From Athens to America…

Is Greece the Lehman Brothers of the next crisis?

Rating downgrades for Greece, Portugal and Spain have triggered fears of a widespread sovereign debt crisis. While an IMF-backed European bailout package is being worked out, it may be a case of too little, too late and at best might help delay the disaster. Given the lack of a sense of urgency among European governments to stitch together a rescue package and the increasing estimates of the size of the bail-out, the financial markets have started pricing in a high chance of a default by Greece.

• What would a default by Greece on its debt obligations mean for Euro and EU (and for global financial markets)?
• Who is the next in line?
• Does UK face an imminent rating downgrade?
• Will the sovereign debt crisis spread beyond Europe?
• What happens to the ongoing global recovery?

The focus now is on the so-called PIIGS economies – Portugal, Ireland, Italy, Greece and Spain – the European economies running heavy debt burden and high deficit position. However, the growing risk aversion might trigger a sovereign debt crisis, where cost of raising money for the countries would increase. A general loss of confidence in the safety of sovereign debt will chill the financial system and would be disastrous for the still fragile recovery. See the position of debt and deficit for other major European economies.

Talking about the risks beyond the peripheral EU economies, virtually no rich country has a “sustainable” debt position. Whether it’s UK, US or Japan, none is running a tight enough budget or growing fast enough to stop the debt burden from rising. It may sound preposterous to compare Britain’s fiscal condition with Greece’s or to talk about the American economy in the same breath, but the stakes are too high to remain complacent.

While a default by Greece cannot be ruled out, it would be interesting to see how the events unfold over the next few months in Spain whose economy is much larger than Greece. If Spain comes out successfully, it would mean the sovereign debt crisis can be contained for now. In the longer run, position of high indebtedness of the rich nations would still be a major risk.

KIDS' GLOVES OFF !!!

Taking a tough stance on the spiraling inflation, RBI has announced a surprise hike in its key policy rates – repo and reverse repo –by a quarter percentage point each. This is the first increase in two years and more tightening measures are expected to follow as the central bank gears up to fight inflation. Post-increase, the repo rate stands at 3.5% and reverse repo rate at 5%.

The hike comes one month before the scheduled annual policy review and follows a 75 basis points hike in the cash reserve ratio in January. The rate hike should anchor inflationary expectations and contain inflation going forward, the central bank said. The measure also shows policy makers’ confidence in the momentum of economic recovery. As liquidity in the banking system will remain adequate, credit expansion for sustaining the recovery will not be affected.

While the headline inflation on a year-on-year basis at 9.89% exceeds RBI’s baseline projection of 8.5% for end-March and is within a striking distance of a double-digit score, India’s industrial production gained 16.7% in January following a 17.6% increase in December from a year earlier - the fastest pace in more than a decade. The high inflation was until recently perceived to be on account of supply-side factors. But, the central bank now recognises the rising demand side pressures accentuating and complicating the risk of rising inflation.

It is clear that the focus of monetary policy will now tilt towards containing the inflation and inflationary expectations, rather than worrying about a pre-mature tightening undermining the recovery. The fine print of the RBI statement indicates that the pace of the ‘calibrated exit’ would be accelerated. Please share your views.

• Will there be another 25 basis points hike in April? My expectation is YES followed by a series of hikes.
• What will be the level of the policy rates in one year from now (March 2011)? My hunch is at least 150 basis points above the current level.

EXCEPTIONALLY LOW …….. FOR AN EXTENDED PERIOD ……..

America’s Federal Reserve indicated it would be keeping interest rates at close to zero for the foreseeable future, in order to nurture the economic recovery. While the Fed has declared its optimism that the country’s economy was slowly recovering, it decided to maintain the target federal funds rate at the current level of 0-0.25% in view of a mixed picture of the recovery from recession amidst low rates of resource utilization, subdued inflation trends, and stable inflation expectations.

The Fed is widely expected to maintain the current level of interest rates through 2010. However, more significant will be its moves on withdrawal of the liquidity stimulus programmes running into hundreds of billions of dollars that have been in force since the beginning of the sub-prime crisis – the pace and timing of the unwinding. Also, when it is going to drop the four magic words from its statements – ‘exceptionally low’, ‘extended period’.

Of froth and bubbles
.…. and fundamentals

In 2003, the Bombay Stock Exchange's Sensex index passed what was seen as the psychologically crucial 4,000 mark. It closed Thursday at 14,203.72, and many traders expect it to hit 15,000 this year.

Stock-watching has become an obsession in India, one that rivals cricket and Bollywood. Believing in India's stock markets means believing in India itself — and in the country's ability to transform its combination of a young population, a dilapidated infrastructure, chaotic streets and unbridled optimism into a corporate superpower.

For now, markets in India are on a roll, surpassing even the rosiest forecasts, thanks in part to a young, wealthy, expanding middle class that is banking on aggressive corporate growth. While Alan Greenspan, the former chairman of the U.S. Federal Reserve, is offering warnings about China, Indian indexes have hit new highs drawing in foreign investors and Wall Street banks.

Many Indian companies are looking to take advantage of the fervor. This week, the country's largest public offering came to the market, the $2.4 billion float of the real estate company DLF. Later this month, the state bank ICICI plans to tap markets in India and the United States for $5 billion.

The frothy share prices and large initial offerings are exacerbating a debate in India. Market bulls say a fundamental shift is under way as consumers tie their personal wealth more closely to India Inc., paving the way for a more prosperous middle class. But bears have begun to talk about a bubble fueled by naïve optimism and day trading. Indian investors have forgotten, critics say, the heavy losses they suffered after fraud racked the markets in the early 1990s and the technology bubble broke a few years ago.

Source : As stocks soar in India, everyone wants in (International herald Tribune)

BOJ Leaves Rate Unchanged at 0.5 Percent

The Bank of Japan decided Friday to keep a benchmark interest rate unchanged at 0.5 percent, maintaining its ;wait and watch’ policy before moving the rates further up. The bank last changed the benchmark interest rate in February, doubling it from 0.25 percent. That was the first hike since July 2006, when the bank ended five years of near zero interest rates. The low interest rates, to a great extent, helped the word’s second largest economy to come out of a decade of stagnation.

The central bank's decision at the end of a two-day meeting was unanimous. There are expectations that the BOJ would like to wait for more signs of economic strength before tightening policy.

Figures released earlier this week showed that the economy grew at an annual pace of 3.3 percent for the January-March quarter, up from an earlier estimate of 2.4 percent. The nation's unemployment rate has also declined to 3.8 percent in April, the lowest level in nine years.

However, consumer prices have fallen the last three months, raising concerns that Japan might be slipping back into deflation. The core consumer price index edged down 0.1 percent in April, 0.3 percent in March and 0.1 percent in February — which was the first drop in 10 months.

Inflation in China surges to two year high

Chinese inflation rose to its highest level in more than two years, raising renewed concerns about potential fallout of the sizzling growth in the economy. The surge in inflation is mainly driven by soaring prices for pork and other food items. According to government figures released Tuesday, consumer prices rose by 3.4 percent in May, while food prices jumped 8.3 percent from a year ago.

A rise in food prices is politically sensitive, as it will affect the common masses who have not benefited from the prosperity generated by the country's two-decade-old boom. Beijing has adopted a series of monetary measures aimed at cooling the economy and the latest inflation figure may induce further tightening.

Eurozone rates raised to 4%, UK steady at 5.5%

The European Central Bank (ECB) last week raised interest rates for the eurozone to 4% from 3.75% - taking rates in the area to their highest level in six years.

Though the rate increase was widely expected, what was awaited eagerly was cues on further rate actions. At his news conference, ECB president Jean-Claude Trichet said that eurozone monetary policy is "still on the accommodative side", suggesting that more rate hikes may be in the pipeline.

The eurozone economies, especially Germany, have been growing strongly in 2007, unemployment in the eurozone is at its lowest level since the launch of the euro, while confidence is high and business activity is expanding.

Meanwhile, the Bank of England decided to keep its benchmark rate at 5.5%. Even as the bank freezes the rate and goes in a ‘wait and watch’ mode to assess the impact of the series of recent rate hikes, a rate rise later this year remains likely. UK rates have been increased four times since August last year in an attempt to rein in inflation. But price growth still remains strong. While consumer price index (CPI) inflation fell from 3.1% to 2.8% in April, the measure still remains well above the government's target of 2%.

ECB Expected to Raise Key Rate

The European Central Bank is expected to raise its key interest rate by a quarter of a percentage point to 4 percent when it meets today, taking the borrowing cost in the 13-nation euro zone to its highest level in six years. The corresponding benchmark rate is 5.25 percent in US and 5.50 percent in Britain.

Besides the rate decision today, on which there is a near unanimity, the markets will be looking for clues on future rate moves.

The euro zone economy has been growing at a healthy pace, unemployment is at its lowest level since the launch of the euro while business and consumer confidence are up. ECB has been calling for “strong vigilance" to keep inflation under control – a phrase considered by the market as a signal of continued rate increases, typically a quarter of a percent. Year-on-year inflation in the zone was 1.9 percent in May — unchanged from the previous two months, and around the ECB's guidelines of just under 2 percent. While there are concerns about inflationary risks, the ECB will also have to consider global developments such as the problems in the US housing market and uncertainty about Chinese stock markets.

Bernanke expects economic rebound, dashes rate cut hopes

Federal Reserve Chairman Ben Bernanke has re-iterated his belief that the US economy will bounce back from its sluggish performance so far this year to advance at a “moderate pace” in the coming quarters - close to or slightly below the economy's trend rate of expansion, even if the housing slump persists. The US economy's trend or normal growth rate is put at around 3-3.25 percent. The assertion dashes the prevailing expectations that Fed will start cutting interest rates in order to stimulate growth. A section of the market has been expecting that Fed will be forced to cut interest rates later this year, as the economy struggles to come out of the slowdown.

Economic growth in the year's first three months nearly stalled, logging just a 0.6 percent pace. It was the worst quarterly showing in more than four years. Bernanke said he believes some forces that figured prominently in that poor performance — including a bloated trade deficit, cutbacks by businesses in inventory investment and weak federal defense spending — "seem likely to be at least partially reversed in the near term."

The Fed meets next on June 27-28 and many economists predict policymakers will again hold a key interest rate steady at 5.25 percent, where it has been for a year. Many economists think rates will stay where they are for the rest of this year.

Regarding the housing slump, the US Fed Chairman accepted that it may continue to be a drag on economic growth for longer than previously expected. The saving grace is the housing market's problems haven't spread through the broader economy in a significant way. "We have not seen major spillovers from housing onto other sectors of the economy," he observed.

Chinese Stocks : Rebound from Free Fall

China's stocks have been in a virtual free fall since the government tripled the tax on securities trading on May 30. The slide has wiped out more than $500 billion of market value - more than the combined GDP of Taiwan and Singapore.

The benchmark Shanghai index closed more than 8% lower on Monday on concerns that the government is set to launch further measures to cool the gravity-defying rise, including a capital gains tax. On Tuesday, a late rally saw the market rebound to finish more than 2.5% higher after a volatile day of trading that saw a 7% decline earlier in the day.

In an apparent bid to reassure investors, editorials in official newspapers have said that the market's medium- and long-term outlook was still positive, and that the tax hike was merely aimed at speculators. Terming the fall as a healthy short-term correction that won’t hurt the “bull run”, the newspapers have advised investors to take a long-term view of the development of the Chinese capital markets and the importance of the financial reforms.

The meteoric rise of the Chinese stock market has led to widespread fears of a bubble-in-making and warnings of dramatic corrections. Significantly, global markets, which were shaken by a heavy Chinese market sell-off in late February, appear relatively calm to the latest meltdown.

America’s Economy

Sunny outlook, but the weather may turn


THE primary job of any pundit is to forecast all the ways in which things could go wrong. So far, however, the American economy has stubbornly defied the dire prognostications of those expecting bad weather. Economic growth has swayed and faltered. Revised figures announced on Thursday May 31st showed that the economy grew at an annual rate of 0.6% in the first quarter of 2007, less than half the initial estimate. But no matter how close recession seems, somehow the storm clouds never quite break. This may explain why Americans are gaining in confidence, despite a negative household-savings rate, a collapsing housing market, increasing global competition, and a currency that looks decidedly anaemic.

The Conference Board's consumer-confidence index has risen, admittedly from a five-month low. And house prices are still increasing, though at the slowest quarterly rate for ten years, according to the Office of Federal Housing Enterprise Oversight. And even if the American economy is doing all right now, what of the future? This is the question asked in a new survey by the Organisation for Economic Co-operation and Development. The report is surprisingly upbeat on current trends, saying that the economy seems to be weathering the sharp correction in the housing market surprisingly well. Though the Federal Reserve must restrain lingering inflationary pressures without unduly straining growth, the outlook for the short term seems reasonably sunny.

Over the long term, however, America faces gloom: a shrinking labour force. In essence economic growth depends on two things: how fast the number of workers rises and how much more they can produce. For most of the past two decades, both have grown briskly. And the American economy has enjoyed the fastest pace of growth in the developed world.

Since the 2001 recession, however, the labour force has not grown as robustly as after previous downturns. More importantly, labour-force participation is still more than a full percentage point below what it reached in 2000. If the size of the labour force does not track population gains, the remaining workers will have to work harder, or more efficiently, if living standards are to keep rising.

There are reasons to think that the slowdown in labour-force growth is permanent. The great transition of women into the working world, which has boosted participation rates for decades, seems to be over. The proportion of women working is expected to remain roughly stable, or grow only slowly, barring big social or institutional change. Meanwhile, another enormous demographic shift is on the way: the retirement of the baby boomers. That will place an extra burden on tomorrow's workers unless productivity growth is strong enough to plug the gap.

On this point, the OECD is sceptical. American productivity growth has been well above the OECD average for more than a decade and should remain strong. But expected gains will come more slowly than in the past ten years. Unless America undertakes structural reform to make its economy even more competitive, the nation will struggle to support its ever-increasing number of dependants.

The proposed reforms are mostly tricky: trade liberalisation and an end to the distortions caused by farm subsidies; tax reform to broaden the base and remove economically inefficient tax breaks; changes to social security in order to encourage saving and delay retirement; and deep changes to the education system at all levels. Most of these will be politically unpopular. Even improving education, by itself an uncontroversial proposition, generally ends up becoming highly contentious when the details of reform start undercutting powerful interest groups such as the teachers’ unions.

The OECD also wants changes to disability benefits. Some evidence indicates they depress labour-force participation rates. Low-income workers struggling to find jobs may be turning to permanent sick leave when their unemployment benefits run out. But picking on the sick and old to make life easier for young workers will be a hard sell even to the hard-hearted American electorate looking for protection as the clouds begin to gather.

Source : Economist