Posts Tagged ‘International Monetary Fund’

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There are almost as many opinions as there are Chinese. Some say the Chinese growth miracle is at an end. Others see a temporary lull. Others still, point to demographics and see problems ahead. Yet others say we are confusing western culture with that of China; that it is unstoppable. Some go even further and say that China – via its system of central control – has been deliberately manipulating a system and it will soon reign supreme over the global economy. Or to put it another way: some say ‘this time it is different’, and although China portrays many of the hallmarks of a bubble, it is just different from the West, while others say the claim that ‘this time it is different’ is always – and without fail – a sign that things are set to come very badly unstuck.

You may have picked up on the irony. After 1989, the consensus seemed to be that capitalism had won; that any system of central control was doomed to fail. Now there seems to be a view held by many that China is unstoppable precisely because it has so much central control that its state can force through reforms and regulations that western governments can only dream of.

This view is almost certainly wrong. For one thing, to argue that China is unstoppable because of its central control appears to be ignoring the lesson of the history of the last half of the 20th century. For another thing, it is debatable how much power the Chinese government really has. China is a massively complex country, and while Beijing may issue directives on how things must be done, the extent to which they are followed across the country is open to debate. In any case, China’s government is terrified of social discontent. For the country’s government there is always the fear of how the people will react if the government mismanages the economy.

This fear of popular discontent can often stop the government from doing precisely the things it should do for longer term prosperity. Take as an example its policy regarding its currency – the yuan. The US government is screaming at China to let the yuan trade freely. Many US politicians blame a cheap yuan on just about all of the US ills. They are surely wrong, but there is no doubt that if the yuan were to rise, US exporters would benefit, but how much is open to debate? But what people often overlook is that there is very strong evidence to suggest that China too needs a more expensive currency.

A consequence of China’s currency policy has been too low interest rates, which has all kinds of undesirable consequences – among them a credit bubble, too much emphasis on investment, and there appears to be evidence that low interest rates have led to Chinese companies paying out lower dividends, which has helped to accentuate imbalances in the economy.

Part of China’s problems can be dated back to 2008, when the West hit the crisis button. China responded with a massive stimulus of its own. It kept growing during the worst days of 2008 and 2009 but at what cost? According to the IMF, in 2008 China’s money supply jumped 30 per cent – and that is ironic. While China was accusing the West of debasing its currencies via QE, and lecturing the US on living within its means, China began to apply the kind of policies that got the West into its mess in the first place.

Then there is credit. In 2008 total outstanding credit in China was 130 per cent of GDP – a level that had pretty much been unchanged for several years. Now the ratio is at 187 per cent – that was a massive hike for just half a decade. The IMF has said that when a country sees credit increase by 3 per cent of GDP or more in a year, there is a good chance that a crisis may follow. Yet In China the rate of credit growth dwarfs what the IMF might refer to as the danger level.

For China corporate sector debt is the real danger. This has risen from just over 20 trillion yuan in 2007 to over 60 trillion in 2012.

This may all sound like western cynicism, but just remember it was the man who until last year was China’s premier – Wen Jiabao – who described China’s economy as, “unstable, unbalanced, uncoordinated, and unsustainable.”

It is not all woe, however. Recent anecdotal evidence such as the latest Purchasing Managers’ Indices, and data on freight transport, electricity output and volume of cargo all point to China’s economy seeing a mild pick-up. It is not going to see growth in excess of 10 per cent again for a while – if ever – but the recent data is consistent with growth of around 7.5 per cent, which is much better than many had warned.

The pick-up may be occurring because once again China is implementing short-term policies to push up growth via the very things that it has too much of anyway – namely investment, government spending, credit. But with signs that the US economy is at last on the mend, it may be possible for China to tighten up monetary policy allowing the yuan to rise, without taking too big a hit on exports.

Looking further forward, what China really needs is higher wages. Well this is happening. McKinsey has forecast that by 2022, 75 per cent of China’s urban workers will earn between $9,000 and $34,000 – a level that sits half way between current levels in Italy and Brazil. To put this figure in context, in 2000 just 4 per cent of Chinese urban workers had earnings falling within that band. McKinsey also forecasts that by 2022 urban income will double from current levels. These are precisely the developments China needs.

Then there is education. The OECD measures pupil skills in reading, numeracy and science, in a test known as PISA. The BBC recently quoted Andreas Schleicher, a leading figure behind these PISA tests, saying there are signs that China is closing – if it has not already closed – the education gap with the West. Shanghai has excelled, but said Mr Schleicher: “What surprised me were the results from poor provinces that came out really well. The levels of resilience are just incredible.” He said that he gets the impression China is investing in the future. Unlike the US, there are indications of a high degree of education equally between rich and poor.

China’s next big challenge is how it can manage being a middle income country. Over the last half a century only a handful of countries managed that transition. Many saw rapid growth, but then stopped before income levels had reached anything like western levels. Will China be one of those rare successes?

It does have one major hurdle to climb, however, and that is demographics. According to the UN, the population of China aged between 15 and 59 is set to fall by 7 per cent between 2010 and 2030. The policy of one child per family is about to be relaxed, but even so, many Chinese couples don’t want more than one child. In any case, even if the birth rate shot up overnight, it would take the best part of two decades before this showed up in the work force.

Associated with demographics is the question of the so-called Lewis Turning Point – a point familiar to economists – when a country runs out of workers to migrate into urban areas.

Let’s finish with what the IMF says on this subject: “Within a few years the working age population will reach a historical peak, and will then begin a precipitous decline. The core of the working age population, those aged 20–39 years, has already begun to shrink. With this, the vast supply of low-cost workers—a core engine of China’s growth model—will dissipate, with potentially far-reaching implications domestically and externally. The reserve of unemployed and underemployed workers (which is currently in the range of 150 million)—will fall to about 30 million by 2020 and the LTP [Lewis Turning Point] will be crossed between 2020 and 2025.”

For more see:

IMF: Chronicle of a Decline Foretold: Has China Reached the Lewis Turning Point? 
Trading Economics: China Labour Costs 
Ernst and Young: China’s productivity imperative 
FT: China’s debt in charts
McKinsey: Mapping China’s middle class 

© Investment & Business News 2013

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George is blowing a bubble, and no this is not a reference to the royal baby, rather to the right royal mess George Osborne may be creating with his Help to Buy scheme. The list of those accusing our chancellor of creating a new housing bubble is getting longer. But then our George says he is just trying to create a construction boom, and if he can do that, this will surely be a good thing. So which one is it: construction boom or housing bubble?

Help to Buy comes in many guises. New Buy, was a scheme aimed at first time buyers and provided assistance solely if they bought a new home. So the idea behind the scheme was actually quite laudable. But the latest iteration is not like that. This is destined to help people who can only rustle up say a 5 per cent mortgage.

Home builders say that the latest idea will encourage them to build more, but then, frankly they would say that wouldn’t they? What house builders really want, what they really really want is for house prices to go up in value enabling them to build and sell homes for a very substantial profit on land which they have already paid for.

This week credit ratings agency Fitch stated: “The scheme, [that’s Help to Buy] along with the phase that began in April [New Buy] could have an impact on sovereign gross debt and its dynamics, particularly if there is strong pent-up demand as the tighter loan-to-value ratios that have prevailed since 2008 are relaxed.” It continued: “For house builders the main benefit from the second phase of the scheme will come from rising house prices, rather than increased volumes.”

A couple of weeks ago Vince Cable warned that a housing bubble was a danger, and the IMF made similar warnings before that.

Oh why, oh why won’t George listen?

It is just that according to a housing construction survey from the Royal Institution of Chartered Surveyors (RICS): “59 per cent more respondents predicting workloads continuing to rise rather than fall once more.” According to recent data from the ONS, construction activity grew by 0.9 per cent in Q2. The latest Purchasing Managers’ Index from Markit/CIPS for construction rose to its highest level since June 2010.

This is good stuff. Apparently, or so says RICS, every pound spent on construction leads to £3 more economic growth, so that is a good thing. On the other hand, to put the construction boom in perspective: in Q1 2013 construction output was at its lowest level since Q1 2001.

Is George blowing bubbles or creating a construction boom? The most likely consequence is that this is doing both, and that is both good and bad.

© Investment & Business News 2013

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Beware of the TROIKA bearing gifts. The TROIKA is the collection of letters we use to describe the IMF, ECB and EU Commission and the organisations that, have clubbed together to provide money to Greece.

And everyone, with the exception of people living on Mars and members of the TROIKA, knows that the conditions imposed on Greece in return for providing more loans have caused the country to suffer economic depression. The IMF has already broken ranks, and said the TROIKA should have realised that Greek debt was not sustainable much sooner than it did, and should have agreed a haircut, in the process greatly alleviating Greek pain, at around a year earlier than it did.

Now a trio of economists – Dimitri Papadimitriou, Gennaro Zezza, and Michalis Nikiforos – have produced a model based on stock flow analysis, which suggests that Greek unemployment might rise from the horrendous 27.4 per cent level it is currently at, to 34 per cent by the end of 2016.

The lexicon is bare. Words fail. If 27.4 per cent is horrendous what is 34 per cent unemployment?

The three economists say Greece needs a kind of latter day Marshall Plan. They are right. Austerity in some sectors of the Greek economy, in particular the public sector, has to be tempered with equally significant levels of investment.

If Greece was Germany, global leaders would not agree to such austerity because they would fear the political repercussions. But this is little Greece. It may have been a superpower 2,500 year ago, but Alexander is dead, Sparta defeated, and the TROIKA vents its fury like the Titans escaped from Hades. For more see: A New Stock-Flow Model for Greece Shows the Worst is Yet to come 

© Investment & Business News 2013

The markets are not always rational, and in times of backlash can sometimes punish a country which may have been seen as quite strong under different circumstances.

Credit growth has been common across much of the emerging world, but in some countries while credit growth has grown rapidly it remains at modest levels. No one can be sure how markets may react once QE is ended or even reversed, and we cannot be certain whether markets will punish countries, even if total credit levels are modest.

However, some countries are more obviously more vulnerable to markets reacting against emerging market debt than others.

Egypt, which has both high government debt and a prime fiscal deficit, would appear to be susceptible, as might the Ukraine, the Czech Republic and Croatia. Hungary has gone some way to reducing its prime fiscal deficit, but government debt remains high, which means it may prove to be dangerously exposed in the event of higher interest rates.

Another country to watch is Turkey, although it also offers great potential. The IMF predicts that its trade deficit will be around 7.3 per cent of GDP next year. Unemployment is currently 9.4 per cent.

Turkey’s main stock market index – the Borsa Istanbul 100 – surged some 50 per cent over the 12 months to 22 May – an all-time high. In the subsequent two weeks the index lost 10 per cent. It is not clear whether the falls were down to fears over recent protests, doubts over Turkey’s current account, or merely a correction following such rapid rises.

Turkey’s gross external financing requirement (current account deficit plus debts maturing over the next 12 months) is roughly 25 per cent of GDP.

© Investment & Business News 2013

The EU’s financiers responsible for the Greek rescue scheme in 2008 have reacted strongly to accusations from the IMF that serious errors were made in the initial bail-out of Greece. Maybe it is time that these deniers started being a little more honest with themselves and us.

Haircuts can be good things. Sampson may not have agreed with such a sentiment, but, on the other hand, we tend to feel better afterwards. It can be like that with sovereign debt too, but in 2010, the so-called TROIKA – that’s the organisation made up of the IMF, EU commission and ECB – thought the very idea of a haircut of Greek debt was about as sensible as turning the Acropolis into a new apartment block.

Plenty of people warned that it was dangerous, and over and over again we were told that the harsh terms imposed on Greece were not necessary. Now the IMF is saying it was all a terrible mistake.

In a report published yesterday the IMF said: “Not tackling the public debt problem decisively at the outset or early in the programme created uncertainty about the euro area’s capacity to resolve the crisis and likely aggravated the contraction in output.”

Of course this is the IMF. It is not going to wear a hair shirt, or be too vocal in slating its partners for that matter.

It said that after the initial bail-out Greek public debt “remained too high and eventually had to be restructured, with collateral damage for bank balance sheets that were also weakened by the recession. Competitiveness improved somewhat on the back of falling wages, but structural reforms stalled and productivity gains proved elusive.”

And, it continued: “There are…political economy lessons to be learned. Greece’s recent experience demonstrates the importance of spreading the burden of adjustment across different strata of society in order to build support for a program. The obstacles encountered in implementing reforms also illustrate the critical importance of ownership of a program, a lesson that is common to the findings of many previous EPEs. To read the report, go to Greece: Ex Post Evaluation of Exceptional Access under the 2010 Stand-By Arrangement 

A spokesman for the EU commission said: “We fundamentally disagree… With hindsight we can go back and say in an ideal world what should have been done differently. The circumstances were what they were. I think the commission did its best in an unprecedented situation.”

ECB President Mario Draghi has entered the debate too, saying: “We tend to judge things that happened yesterday with today’s eyes. We tend to forget that when the discussions were taking place the situation was much, much worse.”

Hindsight bias is indeed a real phenomenon, and maybe we are all too keen to claim wisdom after an event. Psychologists can even cite studies to show that we have a distorted view of our own history, claiming, or even believing we predicted certain events when in fact we did no such thing.

But on this occasion citing hindsight bias as an excuse is not good enough.

Plenty of media, including, but not only, this publication warned at the time that the TROIKA was failing to see reality, that it was punishing Greece unnecessarily and that debt has to be cut via write-downs.

The TROIKA ignored what was obvious to outsiders. To now claim it had no way of knowing; that we are applying hindsight bias shows it has not learned anything. It is, frankly, arrogantly ignoring what is happening around it, stuck as it is in an ivory tower, or wherever it is that these financiers live.

There is a lesson today. Still the TROIKA, EU Commission and grandees of the Eurozone claim that the worst is over; that the troubled economies of indebted Europe are on the road to recovery, and by doing so they continue to make fatal mistakes.

What will happen in two years’ time, when the IMF says that too much austerity in 2013 led to unnecessary human hardship? Will the TROIKA accuse the IMF of hindsight bias, and say it had no way of knowing this at the time?

Rather than denying errors, perhaps the TROIKA et al, should tuck into some humble pie, and then, just maybe they will notice they are repeating this mistake.

© Investment & Business News 2013

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There seems to be as many reasons for the protests in Turkey as there are protestors. Protestors appear to have quite different ideologies, quite different beliefs, although a desire for more secular politics seems to be a common thread.

But what about the economy?

The Turkish economy has been seen by many as one of the most exciting economies in the world. Indeed, it is one of the TIMPs – Turkey, Indonesia, Mexico and Philippines, the economies that may take over from the BRICS as the countries for investors to plough their money into.

Turkey’s main stock market index, the Borsa Istanbul 100, surged some 50 per cent over the 12 months to 22 May – an all-time high. In fact, the index more than trebled between September 2009 and the peak price two weeks ago.

Not surprisingly, the index has since fallen sharply, down some 10 per cent over the last fortnight

But then again, there might be explanations other than protests for the fall.

Turkey’s problem is its trade deficit and overseas debt. The IMF predicts that its trade deficit will be around 7.3 per cent of GDP next year. Unemployment, by the way, is currently 9.4 per cent, that’s low by, say, Spanish standards, but too high for comfort. Maybe this was a contributing factor to the protests.

According to Capital Economics, Turkey’s gross external financing requirement, that is to say its current account deficit plus debts maturing over the next 12 months, is 200bn, which is roughly 25 per cent of GDP. In fact, its external financing requirement has doubled since 2008.

Many people believe QE has created a bubble in bond prices, that by buying government bonds, central banks have artificially inflated prices, meaning the market for bonds is set for one mighty fall. This may or may not be right, but it is clear that emerging market bonds carry greater exposure than bonds pertaining to, say, the US, UK or Germany.

When it comes to emerging market bonds and the risk of a crash, Turkey is near the top of the pile – unlike, for example, much of South East Asia that this time around, unlike in 1997, has managed to fund much of its debt internally and in any case has not run the kind of debt levels seen in the past.

© Investment & Business News 2013

Here are two technical terms, before we get underway: fiscal multiplier and blinkered. A fiscal multiplier simply describes the relationship between government spending and GDP. Blinkered, which was a theory developed by Professor Obvious from the school of common sense, may apply George Osborne.

Here is some simple maths. Let’s say that for every pound the government spends on welfare and department spending, the economy grows by 60p. Let’s say that for every pound spent on infrastructure, the economy expands by one pound. Professor Obvious might suggest the following: spend less on welfare and departmental spending, and use the money saved to boost spending on infrastructure.

If you want to take a view from the ‘School of the Not Quite so Bleeding Obvious’ (SNQBO), then things change. What is true now may not be true tomorrow, next week or in, say, ten years’ time.

It does, however, feel as though the equations described above are roughly right at the moment.

Yesterday the IMF said: “The United Kingdom could boost growth by bringing forward measures already included in its fiscal plan, such as spending on infrastructure and job skills.”

Capital Economics reckons that if the government was to spend £10 billion in this way, it could cancel out the GDP dampening effect of its planned £6 billion cut on welfare and department spending for 2013.

The other benefit of investment into infrastructure, and indeed job skills, is that it can lead to improved productivity, precisely the area where the UK is so weak.

Furthermore, by taking money scheduled for expenditure at a later date, Mr Osborne could implement the IMF recommendations without worsening the UK’s public debt in the long run.

So why not do it?

One reason might be, and excuse the introduction of another technical term, the slippery slope. Osborne may fear that short term one-off initiatives have a habit of becoming entrenched. That is to say that theory might suggest we just need to take the money from planned future expenditure, but when we get to that future date, the government may find that it is still under pressure to spend that money.

The other reason is that Mr Osborne, to use the jargon, is blinkered.

© Investment & Business News 2013