Does the Counter Cyclical Regulation ensure the cycle free regime?

During the run up of 2004 to 2007 world economies in general and emerging economies in particular have experienced the highest levels of consumer confidence and corporate optimism. The increased purchasing power driven by increased investments and confidence among the economic agents (I mean corporate entities and individuals) has escalated the inflationary pressures around the world.  To counter such an imbalance in the system, the apex bodies around the world have resorted to counter cyclical monetary measures such as increasing the reserve capital (which may be used in the event of negative outcome). Such a counter cyclical regulated environment has forced the firms to incur more cost of capital than market requires.  In fact during the boom times, given the confidence level in the economy, the probability of default though is very remote; the cost of capital in the economy remained irrationally high. Hence such a regulatory environment prompted the firms to shift to unregulated or less regulated activities such as structured investment vehicles which in a way caused the present trough. 

 

Aftermath of the bursting of the bubble in the housing sector, almost all the apex financial institutions around the world resorted to the (traditional) counter cyclical monetary measures which are again proved to be irrational and may contribute to the potentially void results. The trouble in the housing sector has been translated into disastrous crisis in the financial sector by the so called counter cyclical regulations of the boom period. The resulted crisis has evaporated the confidence among the economic agents and drafted vague picture about the future prospects thereby steep fall in consumer demand, accumulated inventories and unimaginable job cuts. Given the present pessimistic environment, market demands a relatively higher cost of capital from the firms and financial institutions requires higher cushion in terms of higher reserve to tide over the potential uncertainty. Counter intuitive to such an end, the regulatory bodies brought down the reserve requirements of the financial institutions and virtually advocating the low cost of capital to the firms. The credibility of these measures in the event of possible corporate mass defaults is not only questionable but they may also pose the terrifying questions about the future systemic cushion…  (to be continued)

(Comments and suggestions are hightly respected)

Japanease Slump and its Implications

Japanease stock index Nikkie touched 39,000 mark in late 1980s, today it is struggling around 9,000. Virtually there was zero growth for last two decades in the Asia's largest and world's second largest economy. Fiscal measures, monetary measures all failed one after another in bringing back the normalcy.  When one look into the reasons (Irrational credit expansion and reality boom) that caused the downfall of the Japnease economy, one certainly get scared of their future prospects from the current juncture.  

Here i would like to initiate for a year end debate on the possible causes for the continued slump in the Japnease economy. Particularly i invite the arguments on the following issues:

• Reasons for the failure of fiscal and monetary measures in Japan
  
• Why an average Japanease citizen save so high? (even after realising that their savings and investments have gone for a vain)
• Possible measures to be adapted to cure the Japanease truma
• Implications of prolonged Japanease slump to the current debacle of the global financial system

As i mentioned it is the year end debate, i request your valuable arguments and comments by the end of the current year.  I also hereby promise that your contribution will be duly recongized in my forth coming blog post on the same issue.

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Unviable Suggestion!!

The present crisis over turned the basic idea of the capitalism that "the state should assume the role of facilitator rather than the role of regulator". It is quiet evident from the recent acts of the notable 'leaders of capitalism' as United Kingdom nationalized the private commercial and investment banks (pearls of capitalism), United States embarked on entering into the governing bodies of yesturdays corporate kingdoms. With the yesturday's statement, the Government of India took the anti-capitalist movement to the next levels.  Given the status of the economic environment, i propose to critically evaluate the Govt of India's move in asking the industry to cut the prices of the goods produced by them.

During the last couple of months, the Govt of India infused Rs. 2,80,000 crore through a host of monetary measures and another Rs 1,00,000 crore through various fiscal measures. Thanks to the cordinated efforts by Ministry of Finance and RBI, the inter bank rates have (virtually) came down to the normal levels (though i suspect the normalcy in terms of transactions among the banks). Here, one should question the effectiveness of the measures so far taken by the MoF and RBI. These have been initiated at a time when the transactions among the banks were virtually non-existent, call money rates were at their hights of around 23% and most importantly the banks were no where near the position of either continuing or renewing the expired credit lines to the corporates. As noted by the pink papers, these measures are successful as they claimed to be drived down the inter bank rates. Here one should understand the real picture  what made the inter bank rates to reach the normal levels?.  It would have been appreciated if the RBI & MoF measures improves the confidence among the banking community over the solvency of their peer and if they transferred the newly infused liquidity to the real economy through continuing and extending the credit lines to the industry. Hardly there is no evidence on this front, there is no evidence of either new or renewed credit lines (without additional restrictions) to the industry; there is no evidence of healthy inter bank transactions. Hence, it is very clear that the RBI & MoF measures reduced the demand for call money (thereby interbank rates) by boosting  the banks with the large chunk of easy money which has no signs of reaching the proposed ends (moreover it is reaching back to government coffers as banks are now heavily purchasing the government securites). Essentially, these measures so far taken have neither yielded  fruits to the (real economy) industry nor to the banking sector as they failed to improve the confidence among the ultimate economic agents (consumers).  Moreover, the steep fall in retail sales have jeoparadized  the industry (which never had the chance of earning super normal profits given the fierce competition resulted from opening up of the economy) prospects by resulting in accumulated inventories, and increased credit bills. At this stage, the viability of the earnest Minster of Finance statement may be questioned? It makes me to suspect that the Govt of India is still in the dreams of "strong fundamentals" and not yet ready to accept its vulnerability to the crisis. 

In this situation, the government should have the sole goal of 'improving the confidence' among the economic agents.  It may be effectively achieved by relying heavily on fiscal policy measures. That is increasing the benefits to the unemployed (social security measures), infrastructure spending  to boost the aggregate demand. The agrument against infrastructure spending in the prevailing situation is that they take too long to show the impact, but such an arument has no validity as the chances that this slump will be over anytime soon are virtually zero.  Hence, it may be reasonable to get such projects get rolling and slowly injecting the confidence among the economic agents.!! (as i blogged for quite some time ago).

 (http://surenderkomera.blogspot.com/2008/10/current-recession-policy-implications.html) 

(Constructive comments and suggestions are encouraged!!)

Break the Path Dependent Ideas!!

Eversince sub-prime crisis  initially unearthed during April 2007 in United States, it has been widely written and extensively discussed by the independent scholars, policy makers and so on saying that: the fundamentals of the Indian economy are extremly strong, India has not yet been integrated to the world economy. Hence, the possible impact of the crisis in the western financial system will be very mild on the Indian economy.  By naively subscribing to this view, RBI has maintained the real interest rate as high as 4% (three month rates), SEBI continued to control capital inflow by many ways such as restricting Paricipatory Notes untill early September 2008. Where as the central bank of US (Federal Reserve) kept the credit policy so loose that short term interest rates are in the negative territory during the period.

Almost a year later now after September 2008 which experienced the major collapse of financial system in the western world, we are now feeling pinch and observing the worst part of the effect in our economy.  Our stock markets have fallen steeply by almost 40%, inter bank call rates touched the peak of 23% unearthing the worst ever credit crunch. This resulted in either fully or partially abondened credit lines to the corportes and there by affected the indusrial production. The real estate markets in India have slowed down and the home prices in most of the cities are falling sharply.  In a way high degree of distress has been witnessed in the overall economy. This has disproved the perception of our policy makers over the 'strong fundamentals' and 'decoupled of the economy with the rest of the world', that is based on the position of India 10 years ago. 

 Coordinated effort of RBI, SEBI and Ministry of Finance:

Similar to most of central banks of the developed world, Ministry of Finance and SEBI led by the Indian central bank has now (after realising the true picture) come out with a series of positive steps to correct the system during the last three weeks. a 250 bps cut in CRR, a special window of Rs 20,000 crores to MF to ease the redemption pressure, reliease of Rs 25,000 crores under the loan weaver scheme, a 100 bps cut in the (repo rate) policy rate, a de facto 100 bps cut in SLR, the reversal of the mistakes on PNs of October 2007 and ease of FDI norms. All these measures seems to bringing back the normalcy in to the system as they resulted in bringing down the call rates to around 6% and reduced the panic selling in our stock markets (Indices have taken the northward direction!!) In a way RBI and SEBI exhibited the greater maturity in dealing with the present borrowed crisis without resorting to possible politically motivated measure of "banning of short selling".  Hence, it may be highly commendable to break the subscribing to the path dependent thinking process and accept the Indian economy as nascent market economy in arraiving at policy decisions !!

(The author has highly benefitted from the writings of Ajay Shah, Ila Patnaik and Arthur M Okun)

Comments and suggestions are encouraged!!

New dimension to Trade theory

You might be well aware of David Ricardo's 'Theory of Comepetitive advantage' which advocates that the countries which are relatively competitive enough in producing different goods/services should participate in trade ( E.g. you are a better baker and i am a better shoe maker, the trade between us improves the prospects of both of us). This basic idea of trade relevence dominated the thought of International economics and trade, in a way it laid the path of economic thinking of international trade.  

Paul Krugman is one of the first to realize that those kinds of path dependent models only explained about half of the trade in the world, and he became the first one to explain economicially why it (also) made sense that countries that are similar should trade as opposed to courtries that are differnt. He explains that  such trade between the countries that are similar, enables specialisation and large-scale production, which results in lower prices and greater diversity of commodities. The development of large scale production for the world market has contributed significantly for the enhancement of standard of living of most of the countrymen (mostly in developing counries)  by the way of attracting more people to cities and higher wage rates.  Paul in his path breaking work on trade theory showed how economics of scale influence trade and urbanization.

(The author has greatly benefited from the writings of Simon Kennedy and Rich Miller)

Comments and further contributions are encouraged!!

Current Recession: Policy Implications

Before going ahead with this weekend blog let me Congratulate PAUL KRUGMAN who has been honoured with the Noble prize for the year 2008 in Economics. His theoretical contributions to International trade and economic geography are detrimental in bagging the highest honour. In his recent piece in Newyork Times, the 2008 Noble Laureate in economics said that "it is politically fashonable to rant against government spending and demand fiscal responsibility.  But right now, increased government spending is just what the doctor ordered, and concerns about the budget deficit should be put on hold". In the following piece of my blog, i will try to relate his statement with the current global financial condition (I dislike to call it as "crisis").

Stock markets are finding new depths in most of the days, money markets, credit markets are vitually shut down. In addition to that we saw the falling retail sales so as the industrial production. All these prevailed conditions makes me to remember the recent recession of late 1990s resulting from technology bubble. The policy response to such recession was a success story.  The Federal Reserve could engineer that recession by cutting interest rate which resulted in the increased employment opportunites. But the current prevailing situation is different from that of the situation prevailed during late 90s in many ways. For quiete sometime Federal Reserve has been resorting to  interest rate cut to prevent the unemployment rates from raising for several other reasons of global slow down. This brought us to see the fed rate at around 1%, but there is no sign of declining trend in unemployment rates. Moreover, the decline in the retail sales caused the accumulated inventores, forced reduction of the industrial production and further retrenching of jobs. As per the old dated economic text books the current economic situation is precisely referred as the "Economic down turn" as a synonym to "recession".  How long our markets have to suffer from such epidemic? , is the trillion dollor question!!

In this situation there is not much can be done by the central banks. On the other hand, as J.M. Keynes advocates a lot that government can do through its fiscal measures - increasing the benefits to the unemployed (social security measures), infrastructure spending  to boost the aggregate demand. The agrument against infrastructure spending in the prevailing situation is that they take too long to show the impact, but such an arument has no validity as the chances that this slump will be over anytime soon are virtually zero.  Hence, it may be reasonable to get such projects get rolling and slowly injecting the confidence among the economic agents.!!

Constructive comments are honoured!!