The finance minister told the country it should be prepared to deal with capital inflows and the steel minister is reported to have asked steel companies to hold back on increasing prices. The Prime Minister, too, has weighed in with his advice to corporate India that it should keep executive compensation growth at moderate levels and avoid conspicuous consumption. Perhaps I missed something. Did we also change our name to Venezuela or Cuba in the last week?
As Rajeev Malik observed in Business Standard, the government is not doing enough to rein in relatively “frivolous” external commercial borrowing while the central bank is damned if it intervenes and damned if it does not. Yes, capital inflow is mostly a good thing. It comes in various guises and the devil is in the details. If it finances construction of shopping malls and luxury-gated communities and condominiums for expatriate Indians or for resident non-Indians, then it is not necessarily a good thing.
The Philippines is a case in point. Its foreign exchange reserves are rising, stock market is booming, currency is super-richly valued and analysts are gushing. Reality, though, paints a sober picture. Investment spending has grown at a measly annual rate of 0.8% in the last eight years, whereas export growth rate has been nine times higher. Its banks are lending more for financial activities than for manufacturing or construction.
Clearly, our government is not getting it. The prescriptions and policies of the government point to the fact that productive investment is lacking and the government has neither the desire nor the motivation to infuse life into it. Hence, low-quality growth looks set to continue, with all its attendant economic costs. Inflation might yet prove to be sticky in the country.
It follows, then, that the days of monetary policy tightening are not over. At the same time, if global risk appetite continues to remain high, the Central bank would have to invent ways of stopping the inflows at the borders or making them disappear inside the country. Further, with these demand-stimulating macro-economic measures and price-caps, the country would not only continue to face inflation but also eventually squeeze the “animal spirits” of the corporate sector back into the bottle. In other words, today’s growth strategy is immiserising the future.
The Prime Minister is right that high growth rates do not fall from the heavens but are due to prudent and sensible policies. As an economist, he knows well that economies operate with a lag. The UPA government has enjoyed the benefits of a few sensible initiatives from the previous government. Similarly, the next government would reap the consequences of inaction and confusion on the part of the present government.
While global growth might be considered supportive of developing countries, that it is boosting animal spirits well beyond desirable levels is evident in the capital sloshing around and looking for assets to buy, including used violins. Yes, a hedge fund is investing in used violins. That is why Colombia joined Thailand in imposing capital controls. It has asked investors to place 40% of their investments in a no-interest deposit with the central bank for six months. The Colombian currency has appreciated 29% in the past 12 months, the most among 70 currencies that Bloomberg tracks, against the US dollar.
Alan Greenspan, the former chairman of the Federal Reserve, warned that Chinese stocks were at risk of a serious correction. It had an impact—in every market except China! That should not be a surprise, for the government in China has done precious little to stem the flow of liquidity that naturally arises from its exchange rate policy. Interest rates are simply too low. Its widening of the trading band from 0.3% to 0.5%—and its anaemic deposit and lending rate increases on the eve of the strategic economic dialogue (SED)—prompted one observer to wonder whether China thought the US supine and stupid and to conclude that perhaps, it did. As expected, the SED yielded little. The yuan would strengthen gradually and that would barely make a dent on China’s export competitiveness. Little wonder that the risk of protectionism is rising as alarmingly as China’s reserves are.
Speaking to clients at a Citigroup seminar, Robert Rubin, former Treasury Secretary in the Clinton cabinet, said that as far as he could recall, the current environment was the most testing. Of course, he conceded his propensity for caution. Perhaps, in making this remark, he was not being cautious enough.
There is one thing that is common between India’s stock market and macro-economic policy management: Both are ill-prepared for any global economic or financial shock.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer (Singapore) Ltd. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org