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Global efforts to reflate the world economy

November 3rd, 2008 · No Comments

Not only the developed world is throwing everything and the kitchen sink at the economy, big developing economies like China and India are following suit. That’s a good development. We can only hope the European Central Bank is not going to do something stupid this week, like worrying about inflation..

India, China Attempt to Cushion Economies From Global Crisis
By Michael Dwyer

  • Nov. 3 (Bloomberg) — India and China are accelerating efforts to prop up growth as a global slump threatens the world’s fastest-expanding major economies.
  • The Reserve Bank of India on Nov. 1 lowered its benchmark repurchase rate for the second time in two weeks, and for the first time in 11 years reduced the amount of money lenders are required to keep in government bonds. The People’s Bank of China on Oct. 29 cut its key rate, three days before a weekend report showed manufacturing shrank in October.
  • “The gathering crisis in more advanced economies is forcing Asian policy makers to jettison assumptions about the health of export sectors,” said Mark Williams, an international economist at Capital Economics Ltd. in London. “Interest rates will tumble.”
  • Emerging Asian economies that account for one-fifth of world growth are being dragged down as their main markets in the U.S. and Europe contract, increasing the likelihood of a global recession. Policy makers in India and China are also boosting spending to prevent their economies from going under.
  • India’s Finance Minister Palaniappan Chidambaram is planning to spend an extra 2.4 trillion rupees ($49 billion) this year, telling parliament last month that now was “the right time” to stimulate the economy.
  • China’s Premier Wen Jiabao says sustaining economic growth is the government’s “first priority.” China has already raised export incentives, cut costs for home buyers and pledged infrastructure spending.
  • `Extremely Aggressively’
  • India and China need to move fast to implement their stimulus plans, with growth already slowing in Asia’s second-and third-largest economies amid weaker foreign demand.
  • Asian policy makers understand the importance of “reacting extremely quickly and extremely aggressively to try to stimulate growth and prevent the worst-case scenario,” said David Mann, senior strategist at Standard Chartered Plc in Hong Kong.
  • China’s $3.3 trillion economy grew at the slowest pace in five years in the three months through September as export orders shrank and industrial production waned. The expansion cooled for a fifth straight quarter, to a 9 percent gain from a year earlier.
  • The Purchasing Managers’ Index prepared by China Federation of Logistics and Purchasing fell to a seasonally adjusted 44.6 in October, the lowest reading since the gauge was launched in July 2005, according to a Nov. 1 statement. A reading below 50 reflects a contraction in manufacturing.
  • Slowing Growth
  • India’s central bank said last month that growth in that $1.2 trillion economy may be as little as 7.5 percent in the year to March 31, compared with 9 percent in the previous 12 months. That would be the weakest pace since 2005.
  • The People’s Bank of China and India’s central bank, along with the U.S. Federal Reserve and the Bank of Japan, are already moving to lower borrowing costs and stimulate consumer spending and investment.
  • Over the weekend, India cut its repurchase rate to 7.5 percent from 8 percent, reduced the amount of deposits that lenders need to set aside as reserves to 5.5 percent from 6.5 percent, and lowered the amount of money lenders are required to keep in government bonds to 24 percent from 25 percent.
  • India’s decision was taken “to address concerns relating to the moderation in the growth momentum,” the central bank said in a statement in Mumbai. “Global financial conditions continue to remain uncertain and unsettled, and early signs of a global recession are becoming evident.”
  • Coordinated Action
  • The Chinese central bank reduced its key one-year lending rate to 6.66 percent from 6.93 percent on Oct. 29.
  • China cut borrowing costs for the first time in six years on Sept. 15, the day U.S. investment bank Lehman Brothers Holdings Inc. filed for bankruptcy. It followed up with another reduction on Oct. 8 as the Fed and five other central banks made emergency coordinated reductions to counter the financial crisis.
  • The Bank of Japan reduced its key overnight lending rate by 20 basis points to 0.3 percent on Oct. 31 after the Fed last week lowered its target rate for overnight loans to 1 percent, matching a half-century low. South Korea, Taiwan and Hong Kong also trimmed their benchmark rates last week.
  • Officials are signaling more cuts are likely and the European Central Bank and Bank of England both set policy on Nov. 6. Australia’s central bank may also cut rates on Nov. 4, after lowering them by 1 percentage point to 6 percent last month, the biggest reduction since 1992.
  • “A global dislocation in economic activity is forcing policy makers to take more remedial action,” said Mark Cliffe, global head of financial markets research at ING Groep NV in London. “More policy easing is likely.”

With the traditional forces of the business cycle much diminished (those stories about the ‘new economy’ around the turn of the century did in fact have a considerable nucleus of truth in them), a bubble cycle has largely replaced the business cycle and finance has hijacked policy.

But this time, as policy makers really do not have any choice but to reflate as much as they can, even if they set us up for the next cheap credit bubble, the alternative is far, far worse still.

And we keep saying, proper regulation of financial markets should mitigate against the extreme risks of reactivating the bubble cycle. Regulate off-balance sheet activities of banks, hedge-funds, leverage, securitization, and investment banks (hardly necessary anymore, there few left).

Try not to regulate them in such a way as to not take away most incentives for financial innovation as research show that countries, on balance, benefit from these.

One simple example: enforce conservative mortgage policies, for instance require a down payment as a requirement of getting a mortgage and restrict the size to say three times yearly income and deal with those people not qualifying in another way (or just accept that house ownership is not for everyone).

If this rather crude idea would have been operative this decade, would we have been in the mess we’re in?

Tags: Credit Crisis