Sunday, June 24, 2012

Rampant Liquidity is not the Solution

Central Banks around the world are pumping liquidity in their respective economies to stave off the global economy’s recent softening and to prevent the catastrophic situation which has gazed in the eyes of the world leaders courageously.

To revive the economies around the world the prime banks are trying their best to ease the situation by twisting their operations as done by the Federal Bank of Unites States, Open Market Operations undertaken by the Reserve Bank of India, European Central Bank’s bailout proceedings, monetary easing by the Chinese counterparts or the Swiss and Danes printing money as a means of defending their currency targets, each prime lender to the economy is trying to resurrect its economy deftly.

Will just an injection of liquidity in the crucial sectors create a difference? As far as the last half a decade is concerned, the Quantitative Easings or the Stimuli provided by the governments around the world were just short term solutions. And it is echoed in the global economy that the long term prospect of all the major economies is under the suspect. Take a classic example of India: There has been drought of reforms in the economy since 1990s and this is a major concern in the market. Corporates crave for lower cost of funds and liquidity in the market, which can not only be possible by the OMOs or by unexpected rate cuts but it can only be possible through gigantic reforms which are now a must in the country. Fundamental issues like Foreign Direct Investment in Retail and Aviation has to given a green signal, Infrastructural fast tracking system has to be made robust and the government borrowing finances has to be restructured for giving this economy the required push and to pause the free fall of Indian National Rupee.

Similarly in China the manufacturing growth is plummeting, the PMI data is weak and decline in the global demand is a cause of worry. On the west, Euro Zone survived with the Greece’s elections but the stability of the union is still in doubt. The monetary union don not stand on the fundamentally strong fiscal pillars which is making the survival difficult for the group of countries. And bailouts are not the solutions to the complex issues.

Federal Bank of USA has also extended the Operation Twist (after 2 QEs) till this calendar year end but economy is still growing at a worrisome rate.

All the above mentioned facts highlight the urgency of fiscal consolidation. The government around the world has to take gutsy steps, bring in reforms and infuse positivity in the market to affirm the investors about their safe investments. Even if there are plethoras of more Easings or OMOs planned, the economy won’t stand on its own until the sustainability is assured through prominent reforms. And that is a must now for survival of the global as well as the domestic markets.

Thursday, June 7, 2012

India the Next Greece?

An Italian bank's boss recounts a joke of two hikers picnicking when a bear appears. When one laces up his boots to run, his friend scoffs that he can’t outrun a bear. The shod hiker retorts that it is not the bear he needs to outrun, merely his fellow hiker. “We’re sitting at the picnic with our boots still on,” says the bank boss.

As the ‘Grexit’ scenario looks inevitable, banks and investors have already started taking precautions by pulling out their money from the fragile markets like Portugal, Ireland, Italy, Greece and Spain. Spain and Italy have alone lost foreign bank deposits of about €45 billion and €100 billion respectively from their peaks. On the other hand sales of government bonds by foreigners and capital flight is probably equal to about 10% of GDP in those countries. So the sound of credit crunching can be heard in these countries loud and clear.

Though there are many prominent differences between India and Europe in their economic structures but still there are two apparent similarities with Europe which brings to fore the riskiness of the present volatile economic situation. First is the India’s debt to GDP ratio which has already been unacceptably high, declared by the international financial standards and the soaring Fiscal deficit coupled with the bloated Current Account deficit. And the second similarity lies with the large presence of international investors and creditors which not only increases the volatility but also causes economic instability because the sudden influx and exodus of these investors shocks the economic momentum and leaves it gasping.

Undoubtedly there are external factors which have impacted the domestic economy to a large extent but it should also not be forgotten that the government failed to protect the economy from these shocks through its inaction. Even when confronted with the low growth, the government tends to adopts austerity measures that trap the country in a recession. And this is what happened in Europe and so it can also become a reality for India.

Paul Krugman in his latest article in a leading newspaper describes this situation by saying that the economy is a unit where one’s spending becomes the other’s income and vice-versa. So what happens if everyone simultaneously slashes spending in an attempt to pay down debt? The answer is that everyone’s income falls and it worsens the debt problem.

The way out of this vicious cycle as clarified by economists is to expand the spending and find other alternative way to address inflation or balance of payments difficulties which can only be possible if the government takes on the challenges head on at least now in these dire situations.