Archive for April, 2008

Abhijit Sen Committee on Commodity Future Trading

April 30, 2008

Apart from a season of crisis (which are getting complex by the day) and Mangoes (which  are extremely expensive to eat), It is also a season for committee reports (which are really difficult to read given the time) – Rajan committee on financial sector, Radhakrishnan report on indebtedness, Services Sector, Interest Rate Futures, Currency Futures etc

There has been much discussion and expectations over Expert Committee on Commodity Futures Trading headed by Abhijit Sen of Planning Commission. The main topic of debate has been – whether futures trading has led to rise in commodity prices?

The report is out and as usual I had to waste a lot of time trying to find whether it has been put on a website or not. I couldn’t find it on any of the government website but found the report on Mint’s website. The report can be downloaded here. The press release of the report is here .

The summary is there is no conclusion amidst the members on whether there has been some impact on commodity prices.

There is a lot of coverage of the report. You can see the news items here


Assorted Links

April 30, 2008

1. WSJ Blog points global inflation is accelerating

2. This is a new blog I discovered on behavioral economics – Nudges Blog. Read this post on using defaults for social networking site.

3. Rodrik does an experiment

4. TTR is bullish on India

5. Is it right for a community to educate its own community or should it educate all? IEB has a debate

Does appreciation of the currency lead to lower inflation?

April 29, 2008

I came across this interesting table in RBI’s Macroeconomic and Monetary Developments 2007-08. The table (Table 35) is in Chapter 4 – Price Situation.

The Table summarises the Macroeconomic Indicators in a few emerging markets:

Country Consumer Price Inflation Real Efective Exchange Rate
Mar-07 Mar-08 Mar-07 Mar-08
Brazil 3 4.7 -0.3 13.6
China 3.3 8.3 2.1 5.3
Indonesia 6.5 8.2 0.5 -6
Israel -0.9 3.7 2.8 8.8
Korea 2.2 3.9 0 -13.5
Philippines 2.2 6.4 2.9 9.6
Russia 7.4 13.3 5.1 5.3
South Africa 6.1 10.6 -16.8 -12.1
Thailand 2 5.3 7.6 2.6
India 6.7 5.5 0 1

The table shows that despite appreciation of the currency in some countries, inflation has increased. Why do I point this? Well, oft late there has been a lot of debate over this topic. Some economists have suggested that RBI should let the currency appreciate and this will take care of inflation. Some have said this is the only tool RBI has.

But as the  table shows it has not really worked in other countries. For instance see Brazil, China, Israel, Phillipines, Russia, Thailand- in all currency has appreciated between 2007-08 but the inflation has actually increased. The inflation numbers are based on consumer prices and that is why we see lower inflation. I have raised this issue over measuring inflation over wholesale prices and consumer prices here.

Infact, inflation has increased whether the currency has appreciated or depreciated. This is a global phenomenon with rising food prices (see my research here).  

Capital flows in India: Are they really good?

April 29, 2008

I have written a paper applying the Rodrik-Subramaniam framework on India. I had mentioned in a post earlier on the new framework proposed by the duo. I expanded on the thoughts and put it together on a paper.

Let me know of your comments.

RBI’s Annual Monetary Policy Review 2008-09

April 29, 2008

RBI announced its monetary policy for the financial year 2008-09. The highlights are here and the detailed policy is here.

The much awaited decision on interest rates is:

  • Bank Rate, Reverse Repo Rate and Repo Rate kept unchanged.
  • Scheduled banks required to maintain CRR of 8.25 per cent with effect from the fortnight beginning May 24, 2008.
  • RBI didn’t change the policy rates but just increased CRR. This implies RBI is more concerned over excessive liquidity and believes that interest rates have peaked. Higher policy rates could further slow the growth.

    Prior to the policy, I had pointed thatRBI was into a dilemma. The markets expected that inflation is going to be around 7%-7.5% over 2008-09 and this would warrant a hike in interest rates. RBI’s preferred inflation is around 4.5% to 5% and the expected numbers are much higher. But growth rates have moderated across sectors (it is still high relative to the world) and a further hike could slower growth further.

    So, any change in rates could harm either inflation or growth. Still, the Bloomberg/Reuters Polls showed RBI would take a hawkish stance over rising inflation and hike rates. By not increasing rates RBI is trying to balance growth and inflation.

    What however worries me is that RBI expects inflation to be around 5.5% in 2008-09 which looks really difficult looking at the present numbers

  • Inflation to be brought down to around 5.5 per cent in 2008-09 with a preference for bringing it close to 5.0 per cent as soon as possible. Going forward, the resolve is to condition policy and perceptions for inflation in the range of 4.0-4.5 per cent so that an inflation rate of around 3.0 per cent becomes a medium-term objective.

    RBI has also announced prudential measures to address banks exposure to commodity markets and look at special purpose vehicles/off balance sheet activities of banks.

  • I will keep adding to this post as I am still reading the report.

    The viewers should also take a look at Macroeconomic and Monetary developments released yesterday.


    Another important point to note is that RBI’s targetted growth in Money Supply (M3) is 16.5% -17%. Chapter 3 of Macroeconomic and Monetary developments shows the M3 growth. It is about 21% in 2007-08. Hence, RBI might be taking some more measures to suck excess liquidity from the system.  

    Assorted Links

    April 29, 2008

    1. WSJ Blog points SWFs are being welcomed in Washington. Meanwhile, one of the former Fed official says bailout of Bear Stearns was the worst policy mistake in a generation.

    2. The debate between Rodrik and Cowen hots up a bit with Cowen clarifying his piece

    3. PSD Blog points Bill Gates foundation moves into agriculture.

    4. DB Blog on reforms in property registration system in Honduras

    5. CB Blog has some good posts. Pointsto Esther Duflo article on food price crisis, IRRI note on rice prices, and top 100 intellectuals

    6. Ajay Shah onwhat RBi should be doing in today’s monetary policy. He compares India’s financial system to China’s and criticises India’s policymakers. Another one on crony socialism.

    Is this Finance or Greek?

    April 28, 2008

    JRV Blog pointed to this UBS Shareholder report. In this UBS has given a statement of how the losses occurred in UBS’s books the recent crisis.

    On reading the report I actually asked myself, Is this a shareholder report? Though whoever has written it musty have tried his best to explain the events in “English”, understanding the events is mighty complex. It sounds Greek all the way. 

    There are so many jargons and acronyms for their various businesses, strategies, financial products that it confuses you what is going on. See this for example,

    UBS had significant levels of Subprime investments in three distinct businesses:

    • Within DRCM, there were Subprime positions in the Reference Linked Notes (“RLN “) program, the Asset Backed Securities Relative Value (” ABS Relative Value “) strategy, ABS Collateralized Debt Obligation Trading (“ABS CDO Trading”) strategy and in the US Short Term Asset Backed Portfolio. The business of DRCM was pursued within UBS Global Asset Management (” Global AM “), until DRCM’s re-integration into IB in the second quarter of 2007. Most of DRCM’s “legacy” Subprime positions were subsequently managed by the IB’s Securitized Product Group (“SPG”). More detail on these DRCM strategies is provided at section 4.1 of this Shareholder Report.
    • Within the IB, the Fixed Income business area’s Rates business had Subprime positions.The Rates business had warehoused and retained Collateralized Debt Obligations (“CDOs”) backed by Subprime collateral, including (in particular) Super Senior tranches of such CDOs. These Subprime positions were held principally by the CDO desk within Rates. More detail on this business is set out at section 4.2 of this Shareholder Report.
    • Also within IB the Foreign Exchange / Cash Collateral Trading (“FX/CCT”) business had Subprime positions in the ABS Trading Portfolio, which was a part of the overall Relative Value Trading Portfolio (“RVT Portfolio”) managed by the IB FX/CCT ABS Trading

    The entire report is very similar and you just end up flipping pages backwards to see what this particular acronym etc means. Once you get a hang of the business, comes the jazzy financial products and you know you have a headache.

    I don’t blame UBS though. The entire financial sector has moved from being simple to abstract and somehow the sector takes pride in the same. Some call it Modern finance and some like John Bogle despise the developments.

    That is why we see so much complexity and in a crisis it leads to higher uncertainty. One can only solve a mess (read the government/ regulators or in IMF’s euphemism public sector) if one understands it. Right now it is rocket science at its best. This was the shareholder report, just imagine a technical summary of the events.

    I don’t expect any improvements as far as this development is concerned. It is going to become Greek and if people begin to understand Greek then the sector will turn to Latin and so on. The sector believes in creating more and more asymmetry as may be it is a good way to earn their yachts . As it is most people don’t understand finance and don’t ask questions and such developments even widen the gap. So more complex and exotic is going to be the way for financial systems in future.


    1. Economist comments on the report

    Assorted Links

    April 28, 2008

    1. Tyler Cowen (of MR) on agriculture crisis. He says free  trade to lower prices in agriculture. Rodrik responds

    2. Econbrowser points to Peter Hooper’s (Chief Economist, Deusche Bank Securities) comments on US recession. Interesting graphs

    3. WSJ Blog points ECB is ready

    4. Ajay Shah on rupee. He also points to a new paper on inflation targeting


    Would RBNZ go the BoE way?

    April 25, 2008

    I had pointed earlier that Bank of England is targeting growth not inflation.

    In its recent monetary policy meeting Reserve Bank of New Zealand said the economic conditions have deteriorated quite a bit:

    Economic activity has weakened more markedly than expected in the Bank’s March Monetary Policy Statement. There have been sharp falls in consumer and business sentiment, exacerbated by tighter credit conditions, a further decline in the housing market and weaker prospects for world growth.

    What is RBNZ outlook on inflation?

    …..The weaker economy will, over time, ease accumulated pressure on resources and reduce inflation pressure. However, short term inflation is likely to remain persistently high, due in large part to repeated increases in food and energy prices. There is a risk that wage settlements respond to these short term price shocks rather than adjusting to the changing economic conditions, thus perpetuating inflation pressures.

    So, how does RBNZ balance the two risks?

    We see significant downside risk to future activity but upside risks to inflation. A further risk to the outlook is the persistently strong New Zealand dollar which, while helping moderate headline CPI inflation, remains a drag on export growth.

    And the decision is:

    Given this outlook, we expect that the OCR will need to remain at current levels for a time yet to ensure inflation outcomes of 1 to 3 percent on average over the medium term.

    If you look at the BoE link, you can see the two central banks have indicated very similar economic conditions but have taken an opposite view. BoE sees declining growth as a bigger risk than rising inflation and has reduced its policy rates. RBNZ has done the opposite and hence is actually doing what it should do- target inflation.

    Of course, both the economies are different and have a seperate stucture and driving factors. So both Central Banks will take a different stance. But both are supposed to target inflation and the overall mandate is very much the same.

    It will be interesting to see if RBNZ continues to manage inflation or turn the BoE way. Another bank to watch out for is Reserve Bank Australia which has so far raised its rates. The recent IMF WEO showed economic activity is declining in Australia but inflation expectations and numbers haven’t.

    Really tough times ahead for Central Banks.

    Assorted Links

    April 25, 2008

    1. WSJ Blog points Fed easing may come to an end. Econbrowser also ponders over the same. WSJ Blog also says that recent numbers do not add up to recession.

    2, Rodrik points to a discussion in World Bank where four economists talk over Governance – North, Acemoglu, Fukuyama and himself. I haven’t read much of Fukuyama but other three are a big wow. It should be a treat to read this.

    3. PI Blog on how to value a house/mortgage

    4. DB Blog points to reforms in Mozambique.  

    Urgent need to apply behavioral economics in policies

    April 24, 2008

    I have posted quite a few on the findings of behavioral economics/finance and high time we apply it to make better policies.

    I wrote a piece in Hindu Business Line giving a snapshot on the subject and few examples on where it has been used.

    Monetary growth is an indicator of emerging house price bubbles

    April 24, 2008

    On reading this Wolfgang Munchau article, I came across this new paper which says Central Banks should look at housing prices. This strand of literature is picking up with many new papers coming on the subject.

    Recently IMF WEO April 2008 report said the same. I had argued the same in this paper on 14 Dec 2007.

    The new paper which I mention above has done a good amount of econometric research (which was beyond me) and focuses on the developed economies. This piece (in English) from the authors provides a useful. The conclusion is pretty explicit:

    Against the background of our results the still high level of global liquidity has to be interpreted as a threat for future stable and low inflation and financial stability. Since global excess liquidity is found to be an important determinant of house prices, there might be at least two implications for the adequate conduct of monetary policy.

    First, monetary policy has to be aware of different time lags in the transmission from money to different categories of prices. In particular, strong money growth might be a good indicator of emerging future bubbles in the real estate sector.

    Second, house prices might well serve as indicators of future inflationary pressures on goods markets.

    Assorted Links

    April 24, 2008

    1. WSJ Blog points ships are too full

    2. PGP Blog points WDR 2008

    3. SJ on rising commodity prices. Econbrowser on the same topic

    Should Monetary Policy stabilise real economic activity?

    April 23, 2008

    Riksbank has started a research series called Economic Commentaries which provides a snapshot of debates/economic topics/research.

    I just read this first piece which is a snapshot of this longer article in this report – RAMSES – a new general equilibrium model for monetary policy analysis. The main idea is:

    The new Keynesian theory is currently the dominant paradigm in monetary policy research on flexible inflation targeting. an important result from this research is that monetary policy should eliminate the effects of nominal rigidities. This implies a trade-off between stabilising inflation around a target and achieving an efficient resource utilisation.

    The short piece discusses what this resource utilisation is, how can it be measured and how monetary policy can be used to minimise the gap.

    One might get confused though. The famous Taylor rule also looks at both stabilising inflation and output. This new approach talks about efficient utilisation against stabilising utilisation (which Taylor rule advocates)

    Flexible inflation targeting means that the central bank, in addition to stabilising inflation, tries to bring about the output level that would prevail in the absence of price rigidities. this output is known as flexprice output. the difference between actual and flexprice output is the flexprice gap. it is important to note that this measure of resource utilisation differs from traditional measures. traditional measures tell whether resource utilisation is high or low in relation to the normal level while the flexprice gap tells how resource utilisation relates to the efficient level.

    However, it will be dificult to implement this approach:

    it should, however, be emphasised that using the flexprice gap in practice is not a free lunch. it requires advanced analytical tools and models to calculate the flexprice gap, which can make it difficult for outsiders to replicate the results. in addition, the flexprice gap can differ from model to model, depending on the frictions and shocks included. Finally, it is a relatively complicated concept, which can make monetary policy communication more difficult.

    What if the apartment owner doesn’t pay-back the deposit ?

    April 23, 2008

    I had earlier written about the options one has to find a house in Mumbai. It is tough but one has to do the ordeal. There is no choice really. I just came across this story which I thought was important to share.

    I had mentioned if you rent a house, you have to pay a deposit to the owner. The amount varies from places to places. Like at most places it is 10 months rent but in more expensive areas you pay something like 4-5 month or a fixed amount say Rs 2 Lakhs etc. This deposit is like a security you place with the owner and you are supposed to take care of his/her house.

    Now, this money is a free-float for the flatowner and he is only entitled to pay you the actual amount. He can save it is a fixed deposit, invest in equities etc and keep the returns to itself. So apart from rent there is an added source of earning. But is it is a huge amount and it is important that the owner pays back the amount.

    Now there are two situations-

    • Your term is over and it isn’t renewed- if the owner doesn’t pay the deposit back, then one can refuse to vacate the flat (though am not sure how many are successful)
    • You might have to leave the house because of a job change/place change etc – This is a trick situation as you have to leave but the term isn’t over. And now if the person doesn’t payback the deposit what do you do? What is the recourse?

    I know somebody who was trapped in the second situation and the poor person didn’t know what to do. The owner said he had invested the money in equities and lost it and was unable to pay. He had to move to a new house as office was very far from the new workplace. So, he had to find a new apartment for rent, pay the deposit and rent and also haggle with his previous apartment owner to pay-back the deposit. And in all this he had to manage his office as well!  All know nothing can be done as there is no legal recourse. I am sure many in Mumbai and elsewhere must have faced this problem. But there is no way out.

    In India, the legal system is so poor that everything comes to a standstill. You have a complaint, stay with it. Only those who have enough energy can run after the courts for redressal. But overall, it is really pathetic.

    I had earlier raised an issue why Indian companies have such poor after sales service? One very good way to assess how bad the situation is to visit all these companies after sales service outlets. Huge frustration everywhere. One very important reason is that they know even if you have a complaint, the company is actually doing you a favor by rectifying it. As we have a poor legal system most companies know they can get away with these abysmal standards. 

    The importance of an effective legal system is extremely important. There is huge evidence how certain legal systems lead to better financial system and a better economy. People know they can’t get away if they have signed a contract. In India, the sanctity of the contract is hardly respected. We need to address this urgently as contracts are central to a functioning market- based economy. Otherwise we will never see the kind of infrastructure, financial system etc which we keep debating endlessly. 

    Assorted Links

    April 23, 2008

    1. JRV points to UBS shareholder report which says:

    UBS started buying US asset backed securities in 2002 because it thought that Japanese Government Bonds were too risky!!

    So Government bonds were riskier than sub-prime!!

    2. IDB points to a new document on inclusive growth and role of panchayats

    3. WSJ Blog points ECB can go eitherways

    4. Frankel points that LIBOR spreads have corrected a bit and financial crisis becomes worse

    5. FIn Rounds Blog points to a new blog on empirical finance

    Similarities between subprime crisis and Sweden 90’s crisis

    April 22, 2008

    I had pointed earlier about that the ongoing sub-prime crisis is very similar to 1987 crisis. And then we have a paper from Rogoff et al which says there is nothing different about it. Yes, the speech does attribute to the Rogoff paper so makes sense to read the paper. But, the speech is surely easier to read.

    I came across this speech from Riksbank Governor, Stefan Ingves:

    Some common denominators for the period prior to the outbreak of the crisis include a rapid increase in property and share prices, the fact that the current account deficit was large and growing and that economic growth had declined from an earlier high level. One important difference is that the exchange rate regime has not played a prominent role in the US case. 


    Assorted Links

    April 22, 2008

    1. WSJ Blog points to Stephen Cecchetti’s new research. Meanwhile futures markets trims hopes of a rate cut

    2. NEB on Joe Stigilitz

    3. Rorik takes on Zoellick

    4. Johnson on rising food prices

    5. PI Blog on whether it is rational to visit one’s mother?

    Did Term Auction Facility (TAF) work?

    April 21, 2008

    TAF was initiated by Fed in response to the crisis where both Libor spreads were widening and liquidity drying up dramatically.

    So did it work? This paper by John Taylor (of Taylor rule) says it didn’t !!

    At the center of the financial market crisis of 2007-2008 was a highly unusual jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spreads became a major focus of the Federal Reserve, which took several actions–including the introduction of a new term auction facility (TAF)–to reduce them. This paper documents these developments and, using a no-arbitrage model of the term structure, tests various explanations, including increased risk and greater liquidity demands, while controlling for expectations of future interest rates. We show that increased counterparty risk between banks contributed to the rise in spreads and find no empirical evidence that the TAF has reduced spreads. The results have implications for monetary policy and financial economics.


    Mercantilism is back!

    April 21, 2008

    Who says times have changed? It isn’t just about finance crisis or food crisis, but even growth theories. Most of the now developed countries grew on the basis of Mercantilism or export driven strategies. These were then discarded for fancier ideas like Washington Consensus. Now, the whole things seems to be coming back.

    Growth Commission is set up to look at the overall growth experience in the world. It is headed by Michael Spence and on looking at their website have put up lot of papers/case-studies on their website.

    I read this Growth Commission paperby Michael Spence and Mohamed El-Erian where the authors say exports are really important for a country’s growth. The authors put up a good picture on what drives growth in an economy and exports is one of them.

    All successful high-growth economies have had policies that were designed to help start and accelerate the process of export diversification and structural transformation. These included the following (with the mix varying):

    • Tax and other incentives to attract foreign direct investment.
    • Special export zones with supporting infrastructure, tax provisions, and import tariff relief.
    • Management of the exchange rate to maintain competitiveness in the export sectors

    These comments by Spence are being discussed widely. For instance at the WSJ Blog, Simon Johnson (see this one as well) (IMF Chief Economist). Once this reported is submitted in May, I am sure more would follow.

    So, has anything changed?

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