Simple Economics: the US way

On the last once-in-a-lifetime date of this century, the US Federal Reserve chairman Ben Bernanke (BB) announced a decision to buy additional $45 billion a month of long-term securities along with $40 billion a month of mortgage backed securities – widely referred to as QE4. Yes, its $85 billion a month of buying securities that BB was talking about!!

The trigger point: Post the economic crisis in 2008-09, the Fed, to support a stronger economic recovery, took some bold steps to loosen monetary policy and increase demand. It decided to keep interest rates at ultra low levels and begin a program of bond buying to inject money into the economy to boost nominal spending. This helps because buying long-term securities pushes up the asset prices and lowers yields, thus lowering the borrowing costs for the firms.

In order to stimulate borrowings and create jobs in the economy, BB promised himself and to the world to keep the rates low and continue spending until the unemployment rate falls below 6.5%.

But looks like BB totally ignored the impact of this program on other important economic factors!!! Won’t keeping interest rates low and infusing $85 billion every month push up the inflation in the medium to long term? It’s a concern because, after all, high inflation rate doesn’t support economic growth.

Now, let’s go back to 2011 when the US Congress agreed to the Budget Control Act 2011 in exchange of raising the debt limit by $2.1 trillion. The BCA 2011 was introduced to reduce the deficit of the country by $1.2 trillion by the end of 2012. However, there was this condition that if the government is not able to meet this target, spending cuts in defense and other discretionary expenditures will automatically trigger at the start of 2013. That’s exactly what happened on the 1^st of March this year!! This is referred to as the ‘sequestration effect’ which triggered automatic spending cuts of $85 billion over the remaining seven months of this fiscal year and will continue to cut $1.2 trillion every year till 2021. As one would easily interpret, the underlying aim here is to reduce the fiscal deficit of the country by cutting on expenditures, drastically.

An analysis, however, says that this automatic spending cuts is expected to put 2.14 million American jobs at risk pushing the unemployment rate to above 9% (current rate is 7.6%). It is also expected to push the US economy towards recession.

This leads to another argument: Won’t the (desired) impact of spending $85 billion per month be set off against the (undesired) impact of automatic spending cuts due to the sequestration effect? What about BB’s dream to reduce unemployment rate and boost economic growth? Pchch… wondering when will that turn into reality?

The current situation of the US economy reminds me of the 2008-09 recession. The only reason why we saw the recession of 2008-09 was that money was made available easily, at cheap rates. The current economic situation resembles very much to the situation of 2008-09. Money is available at cheap rates, housing prices are rising again, US stock markets have hit an all time high breaking 16 years record and there is political instability too.

Wondering over where’s the US economy going again? Well, we can only wait and watch and hope for the best!! *fingers crossed*

..And the buzz over the Budget 2013-14 is over!!

The so-called ‘responsible’ budget 2013-14 was presented by the Finance Minister P Chidambaram in the Lok Sabha yesterday. Union Budget 2013-14 was a special budget for many reasons: One, it was Mr. Chidambaram’s eighth budget presentation as the Finance Minister of the country. Two, India, today is in a very tight fiscal situation and the investment sentiments are hurt due to many reasons. The twin deficits i.e. the fiscal deficit and current account deficit are of prime concern to the government. Economists and industrialists have been shouting their throat out that only major policy reforms can pull India out of this worsening situation. This year’s budget, therefore, was expected to focus on fiscal consolidation and discipline. Three, to finance the rising CAD, we need foreign investments in the form of FII and FDI. But these investments have slowed down on account of rising uncertainty and increasing riskiness in the economy. A daunting task of Mr. Chidambaram is to attract foreign investments in the country. Remember, on his tour to various countries, he promised the foreign investors of a responsible budget. This budget was supposed to deliver his promises and to make investments and related policies easy and friendly for the foreign investors. Fourth, the country’s economic growth has been hampered due to lack of investments and infrastructure development. Central Statistical Organization (CSO) estimates India to grow at a rate of 5% in 2013, the lowest growth rate in a decade. This budget was expected to provide for steps that will promote investments and infrastructure development in the country. Fifth, it was supposedly Congress’ last budget to gain voters’ confidence before the general elections next year. Considering that, the FM had to keep the lady-in-power happy too. Overall, P Chidambaram had a very challenging task to deliver in this budget where hopes were high on account of his credibility.

They say in order to correct past mistakes, it is very important to first acknowledge them. In the budget speech today, it was noteworthy that the FM acknowledged 2012-13 has been the worst ever growth period in the UPA term. He looked very determined and serious about repairing the damages caused to the domestic environment. At the beginning of the budget speech, he noted that the widening CAD is more serious a concern than the fiscal deficit and bold steps are required to challenge this situation.

Let’s compare some of the elements of the budget 2014 with the expectations outlined above. Let’s understand if the budget answers the simple and difficult questions in the minds of the people.

From the fiscal consolidation front, the FM has fulfilled his promise of restricting the fiscal deficit to within 5.3% of GDP, at 5.2% of GDP in the current year. He forecasted the fiscal deficit for the next year at 4.8% of GDP in line with the aim to reduce the fiscal deficit to 3% of GDP by 2017. Also, noting that the CAD has been rising on account of huge imports of oil, coal and gold, he announced a slew of measures that would reduce dependence on these imported commodities. Estimating that India’s coal imports are expected to rise to 185 mt by 2017 driven primarily by the needs of the power sector, he said, “There is no alternative except to import coal and adopt a policy of blending and pooled pricing. In the medium to long term, we must reduce our dependence on imported coal”. He also suggested devising a PPP policy framework in order to increase the production of coal for supply to power producers and other consumers. Whereas to reduce gold imports the government wants to shift the focus of domestic investors from gold by introducing new investment instruments. Some of those announced in the budget are introduction of inflation-indexed bonds, modifications in the RGESS, reduction in STT and additional tax relief on house loans.

For the FII/FDI investors, the government has simplified the KYC norms and made rules uniform for all class of investors. It allowed them to transact in currency derivatives and also, use their investments in corporate bonds and government securities as collateral for meeting margin requirements. Postponement of GAAR implementation to April 1, 2016 was another relief for the foreign investors.

To promote investments in the country, the FM has allowed an investment allowance of 15% on new purchases of P&M valued above Rs 100 crore. This means apart from depreciation, companies can now use an additional deduction in the form of investment allowance to reduce their taxable income. This will drive investments overall. On infrastructure sector, the FM said, “While every sector can absorb new investment, it is the infrastructure sector that needs large volumes of investment...” For this, government will encourage infrastructure debt funds to raise resources and provide low cost debt for infra projects. Some institutions will be allowed to issue tax-free bonds in 2013-14 up to a sum of Rs 50,000 crore.

Though the budget meets some of the many objectives outlined above, it also raises few questions. It is very confusing when the government, in the Economic Survey 2013, says that its focus will be to fight inflation and in the budget, announces rise in government expenditure by 16% in 2014. How will the government control inflation when it is planning excessive spending in the form of government expenditure? Valid question, isn’t it?

#FiscalConsolidation: Revenue estimates look way too optimistic whereas expenditure estimates are way too conservative. Aren’t the revenue assumptions (e.g. divestment receipts of Rs 54000 crore and spectrum sales receipts of Rs 41000 crore) questionable? Looks like, basic accounting principles are simple to read and understand but difficult to implement!!

On one hand, the FM talks about deepening the debt markets and on the other hand, he plans to borrow huge amounts from the market (Gross borrowing in FY14: 6.29 lakh crore). The preferred way that the government borrows from the market is by issuing bonds. The excess government borrowing plans will increase supply of the bonds in the bond market and push the yields up - bad for bond market. Isn’t there a contradiction clearly?

To summarize, this budget is a balanced budget which not only addresses the problems of the country but also manages to gain voters’ attention. It is a reformist budget which is populist too. But what we must also wait for is the view of the RBI Governor on the budget and on the monetary easing scope following the budget.

The critics and markets have taken the budget positively...and the buzz over the budget is finally over!!