The Indian Economy Blog

June 24, 2008

Guest Post: An Exercise in Damage Assessment

Filed under: Business — Nitin @ 7:34 am

By V Anantha Nageswaran

For a while, at least, Asian currencies are caught between rocks and hard places. We struggle to construct realistic scenarios under which Asian currencies rally. Only a credible and reasonably aggressive policy response to the inflationary impulse washing through the region would do that. It would restore policy credibility, improve local currency returns for domestic savers, and slow import growth, thereby acting to restore trade surpluses. The actions of most regional central banks thus far, however, fall short of what is needed.

While exports in some countries have softened of late, the negative impulse from global slowdown remains modest. Policy, however, has for some time been set for a sharp growth slowdown and fears about imminent export slowdown have dominated policy announcements for quite some time. While more recently this has been joined by verbalized concern about inflation, the relative inaction of central banks suggests that concerns about future growth still dominate. The effects of this policy loosening were compounded by the food price shock, and the existence of price control regimes in a number of markets, which concentrated the adjustment in a way which did not occur in countries with freer pricing regimes.

Our economists, therefore, argue that not only is inflation in Asia generally likely to remain high over the next few months, and even increase further in a number of countries, but it is likely to be much slower to come down than most expect. It is no coincidence that Taiwan and Singapore have had the strongest performing currencies this year, and they are the only central banks that are tackling this issue reasonably proactively.

The key here is that it would be a mistake to argue that high commodity prices are the only reason policy settings have ended up being too loose. Policy was set for recoupling in almost all markets in Asia, and yet decoupling in exports and GDP growth has persisted. Chart 3 (see below) shows an average core CPI for Asia ex-Japan. Clearly, once we account for the contributions of food and energy price inflation, Asia’s inflation issues are not settled. Along with concerns about policy being too loose, growth decoupling has contributed to a surge in imports, which has been compounded by the rise in commodity prices, to result in sharply worse trade balances. Decoupling has ended up not being all that it cracked up to be.

Source: Emerging Markets: FX Road Map (June 2008), HSBC Global Research

Certainly, the independence of central banks is an issue. As well, the political environment in many countries is doing little to help central banks respond to the inflation threat in a way which is most prudent from a longer term perspective, but also most uncomfortable from a shorter-term perspective.

[All of the above capture our views on Asian macro-economic policy rather well and are excerpted from the following publication: “Emerging Markets: FX Road Map (June 2008)” from HSBC Global Research]

Realistic to have assumed no de-coupling
To be clear, it was realistic on the part of Asia not to have assumed de-coupling on the part of Asia from the ongoing troubles in America. But the mistake was in setting “no decoupling” policies proactively without waiting for slowdown to set in, in American consumer spending. American consumer is yet to flinch and, perhaps, is acting with even higher than usual optimism in visiting shopping malls. They are trying to drown their blues in shopping and, in the process, setting themselves up for deeper blues in the years ahead.

But, policy was set in anticipation of slowdown
The important point here is that consumer-spending weakness in the U.S. is yet to set in. But, global monetary policy is too loose already as this chart below from JP Morgan shows. The global policy rate is far below where it ought to be, according to the simple rule devised by a U.S. academic John Taylor teaching in Stanford University.

Source: Global Data Watch, Economic Research, JP Morgan Chase Bank, New York, June 20, 2008

Be prepared for deeper and longer downturn
The troubling message from the chart above is that there is not much room to ease policy (and we include fiscal policy too) when they are likely to be most needed in 2009 – when the consumer in the U.S. wakes up to the reality. The absence of policy lever should lead to the acceptance that the economic impact on Asian households and the earnings impact on Asian corporations would be deeper and longer.

Where is the floor for Asian asset prices? – lower than you think
What is clear is that the price for these policy errors has to be paid in the form of lower asset values. That means weaker currencies, higher bond yields and declining stocks. The process is currently under way. Most of the Asian stock markets have yet to breach the previous lows reached either in January/February 2008 or in July 2007. That has to happen first. Hence, prices must first reflect bad news. Second, the flow of bad news must stop. Since much of the bad news is in the form of policy errors, the turnaround must start there. That is, policymakers must acknowledge their mistakes, promise a credible timetable for reversing them and begin to implement a few steps. Frankly, we are far away from that in Asia as admitting mistakes in public is not very Asian. Therefore, the floor for Asian assets is probably lower than it is for other regions, particularly in the West.

(These are the author’s personal opinions and do not necessarily reflect those of his employer)


  1. India is extremely vulnerable to capital flight. india’s forex reserves are accumulation of fii, ECB’s, private equity, nri deposits. these things must be paid back after 5 years. if we dont get more than 30 bn dollars than previous year every year. Rbi cannot sell dollars to defend rupee to accomodate oil impors because the above hot money inflows will turn to outflow in next 5 years. RBI has to decide to have long term or short term view. If rbi expects oil prices to remain high for forseeable future, its a tradeoff between short term pain or long term pain. Pain is sure.
    Even IT exports could be in jeopardy in near future if US slip into a recession( US is still not in a recession yet). Even less forex inflows into the system. Thus whole economic setup must be changed and tuned to run balanced current account

    Comment by satish — June 24, 2008 @ 9:07 am

  2. [...] points to rising inflation in Asian [...]

    Pingback by Assorted Links « Mostly Economics — June 24, 2008 @ 10:05 am

  3. Do you think that the oil price is entirely determined by physical supply and demand. How it is affected by speculative market especially future market. These are some of the often asked questions. This once again compels one to think of planing models of development. To do away with capitalistic direction of markets for very essential commodities.

    Comment by oommen cherian — June 24, 2008 @ 5:22 pm

  4. OC-
    listen to boone pickens. 85 mbd of supply and 87 mbd of demand. There is no speculation in oil market. In futures market there is a seller for every buyer. At expiry of current month futures, all long and short positions must be squared ie. at the day of expiry we will find real value of oil. at last expiry oil price was 135.7 d/b. there is spot buyer at 137 dollars. yesterday spot prices was 137 d/b.

    If we think oil is in speculation why not saudi aramco issue sell contracts in future market if they are not afraid of delivery default.
    yesterday iron ore prices for bao steel was raised by rio tinto by 95%.
    Dont you think iron ore price is in speculation if you think oil is in speculation. prices are determined by demand and supply for non tangible commodity.

    your intentions are quite wrong . After current price level oil is no
    essential commodity, it is a luxury. IT is this complacency that caused the price rise. people has decided comsuming oil is a birth right.

    Comment by satish — June 25, 2008 @ 8:37 am

  5. listen to boone pickens.There is no speculation in oil market. In futures market there is a seller for every buyer. At expiry of current month futures, all long and short positions must be squared ie. at the day of expiry we will find real value of oil.. there is spot buyer at 137 dollars. yesterday spot price If we think oil is in speculation

    Comment by Harishchandra Sharma — June 28, 2008 @ 10:56 am

  6. The sustainability in the speculation of oil prices is mainly due to the higher valuations given to the emerging markets across the globe and the growth anticipations that were created a year ago. If the pace of growth expected in emerging markets are real, then there is no problem for oil to sustain the speculation it is seeing.

    Comment by Prabhu — June 29, 2008 @ 7:59 am

  7. Value of assets measured on what scale? Reality is value of assets don’t change, it is the measuring scale that keep changing….. or purchasing power of paper currency backed by “nothing” is falling, how long can we sustain a blatant scam……

    The day Indian Farmers stop accepting paper currency in exchange for food grains India will be back on a path to prosperity.

    Comment by Ram K — June 30, 2008 @ 10:25 pm

  8. The actual problem with India is that we have a “Tax Greedy” government.
    And unless that is not brought under order, the parallel economy(black money)will dash all hopes of our prosperity dreams.

    Comment by Deepak Sahijwala — July 2, 2008 @ 12:53 pm

  9. [...] his opinions on how Global Market trends towards Decoupling have led to the Asian Market setback, in this article The key here is that it would be a mistake to argue that high commodity prices are the only reason [...]

    Pingback by What brought down the market « ???????? per diem !!!!!!!!!! — July 4, 2008 @ 10:42 am

  10. I disagree with Ram K.

    The problem is Indian people are greedy and do not want to pay tax.
    They are not used to the culture of tax.
    Let us face it India has low income tax rates compared to many countries.

    What is the percentage of tax assesees we have in this country of 1 billion may be 0.01%.
    If people dont pay tax how is the goverment expected to build roads,schools,hospitals etc.
    The person who doesnot pay tax doe not have right to complain.

    India is still a thirdworld country because the wealthy do not pay tax.

    If most people paid income tax we do not need indirect tax like sales tax,ET,LT etc.

    Indian should understand “USER PAYS” If you or your fellow citizens use the road,bus,train,police,court,hospital,universities,Army protection against Pakistan then you need to pay tax on your income.

    Change your attitude for the future your kids and grand kids.

    Comment by galicula — July 10, 2008 @ 11:01 am

  11. “If most people paid income tax we do not need indirect tax like sales tax,ET,LT etc.”

    Nonsense – Income tax is a draconian socialist/colonial concept which assumes that the state OWNS your income and it can decide what part of your income you get to keep.
    The US didnt even have income taxes till 1913 (not so surprisingly the Fed too made its appearance in 1913).

    User pays is “consumption” tax. which is ok. Except that it should not go to the goverment -it should go to the entrepreneur who is providing the service.Few innovative tarrifs should be good enough to take care of the defense needs. Its shameful that we have a monstrous government looming large over our daily lives.

    Comment by Dsylexic — July 31, 2008 @ 2:01 pm

  12. Dslexic says we do not need Income tax and user should pay for service.
    If there is no tax than how would the goverment subsidise things like petrol,court system,Public transport etc.

    If all those services need to run on no-loss policy (Or private ownership),then Indians would be paying a lot more on road tolls,bus fairs,petrol,legal system,water rates,drinange services.

    I agree with Dslexic that privatisation of many services would help increase quality of service,however we have a lot of people who cannot afford private service or unsubsidized service.

    The answer to this is a balanced sysytem,where a lot of people who don not pay tax has to be brought to tax net and also a lot of services must be privatised with goverment montitoring priceing.

    I understand the frustration of tax payer:

    1.They dont get value for their tax in form of service.
    2.A lot of their tax money is wasted on unsound spending decisions.
    3.Large portion of tax payers money are lining the pockets of corput politician and Buracrats.

    but what is even more frustrating is some middle class worker earning Rs 30,000 a month pays tax,but a business man or polotician who earns lakhs of rupees a month does not pay a cent in tax.

    Educated people like Dsylexic should increase awarness among indian people to question the goverments.I am trying for tax payers awareness program.

    We need transperancy on goverment expenditure at every level and we need debate on Goverment spending.
    Currently all levels of goverment is unchalanged on how they spend tax payers funds.

    Comment by Galicula — August 1, 2008 @ 5:03 am

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