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Saturday, 25 August 2012 00:00
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Governments dither, central banks asked to step in


The US Congressional Budget Office’s (CBO) latest warning is perhaps the most eloquent sign of our times. While the minutes of the last meeting of the US Federal Reserve suggest most participants are in favour of a QE3, the CBO projections show that, in the absence of any agreement between US politicians to reverse the Bush-era tax cuts that are legislated to come to an end soon (this is the ‘fiscal cliff’ that will reduce government expenditure by 4% of GDP), 2013 GDP growth will fall by 2.9% (on an annualised basis) in the first half of the year and 0.5% in the full year. This is a far more worrisome projection than one by the IMF after its Article IV consultations—it projected a 1% growth in 2013—with the US. But since there’s little hope US politicians will get together to tackle the fiscal cliff, the big hope right now appears to be QE3!

Across the Atlantic, an interview given to this newspaper by Klaus Regling, the CEO of the European Financial Stability Fund (EFSF), shows the problem is quite similar. While Regling spoke of how the overall deficit of 17 euro area economies is likely to shrink from more than 6% of GDP a few years ago to under 3% next year, the immediate problem is not the fiscal deficit. It is of the lack of faith of investors to lend to governments—or their banks—funds that would have been available in the normal course. So, if European banks need 420 billion euros (according to Nomura, in a severe recession scenario), those are not going to be available. Italy is a good example since, despite running a primary surplus, investors are still wary. Shrinking government, still the German mantra for what it derisively calls the Club Med nations, is all very well, but only worsens things. If Greece, for instance, is borrowing short-term (3 months) at 4.4%, its debt stock is going to go up each year and, in the event of the economy shrinking (it shrank 6.2% in Q2), the relative increase will be even more dramatic. Do the same exercise for Italy and Spain, and the enormity of the problem really hits you in the face.

It’s not as if the problem is restricted to the Atlantic ocean area, much the same is being played out in India, with the government breathing down RBI’s neck to lower interest rates (a necessary but not sufficient condition) to improve investor sentiments, but doing little on its own to improve the policy stasis. What complicates matters for India is that, were there to be a QE3 in the US or an LTRO in Europe, there would be two opposite reactions, and it’s not clear whether the net impact will benefit India or not. More global liquidity as a result of a QE3 or an LTRO will mean a ‘risk-on’ behaviour and therefore more FII and other financial flows into India. That will boost the Sensex and shore up the rupee. More liquidity and ‘risk-on’, however, also means more global funds for investing in commodities like oil which, in turn, would mean higher oil sector losses, greater public sector dis-savings, higher budget deficits … basically, there’s no such thing as a free lunch.


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