On Saturday morning, as my wife and I were savouring the Pongal weekend, someone arrived offering to show us apartments for us to buy. It is one thing for developers to distribute pamphlets and leaflets, announcing the launch of new housing projects, but quite another for agents to come canvassing for new projects, offering to take potential buyers to the project site, view model apartments, and so on.
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Just the day before, the Singapore government had announced further tightening measures to cool down the fervour in the property sector. Second homes would be eligible for bank loans only up to 60% of the value of the property. There would also be a stamp duty of 16% on the value of the sale, payable by the seller, if the unit is sold within a year of purchase; this would drop to zero after four years. It is clear that either the message has not sunk in, or that more of it is needed. Bare Talk suspects that governments in the developing world need to do more to avoid the painful fallout of booms turning into bubbles and finally ending up in busts.
Thus far, all of them have been caught by surprise. First, they did not expect the recovery from 2008 to be as big and as fast as has been the case. Whether the recovery is on firm foundation and is sustainable is a different debate. But it has been a strong one so far. Second, they had given greater weightage to economic linkages between the developed world and their countries. This, coupled with their disbelief about the strength of the recovery, made them hesitate in tightening their policy stance pre-emptively. Third, and a corollary of the previous two, is that they underestimated the impact of capital flows from the developed world on their economies (economic growth and cost of living) and asset prices. Of course, fourth and finally, winners from asset price booms usually carry more influence with governments than non-participants or losers. Hence, politically it is difficult to tighten policy to slow or end asset price booms.
This explains the vacillation of many Asian countries in 2010 in tightening monetary conditions in their economies. Their window of opportunity is closing fast. They have to act now. Some are beginning to act, even if belatedly. The Bank of Korea and the Bank of Thailand raised interest rates last week. China raised bank reserve requirements (amount of cash banks have to hold against their deposits). More remains to be done by these and others. India has its monetary policy meeting on 25 January. Rates should go up by at least 50 basis points.
It also brings us to the point that is often overlooked in the appraisal of easy monetary policy. Other things being equal, low interest rates are supposed to boost investment spending in residential, non-residential structures and capital goods. Invariably in the last decade-and-a-half, as the world began to experience ultra-low real rates in the developed world, investments have taken place in speculative sectors and assets rather than in long-run potential growth-enhancing sectors. In an interview to this newspaper, a former governor of the Reserve Bank of India noted the failure of market forces to allocate credit to the right areas. The newspaper agreed with his diagnosis, but disagreed with the suggestion that countries should or might consider credit controls and direction.
Both were right. The former governor was right about the diagnosis, and this newspaper was right to be agnostic about the prescription. The problem is as much with policymakers in the West as it is with market forces.
In recent times, central banks in the Western world have depended on asset prices to rebuild their economies after every downturn. Partly, they have had no choice as their public and political leadership have had no stomach for real reforms and the pain needed for restoration of competitiveness. Partly also, they have been captive to the interests of the financial sector. Low interest rates help banks rebuild their balance sheets and profitability quickly. It is easy to lend for speculative purposes, as the returns are bigger and quicker. Hence, low interest rates are mostly about creating asset price bubbles and not about investment spending. The situation is unlikely to change in the near term.
While the developed world struggles with these policy chains imposed by political economy considerations, the implication for the developing world is clear. Unwillingness to recognize the dangers posed by the repetition of boom and bust cycles would bring the prospect of the developing world down, to be on a par with the ageing developed world, carrying excess debt and commitments.
The amount of increase in the cost of capital required to make the returns on their domestic assets unattractive for overseas and speculative funds is too high to be acceptable to their domestic population. The only recourse left for them is capital controls.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views.
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