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UK making macro mistakes

UK policy makers are starting to make macro-economic mistakes with the amount of public debt steadily increasing, writes Dr Bhaskar Dasgupta.

india Updated: Jun 07, 2003 21:29 IST

The India Babble

The market started off on a slightly positive note, which showed a bit of steam, but petered out by Wednesday and ended down about 40 points over the week. So, it was rather tight trading through the week, the earlier mini rally being driven by the banking stocks.

The power sector got a boost by the passage of the Electricity Bill, which was pending for over 3 years. One wonders if this speed of regulation will help or hinder the economy, while being reminded of one of the jokes, which was doing the rounds before Y2K. It was said that the Indian Government will not be affected by the Y2K problem because they were still in Y1K.

Reliance Industries lead the bear pack later in the week, with Parliament getting involved in discussing the long Reliance saga. This spread a general gloom over the market, still the news is reasonably good, as with last week's prediction, expect thin trading, but keep a beady eye out on the IT companies. The news from the US TMT sector is good and could spike the IT sector upwards thus giving a potential disproportionate upwards fillip.

The rupee maintained a steady upwards trend against the dollar. There are two trends driving this movement: First is the steady increase in the value of the official reserves, currently hitting a record value of $77 billion and second is the dollar in search for its new level.

Some other interesting results, which made the news, related to the harvesting of the first biotech cotton crop. About time too! One farmer reported that he sprayed pesticide only 3 times on this crop compared to over 20 times on his non-GM crop. We have the world's largest cotton acreage with the world's lowest productivity. The caution required not-withstanding, the flip-flop over GM issues is simply postponing the inevitable.

On a brighter note, the thaw in the Indo-Pak relations and the impact of SARS in China is improving India Inc. prospects. Higher value added jobs, such as bank research, are showing up in India, as are redirected textile orders from China. Toyota and Hyundai have been reported as being interested in increasing their investments in India. Overall, the direction of the economy looks good.

The Babble in the Ivory Towers
Last week, we looked at the political risk of secession. This week, we look at how countries manage their macro-economic financial policies. Gerald Epstein, Ilene Grabel and KS Jomo recently published a Political Economy Research Institute, University of Massachusetts at Amherst working paper entitled "Capital Management Techniques In Developing Countries: An Assessment of Experiences from the 1990's and Lessons For the Future.

They conduct a detailed analysis of policies that governed international private capital flows and those that enforced prudential management of domestic financial institutions across Chile, Colombia, Taiwan, India, China, Singapore and Malaysia during the 1990's. After their analysis, they come up with some significant policy recommendations, such as Capital management techniques can enhance overall financial and currency stability, buttress the autonomy of macro and micro-economic policy, and bias investment toward the long-term. The efficacy of capital management techniques is highest in the presence of strong macroeconomic fundamentals, though management techniques can also improve fundamentals.

Controls over international capital flows and prudential domestic financial regulation often function as complementary policy tools, and these tools can be useful to policymakers over the long run.

While giving relatively high marks to India, some commonly held shibboleths are shattered. Are you listening, IMF? Capital Management has proven to be better at achieving macro-economic objectives over the long run, rather than the orthodox view that capital management should only be applied in the short term.

Furthermore, for the commonly held view that over time, capital management techniques should be consistently strengthened is shown to be too blunt. Countries in the survey have successfully calibrated their policies depending on the circumstances and have loosened and strengthened controls suitably.

Another commonly held view is that an experienced bureaucracy should be in place to manage this process which is negated by experiences of Malaysia and Chile. Another observation that is frequently made, is that controls on outflows do not work, while they do work on inflows, which is not borne out by the experience of China, India, Singapore, Taiwan and Malaysia.

On the negative side, the authors do mention the slow pace of reforms in India, the increase in the cost of capital, once controls are in place and most importantly, the importance of having a consistent and coherent policy framework within which these controls work.

The World Babble
There is no question about where to start this week on the babble in the world. It's the US dollar, which is the cynosure of all eyes. It hit a high of $1.1537 against the Euro, another 4 year record!

The Fed, Reserve Bank of Australia, Bank of England and the European Central Bank all left the rates unchanged, so the market was basing its actions on the speeches of the great and the good. The worrying word "deflation" was in sight and while not mentioned directly, the risk of too little of inflation was driving the thoughts of the central bankers around the globe. While there are some encouraging signs from the US economy, the world movers and shakers seem to agree about the dollar falling more, so as to stoke a bit of inflation and push the US economy a bit more.

This fall is great for the US economy; it will make the imports more expensive and will push exports. The only worry is the financing of the deficit and the requirement to have almost $1 billion of inflows to keep the US system ticking over. Whether the foreign investors have the appetite to keep funding the US economy is a difficult question and one expects some more uncertainty to hang over the market for some time to come.

The sterling took fright as well and dived down against the Euro. The feeling in the market is that the UK policy makers are starting to make macro-economic mistakes with the amount of public debt steadily increasing.

Manufacturers in the UK are not that happy with the fall but the pro-Euro camp will be happier as sterling sinks. Some grumblings from the airline, tourist and travel industry emerged, as it will become more expensive to travel abroad. The UK travel industry had another reason to complain. While everybody and his dog is trying to show that the UK is a great place to visit to bump up the tourist numbers, Ken Livingstone, the London Mayor, went off on an extraordinary rant on the Americans. This royally hacked off the travel industry for whom the American market is so vital. Nice one and thanks for nothing, Red Ken.

While this is all good and nice from the perspective of UK and USA, Europe and Japan are hurting and will yet hurt some more. The Bank of Japan has intervened mightily to keep the yen down (still the yen ended up at a 10 month high against the dollar), it seems like its managing a bit, but the auto industry and the export industries are starting to hurt. This quarter's Japanese results will not be very good. Some of the European sectors are starting to feel the pain, such as engineering, machinery, banks and auto sectors. Volkswagen & Henkel reported a big hit.

The markets started off on a rally, but paused to take a breath and the DOW ended the week at about the same place where it started it. Europe was slightly down about 1 per cent, while the Footsie broke through the critical 4000 level and then fell back to close at 3969. Gold saw a bounce, mainly coming from the dollar weakness and reached $349 per troy ounce.

The gold speculators are taking another look at the market and liking what they see. Expect higher gold activity in the coming weeks and a gentle upward trend to continue on the equity markets.

Because of the Fed's comments, bond yields tumbled across the board and Europe followed suit. Inflation is on the way down (for now) and this is hammering the yields in the US Market. The European Central Bank made a significant change to its macro-economic framework and said that it is going to soften its inflation target, due to fears of deflation, especially because of the dire economic news coming out of Germany.

Over on the institutional front, the World Bank released a study of the public sector banks in transition economies in Eastern Europe and Central Asia. Their main point is that governments are better off moving swiftly to privatize or liquidate their remaining state banks, rather than rehabilitate them.

From an economic perspective it makes sense, but from a political perspective, one has to wonder if this step is really feasible. The World Trade Organisation gave the go-ahead to Europe to impose economic sanctions worth up to $4 Billion on the USA because of the foreign sales corporation / export subsidy issue.

The European Commission is trying to keep this quiet, but it's considered to be a warning shot. One hopes this is all that it is, otherwise the USA may well decide to proceed on its own, with sanctions on Europe over the Genetically Modified Food issue. The WTO also released an overview discussion paper on "Industrial Tariffs and the Doha Development Agenda", which shows the mandate given to the negotiators and looks at the issues facing the various countries.An excellent publication for anybody wanting to understand the intricacies of the Doha Round.

(Dr Bhaskar Dasgupta works in the City of London in various capacities in the banking sector. He also lectures at several British Universities. He holds a Doctorate in finance and artificial intelligence from Manchester Business School and is currently working on another doctorate at Kings College in international relations and terrorism.
He will be writing a weekly Monday round-up on markets and indicators.)