A Must Read for Central bankers and Forex / bond dealers -Learned Observations from Graeme Wheeler

Some reflections on the world of central banking: Excerpts from the speech of the Governor of the Reserve Bank of New Zealand,  to the Institute of Finance Professionals NZ, Auckland, 14 October 2015. (Emphasis is that of this blog author) 

The global economy appears to be growing at around 3 percent - slower than its average over the past three decades and the weakest growth since 2009. This weakness comes despite several supportive factors including: the unprecedented monetary stimulus; the positive effect of low commodity prices on spending power; and cheaper and more sophisticated information technology. For example:

• the world has never seen cheaper financing. Policy rates are close to zero in advanced economies that collectively generate 2/3rds of world output, and quantitative easing by major central banks in advanced economies has totaled around USD7 trillion in recent years.¹
• due mainly to the weakening in Chinese demand (but also to strong supply in many markets), prices of a wide range of commodities have been falling since early-2014.² While this slows growth in the developing world (which is the main global source of commodities) falling commodity prices are generally positive for growth in developed countries.
• the decline in the cost of information technology over the past three decades possibly represents the largest continuous set of factor cost reductions the world has experienced. Not only is the marginal cost of storing, processing and transmitting information essentially zero, the creative destruction of information technology has generated new products and consumer markets, and enabled further efficiencies to be squeezed out of global supply chains.

Despite these factors, and the ease with which capital can flow across borders, economic growth rates even in the advanced commodity importing countries remain below potential growth rates eight years after the onset of the Global Financial Crisis (GFC).

 The inflation picture (also), is complicated. In the vast majority of the 30 or so economies (mainly advanced economies) whose central banks pursue inflation targeting, headline and underlying inflation have averaged below specified goals over the past few years. There are several reasons for this: levels of excess capacity in factor and product markets remain high in many economies; wage outcomes have been subdued, even in countries with low unemployment; surveys show that inflation expectations have declined; commodity prices have fallen substantially over the past 18 months; and the internet and other technologies may be changing the tradables content of traditional non-tradable goods and services.

...the greatest concern at this point lies around the growth outlook for China. Over the past 35 years, China has been the world's most successful economy, increasing its share of world output from below 3 percent to 15 percent currently. Although China's economy is just over 60 percent of that of the United States (at current exchange rates) it has a much greater impact on commodity markets and global trade volumes. China is now the number 1 or 2 trading partner for over 100 countries and its imports of non-oil commodities are around 2 ½ times higher than those of the US.

...China's construction and manufacturing sectors continue to be a concern, particularly as much of the investment has been financed through extensive borrowing, much of it in the rapidly expanding shadow banking sector. China's debt burden has increased at an unprecedented rate - from 130 percent of GDP in 2008 to around 200 percent currently. But financial markets have also been unsettled by other factors, including the types of policy measures introduced as the Shanghai index began declining, the magnitude of recent capital outflows, and the questions raised by the decision to allow the RMB to depreciate by 3.5% over two days in August.

Although the Chinese Authorities have indicated they want a stable RMB, private capital outflows continue to be large. Any substantial depreciation in the RMB would have serious implications for the world economy: it would risk triggering exchange rate adjustment among competitor economies - particularly in Asia, and would spread deflationary forces across the globe.

...there are significant puzzles around the (US) labour market and investment climate. Why, for example, has recent US labour productivity growth been so slow, and what explains the substantial wage moderation and weakness in business investment at this stage of recovery? On the policy side, there is uncertainty as to when and how fast the process of raising interest rates might take place, and its possible impact on international growth and asset prices - especially at a time when the Bank of Japan and European Central Bank are considering expanding their quantitative easing programs.

It's a world of complex linkages, of instantaneous information, massive daily cross-border portfolio flows, unprecedented monetary accommodation and, in some instances, sharp swings in market liquidity and asset prices.

It's also a world in which high expectations have been placed on central banks to use all of the scope within their mandate to stimulate growth in demand and counter the risk of inflation remaining below desired goals for extended periods. In seeking to do so, central bankers have often had to work without the support of fiscal policy, or the structural adjustment reforms needed to raise potential output growth.

 Flexible inflation targeting has been successful over the last 25 years in reducing inflation to low and stable levels - the best contribution monetary policy can make to an economy's long-run growth.  

Monetary policy is, however, relatively powerless to influence the decisions that determine long-run economic performance and distributional outcomes. For example, over the long run, monetary policy can do little to generate higher spending by households and firms. Even in the shorter term, monetary policy's influence may be low in an environment where debt levels are high and where there is considerable uncertainty about economic prospects.

Monetary policy can influence risk-taking in asset markets, but this does not necessarily translate into risk taking in long term real assets - requiring the investment and entrepreneurial decisions that underpin productivity growth and hence long-run improvements in living standards.  

Similarly, the Reserve Bank is unable to influence long term real interest rates. These are affected by a range of factors, including global savings and investment flows, risk premia and expectations for economic growth and inflation. Monetary policy can only influence short term interest rates and, over the medium term, actual and expected rates of inflation.

Monetary policy generally affects inflation outcomes with a 12 to 18 month lag, reflecting the pace at which changes in interest rates and the exchange rate typically spread to risk-taking and spending in the economy. This means that central banks are constantly trying to interpret the outlook for inflationary pressures, growth and financial stability 12 - 18 months ahead.⁷

Financial markets, which respond almost instantly to policy signals and expectations about risk and returns across the world, operate with a more immediate focus. Moreover, the magnitude of their transaction flows can swamp the balance sheet strength of any central bank.

Mechanistic approaches to setting monetary policy don't work, and since monetary policy affects inflation with a 12-18 month lag, by the time one is certain as to the correct policy adjustment, it may already be too late to be effective.

At a technical level, setting monetary policy involves estimating output levels and forecasting how they might evolve relative to the level of potential output. This "output gap", together with inflation expectations, are seen as the main drivers of inflation pressure in the economy.  A major challenge is that potential output, the output gap and the level of neutral interest rates are not observable; all have to be estimated through economic modelling.

 

Are not Indian banks unfair to customers?

India's banks seem to be manifestly and insensately unfair to customers.  They reveal an anti-consumer bias in their approach to interest rates. One IMF study shows India's banks are faster in effecting a hike in lending rates, but a rise in their deposit rates is not so quick[1]. The IMF research also showed that these banks are slow in effecting consequential changes in their interest rates pursuant to the changes announced by RBI in its policy rates.

In her research paper on 'Monetary Policy in India: Transmission to Bank Interest Rates', IMF Economist Sonali Das has said there is evidence of "asymmetric adjustment to monetary policy: throughout most of the sample period, deposit rates do not adjust upwards in response to monetary tightening, but do adjust downwards to loosening; and the lending rate adjusts more quickly to monetary tightening than to loosening". 

As if to re-emphasise the  IMF study, pursuant to the repo rate cut of the RBI, the two domestic systemically important banks State Bank of India (SBI) and ICICI Bank have reduced their base rate , (the benchmark to which all loan rates are  ratcheted to, by 40 and 35 basis points (bps), respectively. However, the home loan rate for new customers has come down by only 20-25 bps.[2]

Banks act in oligopolistic herd behaviour. They  can afford to keep rates high as customers seem inelastic to rate movements but only sensitive to outlook. So if SBI and ICICI the big banks (TBTF- too big to fail banks) keep on to high rates, all others muster courage to delay the transmission or pass on only a portion of the benefits. Banks in India are passing on their inefficiencies  ( of NPA, of staff expenses, wasteful extravagance) to the customer. Banks are profiteering and protecting the shareholders ( who get better dividends because of lack of pass through) and their own staff members  at the cost of customers.

India needs a Ralph Nader.

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[1] http://profit.ndtv.com/news/banking-finance/article-banks-in-india-slow-in-passing-on-rbi-rate-changes-imf-paper-776372

[2] http://www.business-standard.com/article/finance/banks-to-face-rbi-heat-for-not-passing-on-base-rate-cut-benefit-115100701183_1.htmlRegulators suggest that they license more banks to ensure greater competition.

Source: Business Standard

A tale of 2 Central banker speeches

Is it that the advanced economy's central bankers are deliberately sending contrarian signals in a  subtle tactic with the following objectives:
 (a) keep emerging markets in an unstable equilibrium from  a competitor point of view; (a hit and run technique to weaken the potential opponent)
(b) have the hot money flows back to home turf so as to keep wealth values on the move up in home countries; 
(c) a modern day drain of wealth theory where foreign investors sell in hordes at market peaks and exit for home in anticipation of such rate hikes;
(d) avoid an excessive rise of home currency...

At Brighton, Kristin Forbes. of the Bank of England said quite a few things that seemed to suggest that she may join in for an interest rate hike:

• the widespread pessimism (in the global markets) is overstated.'
• China  is responsible for over one-third of global GDP growth since 2011, and is still expected to drive about 35% of global growth this year. India is on track as per IMF.
• Ukraine, Russia, Brazil, Belarus, and Ecuador are the only emerging markets that are in recession (defined as two quarters of negative quarterly GDP growth). 
•  Emerging economies will continue to face  challenges related to its debt overhang, financial system, and demographics...
• .. much of the current gloomy discussion appears to be overblown.  

Source Bank of England

At Amherst- Janet Yellen 

"The labor market has achieved considerable progress over the past several years. Even so, further improvement in labor market conditions would be welcome because we are probably not yet all the way back to full employment. Although the unemployment rate may now be close to its longer-run normal level--which most FOMC participants now estimate is around 4.9 percent--this traditional metric of resource utilization almost certainly understates the actual amount of slack that currently exists: ..."

"judgments imply that the real interest rate consistent with achieving and then maintaining full employment in the medium run should rise gradually over time. This expectation, coupled with inherent lags in the response of real activity and inflation to changes in monetary policy, are the key reasons that most of my colleagues and I anticipate that it will likely be appropriate to raise the target range for the federal funds rate sometime later this year "

Source FRB

The views expressed here arewithout any risk or responsibility. 

RBA's Financial Stability Report voices concerns:

Reserve Bank of Australia in its latest financial stability review report points to some countries  such as Brazil, India, Indonesia and  have increased their foreign currency borrowings in recent years. 

"Depending on whether and how they hedged, the profits of some corporations might come under pressure because of domestic currency depreciation... and slower economic growth."

The Report also points out that increased exposures of advanced economy investors to emerging market corporations and sovereigns in recent years may be a channel through which financial stresses in emerging markets spill over to advanced economies.

Liquidity risk might be underpriced by some investors.

There is apparent over-investment in some sectors of the Chinese economy such as real estate and heavy industry

Risks in China are particularly prominent for highly leveraged firms, including some firms in the oil and gas industries that are exposed to a decline in energy prices and construction firms that have raised significant foreign currency denominated bond funding in recent years.

Many Chinese local governments have large debts, and land sales account for a sizeable share of their revenues

(Note: Emphasis ours) 

Reference: http://www.rba.gov.au/publications/fsr/2015/oct/pdf/global-fin-env.pdf

Trying times at India's banks? Human Resource risk aggravates Operational risk.? Accountability of the regulators?

The executives and governance tiers of India's public sector banks and regulators seem to have much to be ashamed of as exemplified by: 

1) It is reported that Rs. 6,172 crore  ( Rs  1 billion = 100 crore ) was remitted from Bank of Baroda to Hong Kong as payments for non-existent imports in  cashew, pulses and rice. The amount was purportedly  deposited in 59 accounts in cash as advance for imports that never existed. The amount remitted in each instance was below $100,000. These remittances were presumably an advance towards imports ;  in most of the cases, the beneficiary was the same. The  exchange-related transactions were carried out in newly opened  accounts. Heavy cash receipts did not seem to trigger exceptional transaction report (ETR). The bank should have monitored the high-value transactions and reported suspicious transactions. The systems and procedures were flouted. 

2) It is reported that at Bank of Baroda there has been a  bill discounting scam in Gujarat by a textile borrower involving Rs 350 crores also.

3) There has been  non-payment of dues by Mr. Ramachandran 's Atlas Group, an Indian jeweller with operations in the Gulf. BoB has an exposure of 70 million dirhams or Rs 120 crore through its Dubai branch. The Atlas group owes 20 banks a total sum of Rs 1,000 crore according to press reports.

4) The recent transfer of BoB’s Executive Director KV Ramamoorthy to United Bank, reportedly  due to certain transactions made by the Dubai branch which were allegedly not in compliance with existing rules  seems to indicate managerial and executive connivance or complacency.

 5) The cup of woes of United Bank of India is over full. Archana Bhargava  chairperson and managing director, who had a  brief stint of about 10 months brought  accounting malpractices at the Kolkata-based United Bank of India to the Reserve Bank of India (RBI) attention but had to leave for some reason .  By sending Ramamoorthy there, the regulators seemed to add to the bank's non performing assets! 

5) Mr Jain CEO  of Syndicate Bank was arrested by CBI for allegedly taking a bribe of Rs 50 lakh for increasing credit limit of some companies. He was held for allegedly negotiating with Bhushan Steel for 'illegal gratification' in return for granting credit extension to that company as it had defaulted on payment of loan instalments amounting to crores of rupees to the bank.

7) Vijay Mallya’s  Kingfisher's borrowings from   17 banks including the largest of all  State Bank of India (SBI) exceed Rs 7,000 crore of non perforing loans with interest overdue. Central Bureau of Investigation (CBI) has found that Mallya even diverted part of the loan amount to tax haven countries.  It is investigating the IDBI case and this enquiry is likely to spread to other banks.

Regulators   seem lost in making exhortation speeches rather than taking action. 

This blog's views are academic views expressed without any risk or responsibility. The blog recommends no investment 

The value of an asylum seeker...

Germany has received 547,034 applications for asylum since 2011 ; France: 255,800; Italy 155,536 United; Kingdom 125,139. according to New York Times. This blog attempts to draw up a value sheet:

Value = Benefits minus costs

Benefits and costs of the worker migration to Europe would be:

Benefits	Costs
Outflows are  reverse of Dutch disease	Forex outflow  weakens if not deteriorates balance of payments
Lowers cost of production; wages move downwards	Unpredictable flows of human capital adds to severe unemployment woes
Stimulates  demand for locally produced and traded goods	Unpredictable flows of fund flows- might be used by launderers
Helps consumer by reducing the cost  of  production	Substituting local labour adding to social tensions
Good work habits as they look to earning incomes	Dis-savings and lack of capital formation
Higher saving rates	Virtually little investment in capital generation
Income lubrication in the circular flow of funds	Lowers standard of living directly
Financial Sector transaction volumes increase	Income distribution turns adverse

Note:

An asylum seeker is defined as a person fleeing persecution or conflict, and therefore seeking international protection under the 1951 Refugee Convention on the Status of Refugees;

A refugee is an asylum seeker whose claim has been approved. However, the UN considers migrants fleeing war or persecution to be refugees, even before they officially receive asylum. (Syrian and Eritrean nationals, for example, enjoy prima facierefugee status.)

An economic migrant, by contrast, is person whose primary motivation for leaving his or her home country is economic gain. The term "migrant" is seen as an umbrella term for all three groups. (Said another way: all refugees are migrants, but not all migrants are refugees.)

Deutschland: Its more of Debit than Credit...

First came the ignominy of corporate manipulation by Volkswagen in its software. German management principles are as much under stress as the economic firmament.

Then comes the news that exports fell hard and long - by 5.2% in August compared to July, according to Germany's  Statistics Office.  The imports in to Germany too had fallen ; so trade inwards and outwards were both affected.  

Then came the losses for 3rd quarter at Deutsche Bank where losses exceeded $ 6. 7 billion . 

If Europe's  big economy is weakening. markets will capture the economic seismic tremors. 
It seems a seller's day. 

The views expressed are without risk and responsibility. This blog recommends no investment.