Assessing July

I’m back from my usual Ramadhan blogging break, and my, aren’t there lots of things to comment on. This will be a kind of omnibus blog post, covering some of the developments over the past month.

2Q2015 GDP Growth

A funny thing happened with the change in national accounts base year to 2010 – the economy all of a sudden got a lot harder to forecast. The usual indicators no longer seem to matter as much – for example, MIER’s confidence indices appear to have totally decoupled from GDP – which makes forecasting growth more than a little bit more difficult. IPI and trade remain good predictors, but their standard deviations have doubled and the forecasts are suggesting two completely different pictures of the economy.

Euro Debt Crisis and Contagion Roundup At Morgan Stanley

Morgan Stanley’s Global Economic Forum has a fantastic roundup of developments in Europe and possible contagion effects around the globe, including East Asia as well as a piece on Malaysia (excerpt):

We think that the impact on Malaysia would be more significant from the perspective of trade linkage rather than capital flows. On the latter, Malaysia's FX reserves are about three times its short-term external debt. This is way above the global adequacy benchmark of one, reducing the currency's vulnerability should capital flows dry up. Moreover, the basic balance surplus (comprising more stable flows such as current account balance and FDI) had been the key contributor to the balance of payments position and FX reserves, rather than portfolio flows. This also further mitigates the impact on domestic liquidity conditions and currency amid a decline in risk appetite. Indeed, Malaysia's exposure to the fiscal debt concerns in Europe would come predominantly via the trade front. As a portion of total exports, ASEAN exporters' exposure levels to Europe demand look fairly similar. About 8.6-11.0% of total ASEAN exports are bound for the EU15. More specifically, 0.5-3.2% of ASEAN total exports are bound for Greece, Italy, Portugal and Spain. However, within ASEAN, we note the high export orientation of Malaysia's economy, with exports of goods standing at 82% of GDP (of which 10.3% is to the EU15). In this regard, Malaysia would thus be the second most exposed (after Singapore) to a slowdown in euro growth and the cascading effects of that on Europe's trade partners.

Note: Since the page link will change depending on updates to GEF, I’ll be updating the hyperlink to the MS page once it gets posted to the GEF archive.

About the only (technical) quibble I have is this line in the article analysing the compromising of the ECB’s independence:

Tonight the ECB decided to take one step further and - in addition to reinstating some of the measures it had already taken during the height of the financial crisis (term funding and USD swap lines) - also open the door to outright purchases of government bonds. These purchases will be sterilised and as such do not constitute quantitative easing, i.e., an expansion of the ECB's balance sheet.  So far, the size of the intervention programme and the details about which debt instruments the ECB is going to buy are not known.

They’re right that sterilised purchases of Eurozone government bonds would not constitute quantitative easing, but they’re wrong that it would not result in an expansion of the ECB’s balance sheet. My understanding of the process goes something like this:

1. Purchase of Euro government bonds through Euros created at the ECB (+ assets, +liabilities)

2. Sterilisation through issuance of ECB bills to drain the excess money created in step 1 (+ assets, + liabilities) – money supply stays constant

3. Offset of Euros created and bought back in step 1 and 2 (- assets, - liabilities)

This means the ECB’s balance sheet will still increase by whatever amount of government bonds it purchases, except that its liabilities will be interest bearing (ECB bills) rather than non-interest bearing (Euros).

Update:

Link to the archived page.

Silly Reporting, Sillier Analysis

From Bloomberg a couple of days ago (excerpt, bold emphasis mine):

Inflation Fears May Slow Malaysia Subsidy Cuts, Economists Say

By Barry Porter

May 10 (Bloomberg) -- Malaysia may cut subsidies slowly to prevent triggering record inflation as it prepares to revamp a system that’s hampered efforts to reduce the budget deficit, Standard Chartered Plc and Citigroup Inc. said.

A taskforce is exploring ways to revamp the government’s entire portfolio of subsidies that keep the cost of essential items from flour to highway tolls low for consumers. An attempt to reduce the amount the state pays to cap fuel prices caused inflation to surge to a 26-year high in 2008 as gasoline became more expensive.

The government will learn from past experience and ensure its subsidy cuts will be a “very tempered, gradual process,” Alvin Liew, an economist at Standard Chartered in Singapore, said May 7. “They still have time on their hands. It’s not a Greek situation where they need a bailout, not yet anyway.”

Malaysia spends about 73 billion ringgit ($22 billion) a year on subsidies, Prime Minister Najib Razak said on April 6, calling the amount “not sustainable.” The government, which has said it is considering a global bond sale, aims to narrow its budget deficit to 5.6 percent of gross domestic product this year from a 22-year high of 7 percent in 2009.

What’s wrong with this picture?

First, take note that in July 2008 crude oil reached over USD140 per barrel on the world markets. That’s about double the level it’s at now. The level of price increase necessary to equilibrate domestic gasoline prices with world prices are far lower right now than it was in 2008. Since the outlook for crude oil prices are still up, that means the time to cut subsidies is now, not later.

Second, Alvin Liew’s comments are so off base that I’m wondering if we’re looking at the same country. Greece has a public debt to GDP ratio of 125%, an external debt to GDP ratio of 170% (public and private debt), a budget deficit of 13.6% (all 2009 numbers) and external reserves of just USD3.5 billion (2008). Malaysia’s corresponding numbers are 53.7%, 36.1% and 7.0% (2009 numbers) and USD96 billion (as of end-April 2010). Huge, huge difference in terms of national and external liabilities, and the financial resources to meet them.

Greece also has the problem of having its entire national debt denominated in Euros or other currencies, whereas Malaysia’s is mainly in MYR. That means that in extremis Malaysia can print Ringgit to meet its national obligations, while Greece has to beg the European Central Bank to pick up its debt (which after much arm twisting and teeth gnashing, the ECB has finally committed to do) and rely on the EU and the IMF to provide short and medium term financing. While printing money is not an ideal solution as it risks a run on the currency and rising inflationary pressure, it does mean that near term debt obligations can always be met by a country issuing its own currency.

In addition, membership of the Eurozone means that a de facto devaluation of the currency cannot in fact happen (relative to other Euro members), which means that Greece has no chance to improve its external competitive position, unlike what occurred in East Asia during the 1997-98 crisis.

In short, Malaysia doesn’t – and won’t – need a bailout.

Third, I think our Prime Minister is guilty of hyperbole when quoting that figure of RM73 billion in subsidies. I can’t actually reconcile this statement with the actual published figures, and the only way I can get near that number is to add development expenditure to operating expenditure that’s classified as subsidies. Otherwise, spending on subsidies in 2009 was only RM18.6 billion.

Also on Bloomberg (not on Malaysia, but just as silly):

Fed Restarts Currency-Swap Tool With ECB Amid Crisis (excerpt)

The Fed’s swaps come at a time of increasing political scrutiny. Congress could ask why the U.S. central bank is expanding the supply of dollars to help smooth disruptions caused by fiscal imbalances in Europe.

Senator Bernard Sanders, a Vermont independent, wants the Government Accountability Office to look into Fed lending facilities during the crisis, including swap lines with foreign central banks, such as the $20 billion facility the Fed opened with the ECB in December 2007.

A vote on the Sanders amendment could come as soon as May 11 as Congress proceeds on the most sweeping overhaul of financial regulations since the Great Depression.

“Many members of Congress are deeply suspicious of the Fed’s interventionist instincts,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “Bailing out Wall Street caused enough resentment; appearing to bail out Greece would be even more problematic.”

“The Fed cannot afford to rile up its congressional critics while the financial reform bill is still in play,” Crandall said before tonight’s announcement.

I’ve commented on this before (read this post for details) – a swap line is not a loan in the conventional sense. And the Fed supplying USD to the ECB under the current circumstances simply means those Dollars go straight back to the US. Factual note: the Fed’s swap line with the ECB in 2007 was US$300 billion, not the paltry US$20 billion quoted in the article.