Archive for March 26th, 2009

India’s Inflation: Understanding the sharp fall

March 26, 2009

I have written a new paper with the same title.

This paper reviews the developments in India’s inflation trajectory focusing on FY 2008-09. Section I shows how volatile inflation has been in FY 2008- 09. Section II presents sector-wise analysis. Section III presents comparisons between WPI and CPI, Revised and Provisional etc. Section IV analyses on whether there is a deflation concern in India

Comments are welcome.

How did India fare in previous crises?

March 26, 2009

ICRIER has released a new paper updating on Indian economy and financial markets. It forecasts India’s growth rate in 2009-10 at 4.8% without policy response and 5.5% with policies. In 2008-09 the growth is expected to be 6.3% minus or plus the policy response.  They use a leading indicator methodology to predict growth rates which they believe is quite good forecasting tool.

What I find more interesting is their analysis of how India fares in previous global crisis. This paper looks at impact of previous crisis on India’s growth, exports, imports and industry. I had pointed to two previous papers – one on India’s Banking crisis, Great Depression impacting India. This new paper further fills the gap.

The methodology is:

The past crises that have been considered are the three major crises – 1991-92 balance of payment (BOP) crisis; 1997-98 fallout from the Asian financial crisis; and 2000-02 crisis caused by the worldwide bursting of the dotcom bubble and 9/11 incident. The period selected is three years prior to and three years after the worst year of the crisis.

Impact on macro variables

Exports: In the past crises we find that export growth slumped by 12 percentage points during the crises period. But the export sector recovered in just one year after the slump in all the three major crises. The sudden recovery of exports can be due to the huge depreciation that is seen during the crises period.

Imports: import growth starts falling two years prior to the crises. The fall in import growth in the three major crises is greater than the fall seen in export growth. Import growth fell at an average of 14 percentage points and recovery also takes longer than for exports. The sharp depreciation during the crisis period makes the imports more expensive, hence, leading to their prolonged slump. The recovery in the case of imports is longer of a period of two years as compared to just one year in the case of exports.

IIP:As can be seen from the average of past crises, IIP growth in the peak year of the crises has fallen by an average of 3 percentage points, year on year

GDP:  in the case GDP growth we find it falling by about 3 percentage points during the peak crises year

So, it will all depend on whether we are at time T or still T-1 or T-2.  From the graphs ICRIER assumes that 2008-09 is  T-1 and 2009-10 is T (hopefully we will begin to recover from 2010-11 onwards). Let us see how we compare now?

  • Exports-Imports have already fallen sharply and I will just compute the numbers to see where are we placed.
  • IIP average growth between Apr-08 – Jan 09 is 3.1% and in Apr 07-Mar 08 it was 8.6%. So, it has fallen by nearly 5.5% from T-2 and by 8.4% from T-3. And we are still in T-1. T could be a lot worse. As ICRIER puts it, slip in IIP could be much higher.
  • GDP for 2007-08 was 9.0%. In 2008-09 ICRIER expects a growth of 6.3% a slip of 2.7%. In 2010-11, a growth of 5.5% a slip of 4.5%. In previous crisis the growth has fallen by 3% in the crisis year compared to previous years. Here also the impact is more than previous crisis.
  • The global crisis seems to be effecting the Indian economy the most. But again, we seem to much better off. The average growth in previous 3 crisis was around 3% but here we are still seeing 5.5% growth in 2009-10.

Interesting analysis from ICRIER. We need more of this to understand how are we placed compared to previous crisis. 

Moveover real and financial crisis, here is trust crisis

March 26, 2009

I r’ber attending a presentation at college where I was told markets are not about demand, supply or prices. It was completely about trust. You may have all the other three but if no trust markets are not going to be effective. Trust is more crucial in a market for financial products where benefits are going to exist after sometime in future.

It is very interesting to note that two economists – Luigi Zingales of Chicago and Paola Sapienza of Kelloggs are doing tons of research on the subject. They have even developed a index Financial Trust Index:

The mission of the Financial Trust Index is to monitor the level of trust Americans have in banks, the stock market, mutual funds, and large corporations, and to regularly assess how current events, policy and government intervention might affect this trust.

The duo has written numerous papers as well on the subject. Check Professor’s websites for papers.

I just read this paper from the duo which says that trust in financial markets  is very low and has slipped sharply in recent months.

If a modern Rip Van Winkle had fallen asleep two years ago and woken up now, he would wonder what had happened to the U.S. economy. Two years ago, we were in the middle of an economic boom. Banks were eager to lend even at the cost of forgoing important covenants, and corporate America (and the entire world) was producing at full steam, so much so that commodities prices were rising in anticipation of a future scarcity. Today we are quickly sliding into a deep recession. Banks are not lending and commodity prices are plummeting in expectation of a dramatic slowdown of production throughout the world. Neoclassical economic models cannot explain this dramatic change. There was no apparent shock to productivity nor a clear slowdown in innovation. The government has kept taxes low. The Federal Reserve has kept interest rates low and cut them even further. What happened?

What happened?

Something important was destroyed in the last few months. It is an asset crucial to production, even if it is not made of bricks and mortar. While this asset does not enter standard national account statistics or standard economic models, it is so crucial to development that its absence — according to Nobel laureate Kenneth Arrow — is the cause of much of the economic backwardness in the world. This asset is TRUST. As stressed by Arrow: “Virtually every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time.” Without trust, cooperation breaks down, financing breaks down and investment stops.

They then present results of their latest survey. Here are the broad findings:

We find that trust in the financial sector is indeed very low and is reported as having declined sharply in the last few months. This lack of trust is correlated with people’s willingness to invest in the stock market and their tendency to withdraw deposits. While the heavy losses suffered can in part explain this reduced trust, a crucial factor seems to be the way in which the government has intervened. While the majority of respondents favor government intervention in financial markets, 80 percent of the pro-intervention majority think that the way in which the government has intervened in the last few months has made them less, and not more, confident in the market. A big factor in this lack of trust is the perception — shared by 40 percent of the respondents — that the main purpose behind Treasury Secretary Paulson’s act was the interest of Goldman Sachs and not the interest of the country.

Fairly interesting stuff. It looks pretty simple and obvious if we think of it. Trust is going to be broken in times of crisis. A trust crisis simply deepens the crisis.  However, to put it all empirically is really the challenge. The paper was written when Paulson was the Treasury Secretary. It will be interesting to see where the index is headed now. I think it would have slipped even lower since then.  The policies have only gone worse and moreover it is Paulson’s earlier policies which are making a comeback.

It is interesting to note that economists are now researching in areas which were assumed as given. Behavioral economics has made leaps of progress to show humans are anything but rational. Then there is ongoing research on neural economics.  And now this research on trust.

The way economics concepts and theories are being questioned now (by really big names like Greenspan, Acemoglu, Willem Buiter etc) it will be interesting to see which other areas would field of economics move into? It is surely an exciting time for economics research. Thinking differently may not have been appreciated earlier, but looks set to be rewarding now.

Research on Measuring Financial Integration and whether SWFs help?

March 26, 2009

I had recently posted on the need to have better measures to find out how much an economy is financially integrated with rest of the world.

IMF in its March research bulletin has an interesting lit survey by Martin Schindler:

Over the past several years, an increasing number of  such measures have been made available, including de jure measures, aiming to reflect the extent to which countries impose legal restrictions on cross-border financial flows, and outcome-based de facto measures, aiming to capture a country’s actual degree of financial integration. For the purpose of policy analysis, de jure measures, which are under policymakers’ direct control, are more relevant, while in other applications, de facto measures may be more appropriate; in still other situations, both may be necessary, for example, if the research question centers on the effectiveness of capital controls in stemming de facto outcomes.

He then explains the various databases developed by economists. He summarises it as:

Overall, a wide array of measures exists from which researchers can choose those that best fit their research question. For example, the inflow/outflow distinction in Schindler (forthcoming) allows Prati, Schindler, and Valenzuela (forthcoming) to identify the differential effects of capital account liberalizations on different subsets of firms; Binici, Hutchison, and Schindler (forthcoming) use both de jure (Schindler, forthcoming) and de facto (Lane and Milesi-Ferretti, 2007) measures and find significant differences in the effectiveness of capital controls between equity and debt flows and inflows and outflows; and Kose and others (2006) argue for the use of de facto measures. For further discussion of financial integration measures and related issues, researchers are referred to Edison and others (2004), Kose and others (2006), Miniane (2004), and Schindler (forthcoming).

The bulletin also carries a lit survey on whether Sovereign Wealth Funds help or worsen financial markets. It looks at research papers (though limioted data is not public) which have used event studies. Findings:

Overall, these event studies do not find any significant destabilizing effect of SWFs on equity markets. It will be hard to draw conclusions for overall global and regional financial stability or stability in markets other than equity markets from these event studies. Other methods to examine the empirical impact of SWFs would require more detailed knowledge of SWFs’ investments and their timing and amount—data that is presently not available. Hypothetical market responses to SWFs’ investments require a thorough understanding of how asset allocations are constructed and the size, depth, and breadth of the corresponding markets.

To summarize, existing research on SWFs suggests that they can be a stabilizing force in global financial markets. Event studies do not find a destabilizing impact from SWF investments and divestments in equity markets, while simulations of SWF asset allocations only imply a gradual shift with modest economic effects. With SWFs improving their transparency and disclosure over time, the availability of historical SWFtransactions would provide researchers with the necessary data to further examine their implications for financial stability.

Superb short readings.

Assorted Links

March 26, 2009

1. Urbanomics summarises various views on the new Geithner plan

2. Krugman says he is only human :-)

3. Mankiw advertises for the IMF

4. Finprof points to Hernando De Soto’s analysis of the crisis

5.  Pestonblog points that the recent failed auction of UK G-sec is a cause for concern

6. CTB says monitoring leverage ratios is useful


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