Over the past year or so, the micro-finance movement has been the subject of intense scrutiny, faced with charges of fraud and exploitation. In Bangladesh, the Grameen bank and its iconic founder Mohammed Yunus have been accused by the Government of accounting fraud and diverting money. In Andhra Pradesh, micro finance institutions (MFIs) have been found indulging in practices that exploit the poor.
I have already blogged and written about these allegations and will not dwell on them here. Suffice to say that there are critical procedural/administrative problems and more importantly, serious corporate governance issues with many MFIs. In the absence of meaningful steps to address them, there are strong headwinds against any sustainable progress for the MFI model.
However, there are two interesting macro-perspectives from this debate, especially in Andhra Pradesh, that deserve greater discussion.
1. There is the argument that the spectacular success of MFIs in Andhra Pradesh overlooks the role of the government in creating a million-strong Self Help Groups (SHGs) that the MFIs could readily use (a la "ready cooked food"). There is palpable resentment at the fact that the MFIs, who merely walked in and piggy-backed on the fruits of the state government's efforts of more than a decade to develop SHGs, are claiming and getting a disproportionate share of the credit for the success of micro-finance activities in Andhra Pradesh.
In fact, the officials of the state government have even gone on record to argue that MFIs should confine themselves to non-SHG lending, "They cannot make profit by lending to the poor. Let them lend to the rich and make profit and leave welfare of the poor to the Government."
Without getting into the merits of how the credit for the success of micro-finance should be apportioned, it may be useful to examine what should be respective roles of the government and private sector in such areas.
Clearly, there are two distinct activities - formation and strengthening of SHGs and micro-lending to these SHGs. The strength of the former determines the success with the latter. In other words, SHGs form the fixed social infrastructure on which micro-finance rides.
I am inclined to see striking parallels between SHGs and classic public goods. It is now well-documented that apart from being channel to funnel credit to the poor, SHGs also play a critical role in women's empowerment and is a platform for enhancing the effectiveness of government interventions in many areas. Therefore, the net social benefits of SHGs exceed its net private benefits to the agency forming such groups. Private agencies like MFIs will naturally have less of an incentive to invest time and resources in forming SHGs.
In the circumstances, as is the case with public goods, it may be appropriate if governments focus on the formation of SHGs and invite the private sector to play a greater role with micro-lending. This does not mean an exclusive role for each in their respective areas, but a major role. So the way forward may be for governments to focus on forming SHGs and strengthening them, and for private sector to partnering with governments in increasing the volume of micro-lending. And all this assumes that the governance and other problems related to MFIs are largely resolved.
2. The second issue is related to the respective roles of the government and the private sector in combating poverty. More specifically, the success of the MFIs (most conspicuously, the success of SKS with its IPO) has generated a strong feeling that MFIs are making super-normal profits by exploiting the poor. This in turn raises the issue of what should be ethical standard for private agencies working in the area of development, the so called social enterprises.
Is it alright for a private social enterprise firm, playing by the rules of the game (assuming that the rules are themselves fair), to make profits even as it delivers on certain social objectives (as being delivered through the regular government initiatives)? In this case, is it acceptable if MFIs follow the rules, make micro-loans, and in the process also make handsome profits? Or should their profits be capped at some level? Or should the cost of lending be brought down and thereby reduce the excessive profit margins? Or should a share of their huge profits be ploughed back into helping the poor in some other effective manner?
In other words, is it acceptable for a private social enterprise, functioning with its capitalist efficiency and playing by the letter and spirit of the rules of the game, to work towards the objective of maximizing its profits?
Wednesday, April 13, 2011
Tuesday, April 12, 2011
China Vs Europe - study in labour competitiveness
China and Europe stand at the two ends of the spectrum on manufacturing labor costs, and it reflects in their respective economic situations today. The US BLS editorial writes,
The index of hourly compensation costs in manufacturing across countries and regions captures the competitiveness gap accurately.
The main point is the fact that despite the recent increases, China's average hourly compensation continues to be more than 30 times less than that of Europe, whose labor costs boomed in the last decade and considerably eroded its economic competitiveness.
As measured in U.S. dollars, Chinese hourly labor compensation costs in manufacturing were roughly 4 percent of those in the United States and about 3 percent of those in the Euro Area in 2008. China's costs were roughly on par with those of some developing countries like the Philippines, but lagged noticeably behind those of other countries like Mexico and Brazil. Average hourly compensation costs in China were $1.36 in 2008. China's hourly compensation costs remain far below those of many of its East Asian neighbors like Japan ($27.80) and Taiwan ($8.68), but are roughly on par with those of others like the Philippines ($1.68)
The index of hourly compensation costs in manufacturing across countries and regions captures the competitiveness gap accurately.
The main point is the fact that despite the recent increases, China's average hourly compensation continues to be more than 30 times less than that of Europe, whose labor costs boomed in the last decade and considerably eroded its economic competitiveness.
Monday, April 11, 2011
The bubble-debt parable
Let me illustrate what it means to mistake a solvency crisis for liquidity crisis, using the parable of Bubbleland.
Bubbleland has been experiencing an unprecedented property boom for the past five years. Land values have shot through the roof, rising above 500% in some areas. The rising property prices fuelled a speculative boom, in which investors, home buyers, financiers, and real estate developers participated with great fervour.
Bubbleonians scrambled to buy land and homes, investors came to see property as the asset class to be in, and banks bent over backwards to finance property deals. The three major real estate developers of Bubbleland, Messers Bubble Constructions, Greedy Developers, and Fly-By-Night Realtors, purchased huge tracts of lands and have made massive investments in new residential and commercial projects.
Sensing the great business opportunity, the two government run banks of Bubbleland - Too Big to Fail Bank and Too Inter-connected To Fail Bank - lend massive amounts in home mortgage finance and to real estate developers. Then property prices crash and the party grinds to a halt. Fear and uncertainty about counter-party risks ensure that property sales get frozen and real estate credit runs dry.
Heavily leveraged purchasers, developers, and financiers are left holding assets whose values have plumetted three to five-fold. In the absence of continuing cash-flow from sales, debt-laden property developers face default. A substantial share of mortgage holders who purchased their homes during the boom have negative equity, stop paying their instalments. The knock-on effect of these defaults on both banks is massive. In three months, both are on the verge of going under, taking the financial system of Bubbleland with them.
The Government of Bubbleland steps in to avert a major financial meltdown and economy-wide recession. The Central Bank of Bubbleland (CBB) aggressively lowers interest rates and opens an unlimited liquidity access facility. It also provides massive amounts of loans at very attractive terms to both major and other smaller banks. The banks in turn reschedule the loans provided to the three major developers and the mortgage holders.
There is another sub-plot to the tale. As the crisis unfolds, driven by the massive credit-injections to keep the financial markets unfrozen, cassandras believe that inflationary pressures are taking hold. The inflation-targeting CBB hikes interest rates. The repayment burdens of the developers and mortgage holders climb. The balance sheets of the banks fall deeper into the red. Recession turns into a depression.
We could easily replace Bubbleland with Euro zone, the three property developers with Greece, Ireland, and Portugal, and the two banks with French and German banks, and the story and plots will be strikingly similar. Consider this NYT report
The hope with the Bubbleland case is that once normalcy is restored, the borrowers will return to repaying their dues, and the banks (and their investors) will be back to getting the expected returns on their lending and investments. In simple terms, the fundamental assumption behind this bailout strategy is the hope that with reasonable time, the asset values will return to its bubble-era peak and property market will get unfrozen. This is critical for borrowers to repay their liabilities and lenders to get their balance sheets back in order.
In other words, the strategy revolves around the belief that it is a liquidity crisis and not a solvency problem. But what if the property market remains depressed for too long? It is after all not possible to keep re-scheduling loans to banks and homeowners forever. The liquidity strapped banks and developers will soon realize that there is no light at the end of the tunnel. Defaults and bankruptcy filings will become inevitable. The tax payers of Bubbleland have to pick up the tab for the massive losses that will ensue and bear the debilitating burden of its devastating impact on the economy.
Similarly, at some point in time, the lenders to Portugal (and their investors) and the Portuguese Government itself will realize the futility of such debt roll-overs. Government revenues are declining or at best stagnant, and debt-to-GDP-ratios are climbing. Borrowing costs are spiralling in the face of the double impact of lower credit rating and interest rate hikes.
Debt rescheduling will slowly turn into debt restructuring and even defaults. It is inevitable that the German and French banks will be forced into taking haircuts as sovereign defaults loom large and the European Commission will have to offer long-term concessional financial support to these countries.
Creditors will have to bear the costs of their recklessness and greed. Tax payers will end up bearing the costs of someone else's greed. It is certain that just as with Bubbleland, the denoument will not be pleasant for the Eurozone economies.
Bubbleland has been experiencing an unprecedented property boom for the past five years. Land values have shot through the roof, rising above 500% in some areas. The rising property prices fuelled a speculative boom, in which investors, home buyers, financiers, and real estate developers participated with great fervour.
Bubbleonians scrambled to buy land and homes, investors came to see property as the asset class to be in, and banks bent over backwards to finance property deals. The three major real estate developers of Bubbleland, Messers Bubble Constructions, Greedy Developers, and Fly-By-Night Realtors, purchased huge tracts of lands and have made massive investments in new residential and commercial projects.
Sensing the great business opportunity, the two government run banks of Bubbleland - Too Big to Fail Bank and Too Inter-connected To Fail Bank - lend massive amounts in home mortgage finance and to real estate developers. Then property prices crash and the party grinds to a halt. Fear and uncertainty about counter-party risks ensure that property sales get frozen and real estate credit runs dry.
Heavily leveraged purchasers, developers, and financiers are left holding assets whose values have plumetted three to five-fold. In the absence of continuing cash-flow from sales, debt-laden property developers face default. A substantial share of mortgage holders who purchased their homes during the boom have negative equity, stop paying their instalments. The knock-on effect of these defaults on both banks is massive. In three months, both are on the verge of going under, taking the financial system of Bubbleland with them.
The Government of Bubbleland steps in to avert a major financial meltdown and economy-wide recession. The Central Bank of Bubbleland (CBB) aggressively lowers interest rates and opens an unlimited liquidity access facility. It also provides massive amounts of loans at very attractive terms to both major and other smaller banks. The banks in turn reschedule the loans provided to the three major developers and the mortgage holders.
There is another sub-plot to the tale. As the crisis unfolds, driven by the massive credit-injections to keep the financial markets unfrozen, cassandras believe that inflationary pressures are taking hold. The inflation-targeting CBB hikes interest rates. The repayment burdens of the developers and mortgage holders climb. The balance sheets of the banks fall deeper into the red. Recession turns into a depression.
We could easily replace Bubbleland with Euro zone, the three property developers with Greece, Ireland, and Portugal, and the two banks with French and German banks, and the story and plots will be strikingly similar. Consider this NYT report
"Banks in well-off countries like Germany, France and the Netherlands, as well as Britain, hold a lot of Greek, Portuguese and Irish debt. And if these countries cannot pay their debts, they would have to reschedule them, reduce them or default, causing a major banking crisis in the rest of Europe. That reckoning would require governments to ask their taxpayers to recapitalize the banks... We have a banking crisis interwoven with a sovereign debt crisis."
The hope with the Bubbleland case is that once normalcy is restored, the borrowers will return to repaying their dues, and the banks (and their investors) will be back to getting the expected returns on their lending and investments. In simple terms, the fundamental assumption behind this bailout strategy is the hope that with reasonable time, the asset values will return to its bubble-era peak and property market will get unfrozen. This is critical for borrowers to repay their liabilities and lenders to get their balance sheets back in order.
In other words, the strategy revolves around the belief that it is a liquidity crisis and not a solvency problem. But what if the property market remains depressed for too long? It is after all not possible to keep re-scheduling loans to banks and homeowners forever. The liquidity strapped banks and developers will soon realize that there is no light at the end of the tunnel. Defaults and bankruptcy filings will become inevitable. The tax payers of Bubbleland have to pick up the tab for the massive losses that will ensue and bear the debilitating burden of its devastating impact on the economy.
Similarly, at some point in time, the lenders to Portugal (and their investors) and the Portuguese Government itself will realize the futility of such debt roll-overs. Government revenues are declining or at best stagnant, and debt-to-GDP-ratios are climbing. Borrowing costs are spiralling in the face of the double impact of lower credit rating and interest rate hikes.
Debt rescheduling will slowly turn into debt restructuring and even defaults. It is inevitable that the German and French banks will be forced into taking haircuts as sovereign defaults loom large and the European Commission will have to offer long-term concessional financial support to these countries.
Creditors will have to bear the costs of their recklessness and greed. Tax payers will end up bearing the costs of someone else's greed. It is certain that just as with Bubbleland, the denoument will not be pleasant for the Eurozone economies.
Sunday, April 10, 2011
The competitiveness mismatch in Europe
Paul Mason (via Paul Krugman) has an excellent graphic that captures one of the fundamental problem facing many peripheral economies of Europe - lack of competitiveness.
He writes,
And The Economist is spot-on in its analysis of Portugal's problems,
Fiscal austerity is not going to solve the competitiveness deficit, as Greece is finding out, through its three-year €110 billion ($155 billion) EU/IMF combined emergency bailout of May 2010,
The solution, as Paul Krugman writes, is a combination of German inflation and Spanish deflation,
And amidst this gloom, hiking interest rates to ward off inflationary pressures is only going to amplify the woes,
The European policy makers are clearly missing the woods for the trees. They fail to see the competitiveness mismatch and see inflation and lack of market confidence as the problems. Accordingly, their prescription is to raise interest rates and implement austerity measures to regain market confidence. Unfortunately, the first will merely widen the competitiveness mismatch while the second, from evidence of Ireland, UK, and Greece so far, will do little to bring back the "confidence fairy".
Update 1 (12/4/2011)
Paul Krugman makes another interesting point about how the sudden convergence of interest rates in the aftermath of the introduction of the Euro has contributed to the crisis.
He writes that as the euro became a done deal, countries that had previously had to pay a large interest premium found themselves able to borrow on the same terms as Germany; this translated into a big fall in their cost of capital. The result was bubbles, inflation, and the crisis in the aftermath of the bubbles and inflation.
Update 1 (22/4/2011)
The graphic below captures the problems for the peripheral economies. Note the high external debt-GDP ratios and banking sector share of that debt.
He writes,
"There is a huge competitiveness mismatch and a resulting huge trade mismatch. The south became an export market for north-European manufactured goods, and a credit market for the north-European banks - which may have been technically constrained to be dour and presbyterian by domestic law but nevertheless piled into the Irish and Spanish property bonanza with gusto. Everybody benefited from the credit bubble; but Germany has above all benefited from the Eurozone's structural imbalance."
And The Economist is spot-on in its analysis of Portugal's problems,
"Portugal now joins Greece and Ireland in the euro zone’s intensive-care ward. Its public debts are nowhere near as monumental as Greece’s; its banks not as reckless as Ireland’s. It has succumbed because of a humdrum failure to rein in wage increases and to modernise a bureaucracy schooled in tallying the quiet remains of the first global empire, as well as an inability to coax upstanding family companies, which for centuries have crafted textiles, ceramics and shoes, into competing with the Chinese."
Fiscal austerity is not going to solve the competitiveness deficit, as Greece is finding out, through its three-year €110 billion ($155 billion) EU/IMF combined emergency bailout of May 2010,
"The real source of gloom is the shorter-term impact of austerity. A year ago the plan forecast that GDP would shrink by 4% in 2010 and 2.5% in 2011. Instead it fell by 4.5% last year and IOBE predicts it will decline by 3.2% in 2011. The unemployment rate has risen from 9% in mid-2009 to 14.2% in the last quarter of 2010, and is expected to average 15.5% this year... progress in cutting the deficit in 2010 was slower than envisaged. Provisional estimates put it at an oppressively high 10.6% of GDP rather than the original target of 8.1%. Debt is now close to 145% of GDP... Ten-year government-bond yields have climbed to almost 13%. The credit-rating agencies have recently downgraded Greek sovereign debt still further, from junk to junkier."
The solution, as Paul Krugman writes, is a combination of German inflation and Spanish deflation,
"During the eurobubble years, there were huge capital flows to peripheral economies, leading to a sharp rise in their costs relative to Germany. Now the bubble has burst, and one way or another those relative costs need to be brought back in line. But should that take place via German inflation or Spanish deflation? From a pan-European view, the answer is surely some of both — and given that deflation is always and everywhere very costly, the bulk of the adjustment should in fact take the form of rising wages in Germany rather than falling wages in Spain."
And amidst this gloom, hiking interest rates to ward off inflationary pressures is only going to amplify the woes,
"But what the ECB is in effect signaling is that no inflation in Germany will be tolerated, placing all of the burden of adjustment on deflation in the periphery. From the beginning, euroskeptics worried about one-size-fits-all monetary policy; but what we’re getting is worse: one-size-fits-one, Germany first and only. That’s a recipe for a prolonged, painful slump in the periphery; large defaults, almost surely; a great deal of bitterness; and a significantly increased probability of a euro crackup."
The European policy makers are clearly missing the woods for the trees. They fail to see the competitiveness mismatch and see inflation and lack of market confidence as the problems. Accordingly, their prescription is to raise interest rates and implement austerity measures to regain market confidence. Unfortunately, the first will merely widen the competitiveness mismatch while the second, from evidence of Ireland, UK, and Greece so far, will do little to bring back the "confidence fairy".
Update 1 (12/4/2011)
Paul Krugman makes another interesting point about how the sudden convergence of interest rates in the aftermath of the introduction of the Euro has contributed to the crisis.
He writes that as the euro became a done deal, countries that had previously had to pay a large interest premium found themselves able to borrow on the same terms as Germany; this translated into a big fall in their cost of capital. The result was bubbles, inflation, and the crisis in the aftermath of the bubbles and inflation.
Update 1 (22/4/2011)
The graphic below captures the problems for the peripheral economies. Note the high external debt-GDP ratios and banking sector share of that debt.
Hot Coffee, just right!
How do we lower the temperature of scalding-hot coffee to the perfectly drinkable temperature and keep it there while you sip along? Buy Joulies metal beans!
The Joulies are being developed as part of a Kickstarter funded project. Kickstarter is the crowdsourcing way to fund creative projects. Creators can post their ideas with the total funding requirement on Kickstarter website and solicit funding for a certain duration. If the project does not attract the required funding within the duration, none of the pledged amounts changes hands.
(HT: Fast Company)
"Coffee Joulies work with your coffee to achieve two goals. First, they absorb extra thermal energy in your coffee when it’s served too hot, cooling it down to a drinkable temperature three times faster than normal. Next, they release that stored energy back into your coffee keeping it in the right temperature range twice as long.
This amazing feat of thermodynamics happens thanks to a special non-toxic material sealed within the polished stainless steel shell. This material is designed to melt at 140 degrees Fahrenheit, and absorbs a lot of energy as it melts. This is how Joulies cool your coffee down three times faster than normal. Once it reaches this temperature, the special material begins to solidify again, releasing the energy it stored when it melted. This is how Joulies keep your coffee warm twice as long."
The Joulies are being developed as part of a Kickstarter funded project. Kickstarter is the crowdsourcing way to fund creative projects. Creators can post their ideas with the total funding requirement on Kickstarter website and solicit funding for a certain duration. If the project does not attract the required funding within the duration, none of the pledged amounts changes hands.
(HT: Fast Company)
Saturday, April 9, 2011
Fertilizer subsidy rates go up (again)!
It has come faster than expected. I had blogged just yesterday about the inevitability of the revision in fertilizer subsidies for 2011-12 in view of the rising import prices. The Businessline reports,
Interestingly, even if the NBS rate on P is increased to Rs 31, the resulting higher subsidy of Rs 19,220 or so on DAP would take the gross realisation to Rs 29,970 a tonne, leaving the farmer to still pay the gap of Rs 600-700 a tonne. The report also says that the MOP prices are currently quoting at $520 a tonne, far higher than the proposed revised import parity price of $420 a tonne, leaving the farmer to again absorb the losses. Further, there will be no buffer available to cushion against future price increases, which is inevitable given the global petroleum price trends.
Two important market expectations are getting anchored here. The domestic wholesalers and retailers realize that there is nothing sacrosanct about the once a year subsidy fixation announcement. They have the incentive to raise the MRP to cover the full subsidy instead of raising the MRP based on the import prices. As I had blogged earlier, given its size, India's procurement decisions and import parity price signals will quickly get embedded into the global market prices. So what is the way out?
"An inter-Ministerial panel under the Secretary, Department of Fertilisers, is learnt to have approved higher import parity prices of $612 a tonne for DAP and $420 a tonne for MOP, as against the existing levels of $580 and $390. These upward revisions would translate into increased NBS rates for phosphorus (P) and potash (K). Currently, the NBS rate on P, linked to a $580-a-tonne reference price for imported DAP, is Rs 29.407 a kg. On the proposed $612-benchmark price, it will go up to around Rs 31 a kg. Likewise, the NBS rate on K will rise from Rs 24.628 to Rs 26.5 a kg with the assumed landed price being raised to $420 a tonne."
Interestingly, even if the NBS rate on P is increased to Rs 31, the resulting higher subsidy of Rs 19,220 or so on DAP would take the gross realisation to Rs 29,970 a tonne, leaving the farmer to still pay the gap of Rs 600-700 a tonne. The report also says that the MOP prices are currently quoting at $520 a tonne, far higher than the proposed revised import parity price of $420 a tonne, leaving the farmer to again absorb the losses. Further, there will be no buffer available to cushion against future price increases, which is inevitable given the global petroleum price trends.
Two important market expectations are getting anchored here. The domestic wholesalers and retailers realize that there is nothing sacrosanct about the once a year subsidy fixation announcement. They have the incentive to raise the MRP to cover the full subsidy instead of raising the MRP based on the import prices. As I had blogged earlier, given its size, India's procurement decisions and import parity price signals will quickly get embedded into the global market prices. So what is the way out?
Friday, April 8, 2011
Portugal follows, where is the "confidence fairy"?
So finally, after months of speculation, and faced with spiralling borrowing costs, Portugal bows to pressure and follows Greece and Ireland in seeking an emergency financial bailout from the European Commission. It is being estimated that the country would need about 75 billion euros ($106.5 billion) in assistance and the conditions of the assistance is expected to be worked out soon.
The bailout became inevitable after the steep increases in Portugese borrowing costs in the past few weeks.
There have been repeated downgrades by credit-rating agencies (twice last month alone) which have sent yields on Portuguese government debt to their highest levels since the introduction of the euro. Last week Portugal sold 455 million euros (about $646 million) in one-year Treasury Bills at an average yield of 5.9%, up from 4.33% since mid-March. Similarly, the yield on 550 million euros of six-month bills was 5.12% compared to just 2.98% in an auction in early March. The emergency financing will ensure that Portugal can meet its 20 billion euros of borrowing requirements for the year.
Last May, the European Ministers agreed to provide 80 billion Euros to Greece over three years as part of a package in which the International Monetary Fund provided an additional 30 billion euros. Then, in November, they also agreed to a rescue package worth up to 85 billion euros for the Irish government. Further, last month, following Greece's adoption of extensive austerity measures, they also agreed to cut the interest rate charged Greece to help ease its debt burden. However, Ireland's refusal to accede to French and German requests to raise its low corporate tax rate of 12.5%, has meant that no such benefits have been given to Ireland.
The bailout will be arranged from the eurozone’s €440 billion rescue fund, the European Financial Stability Facility, which was set up last year to meet such contingencies. It is being hoped that the Portuguese bailout request may help reduce the risk of contagion to other countries, most notably Spain, by ring-fencing the euro’s three weaker economies.
However, if Greece and Ireland are any evidence, the standard European prescription of fiscal austerity to get the "confidence fairy" singing again and the economy back on the growth track appears not to be working. In a clear indication that its fiscal austerity was not doing much, the sovereign ratings of Greece, which was already downgraded to junk status, was again lowered by S&P to BB– from BB+.
Also, the cost of insuring debts and cost of borrowing has been rising unabated for both Ireland and Portugal despite the severe austerity measures and the emergency bailout package. In fact, as the graphic shows, after a brief drop in the immediate aftermath of the May 2010 bailout, the 10 year bonds have risen from about 7.25% to 12.75 today, while the CDS spreads have doubled, touching 1000 points.
In case of Ireland too, the same story has been repeated with both bond yields and CDS spreads. In Ireland's case, the fiscal austerity, which has been much more severe and has been in operation for more than two years now. Inspite of this, the bond yields and CDS spreads have been rising unabated all the while.
However, fears about Spain being the next in the domino to fall may be slightly exaggerated, atleast for now. Its CDS spreads have fallen dramatically since the beginning of the year and bond yields too have remained stable, albeit at a high 5-5.5% range.
Update 1 (9/4/2011)
Underlining its hawkish stance on inflation, in an unanimous decision, the European Central Bank (ECB) raised its benchmark policy rate to 1.25 percent from 1 percent. Inflation in the euro area rose at an annual rate of 2.6 percent in March, up from 2.2 percent in February and above the bank’s target of just under 2 percent. Since October 2008, the ECB had, in response to the sub-prime crisis and Great Recession, slashed rates from 4.25 percent to 1 percent by May 2009.
This is in contrast to the Federal Reserve, which continues to stimulate the American economy, as well as the Bank of England, which early this week left its benchmark interest rate at 0.5 percent despite higher inflation. In fact, like the $600 bn QE II in the US, the Bank of England too is continuing with its £200 billion ($325 billion) bond-purchase plan.
The rate increase could have dire consequences for Greece, Ireland and Portugal, where they are already having severe problems borrowing money at reasonable rates. More worryingly, the rate hike will also increase the pressure on Euro to appreciate, thereby weakening the competitiveness of European exporters.
This Economist article points to the fact that unlike Greece, Portugal does not have the problem of mountainous public debts or recklessly leveraged banks. Its problem is more structural - lack of competitiveness manifested in high input costs and excessive bureaucracy. It is inconceivable that austerity can do anything to overcome these problems.
Update 1 (15/4/2011)
The British austerity plan (aimed at lowering its budget deficit from a high 10% of GDP) appears to be having its predicted impact - retail sales plunged 3.5 percent in March, the sharpest monthly downturn in Britain in 15 years; a new report by the Center for Economic and Business Research forecasts that real household income will fall by 2 percent this year.
Update 2 (20/4/2011)
Nice graphic on the EU's emergency bailout fund.
Update 3 (4/5/2011)
Portugal has accepted an international (EC, ECB and IMF) aid plan of 78 billion euros ($116 billion). Under the three-year plan, the deficit would need to be lowered to 5.9 percent of gross domestic product this year, 4.5 percent in 2012 and 3 percent in 2013. Last year, Greece secured a bailout package worth 110 billion euros and Ireland 85 billion euros.
Update 4 (16/2/2012)
Times chronicles how austerity is leading Portugal down the cliff. See also this Room for Debate on Portugal.
The bailout became inevitable after the steep increases in Portugese borrowing costs in the past few weeks.
There have been repeated downgrades by credit-rating agencies (twice last month alone) which have sent yields on Portuguese government debt to their highest levels since the introduction of the euro. Last week Portugal sold 455 million euros (about $646 million) in one-year Treasury Bills at an average yield of 5.9%, up from 4.33% since mid-March. Similarly, the yield on 550 million euros of six-month bills was 5.12% compared to just 2.98% in an auction in early March. The emergency financing will ensure that Portugal can meet its 20 billion euros of borrowing requirements for the year.
Last May, the European Ministers agreed to provide 80 billion Euros to Greece over three years as part of a package in which the International Monetary Fund provided an additional 30 billion euros. Then, in November, they also agreed to a rescue package worth up to 85 billion euros for the Irish government. Further, last month, following Greece's adoption of extensive austerity measures, they also agreed to cut the interest rate charged Greece to help ease its debt burden. However, Ireland's refusal to accede to French and German requests to raise its low corporate tax rate of 12.5%, has meant that no such benefits have been given to Ireland.
The bailout will be arranged from the eurozone’s €440 billion rescue fund, the European Financial Stability Facility, which was set up last year to meet such contingencies. It is being hoped that the Portuguese bailout request may help reduce the risk of contagion to other countries, most notably Spain, by ring-fencing the euro’s three weaker economies.
However, if Greece and Ireland are any evidence, the standard European prescription of fiscal austerity to get the "confidence fairy" singing again and the economy back on the growth track appears not to be working. In a clear indication that its fiscal austerity was not doing much, the sovereign ratings of Greece, which was already downgraded to junk status, was again lowered by S&P to BB– from BB+.
Also, the cost of insuring debts and cost of borrowing has been rising unabated for both Ireland and Portugal despite the severe austerity measures and the emergency bailout package. In fact, as the graphic shows, after a brief drop in the immediate aftermath of the May 2010 bailout, the 10 year bonds have risen from about 7.25% to 12.75 today, while the CDS spreads have doubled, touching 1000 points.
In case of Ireland too, the same story has been repeated with both bond yields and CDS spreads. In Ireland's case, the fiscal austerity, which has been much more severe and has been in operation for more than two years now. Inspite of this, the bond yields and CDS spreads have been rising unabated all the while.
However, fears about Spain being the next in the domino to fall may be slightly exaggerated, atleast for now. Its CDS spreads have fallen dramatically since the beginning of the year and bond yields too have remained stable, albeit at a high 5-5.5% range.
Update 1 (9/4/2011)
Underlining its hawkish stance on inflation, in an unanimous decision, the European Central Bank (ECB) raised its benchmark policy rate to 1.25 percent from 1 percent. Inflation in the euro area rose at an annual rate of 2.6 percent in March, up from 2.2 percent in February and above the bank’s target of just under 2 percent. Since October 2008, the ECB had, in response to the sub-prime crisis and Great Recession, slashed rates from 4.25 percent to 1 percent by May 2009.
This is in contrast to the Federal Reserve, which continues to stimulate the American economy, as well as the Bank of England, which early this week left its benchmark interest rate at 0.5 percent despite higher inflation. In fact, like the $600 bn QE II in the US, the Bank of England too is continuing with its £200 billion ($325 billion) bond-purchase plan.
The rate increase could have dire consequences for Greece, Ireland and Portugal, where they are already having severe problems borrowing money at reasonable rates. More worryingly, the rate hike will also increase the pressure on Euro to appreciate, thereby weakening the competitiveness of European exporters.
This Economist article points to the fact that unlike Greece, Portugal does not have the problem of mountainous public debts or recklessly leveraged banks. Its problem is more structural - lack of competitiveness manifested in high input costs and excessive bureaucracy. It is inconceivable that austerity can do anything to overcome these problems.
Update 1 (15/4/2011)
The British austerity plan (aimed at lowering its budget deficit from a high 10% of GDP) appears to be having its predicted impact - retail sales plunged 3.5 percent in March, the sharpest monthly downturn in Britain in 15 years; a new report by the Center for Economic and Business Research forecasts that real household income will fall by 2 percent this year.
Update 2 (20/4/2011)
Nice graphic on the EU's emergency bailout fund.
Update 3 (4/5/2011)
Portugal has accepted an international (EC, ECB and IMF) aid plan of 78 billion euros ($116 billion). Under the three-year plan, the deficit would need to be lowered to 5.9 percent of gross domestic product this year, 4.5 percent in 2012 and 3 percent in 2013. Last year, Greece secured a bailout package worth 110 billion euros and Ireland 85 billion euros.
Update 4 (16/2/2012)
Times chronicles how austerity is leading Portugal down the cliff. See also this Room for Debate on Portugal.
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