Ben & Draghi’s tempting treats should come with a statutory warning against overindulgence.
The “Ben” in question is US Federal Reserve Chairman Ben Bernanke. He’s keeping alive expectations of more quantitative easing. The “Draghi” is European Central Bank (ECB) President Mario Draghi, who is under pressure to create more liquidity now that the euro 1 trillion of three-year, one per cent loans he gifted banks in the single-currency area are beginning to look like dog-eared trinkets from last year’s Christmas.
It’s a delicious dessert, Ben & Draghi’s. Gorging on it, though, can be risky because there is no certainty about how long the cheap-money bonanza will continue to freely flow. (Inflation concerns have forced Bank of England Governor Mervyn King to halt the second round of the central bank’s asset-purchase programme, though Britain’s economy has slipped into a “double-dip” recession.)
Mr Bernanke is confounding the world with his rhetoric on US interest rates, which he promises will remain near zero until 2014. What if an unexpected surge in inflation forces him to advance that calendar by a year? Similarly, Mr Draghi’s liquidity injections have displeased the hawkish German Bundesbank, which is calling for a return to a more normal monetary policy stance. Its protestations can be ignored for now — although when it comes to inflation, the ECB’s German masters have a lower tolerance threshold than the Fed.
Today’s cheap global liquidity is a temporary phenomenon. It’s tough for borrowers to keep reminding themselves of this sobering reality when mortgages cost one per cent annually, as they do currently for households in Singapore. In Asia, the full force of very low global interest rates is being acutely felt in the city-state because the local monetary authority does not control borrowing costs. It’s very easy to lose one’s head in this glut of money and make imprudent decisions.
In other parts of the region, it’s the governments that are losing their heads. Fiscal spending in Malaysia jumped 20 per cent in the second half of last year, and is expected to remain high in 2012, a crucial election year. Public debt in Malaysia is already high at 55 per cent of gross domestic product (GDP), but there’s so much global liquidity – US banks have it “coming out of their ears”, as billionaire investor Warren Buffett puts it – that financing debt and deficits does not worry Prime Minister Najib Razak’s government. Foreign ownership of Malaysian government’s local currency debt is now 28 per cent, according to the International Monetary Fund. Three years ago, it was 10 per cent.
Indonesia, too, relies a great deal on foreigners to buy its bonds. Already there are signs that global investors are getting jittery about a potential inflationary flare-up. Retail fuel prices are capped in Indonesia, as they are in India. The government in Jakarta is not able to raise prices (sounds familiar?) even though uncontrolled growth of oil subsidies has, in the past, posed a threat to macroeconomic stability. Smugglers in this sprawling archipelago with a difficult-to-patrol coastline love getting their hands on heavily subsidised petrol and loading it on to buyers’ vessels at a much higher price. This “arbitrage” demand for refined petroleum products sits on top of genuine consumption demand, leading to a bloated import bill, and expectations of weaker currency.
But Indonesia still has one disciplining force: the government has to keep the budget deficit below the legally mandated ceiling of three per cent of GDP. So if the oil subsidy burden balloons, spending will be cut in other areas. Or a steep increase in petrol prices will be allowed to occur.
In India, there is no such disciplining force left any more.
The Fiscal Responsibility and Budget Management Act of 2003 lies in tatters, though in Finance Minister Pranab Mukherjee’s most recent Budget there was talk of reviving it by refocusing its emphasis on containing the “effective” revenue deficit, or the part that creates no fixed assets. Investors, however, do not believe that the government is really serious about fiscal consolidation.
With Standard & Poor’s lowering the outlook on India’s long-term foreign currency rating to negative from stable, there is now more than a slim chance that the country will lose its investment grade credit standing.
India’s addiction to Ben & Draghi’s is showing up in the country’s current account. The gap between the imports of goods and services and their exports – a gap that needs to be filled with volatile foreign capital flows – is now approaching four per cent of GDP, an all-time high.
This is what makes India uniquely vulnerable. No other major economy in the region is running a current account deficit. To put it another way, while most Asian countries have slightly overindulged on their Ben & Draghi treats, it’s only India that has made it its primary source of nutrition.
All other economies have more than enough local savings to finance domestic investments. India’s government, however, has spent so wildly in the past several years that national savings are now falling seriously short of domestic investment. So the country has developed a very large reliance on foreigners’ largesse in order to keep the economy growing at a respectable rate.
This is a serious vulnerability.
For almost a decade now, India has benefited from favourable debt dynamics: the economy has grown faster in nominal terms than the interest rate the government has paid on its debt. As a result, public debt has fallen to about 70 per cent of GDP, from 88 per cent in 2005, according to Moody’s. But the gains could prove illusory. A repeat of the stressful 2000-2003 period, during which nominal growth fell below the interest rate on government debt, could lead to a new spike in the debt-to-GDP ratio.
A bout of extreme global risk aversion, perhaps caused by Greece’s decision to exit the euro zone, would hurt India because the economy is increasingly reliant on foreign debt and equity flows. On the other hand, if the extraordinary monetary accommodation that we are witnessing in the US and Europe leads to a 1970s-style inflationary spiral, global interest rates will have to rise quickly. In either case, India may get more than a mild stomach ache for helping itself to one scoop of Ben & Draghi’s too many.
The writer is a Singapore-based financial journalist