Showing posts with label borrowing. Show all posts
Showing posts with label borrowing. Show all posts
Sunday 17 September 2023
Saturday 27 May 2023
Deficits can matter, sometimes
Philip Coggan in The FT
Deficits don’t matter. This quote comes not from some spendthrift European socialist but reputedly from the distinctly conservative Dick Cheney, vice-president of the US from 2001 to 2009.
According to an account by former Treasury secretary Paul O’Neill, in 2002 Cheney cited the Reagan administration as evidence for his thesis; the national debt tripled on the Republican’s watch in the 1980s but the US economy boomed and bond yields fell sharply.
In the 20 years since Cheney’s remark, US federal debt has roughly doubled as a proportion of GDP. But 10-year Treasury bond yields are no higher than they were two decades ago; indeed they have spent much of the intervening period at much lower levels, even as debt has soared. The continuing brouhaha over the US debt ceiling has nothing to do with the willingness of markets to buy American debt; any everything to do with the willingness of politicians to honour their government’s commitments.
However, Cheney’s sentiments have not always been borne out elsewhere. Over the past nine months the British government has discovered the problems that can occur when funding costs suddenly increase. And that has rekindled the debate over the ability of governments to run prolonged deficits.
In one camp are the spiritual descendants of Margaret Thatcher, the former British prime minister who sought to balance budgets, arguing that “good Conservatives always pay their bills”. Modern budget hawks often say that governments should not pass on the burden of debt repayment to the next generation. Many also argue that budget deficits are caused by excessive government spending and that reducing this spending is not only prudent but will fuel economic growth. In the other camp are the majority of economists, who argue that unlike individuals, governments are in effect immortal and can rely on inflation, or future generations, to pay down their debts.
They point out that government debt, as a proportion of gross domestic product, was very high (in both the US and the UK) in the aftermath of the second world war. That debt proved no barrier to rapid economic growth. Furthermore, ageing populations in the developed world mean there has been a “savings glut” as citizens put aside money for their retirements, making it easy to fund deficits.
But the freedom of governments to issue debt comes with a couple of caveats. First, a country must be able to issue debt in its own currency. Many a developing country has discovered the dangers of issuing debt in dollars. If that country is forced to devalue its currency, then the cost of servicing the dollar debt soars. Secondly, countries need a central bank that is willing to support its government by buying its debt. The quantitative easing programmes of such buying has undoubtedly made it easier for governments to run deficits.
In the eurozone crisis of 2010-12, deficits did matter for countries like Greece and Italy. Their bond yields soared as investors feared that the indebted countries might be forced to leave the eurozone. This would have either forced governments to default, or attempt to re-denominate the debt into their local currency. Greece turned to neighbours for help but found that other countries were unwilling to provide required support that unless Athens reined in its budget deficits.
To many Eurosceptics, that proved the folly of joining the single currency. Britain was free of such constraints since it issued debt in its own currency and had a central bank that would undertake QE. Given those freedoms, the financial crisis of last autumn, which followed the mini-Budget proposed by the shortlived Liz Truss administration, was even more of a shock.
While Truss tried to echo Thatcher’s imagery, she rejected the budgetary prudence of the Treasury as “abacus economics”. She argued that slashing taxes would lead to faster economic growth so that the deficit would disappear of its own accord as government revenues rose.
However, the markets did not swallow the argument. The mini-Budget was followed by a spectacular sell-off in sterling and UK government bonds. The latter may have stemmed from the leveraged bets made by British pension funds on bonds. Still, the Truss team’s economic analysis failed to account for this possibility.
Investor confidence in British economic policy had already been dented by the Brexit vote and by the rapid turnover of prime ministers and chancellors. The problem has not gone away. Data released this week showed that Britain was still struggling to contain inflation and gilt yields jumped back towards the levels reached after the mini-Budget.
So Cheney’s aphorism needs amending. Deficits don’t matter if the government borrows in its own currency, and also has a friendly central bank, a steady inflation rate and the confidence of the financial markets. It also requires a continuation of the global savings glut. Those conditions mean there is plenty of scope for future governments to get into trouble.
Sunday 16 April 2023
After the easy money: a giant stress test for the financial system
John Plender in The FT
Five weeks after the collapse of Silicon Valley Bank, there is no consensus on whether the ensuing financial stress in North America and Europe has run its course or is a foretaste of worse to come.
Equally pressing is the question of whether, against the backdrop of still high inflation, central banks in advanced economies will soon row back from monetary tightening and pivot towards easing.
These questions, which are of overwhelming importance for investors, savers and mortgage borrowers, are closely related. For if banks and other financial institutions face liquidity crises when inflation is substantially above the central banks’ target, usually of about 2 per cent, acute tension arises between their twin objectives of price stability and financial stability. In the case of the US Federal Reserve, the price stability objective also conflicts with the goal of maximum employment.
The choices made by central banks will have a far-reaching impact on our personal finances. If inflation stays higher for longer, there will be further pain for those who have invested in supposedly safe bonds for their retirement. If the central banks fail to engineer a soft landing for the economy, investors in risk assets such as equities will be on the rack. And for homeowners looking to refinance their loans over the coming months, any further tightening by the Bank of England will feed into mortgage costs.
The bubble bursts
SVB, the 16th largest bank in the US, perfectly illustrates how the central banks’ inflation and financial stability objectives are potentially in conflict. It had been deluged with mainly uninsured deposits — deposits above the official $250,000 insurance ceiling — that far exceeded lending opportunities in its tech industry stamping ground. So it invested the money in medium and long-dated Treasury and agency securities. It did so without hedging against interest rate risk in what was the greatest bond market bubble in history.
The very sharp rise in policy rates over the past year pricked the bubble, so depressing the value of long-dated bonds. This would not have been a problem if depositors retained confidence in the bank so that it could hold the securities to maturity. Yet, in practice, rich but nervous uninsured depositors worried that SVB was potentially insolvent if the securities were marked to market.
An inept speech by chief executive Greg Becker on March 9 quickly spread across the internet, causing a quarter of the bank’s deposit base to flee in less than a day and pushing SVB into forced sales of bonds at huge losses. The collapse of confidence soon extended to Signature Bank in New York, which was overextended in property and increasingly involved in crypto assets. Some 90 per cent of its deposits were uninsured, compared with 88 per cent at SVB.
Fear spread to Europe, where failures of risk management and a series of scandals at Credit Suisse caused deposits to ebb away. The Swiss authorities quickly brokered a takeover by arch rival UBS, while in the UK the Bank of England secured a takeover of SVB’s troubled UK subsidiary by HSBC for £1.
These banks do not appear to constitute a homogeneous group. Yet, in their different ways, they demonstrate how the long period of super-low interest rates since the great financial crisis of 2007-09 introduced fragilities into the financial system while creating asset bubbles. As Jon Danielsson and Charles Goodhart of the London School of Economics point out, the longer monetary policy stayed lax, the more systemic risk increased, along with a growing dependence on money creation and low rates.
The ultimate consequence was to undermine financial stability. Putting that right would require an increase in the capital base of the banking system. Yet, as Danielsson and Goodhart indicate, increasing capital requirements when the economy is doing poorly, as it is now, is conducive to recession because it reduces banks’ lending capacity. So we are back to the policy tensions outlined earlier.
Part of the problem of such protracted lax policy was that it bred complacency. Many banks that are now struggling with rising interest rates had assumed, like SVB, that interest rates would remain low indefinitely and that central banks would always come to the rescue. The Federal Deposit Insurance Corporation estimates that US banks’ unrealised losses on securities were $620bn at the end of 2022.
A more direct consequence, noted by academics Raghuram Rajan and Viral Acharya, respectively former governor and deputy governor of the Reserve Bank of India, is that the central banks’ quantitative easing since the financial crisis, whereby they bought securities in bulk from the markets, drove an expansion of banks’ balance sheets and stuffed them with flighty uninsured deposits.
Rajan and Acharya add that supervisors in the US did not subject all banks to the same level of scrutiny and stress testing that they applied to the largest institutions. So these differential standards may have caused a migration of risky commercial real estate loans from larger, better-capitalised banks to weakly capitalised small and midsized banks. There are grounds for thinking that this may be less of an issue in the UK, as we shall see.
A further vulnerability in the system relates to the grotesque misallocation of capital arising not only from the bubble-creating propensity of lax monetary policy but from ultra-low interest rates keeping unprofitable “zombie” companies alive. The extra production capacity that this kept in place exerted downward pressure on prices.
Today’s tighter policy, the most draconian tightening in four decades in the advanced economies with the notable exception of Japan, will wipe out much of the zombie population, thereby restricting supply and adding to inflationary impetus. Note that the total number of company insolvencies registered in the UK in 2022 was the highest since 2009 and 57 per cent higher than 2021.
A system under strain
In effect, the shift from quantitative easing to quantitative tightening and sharply increased interest rates has imposed a gigantic stress test on both the financial system and the wider economy. What makes the test especially stressful is the huge increase in debt that was encouraged by years of easy money.
William White, former chief economist at the Bank for International Settlements and one of the few premier league economists to foresee the great financial crisis, says ultra easy money “encouraged people to take out debt to do dumb things”. The result is that the combined debt of households, companies and governments in relation to gross domestic product has risen to levels never before seen in peacetime.
All this suggests a huge increase in the scope for accidents in the financial system. And while the upsets of the past few weeks have raised serious questions about the effectiveness of bank regulation and supervision, there is one respect in which the regulatory response to the great financial crisis has been highly effective. It has caused much traditional banking activity to migrate to the non-bank financial sector, including hedge funds, money market funds, pensions funds and other institutions that are much less transparent than the regulated banking sector and thus capable of springing nasty systemic surprises.
An illustration of this came in the UK last September following the announcement by Liz Truss’s government of unfunded tax cuts in its “mini” Budget. It sparked a rapid and unprecedented increase in long-dated gilt yields and a consequent fall in prices. This exposed vulnerabilities in liability-driven investment funds in which many pension funds had invested in order to hedge interest rate risk and inflation risk.
Such LDI funds invested in assets, mainly gilts and derivatives, that generated cash flows that were timed to match the incidence of pension outgoings. Much of the activity was fuelled by borrowing.
UK defined-benefit pension funds, where pensions are related to final or career average pay, have a near-uniform commitment to liability matching. This led to overconcentration at the long end of both the fixed-interest and index-linked gilt market, thereby exacerbating the severe repricing in gilts after the announcement. There followed a savage spiral of collateral calls and forced gilt sales that destabilised a market at the core of the British financial system, posing a devastating risk to financial stability and the retirement savings of millions.
This was not entirely unforeseen by the regulators, who had run stress tests to see whether the LDI funds could secure enough liquidity from their pension fund clients to meet margin calls in difficult circumstances. But they did not allow for such an extreme swing in gilt yields.
Worried that this could lead to an unwarranted tightening of financing conditions and a reduction in the flow of credit to households and businesses, the BoE stepped in to the market with a temporary programme of gilt purchases. The purpose was to give LDI funds time to build their resilience and encourage stronger buffers to cope with future volatility in the gilts market.
The intervention was highly successful in terms of stabilising the market. Yet, by expanding its balance sheet when it was committed to balance sheet shrinkage in the interest of normalising interest rates and curbing inflation, the BoE planted seeds of doubt in the minds of some market participants. Would financial stability always trump the central bank’s commitment to deliver on price stability? And what further dramatic repricing incidents could prompt dangerous systemic shocks?
Inflation before all?
The most obvious scope for sharp repricing relates to market expectations about inflation. In the short term, inflation is set to fall as global price pressures fall back and supply chain disruption is easing, especially now China continues to reopen after Covid-19 lockdowns. The BoE Monetary Policy Committee’s central projection is for consumer price inflation to fall from 9.7 per cent in the first quarter of 2023 to just under 4 per cent in the fourth quarter.
The support offered by the Fed and other central banks to ailing financial institutions leaves room for a little more policy tightening and the strong possibility that this will pave the way for disinflation and recession. The point was underlined this week by the IMF, which warned that “the chances of a hard landing” for the global economy had risen sharply if high inflation persists.
Yet, in addition to the question mark over central banks’ readiness to prioritise fighting inflation over financial stability, there are longer-run concerns about negative supply shocks that could keep upward pressure on inflation beyond current market expectations, according to White. For a start, Covid-19 and geopolitical friction are forcing companies to restructure supply lines, increasing resilience but reducing efficiency. The supply of workers has been hit by deaths and long Covid.
White expects the production of fossil fuels and metals to suffer from recently low levels of investment, especially given the long lags in bringing new production on stream. He also argues that markets underestimate the inflationary impact of climate change and, most importantly, the global supply of workers is in sharp decline, pushing up wage costs everywhere.
Where does the UK stand in all this? The resilience of the banking sector has been greatly strengthened since the financial crisis of 2007-08, with the loan-to-deposit ratios of big UK banks falling from 120 per cent in 2008 to 75 per cent in the fourth quarter of 2022. Much more of the UK banks’ bond portfolios are marked to market for regulatory and accounting purposes than in the US.
The strength of sterling since the departure of the Truss government means the UK’s longstanding external balance sheet risk — its dependence on what former BoE governor Mark Carney called “the kindness of strangers” — has diminished somewhat. Yet huge uncertainties remain as interest rates look set to take one last upward step.
Risks for borrowers and investors
For mortgage borrowers, the picture is mixed. The BoE’s Financial Policy Committee estimates that half the UK’s 4mn owner-occupier mortgages will be exposed to rate rises in 2023. But, in its latest report in March, the BoE’s FPC says its worries about the affordability of mortgage payments have lessened because of falling energy prices and the better outlook for employment.
The continuing high level of inflation is reducing the real value of mortgage debt. And, if financial stability concerns cause the BoE to stretch out the period over which it brings inflation back to its 2 per cent target, the real burden of debt will be further eroded.
For investors, the possibility — I would say probability — that inflationary pressures are now greater than they have been for decades raises a red flag, at least over the medium and long term, for fixed-rate bonds. And, for private investors, index-linked bonds offer no protection unless held to maturity.
That is a huge assumption given the unknown timing of mortality and the possibility of bills for care in old age that may require investments to be liquidated. Note that the return on index-linked gilts in 2022 was minus 38 per cent, according to consultants LCP. When fixed-rate bond yields rise and prices fall, index-linked yields are pulled up by the same powerful tide.
Of course, in asset allocation there can be no absolute imperatives. It is worth recounting the experience in the 1970s of George Ross Goobey, founder of the so-called “cult of the equity” in the days when most pension funds invested exclusively in gilts.
While running the Imperial Tobacco pension fund after the war he famously sold all the fund’s fixed-interest securities and invested exclusively in equities — with outstanding results. Yet, in 1974, he put a huge bet on “War Loan” when it was yielding 17 per cent and made a killing. If the price is right, even fixed-interest IOUs can be a bargain in a period of rip-roaring inflation.
A final question raised by the banking stresses of recent weeks is whether it is ever worth investing in banks. In a recent FT Money article, Terry Smith, chief executive of Fundsmith and a former top-rated bank analyst, says not. He never invests in anything that requires leverage (or borrowing) to make an adequate return, as is true of banks. The returns in banking are poor, anyway. And, even when a bank is well run, it can be destroyed by a systemic panic.
Smith adds that technology is supplanting traditional banking. And, he asks rhetorically, have you noticed that your local bank branch has become a PizzaExpress, in which role, by the way, it makes more money?
A salutary envoi to the tale of the latest spate of bank failures.
Tuesday 2 August 2022
Saturday 23 July 2022
Pakistan - Caught in the Debt Trap
Sultan Ali Allana in The Dawn
THE 22nd IMF programme, circular debt, G2G loans and an imminent 23rd programme lurking around the corner. It reminds one of Jaws the movie, where danger creeps unseen and dread is prevalent amongst all. ‘Borrow more to borrow even more’ versus ‘earn more to borrow less’. Two very different courses, yet interchangeably deployed, admittedly intermittently, in varying blends, over the past 40 to 50 years, have shackled the nation to the debt trap.
Omnipresent in this murky blend, not unlike other debt-laden markets, are what the West terms as ‘economic hitmen’, who pursue self-interests, ostensibly for the greater good. These interests are then propagated scientifically, justified, and then, with the clever manipulation of economic data, communicated to every handheld device.
While economists and financial experts take turns at solving what has now become a complex equation, perhaps it’s time to go back to the basics, which may be termed as Solution 101 — ‘earn more and borrow less’ — a solution which is admittedly easier to state than actualise. It is a course which may well require our urgent attention and, most importantly, political convergence that entails all major political parties, irrespective of their manifestos, unanimously agreeing to sign off on a ‘charter of economy’ that marks milestones at five-year intervals — starting with ‘earn more and borrow less’ to ‘earn more and not borrow at all’ to, ultimately, ‘earn more and build reserves’.
Simply put, this charter may be a 15-year plan for this nation’s way forward and a performance measure to determine the economic achievements of each successive government. Politics and the economy must at all costs be separated in the interest of the nation.
Pakistan’s debt story is interwoven with the country’s 75-year journey. We entered the first IMF programme in 1958 and, since then, it has been one programme after another, while institutional and G2G debts have continued to grow simultaneously. As of Dec 31, 2021, combined foreign currency loans are more than $90.5 billion. The story of Pakistan’s debt is incomplete without taking into account domestic debt, which by the end of December 2021 had crossed Rs26.7 trillion (roughly $151.5bn based on the Dec 31, 2021, closing rate), resulting in total debt in excess of $242bn or around 77 per cent of GDP. There is also the circular debt, which grew from Rs161bn in 2008 to over Rs2.46tr by March 2022. It continues to grow, putting, oil, gas and power supply at risk.
A consolidated picture of Pakistani debt on a per person basis depicts the debt journey. Each Pakistani, irrespective of age and gender, carries upon their shoulders a debt burden of nearly Rs190,000, while devaluation and interest adds to this figure by the day. Pakistan must borrow to pay back its borrowings and borrow to pay back the interest on its borrowings. Bluntly put, we are no longer borrowing for growth, but to service and repay borrowings.
The government may be able to service local currency debt by raising taxes, at the cost of stunting growth; however, foreign currency earnings will have to be significantly enhanced through exports, remittances, privatisation and foreign investments, and imports will have to be managed to make the equation work. Without a balancing act, the debt cycle will grow to untenable levels.
Tough decisions and belt-tightening are essential. The country’s policy framework, which has relied on imports, belies the requirements of a paradigm shift in thinking. The emphasis needs to shift to the development of a robust agro economy, making Pakistan not just self-sufficient in food, thus ensuring future food security, but also a country that can be a global supplier of food. If oil can be extracted (at a cost) and countries can rise to heights unthinkable in the 1960s, surely, agro extraction (at a cost, undoubtedly) can become a source for sustaining growth, which in due course can accelerate industrial growth for a balanced economic model.
The cycle of boom-and-bust can only be broken if there is a meaningful shift in the policy framework. Granting subsidies without assessing the long-term consequences, or imposing heavy taxation regimes, which impair growth, must be examined and thought through. To quote Winston Churchill: “I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up with the handles.” While building a strong SME and labour-intensive industrial base, with the aim of capitalising on the shifting industrial trend in China, is equally important, a focused approach, which entails start-to-finish government support — some call this the ‘ease of doing business’ — must be given top priority.
Competitive markets drive global agendas where Pakistan will have to situate itself and measure its competitiveness. What has not worked before will certainly not work going forward. It is imperative that we plan for future generations to provision for a fulfilling and debt-free life of progress, prosperity and security. We have heard the endless discussions of experts and also novices who have little understanding but who use economic jargon to impress with ‘solutions’. But why has nothing, or very little, worked? Framing policies, ensuring competency and challenging dogma require political consensus and hard work.
Freedom comes at a price and it’s a price we must pay someday. Climate change is upon us, where food security and water management will remain on top of the global agenda for decades to come. Gainful employment for our ever-growing and young population will be challenging. With over 366 million mouths to feed by 2050, surely this must be our primary concern. Debt and more debt are certainly not a solution. It is the problem!
Omnipresent in this murky blend, not unlike other debt-laden markets, are what the West terms as ‘economic hitmen’, who pursue self-interests, ostensibly for the greater good. These interests are then propagated scientifically, justified, and then, with the clever manipulation of economic data, communicated to every handheld device.
While economists and financial experts take turns at solving what has now become a complex equation, perhaps it’s time to go back to the basics, which may be termed as Solution 101 — ‘earn more and borrow less’ — a solution which is admittedly easier to state than actualise. It is a course which may well require our urgent attention and, most importantly, political convergence that entails all major political parties, irrespective of their manifestos, unanimously agreeing to sign off on a ‘charter of economy’ that marks milestones at five-year intervals — starting with ‘earn more and borrow less’ to ‘earn more and not borrow at all’ to, ultimately, ‘earn more and build reserves’.
Simply put, this charter may be a 15-year plan for this nation’s way forward and a performance measure to determine the economic achievements of each successive government. Politics and the economy must at all costs be separated in the interest of the nation.
Pakistan’s debt story is interwoven with the country’s 75-year journey. We entered the first IMF programme in 1958 and, since then, it has been one programme after another, while institutional and G2G debts have continued to grow simultaneously. As of Dec 31, 2021, combined foreign currency loans are more than $90.5 billion. The story of Pakistan’s debt is incomplete without taking into account domestic debt, which by the end of December 2021 had crossed Rs26.7 trillion (roughly $151.5bn based on the Dec 31, 2021, closing rate), resulting in total debt in excess of $242bn or around 77 per cent of GDP. There is also the circular debt, which grew from Rs161bn in 2008 to over Rs2.46tr by March 2022. It continues to grow, putting, oil, gas and power supply at risk.
A consolidated picture of Pakistani debt on a per person basis depicts the debt journey. Each Pakistani, irrespective of age and gender, carries upon their shoulders a debt burden of nearly Rs190,000, while devaluation and interest adds to this figure by the day. Pakistan must borrow to pay back its borrowings and borrow to pay back the interest on its borrowings. Bluntly put, we are no longer borrowing for growth, but to service and repay borrowings.
The government may be able to service local currency debt by raising taxes, at the cost of stunting growth; however, foreign currency earnings will have to be significantly enhanced through exports, remittances, privatisation and foreign investments, and imports will have to be managed to make the equation work. Without a balancing act, the debt cycle will grow to untenable levels.
Tough decisions and belt-tightening are essential. The country’s policy framework, which has relied on imports, belies the requirements of a paradigm shift in thinking. The emphasis needs to shift to the development of a robust agro economy, making Pakistan not just self-sufficient in food, thus ensuring future food security, but also a country that can be a global supplier of food. If oil can be extracted (at a cost) and countries can rise to heights unthinkable in the 1960s, surely, agro extraction (at a cost, undoubtedly) can become a source for sustaining growth, which in due course can accelerate industrial growth for a balanced economic model.
The cycle of boom-and-bust can only be broken if there is a meaningful shift in the policy framework. Granting subsidies without assessing the long-term consequences, or imposing heavy taxation regimes, which impair growth, must be examined and thought through. To quote Winston Churchill: “I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up with the handles.” While building a strong SME and labour-intensive industrial base, with the aim of capitalising on the shifting industrial trend in China, is equally important, a focused approach, which entails start-to-finish government support — some call this the ‘ease of doing business’ — must be given top priority.
Competitive markets drive global agendas where Pakistan will have to situate itself and measure its competitiveness. What has not worked before will certainly not work going forward. It is imperative that we plan for future generations to provision for a fulfilling and debt-free life of progress, prosperity and security. We have heard the endless discussions of experts and also novices who have little understanding but who use economic jargon to impress with ‘solutions’. But why has nothing, or very little, worked? Framing policies, ensuring competency and challenging dogma require political consensus and hard work.
Freedom comes at a price and it’s a price we must pay someday. Climate change is upon us, where food security and water management will remain on top of the global agenda for decades to come. Gainful employment for our ever-growing and young population will be challenging. With over 366 million mouths to feed by 2050, surely this must be our primary concern. Debt and more debt are certainly not a solution. It is the problem!
Sunday 10 July 2022
Friday 25 February 2022
Thursday 3 February 2022
Voters can be convinced China is defeated, but how do you convince jobless they’re earning?
Yogendra Yadav in The Print
It must have been hard for Nirmala Sitharaman. With all her sharp mind, sharper tongue and sharpest sense of political opportunity, it wouldn’t have been easy to manage the Narendra Modi government’s budget for 2022-23.
After all, she happens to be the finance minister of an economy fast approaching 5 trillion dollars GDP while the income of 80 per cent of the families to whom she was presenting the budget, has been declining for two years now. Most of them have had to dip into their savings or take out loans, just to survive. Unemployment is at its peak, triggering job riots in Uttar Pradesh and Bihar the week before.
Small-scale businesspersons — her party BJP’s traditional supporters — are in a bad shape, unable to recover from the triple whammy of demonetisation, GST, and lockdown. Besides, this budget was to be the moment of glory for the much-touted “doubling of farmers’ income” promise, which now seems only a few light years away, beyond the newly discovered ‘Amrit Kaal’.
Managing the art of hiding in plain sight
The finance minister also had the unenviable challenge of hiding a little elephant. The-elephant-that-must-not-be-named. As practically everyone’s income and wealth were suffering a decline, a prodigious child of Bharat Mata managed to defy all odds — the economic meltdown as well as the pandemic-induced lockdown — and emerge as glorious as Sitharaman made all of us feel in her budget speech. But why not? As the pandemic struck, this little elephant’s empire was worth Rs 66,000 crore. By the time the finance minister was presenting her budget, the same empire had grown to a little more than Rs 6.75 lakh crore. Another jewel in Bharat Mata’s crown is that the combined wealth of India’s top 100 billionaire families was one and a half times the size of the budget she was planning to present.
Then there were some minor money matters to be sorted. This was a little tricky, but nothing that could not be managed by a fine budget speech. Even before the pandemic had struck, the Modi government had been spending a few more trillions than it could earn. The Reserve Bank of India (RBI) had already been ‘robbed’ by the government, leaving little space to dip into. The finance minister even tried hard to sell the country’s property, but that also seems to not have earned much. And of course, taxing the rich was ruled out. The only option was to borrow further. But the interest payment on previous borrowings was already one-fifth of the entire expenditure.
As if all this was not enough, Sitharaman was placed in a country with “too much democracy” and “free” media . Perceptions have to be managed. People have to be managed. Orders have to be followed.
We must thank God for Economics and English. They make for such a lovely couple. Their charm obviates the bother of having to explain what goes on in the business of economy to those whose life it affects. Thankfully, though most of them consumed the information in one of the Indian languages, neither the budget nor the commentaries were thought through in those languages. English creates knowledge about the economy. Other languages disseminate this wisdom. English takes your attention away from the wretched everyday world of the ordinary people; they make a guest appearance in their costumes, just as ‘emerging economies’ do at Davos. The jargon of economics puts a gloss on the most painful and humiliating experience.
Be grateful, for you have support of lackeys
Nirmala Sitharaman must be grateful to the media. Ever since the Union Budget became a television spectacle, the more content is generated about the economy, the less we understand it. A small club of businessmen, all in awe or need or fear of the government, represent the economy. An even smaller club of English-speaking economists, mostly sarkari and darbari, or representing a business interest, represent knowledge about the economy. Thank God we have never heard of conflict of interest. And a set of anchors, ignorant or compromised or both, act as interlocutors. It makes for a perfect setting for a theatre of power.
No one makes much of a mismatch between the text of the budget speech and the numbers in the budget document, between past promises and present performance, between claims and truth. Remember the time when the Economic Survey numbers contradicted the data presented in the budget the very next day? Or the spontaneous manner in which the finance minister made up pandemic relief package figures on a daily basis? Or her imperious silence on the doubling of farmers’ income this year?
This is the theatre of power where everyone else feels awkward on the finance minister’s behalf, bending over backwards to find assumptions, theories and rationale underlying a series of disconnected assertions. If all of this is not enough to fill air time, the finance minister’s speech has a lot more — drones for farmers, old schemes renamed, old promises reinvented, acronyms – all that stuff which passes for news.
Democracies always have some trouble-makers. Like ours has the irreverent Ravish Kumar, the acerbic Rathin Roy or the predictable Jayati Ghosh. Thank God, there are enough trustworthy voices in the media to sideline such outliers. A few phone calls in the afternoon can tweak the agenda for evening panel discussion. And not to forget the ideologues who would remind you that creating jobs is not the job of the government, who can be trusted to rubbish the idea of taxing the super-rich.
Well, the media can be managed and more than half the job is done, but then comes the problem of political management. Now it certainly does seem to be ‘too much democracy’. There are voters to be persuaded and elections to be won. Here, Sitharaman needs something more than good English and bad Economics. TV channels can help you convince a voter that India has battered Chinese forces in Ladakh, but how do you convince an unemployed person that she is earning wages? How do you convince a farmer that their income has doubled? For that, you might have missed, we have a sharp political strategy and an even sharper electoral machine.
Uttar Pradesh is a case in point. The finance minister would certainly have had to announce something major for farmers or the unemployed youth, but thankfully that is not what this election is about. This election is about ‘Mr Jinnah’, the temples in Ayodhya and Varanasi and the “gunda raj” during the Samajwadi Party’s regime. Simple recipe: keep the Hindu-Muslim pot boiling, use money-media-muscle to stitch a careful caste coalition and let your good English take care of the bad economics. And if matters go out of hand, you can always throw in some additional ration and cash transfers.
Ain’t that tough? Like every TV expert, I must bow my head to Nirmala Sitharaman for managing a very difficult task. Final score? 8 out of 10, I guess.
Sunday 10 May 2020
Soaring government debt is now inevitable. It’s nothing to fear
Thatcher’s simplistic aversion to borrowing still haunts fiscal policy, but interest rates have been falling for many years writes Philip Inman in The Guardian
There are plenty of Tory MPs who believe there is a bigger threat to health, and possibly their electoral chances, from a damaged economy. They give equal billing to the threat from a flurry of corporate bankruptcies, a steep rise in unemployment and a ballooning debt pile that would dwarf the legacy left by the 2008 banking crash.
And it is this last concern – that of the mortgage to end all mortgages being left on the nation’s balance sheet – to which ministers have turned and begun to debate in the most heated terms. Without a doubt, a fear of debt is the main constraint on funding the current rescue operation and on making a boost to investment once the crisis is over.
If you are a traditional Conservative MP with a picture of Margaret Thatcher on the constituency office wall, you believe debts must be repaid, much like a domestic property mortgage.
This is the household analogy Thatcher used to great effect during her years as prime minister, despite it being economically illiterate, and only ever deployed as a way to keep public spending in check and state power limited.
Now, to tackle the coronavirus outbreak and nurse the economy until a vaccine is mass-produced, there is no choice but to watch the gap between spending and income soar.
The Institute for Fiscal Studies estimates the government will need to borrow an extra £200bn in this financial year alone and is heading for a debt-to-GDP ratio of 95% from the current level of around 83%.
A debt mountain that falls just short of the UK’s £2.2 trillion annual income is a level of borrowing that butts up against a significant psychological barrier – the three-figure debt-to-GDP ratio.
In the mind of a conservative thinker, only countries that are reckless, and possibly morally dubious, have spent so much that their debts exceed 100% of GDP.
In practical terms, a country with high debt levels can become the target of panicky investors, who can orchestrate a strike that means no one lends it money.
A government borrows by issuing bonds with a maturity date, and it needs fresh lenders to step in and buy the debt from existing lenders each time it matures. “Bond vigilantes” make money from orchestrating such bond-buying strikes and are ever watchful for countries that have left themselves vulnerable.
The euro crisis is still fresh in many people’s minds, when Italy and Greece found themselves bond-market pariahs. Italy’s debts equalled 130% of GDP. Greece found itself with a debt-to-GDP ratio of 180%.
George Osborne’s career as chancellor, and his adherence to a debilitating austerity programme, was built on warnings that Britain could suffer the same fate as Greece and Italy. Like his hero Thatcher, he persuaded an anxious nation that debt was to be feared.
Yet it was never true and is even less true today. Central to this argument is the path of interest rates. For the last 20 years in the UK and Europe, and the last 40 years in the US, interest rates on government debt have tumbled. Even though governments have borrowed more over time, the cost of financing each pound of debt has fallen.
There was always the concern that interest rates could increase at some time, but it was never likely and most economists agree it cannot happen now, at least not for a decade or more. There are too many savings in the world looking for a safe haven for the demand for government bonds ever to fall, especially relative to stock markets or lending to corporations. That means the bond vigilantes have no leverage, except in the developing world. For the richer countries, there is always someone to borrow from.
So, as the US and Japan have learned, it is not the size of your debts but how much they cost to service that matters. No wonder the US government debt-to-GDP ratio is at 110% and rising while Japan is a darling of the bond markets even though its government has a debt-to-GDP ratio above 250%.
Margaret Thatcher campaigning in the 1979 election. Photograph: Geoff Bruce/Getty Images
It is clear Boris Johnson has favoured his health advisers as he looks to ease the lockdown. Worries about a second coronavirus outbreak have clinched victory over concerns about keeping much of industry and commerce in a state of suspended animation.
After weeks of pleading by the Treasury to get the nation back to work, No 10 has opted to play it safe with people’s health, and particularly older people. And no wonder, after a hapless first few months in which the UK leapt to fourth place in probably the most ignominious league table in modern history – that of Covid-19 deaths per 100,000 population – behind Belgium, Spain and Italy.
It is clear Boris Johnson has favoured his health advisers as he looks to ease the lockdown. Worries about a second coronavirus outbreak have clinched victory over concerns about keeping much of industry and commerce in a state of suspended animation.
After weeks of pleading by the Treasury to get the nation back to work, No 10 has opted to play it safe with people’s health, and particularly older people. And no wonder, after a hapless first few months in which the UK leapt to fourth place in probably the most ignominious league table in modern history – that of Covid-19 deaths per 100,000 population – behind Belgium, Spain and Italy.
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There are plenty of Tory MPs who believe there is a bigger threat to health, and possibly their electoral chances, from a damaged economy. They give equal billing to the threat from a flurry of corporate bankruptcies, a steep rise in unemployment and a ballooning debt pile that would dwarf the legacy left by the 2008 banking crash.
And it is this last concern – that of the mortgage to end all mortgages being left on the nation’s balance sheet – to which ministers have turned and begun to debate in the most heated terms. Without a doubt, a fear of debt is the main constraint on funding the current rescue operation and on making a boost to investment once the crisis is over.
If you are a traditional Conservative MP with a picture of Margaret Thatcher on the constituency office wall, you believe debts must be repaid, much like a domestic property mortgage.
This is the household analogy Thatcher used to great effect during her years as prime minister, despite it being economically illiterate, and only ever deployed as a way to keep public spending in check and state power limited.
Now, to tackle the coronavirus outbreak and nurse the economy until a vaccine is mass-produced, there is no choice but to watch the gap between spending and income soar.
The Institute for Fiscal Studies estimates the government will need to borrow an extra £200bn in this financial year alone and is heading for a debt-to-GDP ratio of 95% from the current level of around 83%.
A debt mountain that falls just short of the UK’s £2.2 trillion annual income is a level of borrowing that butts up against a significant psychological barrier – the three-figure debt-to-GDP ratio.
In the mind of a conservative thinker, only countries that are reckless, and possibly morally dubious, have spent so much that their debts exceed 100% of GDP.
In practical terms, a country with high debt levels can become the target of panicky investors, who can orchestrate a strike that means no one lends it money.
A government borrows by issuing bonds with a maturity date, and it needs fresh lenders to step in and buy the debt from existing lenders each time it matures. “Bond vigilantes” make money from orchestrating such bond-buying strikes and are ever watchful for countries that have left themselves vulnerable.
The euro crisis is still fresh in many people’s minds, when Italy and Greece found themselves bond-market pariahs. Italy’s debts equalled 130% of GDP. Greece found itself with a debt-to-GDP ratio of 180%.
George Osborne’s career as chancellor, and his adherence to a debilitating austerity programme, was built on warnings that Britain could suffer the same fate as Greece and Italy. Like his hero Thatcher, he persuaded an anxious nation that debt was to be feared.
Yet it was never true and is even less true today. Central to this argument is the path of interest rates. For the last 20 years in the UK and Europe, and the last 40 years in the US, interest rates on government debt have tumbled. Even though governments have borrowed more over time, the cost of financing each pound of debt has fallen.
There was always the concern that interest rates could increase at some time, but it was never likely and most economists agree it cannot happen now, at least not for a decade or more. There are too many savings in the world looking for a safe haven for the demand for government bonds ever to fall, especially relative to stock markets or lending to corporations. That means the bond vigilantes have no leverage, except in the developing world. For the richer countries, there is always someone to borrow from.
So, as the US and Japan have learned, it is not the size of your debts but how much they cost to service that matters. No wonder the US government debt-to-GDP ratio is at 110% and rising while Japan is a darling of the bond markets even though its government has a debt-to-GDP ratio above 250%.
Tuesday 28 April 2020
Should we be scared of the coronavirus debt mountain?
The pandemic has necessitated huge borrowing – but post-crisis austerity would be the very worst way to deal with it
When the central bank buys the debt it does so by creating money. Under ordinary circumstances one might worry about that causing inflation. But given the recession we face that is a risk worth running. Indeed modest inflation would help us by taking a bite out of the real value of the debt.
Of course, ensuring that the central banks continue their crisis-fighting methods into the recovery period will itself require a political battle. Fearmongering about inflation is the close cousin of fearmongering about debt. We should resist both blackmails. We have the institutions and techniques to neutralise the coronavirus debt problem. We owe it to ourselves to use them.
‘A world in which coronavirus debts are repaid by a wealth tax would look very different from one in which benefits are slashed and VAT is raised.’ Photograph: Ben Birchall/PA
We do not know how this pandemic will end. We do know that we will be poorer when it’s over: GDP is plunging around the world.
We also know that there will be a towering pile of IOUs left from the bills run up during the crisis. When it is over we will have to figure out how to repay them – or whether to repay them at all. That question will decide the complexion of our politics, and the quality of our public infrastructure and services for years to come. Unless we tackle this issue, coronavirus debts will be the battering ram for a new campaign of austerity.
The scale of the challenge is huge. Hard cases like Italy grab the headlines. Its debt currently stands at 135% of GDP. As a result of the crisis it will likely rise to 155%. But it is no longer an extreme outlier. According to the IMF, the debt ratio of the average advanced economy will exceed 120% next year. In the US, the debt to GDP ratio may soon surpass that at the end of the second world war.
These numbers are impressive, daunting even. They offer an open door to conservative scaremongering. The first move in that tradition of debt politics is to invoke the tenuous analogy to a household. In this picture, debts are a burden on the profligate; a moral obligation that must be honoured on pain of national bankruptcy and ruin.
There are some circumstances in which this analogy is apt, specifically when you are an impoverished and desperate country dependent on foreign creditors who will lend to you only in the currency of another country, most commonly that of the US. Many poorer countries are in this position. Few rich countries are. Indeed, one of the definitions of being an advanced economy is that you are not.
Advanced economies borrow in their own currency and overwhelmingly from their own citizens. For them, the household analogy is profoundly misleading. In fact, those seeking to rebut the misconceptions of the household analogy sometimes say we merely owe government debts to ourselves.
That is a liberating thought. It makes clear that we are not in the position of a subordinate debtor nation. But it has a dizzying circularity to it. If we are our own creditors, are we not also our own debtors – master and slave at the same time? Ultimately, it is a bon mot that relies on treating the economic nation as a unit. That may look like liberation, but it is an illusion achieved by removing the real politics of debt – which are about class, not nationality.
Historically, government debts were assets owned by the middle and upper classes, the famous rentiers. And taxes were overwhelmingly indirect and thus fell disproportionately on lower incomes.
Today, the richest still own a disproportionate share of government debt. But the liabilities of the government are now widely distributed. They are staple investments for pension funds and insurers. Government debt is not simply a burden; it is a highly useful financial asset, offering modest interest rates in exchange for safety. It is all the more useful for the fact that the government lives for ever and will generate revenue for ever through taxation. So it enables very long-term planning.
The tax base today is much broader than it was a century ago. But who pays taxes – and who does not – remains one of the most urgent questions of the moment. A world in which coronavirus debts are repaid by a wealth tax or a global crackdown on corporate tax havens would look very different from one in which benefits are slashed and VAT is raised. And it is very possible that debt service will be taken out of other spending, whether that be schools, pensions or national defence.
As the great Austrian economist Joseph Schumpeter remarked in the aftermath of the first world war, “the budget is the skeleton of the state stripped of all misleading ideologies”, the truest reflection of the distribution of power and influence.
It is a distributional issue. But not only that. Debts may also affect the size of the cake itself. As we know only too well, a regime of austerity that keeps taxes high and government spending low is not conducive to rapid economic growth. And yet for debt to be sustainable, what we need is growth in GDP – to be precise, growth in nominal GDP, which includes real economic growth and inflation. Inflation matters because it acts as a tax on debts that are owed in money that is progressively losing its value. Price stability, the objective of monetary policy since the 1970s, no doubt has benefits for everyone, but most of all the creditor class.
This is the awesome dilemma we will face in the aftermath of Covid-19. This is the battle for which we must brace. Not right now, but once the immediate crisis has passed. After the financial crisis of 2007-08, it was in 2010 that the push for belt-tightening began. Like revenge, austerity is a dish best served cold.
Progressive politics cannot, of course, shrink from a battle about budgetary priorities. But it should resist fighting on the terms set by austerian debt-fear. In the circumstances of the UK or the US, alarmism about debt is false. And how false is being demonstrated by the crisis itself.
There is one mechanism through which we can ensure we truly owe the debts to ourselves. That mechanism is the central bank. Its principal job is to manage public debt – and at a moment of crisis central banks do what they must. They buy government debts or, in what amounts to the same thing, they open overdraft accounts for the government.
That has two effects that, acting together, have the potential to negate debt as a political issue. Central bank intervention lowers the interest rate. If interest rates are held down, debt service need not be an onerous burden. At the same time, the central bank purchases remove government IOUs from private portfolios and put them on the balance sheet of the central bank. There, they are literally claims by the public upon itself.
We do not know how this pandemic will end. We do know that we will be poorer when it’s over: GDP is plunging around the world.
We also know that there will be a towering pile of IOUs left from the bills run up during the crisis. When it is over we will have to figure out how to repay them – or whether to repay them at all. That question will decide the complexion of our politics, and the quality of our public infrastructure and services for years to come. Unless we tackle this issue, coronavirus debts will be the battering ram for a new campaign of austerity.
The scale of the challenge is huge. Hard cases like Italy grab the headlines. Its debt currently stands at 135% of GDP. As a result of the crisis it will likely rise to 155%. But it is no longer an extreme outlier. According to the IMF, the debt ratio of the average advanced economy will exceed 120% next year. In the US, the debt to GDP ratio may soon surpass that at the end of the second world war.
These numbers are impressive, daunting even. They offer an open door to conservative scaremongering. The first move in that tradition of debt politics is to invoke the tenuous analogy to a household. In this picture, debts are a burden on the profligate; a moral obligation that must be honoured on pain of national bankruptcy and ruin.
There are some circumstances in which this analogy is apt, specifically when you are an impoverished and desperate country dependent on foreign creditors who will lend to you only in the currency of another country, most commonly that of the US. Many poorer countries are in this position. Few rich countries are. Indeed, one of the definitions of being an advanced economy is that you are not.
Advanced economies borrow in their own currency and overwhelmingly from their own citizens. For them, the household analogy is profoundly misleading. In fact, those seeking to rebut the misconceptions of the household analogy sometimes say we merely owe government debts to ourselves.
That is a liberating thought. It makes clear that we are not in the position of a subordinate debtor nation. But it has a dizzying circularity to it. If we are our own creditors, are we not also our own debtors – master and slave at the same time? Ultimately, it is a bon mot that relies on treating the economic nation as a unit. That may look like liberation, but it is an illusion achieved by removing the real politics of debt – which are about class, not nationality.
Historically, government debts were assets owned by the middle and upper classes, the famous rentiers. And taxes were overwhelmingly indirect and thus fell disproportionately on lower incomes.
Today, the richest still own a disproportionate share of government debt. But the liabilities of the government are now widely distributed. They are staple investments for pension funds and insurers. Government debt is not simply a burden; it is a highly useful financial asset, offering modest interest rates in exchange for safety. It is all the more useful for the fact that the government lives for ever and will generate revenue for ever through taxation. So it enables very long-term planning.
The tax base today is much broader than it was a century ago. But who pays taxes – and who does not – remains one of the most urgent questions of the moment. A world in which coronavirus debts are repaid by a wealth tax or a global crackdown on corporate tax havens would look very different from one in which benefits are slashed and VAT is raised. And it is very possible that debt service will be taken out of other spending, whether that be schools, pensions or national defence.
As the great Austrian economist Joseph Schumpeter remarked in the aftermath of the first world war, “the budget is the skeleton of the state stripped of all misleading ideologies”, the truest reflection of the distribution of power and influence.
It is a distributional issue. But not only that. Debts may also affect the size of the cake itself. As we know only too well, a regime of austerity that keeps taxes high and government spending low is not conducive to rapid economic growth. And yet for debt to be sustainable, what we need is growth in GDP – to be precise, growth in nominal GDP, which includes real economic growth and inflation. Inflation matters because it acts as a tax on debts that are owed in money that is progressively losing its value. Price stability, the objective of monetary policy since the 1970s, no doubt has benefits for everyone, but most of all the creditor class.
This is the awesome dilemma we will face in the aftermath of Covid-19. This is the battle for which we must brace. Not right now, but once the immediate crisis has passed. After the financial crisis of 2007-08, it was in 2010 that the push for belt-tightening began. Like revenge, austerity is a dish best served cold.
Progressive politics cannot, of course, shrink from a battle about budgetary priorities. But it should resist fighting on the terms set by austerian debt-fear. In the circumstances of the UK or the US, alarmism about debt is false. And how false is being demonstrated by the crisis itself.
There is one mechanism through which we can ensure we truly owe the debts to ourselves. That mechanism is the central bank. Its principal job is to manage public debt – and at a moment of crisis central banks do what they must. They buy government debts or, in what amounts to the same thing, they open overdraft accounts for the government.
That has two effects that, acting together, have the potential to negate debt as a political issue. Central bank intervention lowers the interest rate. If interest rates are held down, debt service need not be an onerous burden. At the same time, the central bank purchases remove government IOUs from private portfolios and put them on the balance sheet of the central bank. There, they are literally claims by the public upon itself.
When the central bank buys the debt it does so by creating money. Under ordinary circumstances one might worry about that causing inflation. But given the recession we face that is a risk worth running. Indeed modest inflation would help us by taking a bite out of the real value of the debt.
Of course, ensuring that the central banks continue their crisis-fighting methods into the recovery period will itself require a political battle. Fearmongering about inflation is the close cousin of fearmongering about debt. We should resist both blackmails. We have the institutions and techniques to neutralise the coronavirus debt problem. We owe it to ourselves to use them.
Wednesday 24 April 2019
Low national savings rates stores up trouble ahead for Britain
Households, companies and government are all in deficit for the first time since the 1980s writes Chris Giles in The FT
The Scottish economist Adam Smith described Britain as a nation of shopkeepers in his book The Wealth of Nations, published in 1776.
Today, the UK is simply a country of shoppers. Rarely has Britain been consuming so much and saving so little.
As a nation — which statisticians break down into households, companies and the government — Britain spends far more than it earns. On this measure, the UK borrowed 5 per cent of national income in 2015, according to the OECD, the Paris-based international organisation.
This implies that UK households, companies and the government spent 5 per cent more than they earned in that year and financed the deficit by borrowing from overseas.
Britain was still borrowing 5.1 per cent of gross domestic product from foreigners in the third quarter of 2018, according to latest data from the Office for National Statistics on so-called sector balances. Since the 2016 EU referendum, every large sector of the economy — classified as households, companies and the government — has been in deficit at the same time: a situation last recorded in the boom years of the late 1980s.
Senior UK policymakers have long worried that running an economy on such low levels of national savings would be storing up trouble for the future, but they have often been at a loss to find solutions.
Mervyn King, former governor of the Bank of England, regularly expressed concern over Britain’s adeptness at consuming but felt he had to pump it up further at the BoE by keeping interest rates low for fear of a slump.
He called this a “paradox of policy” and noted an irony in his 2016 book The End of Alchemy that “those countries most in need of this long-term adjustment [to higher national savings levels], the US and the UK, have been the most active in pursuing the short-term stimulus”.
Such is the alarm over the lack of national savings that the ONS issued a stern warning in its most recent release about Britain’s accounts. Rob Kent-Smith, head of GDP at the ONS, said last month that “households spent more than they received for an unprecedented nine quarters in a row”.
Martin Weale of King’s College London, a former external member of the BoE’s Monetary Policy Committee, expressed concern that low rates of national savings would lead to future disappointment with living standards.
“National savings is important because if you have a situation where people want to retire you have to ask how they can do it,” Professor Weale said, noting that savings can come from many places — for example, companies’ contributions into defined benefit pension schemes.
“You can save for retirement, you can hope young people will pay for your retirement, you can decide not to retire, or I suppose you could retire and starve,” said Prof Weale. Happy countries, he added, tended to be those with high national savings rates.
Many economists are, however, not nearly as worried. David Miles of Imperial College London and another former MPC member said that low national savings rates might be a flashing warning light, but “the more one delves, if there is a problem, you won’t find it in the aggregate [national savings rate] number” produced by the ONS.
Instead, people should estimate whether households are saving enough for their future needs, companies are investing sufficiently for their long-term prospects and government is maintaining the fabric of the nation, Prof Miles added. In each case there will be some parts of each sector that are fine and others where there are problems, he said.
These issues show up in the measurement of individual sectors by the ONS: government borrowing is now at its lowest level since the early years of the millennium, for example.
In the households sector, the fact that spending is now higher than income relates partly to low savings. But much of the trend is due to sharply rising investment in new homes, which counts towards spending, and paints a much less concerning picture of households’ finances because the sector ends up with valuable assets. Recommended UK economic growth UK economic analysis creates Goldilocks dilemma
But as a nation, one thing has changed for the worse — and this used to be Britain’s get-out-of-jail-free card.
Throughout decades of heavy borrowing by the UK from overseas, policymakers could say British investments abroad were more valuable than equivalents made by foreigners here. So the country’s net investment position — the overseas assets owned by UK residents compared with British equivalents held by foreigners — was positive.
That changed substantially after the financial crisis, and the net investment position is now persistently negative.
Samuel Tombs of Pantheon Macroeconomics said this means “the UK’s dependence on external finance will continue to grow and its stock of external liabilities will increase”.
As any company will verify, in a future downturn a weak balance sheet signals vulnerability and spells trouble.
The Scottish economist Adam Smith described Britain as a nation of shopkeepers in his book The Wealth of Nations, published in 1776.
Today, the UK is simply a country of shoppers. Rarely has Britain been consuming so much and saving so little.
As a nation — which statisticians break down into households, companies and the government — Britain spends far more than it earns. On this measure, the UK borrowed 5 per cent of national income in 2015, according to the OECD, the Paris-based international organisation.
This implies that UK households, companies and the government spent 5 per cent more than they earned in that year and financed the deficit by borrowing from overseas.
Britain was still borrowing 5.1 per cent of gross domestic product from foreigners in the third quarter of 2018, according to latest data from the Office for National Statistics on so-called sector balances. Since the 2016 EU referendum, every large sector of the economy — classified as households, companies and the government — has been in deficit at the same time: a situation last recorded in the boom years of the late 1980s.
Senior UK policymakers have long worried that running an economy on such low levels of national savings would be storing up trouble for the future, but they have often been at a loss to find solutions.
Mervyn King, former governor of the Bank of England, regularly expressed concern over Britain’s adeptness at consuming but felt he had to pump it up further at the BoE by keeping interest rates low for fear of a slump.
He called this a “paradox of policy” and noted an irony in his 2016 book The End of Alchemy that “those countries most in need of this long-term adjustment [to higher national savings levels], the US and the UK, have been the most active in pursuing the short-term stimulus”.
Such is the alarm over the lack of national savings that the ONS issued a stern warning in its most recent release about Britain’s accounts. Rob Kent-Smith, head of GDP at the ONS, said last month that “households spent more than they received for an unprecedented nine quarters in a row”.
Martin Weale of King’s College London, a former external member of the BoE’s Monetary Policy Committee, expressed concern that low rates of national savings would lead to future disappointment with living standards.
“National savings is important because if you have a situation where people want to retire you have to ask how they can do it,” Professor Weale said, noting that savings can come from many places — for example, companies’ contributions into defined benefit pension schemes.
“You can save for retirement, you can hope young people will pay for your retirement, you can decide not to retire, or I suppose you could retire and starve,” said Prof Weale. Happy countries, he added, tended to be those with high national savings rates.
Many economists are, however, not nearly as worried. David Miles of Imperial College London and another former MPC member said that low national savings rates might be a flashing warning light, but “the more one delves, if there is a problem, you won’t find it in the aggregate [national savings rate] number” produced by the ONS.
Instead, people should estimate whether households are saving enough for their future needs, companies are investing sufficiently for their long-term prospects and government is maintaining the fabric of the nation, Prof Miles added. In each case there will be some parts of each sector that are fine and others where there are problems, he said.
These issues show up in the measurement of individual sectors by the ONS: government borrowing is now at its lowest level since the early years of the millennium, for example.
In the households sector, the fact that spending is now higher than income relates partly to low savings. But much of the trend is due to sharply rising investment in new homes, which counts towards spending, and paints a much less concerning picture of households’ finances because the sector ends up with valuable assets. Recommended UK economic growth UK economic analysis creates Goldilocks dilemma
But as a nation, one thing has changed for the worse — and this used to be Britain’s get-out-of-jail-free card.
Throughout decades of heavy borrowing by the UK from overseas, policymakers could say British investments abroad were more valuable than equivalents made by foreigners here. So the country’s net investment position — the overseas assets owned by UK residents compared with British equivalents held by foreigners — was positive.
That changed substantially after the financial crisis, and the net investment position is now persistently negative.
Samuel Tombs of Pantheon Macroeconomics said this means “the UK’s dependence on external finance will continue to grow and its stock of external liabilities will increase”.
As any company will verify, in a future downturn a weak balance sheet signals vulnerability and spells trouble.
Tuesday 17 September 2013
The malaise that drove down the rupee
Desperate attempts to woo foreign capital by boosting investor sentiment is unlikely to result in a lasting solution to India’s currency travails
The recovery of the rupee and the euphoric rebound of the markets in the last few days would appear to suggest that the economy is back on track again. Nothing could be more wrong. The flurry of policy announcements in recent weeks is based on the diagnosis that the relentless slide of the rupee, attributed to the widening Current Account Deficit (CAD), can be arrested if and when capital inflows — as investments or borrowings — fill the gap.
Reserve Bank of India governor Raghuram Rajan’s recent announcement allowing banks to borrow from global capital markets at a time when interest rates are rising because of the expected reversal of the United States Federal Reserve’s easy money policy is tailored to this logic. Indian banks can now borrow up to 100 per cent of their combined net worth and long term borrowings from the international market (compared to 50 per cent earlier) and then “swap” them with the central bank. This is expected to augment the supply of foreign exchange by an estimated $30 billion, which is about one-tenth of Indian foreign exchange reserves. The markets reacted euphorically, but the risks of the country borrowing its way out of trouble have been much less appreciated.
The two-track policy — of making India more attractive to foreign investors by deepening “reforms” and of borrowing more — is fraught with serious consequences. The policy response suggests that the ongoing crisis is only a temporary blip in the Great Indian Growth Story. But it appears that the seeds of the crisis were sown in that very story.
THE GREAT CREDIT BINGE
A striking feature of the story is that Indian corporates borrowed like there was no tomorrow — from not only Indian banks but also from overseas capital markets. Consider this: between 2003-04 and 2010-11 the Indian corporate sector’s share of net bank credit increased from 31 per cent of Gross Domestic Product (GDP) to over 37 per cent. In fact, since 2006-07, their share has been consistently higher than net bank credit to the government.
Infrastructure companies’ (power, roads and telecom) share in total bank credit increased from about 9 per cent in 2003 to more than 33 per cent in 2011. The spectacular increase is responsible for the mounting burden of non-performing assets in the Indian banking sector today. According to an oft-cited report in the media, prepared by the Credit Suisse Group in 2012, the debt of 10 Indian corporate groups whose interests range from oil and gas and steel to infrastructure increased from about Rs. one lakh crores in 2006-07 to Rs. 5.4 lakh crores in 2011-12 — a compounded annual rate of 40 per cent.
ASSET BUBBLE
The fact that private fixed investment did not increase at the same pace is perhaps because a large portion of the credit was diverted by Indian companies to what would appear to be an asset bubble — in land, shares in companies and other speculative assets. The clamour by corporate lobbies that interest rates be lowered has no respect for economic logic, given the state of the country’s external balances. They fail to appreciate that the era of cheap-credit fuelled growth is well and truly over.
But this increase in domestic credit was dwarfed by the remarkable increase in the inflows of foreign capital following the global economic meltdown in 2008.
The share of capital inflows — external borrowings, foreign direct investment (FDI) and foreign institutional investors (FII) — increased from about 5-6 per cent of GDP to about 9 per cent in 2011. The share of costlier short-term borrowings (almost entirely by private companies) in overall borrowings increased from 4.5 per cent in 2002-03 to 25 per cent in 2012-13. Companies, lulled into borrowing at illusorily low interest rates, have been surprised by sharp increase in the rupee-denominated value of their loans.
FDI ILLUSION
Inflows of FDI registered a spectacular rise — from $9 billion in 2005-06 to $33 billion in 2010-11. Popular understanding is that while FII investments are volatile, FDI is much more stable, long term in nature and contributes to improving the competitiveness of recipient nations. However, the story of India’s dalliance with FDI is shockingly different and raises serious doubts about whether the ongoing attempts to woo investors is sustainable or even desirable.
A study co-authored by Biswajit Dhar, Director General, Research and Information Systems for Developing Countries, based on a painstaking dissection of every FDI project entailing an investment of $5 million and more between 2004 and 2009, provides shocking insights that prove that a large proportion of FDI is just as volatile and transitory as portfolio capital. The study that considered 2,748 projects, which accounted for almost 90 per cent of all FDI in the 2004-2009 period, found that the lowering of norms prescribing the minimum level of equity stake in an “FDI invested” project — from 40 per cent to 10 per cent — offered perverse incentives to capital flowing in the garb of FDI.
Less than half of the investment was actually FDI; private equity, venture capital and hedge funds, which are volatile and normally associated with short investment horizons, accounted for 27 per cent; and about 10 per cent was actually portfolio investment. Over 10 per cent of the “investment” was round tripping by Indian entities, which funnelled money back through tax havens in order to take advantage of tax concessions and other inducements available to FDI projects.
A large proportion of the investment was by entities masquerading as investors committed to the long haul or investments that enhanced the productive capacity. Indeed, manufacturing, which advocates of FDI said would be a key beneficiary, received only one-fifth of the investment; but even in this case portfolio and other short-horizon investors accounted for almost 40 per cent of the total investment. Interestingly, while much attention has been focussed on the rising import of oil and gold, little attention has been paid to the fact that the trade deficit in manufactured goods has widened from $1.5 billion in 2004-05 to $45.5 billion in 2011-12 (about 2.5 per cent of GDP).
If there is any truth in the old cliché that a crisis is also an opportunity, surely this is a time to rebalance the Indian economy on a more sustainable path that allows policymakers to use levers that are more easily within their control. Of course, this would require import curbs and other measures suited to these hard times. But rebalancing would also require the use of measures such as the fiscal deficit, which have been for far too long a strict no-no in the policymakers’ handbook.
THE FISCAL DEFICIT OBSESSION
The stubborn opposition to the good old-fashioned Keynesian logic of using a fiscal deficit to get the economy back on its feet is grounded in the apparently intuitive logic that equates a government deficit with a household deficit. A classic example of such misguided thinking is evident in the loud opposition to the Food Security Bill. Quite apart from the fact that such a measure would provide a measure of security to the poor, the implementation of the legislation promises economy-wide benefits.
First, the guarantee of subsidised food grains, which constitutes a significant proportion of the consumption basket for most people, will have the immediate effect of increasing their disposable income. This is not trivial, given that the growth of consumption expenditure has halved between 2009 and 2012.
Second, the provision can play the role of an economic stabiliser because food prices determine the floor wage level, which is why they are termed a wage good. The guarantee would thus not only help in controlling food prices but also stabilise wages. Indeed, it is perplexing that industry lobbies are attacking the provision of an enhanced social wage, from which they stand to benefit significantly.
Third, if the fiscal deficit is run in an imaginative way, even more can be achieved. For instance, coupling the food guarantee to the MGNREGA can help in the construction of a countrywide network of godowns for the Food Corporation of India.
Of course, a cash transfer scheme would negate much of the potential economy-wide benefits that would accrue from the implementation of the food security legislation.
Tuesday 26 March 2013
George Osborne is using Britons as economic cannon fodder
This is a dangerous time to push the property market. The chancellor won't invest – yet he's happy for us to
Britons are already up to their eyes in debt … George Osborne. Photograph: Stefan Wermuth/Reuters
Massive public debt: bad. Massive private debt: excellent. Gordon Brown's bubble: economic ruin. George Osborne's potential bubble: economic salvation. Benefits for non-home-owners: unaffordable. Cash bungs for property buyers: essential.
Recite this catechism often and loudly, and over time you too will appreciate the wisdom of the coalition's economic policy.
The consensus over Wednesday's budget was that it was a do-nothing affair, a feeble huddle of small measures washed away in a sea of red ink and broken targets. In terms of central government giving and taking – the traditional stuff of Red Books – it was as small beer as that penny off a pint indicates. But stack up the announcements that don't touch the public balance sheets and the chancellor was strikingly radical.
Because it turns out that Osborne does believe in that apparent epitome of economic loucheness, borrowing to invest. He just wants you and me to do it, using our own wee savings. Sure, No 11 will give us a leg-up, by guaranteeing over £100bn of our loans and sloshing easy money through the banks. But, despite all Vince Cable's exhortations, the chancellor will not do the obvious and less risky thing of public investment.
Have a look at the supplementary document on Help to Buy that the Treasury issued alongside the budget. Billed as a "technical paper", it's not half as innocuous as that sounds. Rather, it's one of the biggest state interventions in the mortgage market in Britain's postwar history.
Help to Buy builds on (no pun intended) existing, largely failed, schemes to help first-time buyers purchase a newly built home. This is in itself problematic, since it's really a bung for the likes of Taylor Wimpey and Barratts and all the other purveyors of identikit housing estates. But warning signs really start flashing with Osborne's proposal to offer banks government guarantees on £130bn of mortgages where the borrowers have low deposits. This isn't just for new homes, it's for any house worth up to £600,000 and it's available not just to first-time buyers, but to people moving up the property ladder.
When the scheme was announced, Ed Miliband's troops successfully got ministers squirming over whether it would be offered to those buying a second home. But that is to miss the bigger point. The first is the risk to public finances: if the property market turns seriously sour, the government stands to make a loss. But the second is the way that ordinary Britons are now being used as economic cannon fodder. Osborne may say, as he did last week, that "you can't cure a crisis caused by debt with more debt". But he doesn't really mean that, because he's just about to launch a policy aimed to get Britain out of its depression – and it relies on households sinking into the red to take part in a property Ponzi scheme.
As I say, the policy is new – but the strategy it's part of has been knocking around for about three decades. The postwar British state used to protect citizens against market failure through the welfare state, through government pump-priming of the economy and through rising wages. But after Thatcher, it was increasingly left to Britons to protect themselves by taking on shares in privatised utilities, by buying up council houses – and by taking on debt, with all the attendant risks. This is what the political economist Colin Crouch has dubbed "privatised Keynesianism": debt is used to reflate the economy, but it is taken on not by the public sector but by individuals, couples, families.
Privatised Keynesianism sounds a bit joyless, but the political classes found something to give it extra zap. Call it housing-market heroin: the special high the Brits get when property prices are really taking off and Sarah Beeny is on the telly explaining how we can all cash in. Thatcher was the first PM to really push housing-market heroin with her right-to-buy programme and her Lawson boom but, with their love of aspiration and Home Ownership Task Force, Blair and Brown knew its potency, too.
Osborne's strategy combines both privatised Keynesianism and housing-market heroin. Yet this is a particularly dangerous time for him to push either. For a start, Britons are already up to their eyes in debt and, outside London, the housing market is flat on its back.
The estate agency Knight Frank estimates that it will take until at least 2019 before property prices are back to the levels of 2007. Add to that the Office for Budget Responsibility's forecast that real wages in Britain in 2015 will be 9% lower than they were in 2010. So the housing market looks less of a sure thing than at any time since 1994, and Britons' personal finances are a wreck. Osborne may think he's found an update of right-to-buy, but it looks more like right-to-be-repossessed.
Still, back to that coalition catechism. Government borrowing to build council housing: forbidden. Individual borrowing to buy an overpriced two-bed flat: encouraged. The way to make the economy stronger is to make it more fragile. And we're all in it together, except really, when it comes to managing your way through this depression, you're on your own.
Saturday 23 February 2013
India’s public finances - A walk on the wild side
Government borrowing generates inflation, widens the external deficit and crowds out much-needed investment. Can India now overcome its debt addiction?
INDIA has grappled with its public finances for long enough. When presenting its first budget after independence in 1947, the finance minister of the day insisted that the country was not living beyond its means. Yet every budget since has failed to produce a surplus. India borrows more heavily than typical big emerging economies and faces more periodic crises. Palaniappan Chidambaram is the latest to try to tame the fiscal beast. He became finance minister, for the third time, last July. On February 28th he will present his budget, possibly the last one before the ruling Congress Party goes to the polls, which must take place by mid-2014.
India’s economy is a concern. Growth is running at about 5%, nearly half what it once was. The external deficit is at a record, while inflation remains stubbornly high. Last year India faced the threat of a downgrade of its credit rating to “junk” status. Thankfully, Mr Chidambaram has shaken Congress from its stupor. The party is to blame for the present budget mess, having launched a pre-election spending spree in 2008 that continued. Subsidies, mainly of fuel, almost doubled, to 2.4% of GDP. The central government’s deficit has been 5-6.5% of GDP. Add in spending by the states, and India’s overall budget deficit has been running at a wild 8-10% of GDP.
When the economy was zipping along, the borrowing did not matter so much. For a while, the national debt actually fell as a proportion of GDP, despite high budget deficits (the ratio is about 70% today). But now, with slower growth, a debt spiral is a real risk. Borrowing has taken a heavy toll. It has fuelled inflation and a balance-of-payments gap, while crowding out the private investment in factories and infrastructure that India badly needs.
Mr Chidambaram says that for the year to March 2013 he will limit the central government’s deficit to 5.3% of GDP. His budget is likely to project a modest decline to 4% by 2015. Chetan Ahya, an economist at Morgan Stanley, notes that the minister is squeezing spending, which fell by 9% in December against a year earlier. Subsidies on fuel are being cut. And the state is selling shares in public companies. Raghuram Rajan, the government’s economic adviser, insists accounting gimmicks will not be used to meet budget targets.
After the budget, however, the outlook is murky. Some still worry that Congress will try to spend its way to re-election. The last three general elections were preceded by splurges. And if a messy coalition comes to office, discipline may slip.
India is in a bind because normal checks and balances have been overwhelmed. In 2003 a Fiscal Responsibility Act was passed, designed to bind politicians to fiscal rules. Although it has led the states to behave better, the central government has ignored it. Meanwhile, the Reserve Bank of India (RBI), the central bank, keeps the debt market under its thumb. It forces banks to buy bonds, prevents foreign investors from participating, and has propped up prices by buying bonds itself. It now owns 16% of the public debt, not far off the level in the crisis year of 1991.
There is plenty of spending on politicians’ crazy schemes. One sanitation project claims to have built 84m rural lavatories, about 60% more than the 2011 census says exist. Meanwhile, fuel subsidies benefit the richest tenth of Indians seven times more than the poorest tenth.
The solution, some hope, is “direct transfer” schemes that give welfare payments directly to the poor, lowering waste and graft. Yet vital though such reforms are, they will not yield enough cash to come close to balancing the books.
Pressures to spend will always exist, says Subir Gokarn, an economist and former bigwig at the RBI. In areas such as education and infrastructure, that is only right. So revenues need to rise. A new report by the IMF compares India with other countries, adjusting for their wealth. It implies that India’s government revenues should be 25% of GDP. At present they are just 18%.
How to raise revenues? Selling off more badly run state firms would help. Lots of state land lies idle and could also be sold. A recent mapping exercise in Ahmedabad, a modest-sized city, concluded that $4 billion could be raised there.
But the tax system needs changing, too. Before India launched market-friendly reforms in 1991, taxation meant clobbering manufacturers with customs and excise duties. Since then the mix has shifted to direct taxes on individuals and firms and indirect taxes on services, which make up three-fifths of GDP. (Farming, which employs half of all Indians, contributes only one-seventh of all GDP and is largely exempt from tax.)
Compare contrasting GDP and population levels across India’s states with our interactive map and guide
Much of the economy remains out of sight of the taxman. A lot of the services sector is informal and cash-based. The property market is notorious for black money. Big firms in the formal economy pay a decent rate of tax, but many smaller businesses fall under the regime for personal tax, where compliance is poor. Surjit Bhalla, of Oxus Investments, reckons income-tax receipts are two-thirds below what they should be. Just 32m people, or 2.5% of Indians, pay income tax.
Complexity discourages people from joining the formal economy and makes cheating easier. Each state has its own taxes, from the value-added sort and levies on luxury goods to duties on entry to specific areas. To deal with this, the central government has a Goods and Services Tax (GST) in the works. Its aim is to unify the rates of indirect tax across India and replace a tangle of local taxes. It should cut red tape and encourage more activity, such as construction, to enter the formal economy, says Vijay Kelkar, of the India Development Foundation. Encouragingly, rationalisation of the code for direct taxes is also on the government’s to-do list.
The fine print of these measures is still being debated. They have been in the works for years. Some worry that to win over the states, the government will dilute the impact of the GST. Yet these reforms have the potential to bring more of the economy into the tax net, raising revenues by several percentage points of GDP. When Mr Chidambaram speaks on February 28th it will be promises about progress on tax reform, rather than about the deficit two years hence, that will signal whether India is ready to cast off its fiscal chains.
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