Balance of Payments Update: Q1 2007-08

RBI has released India’s Balance of Payments for Q1 (Apr-Jun) 2007-08.

This is quite an important data release as it gives analysts and academicians data on various capital flows to ponder upon. Some points:

• The exports increased by 17.8% in Q1 of 2007-08 lower than 23.7% noted in Q1 of 2006-07. 
• The imports grew by 21.3% in Q1 of 2007-08 lower than 22.9% in Q1 of 2006-07.
• Within imports, oil imports recorded a moderate growth of 8.0 per cent in Q1 of 2007-08 (45.2 per cent in Q1 of 2006-07) where as non-oil imports recorded a strong growth of 47.4 per cent (8.9 per cent in Q1 of 2006-07).
• As exports declined by a higher % the trade deficit was noted at USD 21.6 billion in Q1 of 2007-08 higher than USD 16.9 billion in Q1 of 2006-07.
• However, invisible receipts grew at 27.5% in Q1 2007-08 higher than 23.7% seen in Q1 2006-07; thereby reducing the current deficit.
• The current account deficit was noted at USD 4.7 billion nearly similar to USD 4.6 billion noted in Q1 2006-07.
  The capital account remained buoyant on account of substantial portfolio flows; it was noted at USD 15.9 for Q1 2007-08 billion much higher than USD 10.9 billion noted in Q1 2006-07.
• The overall balance of payments was at USD 11.2 billion.

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Impact of Globalisation on economy

I have  written quite a bit on this topic, first in the form of impact of globalisation on inflation (here and here) and impact of financial globalisation (here and here).

Fed Governor Mishkin revisits the topic in his recent speech. He provides a neat summary of the impact of globalisation on all important variables- inflation, output, monetary transmission etc. There is a very rich reference list to look forward to.

a) Impact on inflation: Not really. The story is similar to what I wrote earlier. Despite many research papers on the subject, none show that globalisation has led to low inflation. There has been some impact but it is very small and not worth mentioning.

b) Impact on output: The evidence is mixed. One set of research shows

globalization may stabilize output by enabling producers to service a diversified global market rather than just the domestic market.

Other set of research shows:

Greater trade integration–including greater trade in services (Markusen, 2007)–could raise output volatility as countries become more vulnerable to foreign shocks.

Even with financial globalisation we have mixed response and we do not really know whether financial globalisation has led to lower risk or higher risk on the economy.

Mishkin however believes globalisation to be beneficial to output as both real and financial shocks are diversified. But the evidence so far is mixed.

Inflation has  come down over the years for most of the countries. Then what explains this development? Mishkin says what others have been saying- better monetary policy:

Tighter monetary policy and a commitment to price stability by central banks throughout the world have led to lower inflation and an anchoring of inflation expectations.  These policies have had huge benefits–not only the achievement of low and stable inflation but also an improvement in the overall performance of the economy.

Globalization, however, may have helped reduce inflation in more-subtle ways.  By fostering increased interactions among central banks, academics, and the public in many different countries, globalization has helped spread a common culture that stresses the benefits of achieving price stability.  The resulting increased focus on price stability has been a key reason for the reduction of inflation worldwide.

A nice summary of research available on the subject.

Assorted Links

1. MR on  Russia

2. WSJ saysit is not Bernanke put but Bernanke Collar.

3. Financial Rounds points to a new website on game theory.

4. Mankiw points to an interesting article on monetary policy institutions.

5. TCA points a new paper.

When the Fed says X, they really mean Y

A reader of my blog pointed out this article to me titled “When the Fed says X, they really mean Y” and he thought the readers of my blog might find it interesting. 

The Fed typically convenes every month to discuss interest rates. It is not only the action (whether rates are raised, lowered, or held constant), but also the accompanying “statement” which is of interest to investors and analysts. In its statement, the Fed may signal both its motivation for the current policy decision as well as offering clues towards the future direction of rates. Unfortunately, the Fed often couches its commentary in vague language and specialized terminology, which may be difficult for amateur traders and investors to understand. The following is designed as a handy translation guide for people who wish to read and understand the Fed Statement but don’t want to train for a PhD in economics

It reminded me of the pretty widely discussed speechby Bernanke in 2004 on Fedspeak. Off course, there are little similarities.

Nobel Prize 2007 predictions

It is that time of the year when the prospective Nobel Prize winners are going to be  discussed. The website informs first prize would be announced on 8 October, 2007 and it would be for medicine.

The Prize for economics is going to be announced on October 15 and we would see a lot of blogging on the deserving candidates in coming years.

Scientific Thomson runs a poll for all the prizes and the one on economics is here. The selection process is here and the successful candidates predicted are here.

This year the poll shows 5 economists in 3 areas:

I. For international trade and economic growth: 

a) Elhanan Helpman: Galen L. Stone Professor of International Trade, Harvard University, Cambridge, MA, USA; Emeritus Professor, Department of Economics, Tel Aviv University, Israel.

b) Gene M. Grossman:Jacob Viner Professor of International Economics, Princeton University, Princeton, NJ, USA; Professor, Department of Economics, Woodrow Wilson School of Public and International Affairs, Princeton, NJ, USA.

II. For Industrial organisation and regulation:

a) Jean Tirole: Scientific Director, IDEI (Institute of Industrial Economics), University of Social Sciences, Toulouse, France; Affiliated researchmember of CERAS, Paris, France

III. For their work on auctions

a) Robert B. Wilson:Adams Distinguished Professor of Management Emeritus, Stanford Graduate School of Business, Stanford University, Stanford, CA, USA

b) Paul R. Milgrom: Shirley and Leonard Ely Professor of Humanities, Department of Economics, Stanford University, Stanford, CA, USA

So far, results are:

41% –  Tirole
35% –  Helpman, Grossman
24% –  Wilson, Milgrom

No Fama & French this time in the list.

Anyways,. it is just a poll. Let us see what happens on Oct 15, 2007.

Keep posted for developments. 

Update 1: Greg Mankiw asks his blog readers to suggest who would win Nobel this year. Here are the comments. Mankiw also shares his predictions.

MR suggests his names.

Update 2: WSJ Blog posts on the propective winners from various sources.

Assorted Links

1. WSJ Blog points out to Larry Summers suggestions that Fed should not be in consumer-protection business.

2. Fin Prof on why cash flow statement matters.

3. MR points to world in 7 pictures.

4. TK Arun on Financial Inclusion.

5. Vivek Moorthy says RBI should provide an exchange rate target. I am not sure whether this would work as numerous examples show that it has not worked and only leads to worsening of the situations.

IMF on Financial Markets (Sep 07)

IMF has released its semi-annual publication Global Financial Stability Report. More than anything else, it always has excellent presentation of facts and more on impact of sub-prime on markets. The report is here.

The findings can be summarised in 3 points:

• Markets face difficult period ahead
• Credit difficulties likely to have broader economic effects
• Market framework needs strengthening

Let me read the details and if anything would share the same .

Assorted Links

1. JR Varma on Bank of England U-Turn.

2. TTR on Moral Hazard.

3. WSJ points to a new paper from Fed which asks:

A key question for the global economy is whether it can grow without tailwinds from the U.S. and even eventually serve as a source of demand growth here via exports. The Fed paper’s conclusions appeared mixed, depending on the country

It points to another paper from Atlanta Fed which says  mortgage led to higher home ownership in India.

4. A nice snapshot of the financial risks in the world.

5. Rodrik on the pains one has to go through after submitting a paper for a journal.

6. SS Aiyar brings a lot of sense to the Fed rate cut.

Bernanke on importance of education

After disappointing some and pleasing some with his rate cut, Bernanke is back doing something he does best- educating via his speeches. And this time it is not on fin markets/ economics etc but on something very basic- the importance of education in economic growth.

He begins by giving an investment advice:

When I travel around the country, meeting with students, business people, and others interested in the economy, I am occasionally asked for investment advice.  Usually (though not always) the question is posed in jest.  No one really expects me to tell them which three stocks they should buy.  However, I know the answer to the question and I will share it with you today:  Education is the best investment.  

He then points to the benefits of education:

From a macroeconomic standpoint, education is important because it is so directly linked to productivity, which, in turn, is the critical determinant of the overall standard of living.  The Bureau of Labor Statistics estimates that, between 1987 and 2006, ongoing improvement in the education and experience of the U.S. workforce contributed 0.4 percentage point per year to the increase in nonfarm business labor productivity (U.S. Department of Labor, 2007), a significant amount.

He points to 3 challenges facing America on education front: the retirement of the baby-boom generation, the inexorable advance of the technological frontier, and the ongoing globalization of economic activity.

As baby-boomers retire, we would have fewer people in the workforce hence

 More schooling for more of the workforce could help cushion the impact of this demographic transition on economic growth by boosting productivity growth.

As technology advances further, America would need more people who can use it. So which jobs would be the ones to gain  most?

Which jobs will be most affected by technology is difficult to predict, although some research suggests that sectors that now use information technology (IT) relatively less intensively, such as health-care and other service sectors, are likely to step up their use of software and IT services.

So health-care is going to be the in thing.

He goes on to discuss how education is not just about schooling and college but is a continuous process. It is in the best interest of the economy if persons continue to learn in their adult lives as well via corporate training etc.

It is a light read and is full of ideas. Highly recommended.

Institutions for Financial stability

I hasd mentioned earlier that most academicians keep their best for the Jackson Hole symopsium . I have covered quite a few papers from the 2007 symposium that focused on housing.

I came across this paper from Rovert Litan presented in 1997 symposium which focused on financial stability. The paper is quite good and relevant for even today. His broad idea is:

In brief, my main message is to urge a shift in emphasis from what I call the “prevention-safety net” approach to maintaining financial stability that has characterized U.S. policy since the Depression toward what I label the “competition-containment” paradigm that I submit should govern policy in the future. The post-Depression prevention model has attempted to ward off systemic danger in large part by sheltering individual depository institutions from competition, an approach that has failed, has been costly to consumers, and in any event, is being outmoded by market developments. The safety nets—deposit insurance and emergency liquidity provided by the Federal Reserve—have been more successful in preventing and containing financial crises, but can be both addictive and seductive, causing institutions and policymakers alike to tolerate excessive risks that are damaging to taxpayers who foot the bill for the safety nets.

He has stressed on the importance of Clearing and Settlement systems for making the financial system better and more efficient.

Assorted Links

1. WSJ Blog points Dallas Fed’s President, Richard Fisher defends the rate cut. I am surprised considering he is an inflation hawk and inflation pressures loom. It has nice assorted links as well

2. Rodrik shares his research in which he asks a question- is it important for a successful blogger (in economics) to also be a good scholar and vice-versa.

3. End Poverty in SA Blog points why basic services do not reach people.

4. Econbroswer on stagflation.

Impact of financial systems on economic cycles

Every country has different financial system. Even if they have a market based system the degree of how much markets intermediate savings differ.

This summaryfrom IMF is an excellent one which explains how different financial systems efect various economic cycles. The shorter versionis also available. Basically it is a part of IMF’s World Economic Outlook where apart from the general outlok it discusses some important research findings.

This research focuses on developed economies and analyses whether a system is more at arms’ length or less. Arms length financial transaction means either it is between 2 unaffiliated parties or even if it is between 2 related parties (say between 2 subsidiaries) it is done in a manner as if they are unrelated (i.e. fair pricing etc). The opposite of it is relationship based fin system in which transactions are done on the basis of relationship. Rajan and Zingales have another excellent anslysis of the two kinds of systems.

The consensus is that most countries are and should move towards arms length fin systems as it is more transparent and thereby efficient. Hence the paper focuses on which advanced countries have more arms’ length systems or less and their impact on economy.

The broad ideas that emerge are:

1) Differences in financial systems among advanced economies affect the behavior of economic cycles.

2) Households in so-called “arm’s length” financial systems (including the United Kingdom and the United States) can borrow more to support consumption, but higher debt makes them more vulnerable to rising interest rates and declining asset prices.

3) The more “relationship-based” financial systems in Europe are less well equipped to transfer resources from declining to growing economic sectors,thereby hampering efforts to boost productivity and respond to technological change and globalization.

Nice study. Highly recommended.

Assorted Links

1. Ajay Shah has done an excellent analysis of the Fed rate cut and its impact. He also points to some good analysis on Maharashtra lagging behind.

2. Rodrik starteda discussion asking the readers which economists they wanted to blog. His listshowed most wanted Stiglitz and Acemoglu to blog. Tyler Cowen also asks the same question. Well we don’t have his list as of now.

3. WSJ has some more on Greenspan.

4. Mankiw on Helicopter Ben.

5. Rodrik points to a paper on trade. Looks quite a food for thought.

6. An excellent FAQ on money creation from James Hamilton in Econbrowser. Phew what a blog this.

7. ET points it is now the turn of EAC to study the impact of sub-prime on Indian economy. I don’t know why we wake up so late. All along, our policymakers have followed what Fed has to say. Earlier Fed felt it was ok, hence no action. Now as Fed reduced rates, we decide to do a report.

8. ET debates do we need an exchange for SMEs? Yes we do.

9. Now, I think MIFC report makes sense.

Understanding financial crisis using information asymmetry framework

There are n (n as in many) number of papers on the subprime crisis .

Whichever way you look at it, the root cause lies in information asymmetry. By information asymmetry, I mean adverse selection, moral hazard and free riding. Mishkin has written a wonderful paper explaining each of these and how worsening info asymmetry leads to financial crisis. 

What distinguishes financial markets from general markets is that degree of info asymmetry is much more in former. And moreover, in a product/service market, once you get delivery of the product/service (which is usually immediate or after a few days), and in fin market your returns only come over a period of time. Hence, information problems continue and you are worried all the time about your investment/ loan.

I have expanded this analysis and have tried to understand the subprime crisis using the same. My paper can be found here.

Comments/Suggestions are welcome.

Roubini says tough times ahead

Nouriel Roubini (NR) has recently given a talk at IMF which is going to be talked about. The title itself would grab eyeballs: ‘The Risk of a U.S. Hard Landing and Implications for the Global Economy and Financial Markets’. He is quite a good economist and his views on global economy and financial markets are quite good.

The transcript of the talk is here and the summary is here. It is quite good, simply said and provides lots of food for thought. The moderator says NR made 3 predictions in his previous talk and 2 have come right:

1) Nouriel said that the U.S. housing correction would not go away quietly, but would go from bad to worse, and I think in this he has certainly been right on the nose.

2) He said that weakness in the U.S. subprime mortgage market would cause broader problems in the financial system, and here again Nouriel was certainly right, although for once perhaps not quite gloomy enough.

3) He put a high probability on the risk of a recession in the United States and a global hard landing. This has not happened yet.

As first 2 were bang-on target Roubini has many people wanting to hear what next. He says it simply that there would be a harder landing in US economy than what others might expect.

His analysis is house prices are going to decline much lower than expected, and as most consumption is funded via loans using  housing as collateral, this would lead to lower consumption. As US is a consumption driven economy (C=72% of GDP), there is an impact on the economy.

Further, as value of collateral falls there would be an impact on all those financial instruments created and there is an impact on the entire economy.

The broad analysis is the same as other analysis, his justifying the facts is quite good. For instance, his take on Fed

This is also the reason why I believe that actually while of course the Fed can ease and they are going to ease significantly, I am not sure that the Fed easing is going to resolve the problem the way they did in 1998 because there is an element of insolvency rather than illiquidity. I do not think what the Fed is going to do is going to be enough because it is going to be probably `too little, too late’: too little because now they are worried still about inflation being on the upper limit of their comfort zone and because they are worried, rightly, about moral hazard issues. Therefore they are not going to aggressively ease the way they did in 2001.

And yes he assumed Fed is going to go for a 50 bps cut as 25 bps may not be enough.

 Highly recommended reading!

Assorted Links

1. Some articles are widely discussed from time to time (eg. Hip heterodoxy). MR points to a new one which asks why most research findings are false.

2. New economist pointsto a new paper on microcredit.

3. WSJ Blog points to a new paper by Fed that says:

The study examined how the U.S.’s trading partners adjust the prices of their exports when their currencies rise or fall against the dollar. The study, posted this week on the Fed’s Web site, found that increasingly, they tend to lower their prices when their currency rises against the dollar. That would tend to keep their prices constant in dollar terms in the U.S. market, minimizing their loss of market share. The reverse is usually also true — that is, they raise their prices when their currency falls against the dollar — with the exception of Canada.

 NY Fed had a similar paper which I mentioned here.

4. Mankiw tries to answer a fundamental question- Why do we need a Central Bank?

5. TTR on Bernanke put.

6. Rajrishi Singhal makes a case for the small investor, Only thing is he should have given the title – ‘The Reality of the small investor’.

7. In these times of transparency, our Central Bank still thinks Policy should spring surprises. I wonder what would SS Bhalla’s reactions be.

8. TCA summarises the research papers presented at Jackson Hole saying no whole answers were presented in the conference.  This is nothing new. Economics seldom offers whole answers.

Assorted Links

1. WSJ Blog pointsout that as Fed cuts rates, Spammers have begun offering loans.

2. WSJ Blog says Mishkin offered clues to Fed actions. I think Mishkin lost a bit of credibility with this Fed action.

3. Mankiw points that Fed should not come under political pressure.

4. WSJ has some interesting analysis on US marriages.

5. MR pointsto Paul Krugman’s new blog. It also pointsto a blog contest

6. Ajay Shah says globalisation cannot be controlled.  

7. TTR on Fed rate cut

Asset Prices and Macroeconomy in India

I was pretty excited when I saw the title and abstract of the new IMF paper by Catriona Purfield titled ‘India: Asset Prices and the Macroeconomy’.

The abstract reads:

This paper examines rising asset prices in India. For the most part, asset prices in India reflect structural factors but the risk of a correction cannot be ruled out. However, at this juncture monetary policy may not be the most effective tool to safeguard financial stability because (i) India’s economy is undergoing rapid structural change making it difficult to identify price misalignments; (ii) the macroeconomic impact of an asset price correction is likely to be small; and (iii) the relationship between monetary policy and asset prices is also weak. Targeted changes in financial regulations are better tools to address potential risks.

The paper starts by discussing which asset markets are important in India.

It says 3 assets are important- real estate, equity markets and gold. 

It justifies real estate’s importance on the basis that households invest 53% of their savings as physical. It should have then used the same parameter for equity markets. But it simply says equity markets are important because of market capitalization, foreign money etc. I can understand gold but equity?? Just 4.9% of households savings go into equity in 2005-06. For most of 2000s the % is below 2%.

Then it discusses the growth in the three asset markets. Nothing much to say there except the fact that in all three, prices have grown.

The interesting part of the paper would have been the impact of rising asset prices on macroeconomy and this is where the paper disappoints the most. It discusses the various channels via which asset prices effect real economy. It argues asset prices would have smaller impact on Indian economy as:

1) Households have low exposure to financial assets
2) Property and gold cannot be leverages as markets are not developed.

As it discusses 3 asset markets you would assume that paper would link all the 3 with real economy but it only covers the linkage with equity prices saying:

The model includes four variables: real private consumption per capita, real stock exchange index to proxy for developments in asset prices (time series on property and gold holdings are not available), real short-term interest rates to control for the impact of monetary policy, and real per capita income to proxy for income, as well as an exogenous dummy variable to capture the structural changes in the economy following the 1991 balance of payments crisis.

This is simply not expected from IMF. Why not call the paper instead- India: Equity Prices and the macroeconomy. They could have added that ideally we would like to cover more asset prices but could not do so. 

As far as results go, equity prices have little impact on consumption, but then the entire idea is lost.

The final section of the paper argues whether mon pol is suited to correct the rising asset prices in India. Well, most know mon pol works via transmission i.e. mon pol impacts various markets indirectly. So atleast you would expect some model from IMF showing how mon pol transmission works in India.

But even that is ignored. It simply says for Mon Pol to target asset prices the central banker needs to identify bubbles and as that is difficult to do, mon pol would not be effective!!

The paper is really disappointing. It could have been a lot better.

Assorted Links

1. Fed has cut its benchmark rate by 50 bps and discount rate by 50 bps (differnce between the two is here). As it was the most awaited event, expect a lot of blogs on the subject.
WSJ Blog points to reactions from economists and politicians.

Econbrowser has an excellent analysis (as usual) of how various asset markets reacted to the mpve.

My take is yes finance is important and disruptions could lead to a possible recession, but this decision from Fed has worsened moral hazard problems. Expect bigger crisis next time.

2. New economist points to a new econometrics book available online for free.

3. PSD Blog says World Bank South Asia Chief Economist starts a blog.

4. Fin Prof points out Britney Spears explains sub-prime. Check it out.

5. TTR points to happening Calcutta

Economics of Securitization

I found this paper from Van Order on securitization pretty good.

It discusses how securitization in a pretty lucid manner. Unlike other papers that get into fancy modelling, this one sticks to basics and explains the same using traditional finance theories like Modgiliani-Miller model.

Much of the focus in studying MM has been on debt vs. equity funding. However, the securitization issue is less about debt-equity structure than it is about the structure of debt funding, particularly as it is related to institutions that typically use different types of debt funding. For instance, the most common type of debt funding for financial institutions is deposit funding by banks, but the important alternative, especially in the U.S. in mortgage markets, has been securitization, typically performed by the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac or the government-owned Ginnie Mae, the three “Agencies.” So the point of departure is why should there be any ifference between deposit funding and securitization?

I never really thought it this way.  

He begins discussing the evolution of the market and how the 3 agencies came up. He then discusses the 2 securitization models and explains the process.

He has 5 lessons for policymakers:

1. It is the function, connecting mortgage and capital markets, especially the long term market, rather than institutional (e.g., charter) details, that is important.

2. While working on the “back end,” e.g., doing some deals and getting some mortgages off banks’ balance sheets may be a good idea, it is the getting the “front end” right that is the sine qua non of developing good mortgage markets. It is even more important to have proper registration, foreclosure and eviction procedures in setting up secondary markets because of the potentially severe selection problems.

3. Controlling safety and soundness requires serious consideration of risk-based capital, not like the old accounting capital ratios, but really risk-based standards that make companies hold more capital if they do things that increase risk to the company (and taxpayer stakeholders). The old Basle model cannot do this.

4. Interest rate risk is a concern, no matter how much you securitize.5. Diversification is important

Nice insights.