Late on Friday evening, an email with an attachment was circulating in the financial industry across the world. The attached picture was that of George W. Bush with a caption, “Missing me, yet?” If this is the best reaction that the industry could come up with for the “Volcker Rule” proposed by US President Barack Obama, then the industry probably deserves more than what the president is belatedly proposing.
The truth is that Obama has finally shown some courage. It is a bit ironic to see Republicans paint him as the architect of bloated government, big deficit and champion of over Main Street. The legitimate complaint that could be laid at his door is that he allowed himself to be the prisoner of the circumstances that he inherited from the previous administration.
The financial industry and investors should welcome any proposal, no matter how imperfect it is, that reduces systemic risk via limited recourse to leverage, since excess debt caused the crisis. Instead, investors appear myopic. They also cheered the election of a Republican senator as his victory made healthcare reform that much more difficult. The US’ consumption ratio (to gross domestic product) is artificially high because of the huge healthcare burden. Proposed reforms might help lower it. That is good news for discretionary consumer spending. Hence, investors should regret the lengthening of the odds of the passage of the Bill. Instead, they cheered and bought healthcare companies. Quite a few of them—reputed ones—are under investigation for various malpractices that endanger human lives. It is unclear to Yours Truly if at any time in the past has such a cleavage opened up between the interests of Main Street and all that Wall Street stands for. Where does this leave Asia?
My perceptive friend, who works for one of the world’s best money managers, sees evidence of intelligent policy coordination between the US and Asia in Obama’s proposals. The US has been at the forefront of creating systemic instability with its willing acquiescence to the interests of Wall Street for at least a decade. Hence, any lead taken by the US is likely to embolden other nations to come up with similar, if not stiffer, measures. They have been chafing at the US’ reluctance thus far. So the proposals would, at the margin, make the world safe from financial innovations.
Second, to the extent that such measures reduce the ability of Western institutions to take risks and send capital to emerging economies—through reduced leverage—it expands policy room for emerging Asia to raise interest rates without worrying too much about capital inflows and undue appreciation pressure on its currencies. He, therefore, sees a method in China requiring its banks to set aside more reserves against their assets and the US coming up with the Volcker Rule in short order.
The caravan moves to India this week. The Reserve Bank of India (RBI)’s monetary policy committee is meeting on Friday. Consensus is strong that RBI would raise the cash reserve ratio by 50 basis points. It is a bit troubling that market opinion does not anticipate interest rate hikes. To be fair, RBI too has been downplaying such expectations by talking about inflation having peaked. We do not know how far that prediction would turn out to be accurate. At best, the risk to inflation remains two-sided.
Therefore, the only justification for RBI to be slow to react to inflation would be private information that the government would undertake credible fiscal tightening in February. Of course, if the government failed to do so, RBI could always tighten more aggressively in March. Hence, for now, the pressure is not so much on RBI as it is on North Block.
The United Progressive Alliance (UPA) government, in general, has been lethargic about either improving governance or in removing the shackles on the economy that entrench poverty. Just reading a blog post by Gurcharan Das on James Tooley’s book, The Beautiful Tree: A Personal Journey into How the World’s Poorest People are Educating Themselves, would inspire a decent human being to make it easier for the poor to educate their children. Instead, the Right to Education Bill seeks to derecognize the unaided private schools that the poor have turned to. The government does not let go nor does it let others go for it.
Bare Talk had written last year that investors should actually embrace the country that opts for “pain now; pleasure later”. Not too many nations took the hard route in 2009. That was partially understandable. China has moved early in 2010 and the US is finally showing signs of coming to grips with the underlying issues. A wannabe superpower cannot afford fiscal profligacy and executive stranglehold on the economy. The Budget is the last chance for UPA II to bring actions into alignment with aspirations. Otherwise, it risks hurting the nation’s standing and long-term growth prospect.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org