Archive for April, 2010

India: Fiscal worries

April 29, 2010
India: CSFB took a trip there to see what's what.  Source: Google Images
India: CSFB took a trip there to see what’s what. Source: Google Images

Countries with divided democratic government that have to pay off constituencies to hold together coalitions often run up government debt and put at risk not only sovereign creditworthiness, but also economic performance.  I have in mind Italy, Japan, Israel and Brazil.  India, alas, is the posterchild of this phenomenon.  By contrast, governments which alternate between parties or at least between stable coalitions of right and left often manage their debt burdens better.  This is because if you mismanage the economy, you’re thrown out of office.  The U.S., the UK, Germany, Mexico, and Chile come to mind.  Granted, not a perfect rule — Mexico can’t raise much-needed non-oil taxes — but an interesting idea nonetheless.

CSFB took a trip to India to explore how the economy is performing, what the status of reforms are, and what the prospects for infrastructure investment are in this lumbering, rising power that links East to West and has every imaginable problem plaguing Emerging Markets from war, terrorism and ethnic tension, to poverty, growing pains, and inflation.  See CSFB’s trip notes below.

India began reforming its public finances earlier this decade to get its government debt burden on a downward trajectory.  At over 80% of GDP, government debt is high, and with deficits in the double digits, not set to decline.  Luckily, GDP growth has been and is expected to be robust at 6-10% per year.  Yet the country is very poor, with per capita GDP of $1000, making China seem rich with about $3500.  This limits the government’s ability to raise taxes to balance the budget.  Moreover, it imposes a constraint on monetary policy because inflation, especially of food prices, means people starve.  So, an easy money policy has to be considered carefully.  

Like Brazil, India’s problems are domestic — India’s debt is not external.  It has amassed nearly $300 billion in fx reserves and has only a small current account deficit.  The problem of late is that measures to improve public finances over the medium term have fallen prey to politics, as the statement made in the first paragraph suggests they might.  Food subsidies and debt relief for farmers have been increased, and tax rates adjusted down in recent years.  As CSFB noted, a planned direct tax reform is on hold. 

With government finances in difficult straits, the only answer to improving India’s woeful infrastructure situation is through private investment, or at least public-private partnerships.  CSFB writes about these below…

From CSFB 4/29/10:

Devika Mehndiratta
+65 6212 3483
We have just published a new report, India: Trip Notes (with a focus on infrastructure); we summarise our key findings below.
Earlier this month we were in India meeting corporates, banks and the government. Our focus was (1) on-the-ground feedback on sentiment, consumption/investment trends and any updates on government policy, and (2) specific meetings on infrastructure spending prospects in 2010 (year beginning April) given investor interest in this and market optimism that the government is giving a ‘big push’ to infrastructure spending in 2010 (particularly on roads).
Household consumption is apparently quite robust. We met with the CEO of one of India’s largest retail companies, who judged that growth in sales volumes was very strong and that some of the consumer goods companies (e.g., Fast Moving Consumer Goods or FMCG companies) were finding it a challenge to meet demand with their existing capacity. The picture on investment spending is still a bit hazy, however. Overall, while there does seem to have been some pick-up, it is not clear how strong this has been.
Housing prices have run up sharply. As the RBI recently indicated in its policy statement, housing prices in certain areas of Mumbai are already above their previous peak and, in Delhi, average prices are only about 5% below their previous peak. In our view, the RBI could tighten risk weights/provisioning norms for bank lending to the real estate sector sometime this year.
Direct tax reforms could be delayed by a year. In our talks with a senior government official, we learnt that implementation of direct tax reforms (scheduled for April 2011) could be delayed by a year.
On monetary policy, we maintain that the central bank is likely to hike the reverse repo and repo rates by 100bps by March 2011, coupled with more CRR hikes. The RBI stated at its meeting this month that it would like to “calibrate” rate hikes – as we stated then, in our view this implies that the RBI could end up having to deliver some intermeeting hikes in 2010.
We also had focused meetings with key players in the infrastructure sector to try to ascertain if infrastructure spending in 2010 is likely to pick up as strongly as many are expecting. Our meetings suggested that roads (national highways, specifically) is the only sector for which the government is clearly trying to speed up the awarding of new projects. Other than roads, the general assessment is that private sector investment in power is doing well and is likely to continue to do so in the year to come. Investment spending on railways, airports and ports, however, seems to be going on a slow/business-as-usual path.
Even within roads, it is worth remembering the government’s recent thrust is not across all categories of roads but is focused on national highways. Government estimates peg investments in roads (such as national highways, state highways, rural roads) in 2009 at about INR650bn (1% of GDP and 13.6% of total infrastructure investments). Of the total spending on roads, expenditure on national highways is likely to have been around 45%, according to government data.
Although the pace of awarding new highway projects has risen, actual construction activity is likely to pick up more in 2011 than in 2010, in our view. In a typical PPP (public private partnership) highway project, from the time that the project is awarded it takes about six months for financial closure, after which construction can begin. While the projects awarded in the past few months should start from 2Q 2010 (July to September) onwards, the clear step up in highway construction activity is likely to take place more at the end of 2010 and in 2011 (assuming the recent fast momentum in awarding projects is maintained through 2010).
Beyond 2010, many of the specialists we met made the point that financing could become an issue for infrastructure spending. Although land acquisition is highlighted as one of the key constraints in the infrastructure sector, many of the specialists we spoke to were concerned that in coming years financing of infrastructure projects is likely to become an issue, some estimating as early as in 2011. For debt, the Indian infrastructure sector is primarily dependant on credit from domestic banks, and most thought that the banking sector alone would not be able to meet the infrastructure sector’s funding requirements in coming years.

Japanese debt: Bad, but not that bad!

April 27, 2010
How big is the Samurai debt?  Source:
How big is the Samurai debt? Source:

Government debt is mounting all across the developed world.  While Emerging Market countries such as China have low debt levels, and Brazil and India are beginning to grow out of their debts, the next crisis (or even the second half of this one) could be a fiscal shock — perhaps even a government bond default — in the industrialized world.  I’m talking about advanced countries with high credit ratings, which will experience sluggish growth and may fail to slash fiscal deficits over the medium term.  Greece may be a foretaste of what’s to come, unless reforms of public finances and efforts to increase growth potential are undertaken in earnest.

Japan’s fiscal woes predate the current crisis, going back to its lost decade of the 1990s.  No matter how you slice it, Japan’s government debt is unsustainably high.  Government debt is 200% of GDP, and GDP growth averages a sluggish 2% or worse in normal times.  Further, Japan seems to be under constant threat of price deflation, which is bad for debtors. 

Fitch Ratings prepared a nice report analyzing Japanese government debt (see press release below).  According to Fitch, Japan’s bond rating remains AA-, even though Japan’s headline government debt figure compares unfavorably with such highly-indebted advanced economies as Italy (AA-) and Belgium (AA+), whose debt/GDP figures are 115% and 98% respectively.  Yet Fitch does an exemplary job parsing the debt numbers to show that…it ain’t that bad.  The headline gross general government debt/GDP figure of 200% overstates Japan’s problem. 

First, Japan’s debt is held domestically.  Domestic savings have been higher in Japan than in most advanced countries. If you net out the amount of debt held by different levels of government, Japan’s debt drops to about 160% of GDP. A further 53% of government debt is held by  public institutions — the biggest one, Japan Post — yes that’s right, the Post Office.  Idiosyncratically, Japanese households deposit a good chunk of their savings at the government post office and these funds are invested in government debt.  A sizable portion of these funds go back to the private sector in the form of government loans to business.  Thus, Japan’s debt problem is a family affair.  It is between Japanese savers (households) and Japanese spenders (the government and business).  They have to work out who bears the burden of adjustment.

Likewise, Fitch points out that if you net out public sector assets, Japan is not such an outlier.  The OECD provides figures for what it calls governments’ net financial liabilities.  This figure subtracts from debt assets such as government deposits and loans to the private sector.  Japan compares more favorably here, with net government financial liabilities at 97% of GDP, the same as Italy and versus 81% in Belgium.  However, whether these loans to the private sector will be paid back in full is an uncertainty. 

Finally, the OECD figure does not include one major asset held by the Japanese public sector, over $1 trillion in foreign exchange reserves, derived from Japan’s persistent trade surpluses (automobile recalls notwithstanding).  This amounts to another 20% of GDP you can deduct from Japan’s debt burden.

In terms of the burden of the debt, the interest rate on Japan’s debt is low, making debt service less onerous than one would expect from the debt/GDP ratio.  Furthermore, with a relatively low tax burden — taxes in Japan were 32% of GDP versus the AA median of 41% — Japan has room to raise taxes to support debt payments in the future. 

The worry, however, is that any early tax hike would shut down GDP growth, which has been so sluggish for years.  Furthermore, Japan’s aging population suggests that the country’s high savings rate will decline.  Ergo, interest rates could rise in the future. 

Fitch suggests that the key to reducing the government debt burden in Japan is achieving higher GDP growth.  Under a scenario of 4% per year GDP growth, Japan’s debt/GDP would decline.  This will require structural reforms to improve growth potential and stave off price deflation.  Have a read…     

Fitch: Japan’s Sovereign Creditworthiness at Risk from Rising Government Debt   
22 Apr 2010 4:51 AM (EDT)

Fitch Ratings-Hong Kong/London/Singapore-22 April 2010: The Japanese government is one of the most indebted in the world. In the absence of sustained economic recovery and fiscal consolidation, government debt will continue to rise, placing downwards pressure on sovereign credit and ratings over the medium term, Fitch says today in a Special Report, “Just How Indebted Is The Japanese Government?”.

Japan’s headline gross government debt reached 201% of GDP by end-2009, the highest ratio for any sovereign rated by Fitch. Public debt sustainability is the central sovereign credit issue facing Japan, whose Long-term local currency Issuer Default Rating (IDR) of ‘AA-‘ is one notch below the Long-term foreign currency IDR of ‘AA’, uniquely among high-grade sovereigns. The lower local currency rating reflects the fact that all government debt is denominated in Yen and Japan’s net external creditor status. The ratings remain supported by low government debt yields, reflected in a budgetary debt service burden that is not especially high as a share of GDP, and by financing flexibility afforded by access to a large pool of domestic savings. The sovereign was a net external creditor to the tune of 15% of GDP at end-2009; but under Fitch’s forecast of rising government debt ratios, sovereign creditworthiness is set to deteriorate.

In the near term, the Japanese government’s funding prospects are further supported by ample banking-sector liquidity and by weak private-sector demand for credit. However, the slow but steady drop in the savings rate could eventually undercut the sovereign’s ability to fund itself domestically at low nominal yields, leaving it more exposed to interest-rate and refinancing risks. Fitch explored some scenarios for Japan’s public debt path using a simple debt dynamics model, and one possible development is that Japan’s government debt ratios could decline if positive nominal GDP growth were restored. However, upwards pressure on Japan’s ratings is unlikely without a sustained drop in government debt ratios consistent with a return to nominal GDP growth and meaningful fiscal consolidation.

The extent of Japan’s government indebtedness is often a source of confusion and conflicting statistics. On a broader measure, net general government financial liabilities reached 97% of GDP by end-2009; while still high, is not significantly more than other similarly rated sovereigns. However, the value and liquidity of the government’s financial assets is uncertain and on Fitch’s measure that only nets off currency and deposits; net government debt is estimated to be equivalent to 184% of GDP, still the highest of any rated sovereign. Fitch estimates the share of Japanese government debt owed to other public sector creditors at around 53% on the latest available numbers, including the postal savings and insurance systems, which partly mitigates concerns over the high level of the debt and reduces Japan’s exposure to ‘confidence shocks’. Nonetheless, on whichever measure is adopted, Japan’s government is amongst the most indebted and the key feature of previous rating downgrades – the adverse debt dynamics and steady rise in the debt ratio – remains the case, Japanese government debt will continue to rise bringing downwards pressure on Japan’s sovereign creditworthiness and ratings over the medium-term.

Applicable criteria ‘Sovereign Rating Methodology’, dated 16 October 2009, are available on

Contacts: Andrew Colquhoun, Hong Kong, Tel: +852 2263 9938; David Riley: +44 (0) 207 417 6338.

China can’t have monetary policy flexibility

April 26, 2010
China's currency:  Can't have it all... Source: Google Images
China’s currency: Can’t have it all… Source: Google Images

In today’s CSFB column on China (see below), Dong Tao and Christiaan Tuntono report that PBoC Governor Zhou Xiaochuan commented that China would like greater monetary policy flexibility in order to combat inflation.  Not that inflation is so high in China, but the Asian giant’s return to breakneck rates of growth (11.9% growth year-on-year in 1Q10) may push prices higher.  But, the Chinese are surely aware that in the world of economics, you cannot have your cake and eat it too. 

Remember the so-called “Mundell Trilemma,” named after ground-breaking economist Robert Mundell, who with Marcus Fleming at the IMF in the 1960s critiqued, or better, refined Keynesianism.  They analyzed the effects of monetary and fiscal policies under different exchange rate regimes (fixed or flexible) and under capital mobility (or not).  The Mundell Trilemma  posits that you cannot have all three of: fixed exchange rates (which China has held to tenaciously, much to the chagrin of balance of payments deficit countries like the US); monetary policy flexibility (which Mr. Zhou announced today he would like); and, capital mobility (on which the Chinese export juggernaut depends — i.e. FDI and other capital inflows).  So, the Chinese have given up monetary policy flexibility in exchange for $2.4 trillion in fx reserves and rising.  Excessively easy US monetary policy for many years (thank you, Sir Alan) has led to easy money in China, sometimes resulting in an inflation problem, though not of late.  Effectively, the Federal Reserve determines the money supply in China.

Do Mr. Zhou’s comments presage a more flexible exchange rate in China (aka a revaluation of the woefully undervalued RMB)?  Do we have one more set of tea leaves to read on China’s policy intentions — in addition to the U.S. government’s agreement to postpone calling China a currency manipulator in exchange for China’s cooperation on sanctions against Iran and a commitment to at least slowly revalue the RMB?  In any case, Mr. Zhou can’t have his desired monetary policy flexiblity without floating his currency. 

From CSFB 4/26/10:

Dong Tao
+852 2101 7469
Christiaan Tuntono
+852 2101 7409
PBoC Governor Zhou Xiaochuan highlighted the importance of inflation management and policy flexibility for China’s monetary policy. Zhou made his latest comments on China’s monetary policy during his attendance at the G20 meeting in Washington DC. Although the importance of policy continuity and consistency remains intact, greater weight appears to have been attributed to the focus and flexibility of policy measures in view of the potential rise of new economic conditions. At the same time, Zhou also stressed the importance of monitoring price movements and managing inflation expectations in his comments. We think Zhou’s comments reflect the PBoC’s concern about the rise of inflationary pressure in China, and its readiness to adjust the existing policy stance to cope with any new situation. The same message was also conveyed in the PBoC’s 1Q10 macro economic analysis published on 23 April, in our view. The report acknowledged the further strengthening of economic momentum, and identified the management of liquidity, credit growth, and price stability as the PBoC’s main tasks. The central bank also said that it will continue to maintain the balance between growth, structural adjustments, and inflation expectations going forward. The PBoC’s heightened focus on inflationary pressures is in line with our expectation for price levels to rise in 2010 on higher food prices and housing rents. Higher inflation is likely to drag real deposit rates into negative territory, prompting the central bank to raise rates in 2H10, in our view.
Meantime, the Chinese government has reportedly been studying the launch of a new round of stimulus measures, despite the fact that the economy grew by 11.9% yoy in 1Q10. This time, we understand the focus will be on helping economic transformation and establishing competitiveness in selected industries instead of boosting GDP per se. The plan is still at an early stage, but it could be as big as the RMB4trn package launched in late 2008 that prevented the Chinese economy from falling into recession. There is clearly a policy desire to upgrade and transform the economy, as China’s export engine may enter into a structural moderation amidst reduced US consumption and RMB appreciation. Unlike the emphasis on infrastructure investment in the previous stimulus package, we think the government intends to let private capital play a much bigger role this time.