The Gold Standard | Spectre of hard-landing

Suddenly, the skeletons seem to be tumbling down. Adrian Mowat of JP Morgan used the phrase ‘hard-landing’ and China in th same sentence. I am not going to claim that this blogger was his inspiration! But, I shall let that possibility circulate :-)

James Kynge who publishes FT China Confidential every fortnight (available for subscribers only) talks of political tensions in China, in the latest FT China Confidential edition (19th May). The People’s Bank of China (PBoC) and the National Development Reform Commission (NDRC) are at loggerheads over the tools to deploy in the fight against inflation. There is looming power shortage due to officially repressed prices for coal and electricity. So, they are sold unofficially at exorbitant prices. The official Consumer Price index then becomes meaningless. The true cost of capital for small and medium enterprises in China is 11% and god knows the true price of coal and electricity. No wonder FT China Confidential of urban middle class households showed inflation rate to be 17%.

See this article (in Mandarin) for a discussion on the issue of loans made by banks against ‘land reserves’ (ht Paul Cavey of Macquarie Securities). Some selected sentences:

Our journalists’ investigation reveals that various localities – such as Beijing, Shenzhen, Hangzhou, and Shanghai – have witnessed a significant reduction of land sales proceeds. Shanghai’s land sale revenue has fallen by 32% YoY, and Shenzhen is enduring a “zero land supply” year.

By putting pressure on land reserve loans, the withering of the land market has dealt a sobering blow to local governments.

China Construction Bank’s (CCB) management revealed that real estate loans increased by Rmb45bn in 2009, and 1/3rd of the increase were land reserve loans. The Industrial and Commercial Bank of China (ICBC) also attributed the rising share of real estate loans to increases of land reserve loans in 2009 (from 10.6% at end-2008 to 11% at end-2009).

In 2010, when listed banks claimed that the share of real estate loans had decreased, local land reserve centers were still among their largest clients.

In 2010, loans made to China Minsheng Bank’s 10 largest clients were worth a total of Rmb36.7bn, or 3.47% of the bank’s total loan stock. Land reserve centers in Beijing, Shanghai, Chongqing, and Xi’an were amongst China Minsheng Bank’s 10 largest clients.

The land reserve loan “bomb” must be defused.

In the case of India, the street has been becoming more realistic about growth prospects in India. Morgan Stanley, last I heard, had reduced India’s growth forecast for 2011-12 from 8.7% to 7.7%. Story link here. Of course, in a more recent interview with Business Standard, Morgan Stanley’s Chetan Ahya denies that the US quantitative easing is part of the inflation problem faced by developing nations via higher commodity prices.

TGS strongly disagrees much as he agrees that the problem of inflation in China and India is predominantly home-grown and they could have attenuated the US impact. But, that is political economy and not economics.

See this piece in Business Line which frames the answer as the question. The Indian growth story has derailed. Earlier, Sanjaya Baru wrote that the new growth-inflation mix is more like 8-6 and not 9-5 as assumed in the 2011-12 budget. But, even 8% growth rate for the current fiscal and next appears a stretch. Abheek Barua, chief economist of the HDFC Bank, had written that India should be prepared to accept lower economic growth at least for the next two years, without committing himself to numbers. That time-frame is realistic provided the problems are recognised and solutions devised. It could be longer too, otherwise.

Part of the problem why we have an unhealthy combination of falling growth momentum and persistently high inflation is well explained by this piece written by Rajiv Lall for MINT. The subsidy regime of the present government exemplifed by the National Rural Employment Guarantee Programme has increased currency in circulation while taking liquidity out of the banking system. Government spending via good infrastructure projects would have done the opposite: kept liquidity in the banking system, raised growth potential and thus kept inflation in check through that and by restricting currency in circulation. This situation was well anticipated by the Business Standard editorial that appeared in Feb. 2009. Just take note of the size of India’s fiscal stimulus response to the global crisis.

Essentially, the UPA government’s fiscal policy has played an important role in the unfavourable growth-inflation trade-off that India faces in 2011-12 and possibly in 2012-13.

As for the medium-term growth prospects in India, clearly, unless there is a recognition that India is going through its own version of gilded age (in contrast to what Professor Arvind Panagariya writes here), medium-term revival of growth cannot be taken for granted. Michael Walton shows three excellent charts that capture the prevalence and the recent rise of oligarchic capitalism in India. See pages 15 and 41.

Although this Op-ed. by Michael Walton is about a year old, his message is quite clear. India does need and can have a welfare State for that helps to achieve high productivity capitalism (e.g., Sweden) provided the State is both effective and accountable. Read the stuff about how the Chilean finance minister braved unpopularity when he held back spending in copper-fuelled boom years. That is how the electorate and the public are in most countries on most occasions (endless examples can be given) and that is why there is need for enlightened leadership that imposes long-term choices. Libertarinism is elegant in blog posts, op-eds. and academic papers.

Such a politician is yet to be found in India. Rahul Gandhi is right to champion the causes of farmers in India. But, the issues are the absence of public investment in the farm sector, the ban on export of farm produce, the mandatory procurement at below market prices by the government and the absence of reliable, quality power and water supplies.

TGS is not particularly thrilled that he had warned of these many times before. Two of them, more recently, here and here.

This brings me to the final point of this long post. Much as both these Asian giants have themselves to blame for the situation that they find themselves in, the United States must be noting their current predicament with quiet satisfaction. To the extent it can help the process of unravelling of the economic growth stories of China and India along, it would not mind doing so. At the margin, this consideration would be a factor in the decision on extending quantitative easing and maintaining very low (negative) real rates in the US. That woud keep the prices of commodities boiling and inflation pressures high in these two countries.

They can respond constructively and reform. They can unravel and/or choose to take the confrontation path – economically and otherwise. Your pick. I know what I would pick.


DISCLAIMER: This is an archived post from the Indian National Interest blogroll. Views expressed are those of the blogger's and do not represent The Takshashila Institution’s view.