect which is weighing significantly on the short and medium term outlook in Japan. Normally and even though global financial and economic analysis has been littered with accounts struggling housing market practically everywhere we have not been hearing a lot about housing in Japan. Of course, we have had steady reports about a bubble in office building prices in downtown Tokyo but that of course masks a much more diversified picture; The Economist linked above marks it down well ...
Although land prices appear to be booming, prices nationwide are falling once sales in Japan's three biggest cities are stripped out.
More generally we need to understand that the housing market and construction in general have not been the driver of the recent 'expansion' in Japan as it has been the case in many other countries; at least not directly although in many ways the issues are interlinked here since the global housing boom has permitted many countries to really wamp up consumer spending which in turn has benefited Japan's export sector and corporate sector in general. The lack of housing dynamic in Japan may be due to various institutional factors but most prominently I think is quite simply the prolonged path which Japan has taken in the demographic transition. These structural points notwithstanding it was recent changes in regulations concerning and essentially delaying housing starts which suddenly made all kinds of skeletons come rattling out of the closet as Housing starts plummeted 43 percent in August; Quote Bloomberg.
Japan's worst housing slump in four decades and rising oil prices threaten growth in the world's second-largest economy, Cabinet ministers said.
``There is concern that a decline in housing investment will become a factor pushing down gross domestic product,'' Economic and Fiscal Policy Minister Hiroko Ota said in Tokyo today. ``I'm more focused on the downside risks to the economy.''
Housing starts fell 44 percent in September and 43.3 percent in August because of stricter rules for obtaining building permits. The government this week said it would relax the regulations after industry criticism that they were too onerous.
This of course looks pretty bad at face value. In order to substantiate this further and as a service to you my dear reader I am featuring below some comments from a Japan mailing forum which I am lucky to be a member of and which contains a lot of very smart observers of Japan and essentially 'people' on the ground. I cannot divulge the name of the commenter but this should matter little in this context ...
Some worse news is hidden in these figures: housing starts on condominiums have fallen 74.8% and even worse, starts on condominiums in the Tokyo area, the locomotive of Japan's real estate business have fallen 85.9%. As well as the worried voices within the industry itself, such as building materials, other voices have begun to be heard expressing clear worry about the knock on effect of these falling housing starts. Some economists are wondering out loud how much falling condominium sales will effect the sales of automobiles, for instance. Real estate in Tokyo, and to a lesser extent several other big cities such as Nagoya, has been the only spot of joy in a general murky panorama of Japan's internal economy.
As should be pretty clear and although the full extent of this is not known it has basically opened up a virtual abyss of downside regarding Japan's economic performance going forward.
As the final topic in this installment I promised above to also have a look at the Yen; where it is now, what drives it, and most importantly where it is likely to go. Let us begin with a chart to get us started which plots the Yen against the USD, EUR and AUD; remember that the y-axis is denominated in Yen which means that movements up means that Yen depreciates against the target currency.
The first issue which should immediately be noted is the carry trade which is an inbuilt and lingering phenomenon of wide global interest differentials. A lot of things have been said about the Yen carry trade, whether it can continue to keep the Yen subdued and subsequently what will happen if it unwinds? One thing which is important to note here is the distinction between an overall normalization of interest rates in Japan which in itself would effectively flush out carry trading and then the potential for unwinding of carry trades at any given point in time. In this way, it is crucial to understand that even though the structural pre-requisites for (Yen) carry trades are likely to linger you can still get burned! This has perhaps best been substantiated since Spring where the credit market turmoil began and where volatility returned to markets. In this way, the carry trade and thus also the Yen tend to be synonymous with risk taking and as such considerable volatility in the Yen seems de driven by the general risk appetite in the market. In general on the carry trade we should also note that flip side of shorting the Yen where especially the Aussie and Kiwi (NZD) have been all time favorites for Japanese retail investors and others as currencies being 'carried'; the chart above of AUD/YEN substantiates this. The bottom line is that the carry trade still seem to be weighing on the Yen (except it seems against the USD at the moment) albeit with the important qualifier that the recent market turmoil has made gung-ho tactics substantially more hazardous.
The second thing I would like to emphasise is related to the issue of carry trade and concerns the structural decline in Japanese home bias whereby Japanese investors, retail as well as institutional, tend/will tend to move funds into foreign denominated assets which would then tend to hold the Yen down. Now, the argument for the decline in home bias is essentially vested in a long term view and economic analysis but signs of a decline in home bias can also be found in the present. The most enticing evidence comes of course from those notorious Japanese housewives who, equipped with some basic FX trading software, have been hard at work to bet against the Yen and as we have seen especially Kiwis seem to have been a favorite dish. Anecdotal evidence of the housewives seem to have abated somewhat in the recent months but what remains is a trend which indeed should be watched both as regards to retail investors and thus those savvy housewives as well as of course institutional investors such as pension funds and perhaps even a sovereign wealth fund (SWF) if and when it comes.
The last thing I would like to note is something which has emerged on the back of the recent rather violent decline in the USD against almost all currencies and thus also the Yen. In this way and in the context of how external demand and in this way also the US economy is crucial to Japan's growth prospects we must also consider the probability that the authorities in Japan are going to intervene if the Yen drifts up too much. A week ago I voiced this probability noting that anything close to a USD/YEN rate of 100 would bring out the ropes and lassos. Recently, Morgan Stanley's Stephen Jen also put the limit at 100. What is more important however than the limit itself is of course the idea of intervention. More generally, which I will treat in more detail in my summary below the whole structure of the BOJ is entering somewhat of a limbo as we move closer to the time where the current governor Toshihiko Fukui is to be replaced.
The bottom line on the Yen is that structural forces are likely to keep the Yen down. First and foremost is of course the whole inbuilt economic situation which effectively seems to hinder any attempt by the BOJ to raise rates although as well will see below markets are mumbling about a quick December raise. In general, I don't want this to come off as an endorsement of a sure bet on the carry trade and mindless short Yen positions. Especially, the re-emergence of risk aversion would almost surely make such positions (highly leveraged as they usually are) very expensive to keep on the books if the Yen were to shoot up. In line with my promise above and a call on the Yen for the remainder of 2007 I don't see a raise from the BOJ which should serve as a principal indication. Sudden market woes and credit risk sparks notwithstanding an interesting play could be to go for a move of the USD/YEN towards 118-120 from its current level of about 114-115 although of course any talk about Dollar strength at this point and until the end of 2007 and beginning of 2008 seems rather contrarian. As for the EUR/YEN it is trading awfully high at the moment as a result of a Euro on helium and I would really not want to stick my neck out here. If you want more technical advice on FX trading Dailyfx.com is my weapon of choice.
In Summary - Movements at the BOJ and Political Risks?
As I have already ostensibly hinted above I don't see how the BOJ will be able to raise rates in 2007. There are two principal reasons for this. Firstly, deflation is not likely to dissipate and especially not with economic momentum destined to slow down. This then brings me to the second reason which relates to the extent of the economic slowdown which seems certain to be rolling in at this point in time. It is really difficult to say at this point. Industrial production as a leading indicator of corporate capex and activity seems to be holding up as well as household spending has been showing some positive signs lately. Yet, coupled with what seems to be a slowdown in external demand as well as a looming correction in residential investment it seems as if the ground is getting shaky indeed. Moreover, I am uncertain for reasons stated above that domestic demand will remain much of a driver of growth since the momentum measured exclusively on 2007 is one of a down trending path. On industrial production we will just have to wait and see how much downward it has to go on the back of the earthquake rebound in August. The bottom line on the economic side of things seems to indicate that as regards to economic fundamentals the BOJ will find much difficult to wring that 0.5% refi rate upwards. Moreover and to add to the uncertainty, it seems as if the political situation might also be turning somewhat sour.
Consequently and before I sign I want to briefly mention another risk which is emerging and which is contributing to the uncertainty is the general political situation both in terms of domestic policy and also most emphatically within the ranks of the BOJ and thus monetary policy decision making. Concerning the former we need to think back to the ousting of Abe which really put the spotlight on a political life in Japan riddled with scandals and what can only be interpreted as poor and half made decisions. Moreover and very important the sacking of Abe also revealed a public which by and large had lost confidence in the politicians' ability to do something with the issues facing the Japanese society and economy. Of course this is past us at this point with Fukuda entering as new Prime Minister but as Robert Alan Feldman brilliantly puts down in just a few words there is now a significant risk of 'political backsliding' and essentially stalemate. The first point I would like to point out is the paralysis which may emerge as a function of a split majority divided on the two chambers in Japan's bicameral system ...
Policy paralysis risk has already emerged in some areas, such as defense policy. In seeking to force a general election, the opposition party, the Democratic Party of Japan (DPJ), is using all possible methods to pressure the government. A key part of this strategy is to use the power of the Upper House, where the DPJ recently won a majority, to stall appointments of candidates for government posts. Many such appointments require the approval of both houses of the Diet, and so the capture of the Upper House by the DPJ gives that party veto power over appointments.
Yet, much more significant is the stalemate and as Feldman puts it 'the backsliding' as Fukuda sees it appropriate to roll back a lot of the initiatives instigated during Abe's reign.
The biggest policy risk is backsliding. Already, the Fukuda government has reversed course on several important reforms. The new government wants to freeze the legislated increase of medical user charges, continue road tax earmarking, and focus on tax hikes (rather than spending cuts) as the main source of deficit reduction. Moreover, there is persistent talk of a major supplementary budget, in order to pay for policy changes. Once the momentum for a supplementary budget grows, it is very likely that many politicians – who face a general election soon – will opt for more spending.
On top of the current rigid state of domestic policies another slight risk has emerged that the BOJ might end up without a governor come spring time 2008. The reason for this shores up, as Takehiro Sato tries to explain here, on the same political quagmire Feldman refers to above where the Democratic Party of Japan holds a majority in the upper house and Fukuda's Liberal Democratic Party which still controls the lower house (the Diet). Normally and according to Japan's constitution the Diet holds precedent but not in this case as regards to the appointment of the BOJ's executive posts. This has thus created a situation in which the DPJ might use their majority in the Upper House to stall the appointment of new BOJ executives as the current members are up for replacement in the spring. The concrete situation as it may unfold is this;
But if the selection of the next BoJ leaderships is postponed because of a general election, the Bank would inevitably face its own form of political vacuum. It would have to conduct the MPMs in April (8th-9th, 30th) and May (19th-20th) without a sitting Governor or Deputy Governors (i.e., with a six-person board), or under Article 23 it is possible that the Cabinet would extend the terms of the incumbents in the interim.
What this means for the BOJ policy is difficult to say but I tend to agree with Sato that under such conditions anything but an abrupt change in economic fundamentals (one way or other) I would meand that policy changes would/should be suspended. This however opens a new risk in the sense that the current and presiding board at the BOJ might see its December or January meetings as the only possibility to raise for quite some time thus ending/entering the year at 0.75%. The reason for this scenario would seem to be Morgan Stanley's high probability forecast that Q3 GDP numbers due on the 13th of November will show a respectable growth clip. As I have argued above I am somewhat uncertain about this but given the underlying political dynamics I concede that the risk has emerged for a hike to 0.75% in December or January although I am not ready to take it aboard in my general forecast.