Archive for the ‘Economy’ Category

India: Solid GDP growth, weak finances

June 14, 2010
India's fractious politics keeps government debt high.  Source: Google Images
India’s fractious politics keeps government debt high. Source: Google Images

In an earlier post, I discussed  a theory I developed that democratic countries with divided, often coalition, governments generally produce weaker public finances than countries where two dominant parties alternate in power.  India is the posterchild for the former, with government debt at about 80% of GDP, very high for an emerging market economy.  In order to keep weak coalitions together, governments must buy off constituencies, at the expense of sound public finances.  We shall see if India’s current government led by the Congress Party can deliver on promises to reduce the government debt burden.

India’s weak fiscal position (with government deficits at around 6% of GDP)  have constrained its credit ratings to low investment grade.  Below find a press release issued today by Fitch in which the rating agency adjusts the rating outlook on India’s sovereign bonds to stable from negative, not due to improved management of government finances, but to stronger GDP growth prospects.  The one-off positive impact on government accounts of recent telecoms auctions also helped sovereign creditworthiness.

CSFB published a note today (also below) explaining how output growth is starting to bump up against capacity constraints.  Fitch forecasts output growth at a healthy 8.5%, though the Reserve Bank of India might tighten monetary policy, keeping the expansion in check.  This is because of another important characteristic of Indian political economy — political sensitivity to inflation.  India is a populous country with high levels of poverty, so when inflation creeps up even a point or two, especially for food prices, people starve (or at least become more malnourished).  In a place as big as India, this can mean millions more malnourished people.  Complicated policy making…

From Fitch Ratings:

Fitch Revises India’s Local Currency Outlook To Stable; Affirms at ‘BBB-‘   
14 Jun 2010 5:33 AM (EDT)

Fitch Ratings-Mumbai/Hong Kong/Singapore-14 June 2010: Fitch Ratings has today revised the Outlook on India’s Long-term local currency Issuer Default Rating (IDR) to Stable from Negative. At the same time, the agency affirmed India’s Long-term foreign and local currency IDRs at ‘BBB-‘. The Outlook on the foreign currency IDR remains at Stable. Fitch has also affirmed the Short-term foreign currency IDR at ‘F3’ and the Country Ceiling at ‘BBB-‘.

“India’s strong growth prospects and the one-off positive impact from the telecoms auctions underpin Fitch’s forecast that government debt to GDP ratio will decline, easing the near-term pressure on India’s local currency ratings. However, public finances remain a clear weakness, and downward pressure on the ratings could resume if India veers too far off the deficit reduction path as outlined by the Thirteenth Finance Commission,” said Andrew Colquhoun, Director in Fitch’s Asia-Pacific Sovereigns Group.

Fitch projects general government debt to fall to 80% of GDP by end-March 2011 (end-FY11) from 83% at end-FY10, reflecting the impact of strong GDP growth on the denominator and the one-off revenues from the 3G licence and broadband spectrum auctions. The agency has revised India’s FY11 growth forecast up to 8.5% from 7% on signs of strong growth momentum, including industrial production growth of 17.6% in April 2010, year-on-year. The telecom licence auctions together netted the government INR1,060bn, representing about 1.6% of projected FY11 GDP, as against the INR350bn budgeted originally (Fitch’s February review of India took the cautious approach of assuming zero auction revenues). The agency anticipates some pressure on the government to spend some of the revenue windfall and estimates an additional 0.3pp spending in FY11, still delivering a net 1.3pp fiscal saving.

However, fiscal management remains relatively weak. Fitch anticipates that the central government’s deficit on the government basis (including privatisation and auction receipts as revenue and excluding some off-budget items) to be at 5.7% of GDP in FY11, just 1pp down from FY10, despite the 1.6% of GDP reaped from the telecom auction. The report of the Thirteenth Finance Commission (TFC) in February laid out a path of deficit reduction towards a “golden rule” of borrowing only to finance investment by FY15. India’s track record on sticking with medium-term fiscal plans is not good, although the Congress-led government has at least voiced its commitment to debt reduction. If the authorities stray too far from the TFC’s consolidation path and debt ratios resume rising, it could impact the ratings negatively.

A significant drop in the country’s growth momentum to below Fitch’s projections would worsen India’s debt dynamics and put downward pressure on its ratings. However, India’s credit profile continues to benefit from the largely local-currency profile of its debt (95% of the stock), and from the sovereign’s stable access to domestic-currency financing, mainly from the banking system. Signs that India’s banking system was under stress would likely be negative for the sovereign ratings, although this is not the agency’s base case. Inflation remains uncomfortably high, with wholesale prices up 10.2% in the year to May, prompting the central bank to hike rates twice in response so far in 2010. An intensified inflation shock that is severe enough to disrupt macroeconomic and/or financial stability would be negative for India’s ratings.

India’s strong external finances, including its sovereign and overall net creditor status and official reserves of USD271bn by June 4 2010 (up 3.6% on a year earlier), continue to support its foreign currency ratings. By contrast, poor physical infrastructure, underdevelopment reflected in low average incomes, and weak governance indicators relative to rated peers constrains the ratings.

Contacts: Andrew Colquhoun, Hong Kong, Tel: +852 2263 9938; Vincent Ho: +852 2263 9921.

From CSFB today:

Devika Mehndiratta
+65 6212 3483
April IP surprised on the upside, with the index rising 17.6% yoy compared with our and consensus estimates of 14.3%. In seasonally adjusted level terms, the IP index had been flat in recent months – after strong gains from June to December 2009, IP was flat in January and February and then declined in March (Exhibit 6). In April, the IP index increased by a notable 3.4% mom.
The large upward surprise in April IP was not that broad-based, however. It was dominated by a 33% mom jump in the capital goods sub-index. This sub-index has been volatile recently (Exhibit 7). It jumped over 30% in December/January, fell back in February/March and was up again by 33% mom in April. A breakdown by product for capital goods is not available for April yet, but data until March showed that these large ups and downs were limited to only a few goods such as computers, ship building & repair, railway wagons, and oil wells/platforms.
Capacity constraints could become an issue. Even if we assume that the broad trend in capital goods (even though volatile) indicates that corporate investment activity is picking up, it is possible that, in the months ahead, capacity constraints start to show up. Anecdotal evidence suggests that industries such as autos, fast moving consumer goods, steel and power are operating near full capacity (the power sector has been capacity constrained for years). This could slow the pace of month-on-month rises (from around 3% pace in April) in industrial production going ahead.
Could the RBI now hike policy rates inter-meeting before the scheduled July meeting? An inter-meeting hike is not entirely inconceivable, but we would still maintain that it is unlikely. This is because: 1) the RBI has indicated ‘cautiousness’ in its policy stance in recent comments, and 2) monetary conditions have anyway tightened in recent weeks triggered by the large one-off 3G auction-related borrowings by telcos. The short-term call rate has consequently moved up from the reverse repo rate (3.75%) to the repo rate (5.25%) without the RBI having taken any policy tightening action since April.

Is there a Yuan bloc in Asia?

June 8, 2010
Asian currencies tracking China's yuan?  Source:  Google Images
Asian currencies tracking China’s yuan? Source: Google Images

Interesting Economist article (below) discussing whether other Asian currencies — the Korean won, Thai Baht, Singapore dollar, Malaysian Ringgit, New Taiwan dollar, Vietnamese dong, Indian rupee, Indonesian rupiah — track the Chinese yuan in order to maintain competitiveness in US markets relative to China as well as access to the Chinese market.  There have been a number of econometric studies on the matter.  The bottom line is that many Asian currencies, like the Chinese yuan, track the US dollar closely — some call it Bretton Woods II — though the correlation has declined since the economic crisis, as the US economy and US monetary policy have been going through anomalous conditions.  Tying strictly to the US dollar right now might mean some unwanted inflation in accelerating Asian economies.  Still, China’s currency remains essentially fixed to the dollar.  Ultimately, a revaluation of the Chinese yuan, and its Asian brethren, is needed to address the current account imbalances that persist and threaten global economic stability.  The euro crisis has, however, thrown a wrench into that adjustment, leading to some safe haven capital flows into the US dollar, just when the greenback needs to decline in an orderly fashion.

 From the Economist on-line:

 Asian currencies

Chips off the block

Currencies around Asia are more flexible than you think

Jun 3rd 2010 | HONG KONG | From The Economist print edition

AMID all the diplomatic ding-dong over China’s yuan, it is easy to lose sight of emerging Asia’s other currencies. There is not much din over the dong, for example. While China has kept the yuan pegged to the dollar since July 2008, ignoring complaints that it is artificially cheap, Vietnam’s currency, the dong, has depreciated by 13% against the greenback over the same period, unremarked and unprotested. South Korea and Taiwan, the only countries besides China ever to be labelled currency manipulators by America’s Treasury, have seen their currencies cheapen by 17% and 6% respectively.

China’s critics justify their preoccupation by invoking a “yuan block”. China’s neighbours and rivals are reluctant to allow their currencies to rise too far against the yuan, for fear of losing China as a customer, or losing out to it as a competitor. Thus although China accounts for only 19% of America’s imports, its peg, it is argued, frustrates a broader realignment of currencies in the region.

Does such a yuan block exist? For over a decade before July 2005, it was impossible to say. Since the yuan did not move independently of the dollar, it was hard to know if China’s neighbours were in thrall to its currency or America’s. But for the following three years, China allowed the yuan to crawl slowly upwards against the dollar. A 2007 study by Chang Shu, Nathan Chow and Jun-Yu Chan at the Hong Kong Monetary Authority took advantage of this interlude to measure the influence of China’s yuan on other regional currencies.

Using a method popularised by Jeffrey Frankel of Harvard University and Shang-Jin Wei of Columbia, they looked at the fluctuations of Asian currencies against the Swiss franc. Insofar as the Thai baht and the dollar mirrored each other’s moves against the Swiss currency, the authors could conclude that the baht was under the dollar’s spell. But if the baht and the yuan strengthened against the franc when the dollar did not, they could identify the separate pull of China’s currency.

That pull was strongest on the Korean won, Thai baht, New Taiwan dollar and Singapore dollar. But it also seemed to reach as far as the Indonesian rupiah and even the Indian rupee. The economists’ results suggested that if the yuan were to appreciate by 1%, independently of the greenback, the Singapore dollar, New Taiwan dollar and the Thai baht would rise by 0.58%-0.68% in sympathy. The Korean won would strengthen one for one.

Since July 2008 the yuan has not moved an inch against the dollar. Does that mean that other members of the yuan block have also stood still? Hardly. Malaysia untethered its currency from the dollar one day after China in July 2005. But unlike China it did not retether it during the crisis. The ringgit fell by 15% from April 2008 to March 2009, before regaining much of that ground over the next 14 months. The won’s wobbles have been even greater. It lost 40% of its value from February 2008 to March 2009, and remains 25% below its pre-crisis peak.

Most of emerging Asia’s currencies strengthened against the dollar this spring. The ringgit rose by 8% from February to May, after Malaysia’s independent-minded central bank raised interest rates in March and again on May 10th. In April Singapore’s Monetary Authority said it would allow a “gradual and modest” appreciation of its currency. But since the debt crisis in Greece unnerved investors, these currencies have mostly lost value again.

This block isn’t scared any more

The flexibility shown by Asia’s currencies is noteworthy, even if most of their flexing has been downwards. Economists used to accuse the region of a “fear of floating”. In 2003 Michael Dooley of the University of California, Santa Cruz, with David Folkerts-Landau and Peter Garber of Deutsche Bank argued that a de facto dollar standard prevailed in much of the region, akin to the “Bretton Woods” regime of fixed dollar parities that emerged after the second world war. But a paper published on May 19th by Ila Patnaik and her colleagues at the National Institute of Public Finance and Policy in Delhi documents a gradual thinning out of the Bretton Woods II regime.

They use a similar method to Messrs Frankel and Wei to show how closely Asia’s currencies track the dollar, euro, yen and pound. They give each country a Bretton Woods II score, based on the rigidity of its currency, especially relative to the dollar. In 2003 the average score in Asia was about 0.85 (a score of one represents a hard peg to the dollar). But the score has since dropped steadily to 0.75.

The new flexibility should stand Asia’s economies in good stead. Their ties to the dollar once guaranteed stable prices at home, as well as competitive exports abroad. But America’s monetary policy, suited to an economy with flat prices and high unemployment, is too loose for a region now growing so rapidly. As Asia’s recovery outstrips America’s, the region’s central banks will have to raise interest rates, as Malaysia, Vietnam and India have already done. Their currencies will appreciate as a result.

This appreciation will be easier to stomach if the yuan also strengthens. But China’s neighbours should not wait for this to happen. Even members of the so-called yuan block should not let the yuan block their progress.

Hotspots for sovereign credit risk: Fitch report

June 1, 2010
What Greece needs is a thunderbolt from Zeus, not a bailout from Frankfurt.  Source:
What Greece needs is a thunderbolt from Zeus, not a bailout from Frankfurt. Source:


Like a thunderbolt from Zeus, financial markets are struck by the perils of a sovereign debt default.  In financial crises, markets and policy makers fight the last war.  In the Great Depression, countries made the mistake of balancing budgets instead of offering a Keynesian stimulus; in today’s crisis, they are spending like crazy by issuing debt (like crazy).  Sovereign balance sheets are in a woeful state. 

Fitch Ratings explains what is going on in Greece, what countries like the US must do to keep their AAA ratings, and what Latin America’s outlook is.  Fitch delivered its annual Sovereign Hot Spots seminar, which I used to run in New York.  Read the summary below and access the powerpoint presentations and the video of the conference to bone up on sovereign credit risk, which preoccupies global markets these days, as it well should.

Fitch belatedly downgraded Mexico, which lacks a dynamic economy and resists reforms to the oil sector and taxes that could improve creditworthiness.  These factors have long been at play in Mexico.  In addition, Fitch highlights Mexico’s dependence on the US market, as opposed to peer countries such as Brazil that export increasingly to China.  This factor is discussed as a weakness for Mexico these days, whereas for years it was alluded to as a strength.  (Who better to export to than the US, went the argument.) On the other hand, Brazil’s ratings are being held down because of its woeful fiscal accounts, in spite of its strong external balance sheet (which Mexico lacks).  I won’t quibble with the importance of public finances to sovereign creditworthiness; I will just point out that time and time again, analysts have let sovereigns off the hook that had strong public finances and weak external finances (e.g. Asia crisis countries and some countries today in Eastern Europe).  This has caused lots of Wall Street analysts to get it badly wrong in the past. (Did they call the 1998 Asia crisis or the problems Eastern Europe is currently having? No.)  Brazil has the reverse profile — strong fx reserves and weakening (though not fragile) public finances.  By penalizing Brazil too much for Lula’s loosening of the fiscal purse, analysts may miss the boat on Brazil (or may already have).

Finally, it might not be enough to say, as Fitch does, that AAA countries remain AAA because of their financial flexibility, but must find an “exit strategy” from all the rising debt over the medium term, as the US and others sure need to do.  This is ratings stickiness again, folks.  Rating agencies have a difficult time adjusting their ratings because it suggests their analysts might be wrong.  Maybe some AAA countries should have already lost their stellar ratings.  Economists are always good at finding powerful intellectual arguments to explain their current positions — remember Alan Greenspan before Congress on low interest rates.  Have a read of the Fitch summary below — it is chock full of good sovereign credit analysis. 

From Fitch:

“Sovereign Hotspots: Diverging Trends” began Tuesday, 2 March, with a conference in New York discussing the divergence of fiscal prospects between high-grade advanced economies and emerging markets. The conference focused on recent credit pressures and bond market volatility in Europe, as well as credit trends in Latin America. Additionally, Fitch distributed a press release commenting on Chile’s sovereign ratings following the country’s catastrophic earthquake and aftershocks. The event concluded with an analyst panel providing more details on specific countries in Latin America and an investor panel debating recent developments and prospects for the global economy and emerging markets in particular.

Below are some highlights of the conference, followed by links to each presentation. If you would like to hear a replay of the event, please click here. For information on next week’s events in London, Frankfurt and Paris, which will include presentations on Emerging Europe, the Middle East and North Africa, please click on or contact Katie Donnelly at 1-212-908-0828.
New York Conference Highlights:
High Grade and Euro Area Sovereign Risk      
Diverging Trends – ‘Advanced’ and ‘Emerging Market’ Sovereigns

Emerging markets (EM) have weathered the global economic and financial crisis relatively well due to their generally strong balance sheets.  Foreign exchange reserves for EM excluding China have shown a strong recovery since February 2009 and are now near pre-crisis levels.  In addition, lower public debt ratios, combined with less sensitive tax bases have led to more solid fiscal positions in EM relative to developed markets (DM).  Over the next two years, Fitch foresees a continued divergence in public debt paths, with government debt/GDP declining in EM and increasing in DM.
High Grade Sovereigns and the Meaning of ‘AAA’

Countries with high financing flexibility are better positioned to withstand economic/financial shocks than countries that are less flexible in terms of funding, with financing flexibility largely depending on the size of the economy (i.e., the amount of real & financial assets to absorb sovereign liabilities) and the depth of demand for a country’s currency (reserve currency status implies strong underlying demand for assets in that currency).  However, while high-grade sovereigns have the capacity to maintain solvency and the cost of debt service is still below mid-1990s levels, Fitch views these sovereigns’ fiscal exit strategies as key to their ratings outlook, with the urgency among the larger AAA-rated countries being greatest for the UK, Spain and France. 
Greece and the Euro Area

With Greece’s greatest problem being its non-credible statistics and poor track-record, Greece needs to bolster credibility and investor confidence in the long-term solvency of the state in order to gain market access at an ‘affordable’ price. At present, the EU is playing a game of “constructive ambiguity” aimed at stabilizing markets and reducing liquidity risk while putting additional pressure on Greece to restore fiscal discipline.  However, it should be noted that at this stage it is not clear that contagion risk is that severe, as so far spread widening has been ‘rational’, focusing on large deficit countries.
View full presentation
Latin America Overview

Although the average rating continues to be higher for Emerging Europe than for Latin America, the change in the average regional rating has been much better for the latter, with five positive rating actions taking place since July 2009.   Thus, while Latin America has been a mixed bag, with the number of negative rating actions exceeding the number of positive rating actions since the onset of the crisis, the region has generally been quite resilient to the global economic storm.  After an estimated 3% decline in GDP in 2009, Fitch anticipates overall GDP to grow by 4% in 2010, aided by supportive monetary and fiscal policies, a renewed credit cycle and stronger domestic demand (particularly in Brazil, Chile, Panama and Peru), as unemployment rates (which rose only modestly during the crisis) are declining, real wages are recovering and consumer confidence is increasing across the board.  In addition, both domestic and foreign direct investments are expected to rebound, general government debt is anticipated to stabilize and current accounts to remain resilient in 2010, with further accumulation of international reserves taking place.

Nonetheless, Latin America still faces important challenges as it copes with a sluggish global economic recovery as well as significant budgetary rigidity, which may hinder fiscal consolidation.  Additional challenges for the region include sustaining prudent policies through a sluggish recovery and avoiding election-related market uncertainty as presidential elections approach in Colombia (May 2010), Brazil (Oct 2010), Peru (Apr 2011), Guatemala (Aug 2011) and Argentina (Oct 2011).  Thus, while Latin America’s economy will rebound in 2010, the pace of the recovery will differ across countries and growth will still be below the rates observed in 2006-2007.  Since Fitch is currently not seeing a strong reform momentum throughout the region, sovereign creditworthiness trends are likely to remain stable to slightly positive.
Mexico: Explaining the Downgrade

Mexico was downgraded to ‘BBB’ with Stable Outlook in November 2009 primarily for structural reasons, including its low non-oil tax base and high oil dependence, combined with uncertain oil prospects (in fact, oil production has been declining in recent years despite an increase in capex, indicating the need for further reforms at Pemex).  In addition, the 2009 tax package, while in the right direction was insufficient, demonstrating the reluctance of political parties to come together to implement major fiscal reforms to improve tax revenues.  Other factors that led to the downgrade include a relatively modest fiscal buffer (the commodity stabilization fund is small compared with Chile’s, Russia’s and Kazakhstan’s), a limited external cushion (i.e., a weak international liquidity ratio compared with ‘BBB’ peers) and Mexico’s historical growth performance, which has been lagging that of its peers.  While Peru, Chile and Brazil have increased their trade links with China and reduced their ties with the US, Mexico still exports over 70% of its products to its North American neighbor.  As a result, the sluggish rebound of the US economy will continue to constrain Mexico’s growth in 2010.  Factors that led Fitch to change its Outlook on Mexico from Negative to Stable include the country’s well capitalized banking system and low balance of payment risk, as well as its track record of disciplined macroeconomic policies, its smooth external debt profile and its demonstrated ability to tap international markets under difficult external conditions.
Brazil: Beyond the Economic Resilience

Investor confidence towards Brazil is supported by the country’s strong external balance sheet, its robust external solvency ratios (Brazil has long been a net external creditor) and the healthy economic rebound anticipated for 2010, with the expected 5.5% growth in GDP being the strongest in Latin America and only behind India’s and China’s.  However, Fitch has not taken a positive rating action as the agency considers that Brazil’s resilience is already captured in its current ratings to a certain degree and that its stronger external balance sheet has been at a fiscal cost.  In fact, the deterioration in public finances and high government debt burden due to double-digit current spending and significant budget rigidity are dampening the country’s upward credit trajectory.  Moreover, Brazil’s domestic debt composition needs to improve further, as a large proportion of its debt is still contracted at floating rates and 2010 maturities are on the higher side when compared to those of its peers.  Finally, with 2010 being an election year, needed reforms are likely to stall until the next administration takes over.  Fitch will observe how the next administration will handle challenges such as the realization of expenditure reforms, the definition of BNDES’ role and the simplification of the tax system, as well as the management of oil sector development given recent discoveries, among other things.
View full presentation 
The presentations will be available free of charge for three months. If you have problems accessing these presentations or for more information, please email Frank Laurents at, or telephone +1 212-908-9127.

Additional information can be found on the Fitch Ratings website,

If you know others who would like to receive this e-mail, please forward this to a colleague.

Image: What Greece needs is a thunderbolt from Zeus, not a bailout from Frankfurt. Source:

(from a blog post of March 5, 2010.)

European Central Bank: Inaction puts global recovery at risk

May 7, 2010
The ECB: will they ringfence Greece?  Source:
The ECB: will they ringfence Greece? Source:

How unwieldy Europe is to manage!  How difficult it is for EU institutions to act…

Bruce Kasman, Chief Economist of JPM, whom I remember from my years at the New York Federal Reserve in the early 90s where he was an international economist, said this morning in a conference call that the main risk to the US economic recovery is contagion from the debt crisis in Europe.  European banks are large holders of government debt, and stresses in these institutions could spill over into funding pressures for US financial institutions, as well as for Latin American institutions. 

Kasman argued that Greece, experiencing a crisis of solvency rather than liquidity, must be ring-fenced, and other highly-indebted members of the euro area — Portugal, Spain, Italy and Ireland — must receive ECB support.  He said that the ECB must act quickly to reassure the markets that there will be ample liquidity for these other countries, so the Greek contagion can be contained.  More aggressive ECB liquidity lines and expansion of the dollar-swap facility with the Federal Reserve are needed.  This will reassure the markets that, unlike Greece, these countries are not insolvent and that policy adjustment in these countries (deficit reduction) will be enough and will be undertaken. Otherwise funding costs for these countries could rise markedly, making insolvency a self-fulfilling prophecy.  Kasman said that the results of the ECB meeting yesterday were, in this regard, disappointing.

US economy: Little optimism, but less pessimism

May 7, 2010
Payrolls up, but unemployment still nudges up close to 10%.  Source:
Payrolls up, but unemployment still nudges up close to 10%. Source:

Jobs expanded in April, with the American private sector back with a vengeance.  But medium-term risks abound, especially regarding very weak public finances at the federal, state and local levels due to the massive economic rescue enacted last year.  Governments at every level in this country must put forward credible deficit-reduction plans, albeit cautiously, or this recovery could falter as early as next year.

Bruce Kasman, Chief Economist of JPM, held a conference call today to go over the US employment figures, released this morning, that showed a huge expansion in payrolls under way over the last three months.  Kasman, whom I remember from my years at the New York Federal Reserve in the early 90s where he was an international economist, explained that the US private sector was hiring, restocking and investing, not out of optimism, but out of “less pessimism.”

Payrolls in the US expanded by 290,000 in April, versus a consensus forecast of 190,000.  Upward revisions of 121,000 to March and February were announced as well.  The private sector, including manufacturing and services, is adding jobs.  The workweek increased in April as well.  Putting this together, this means that labor income (workers’ paychecks) is rising, up 4.2% in in the first quarter of the year.  Further good news is that wage inflation remains muted, as there is considerable slack remaining in the labor market.  So, American consumers will start spending again, and the Fed won’t raise interest rates to staunch inflation any time soon.  Pretty rosy scenario.  With wage inflation muted, profits have been rising, postponing reform of the inherent unfairness in the American economy — firms profit as real wages remain low.

Still, you couldn’t ask for anything better in an economic recovery at this stage.  Kasman said he believed the US recovery has momentum and is broadly based.  The headline unemployment figure did edge up to 9.86% in April, but there was good news in that figure as well.  This figure rose because the labor participation rate rose.  Because not all of those currently counted as participating in the labor market have jobs, the unemployment rate rose, even though jobs themselves expanded robustly in the month. 

Kasman sees self-sustaining economic growth in the coming two quarters of this year as firms and households roar back; however, he is not optimistic about US policy makers taking the right decisions to ensure the economy remains on a sound medium-term growth path.  He also worries about contagion from the debt crisis in Europe, but that will be the subject of my next post!

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.

Brazil: Does Lula have coattails?

March 30, 2010
Can Lula translate his government's popularity to Dilma Roussef, his chosen candidate for president?  Source: Google Images Can Lula translate his government’s popularity to Dilma Roussef, his chosen candidate for president? Source: Google Images

After Lula, it looks like it’s the battle between Dull and Duller.  Brazil’s presidential election in October is an important one, as the country’s success and new-found leadership role within the BRICs and G-20 make Latin America’s largest economy critical on the world stage.  Lula has charisma, but his anointed successor from the PT party, Dilma Roussef, does not.  Luckily for her, her rival, Jose Serra, who is ahead in the polls, is as dull or duller than she.  That’s why he was trounced by Lula in 2002, for a time causing Brazilian bonds to trade at default spreads. 

CSFB reports today (see below) that Serra remains ahead in opinion polls.  Though slightly wider in March, Serra’s lead over Dilma has narrowed in recent months.  The popularity of the Lula government (of which Dilma is a leading member) remains in the stratosphere, with 76% of those surveyed in March appraising the government as “excellent/good.”  Yet only 45% of those saying so said they would vote for Dilma, which is not good enough for her to beat Serra, once mayor of the city of Sao Paulo and now governor of Sao Paulo State, Brazil’s most populous state and the one packing its economic punch.   It’s too early to call this important election, but narrowing poll numbers this far out must worry the Serra campaign.  A recent profile of the dour Social Democratic administrator can be found in this  Economist article

From today’s CSFB report:

Poll shows wider gap between voter intentions for José Serra and Dilma Rousseff in the presidential election. The Datafolha poll, published on 27 March, showed higher voter intentions in the presidential election for José Serra (PSDB), currently the governor of São Paulo, and a slight decline in intentions to vote for Dilma Rousseff (PT), the chief minister of the presidential staff, reverting part of her gain in February’s poll. Voter intentions for Dilma Rousseff declined from 28% to 27% from February to March, while voter intentions for José Serra rose from 32% to 36% (Exhibit 1).
Serra’s leading position in the simulations of the first round of voting in the presidential election rose from 4pps in February to 9pps in March. Voter intentions for federal deputy Ciro Gomes (PSB) went from 12% to 11% from February to March and remained stable at 8% for the former minister Marina Silva (PV). In the simulations for the second round, Serra obtained 48% of voter intentions versus 39% for Rousseff.
We believe that the wider gap between the voter intentions for Serra and for Rousseff represent a natural variation in opinion polls and does not point to any trend for the coming months. Since the February Datafolha poll, José Serra has suggested he would be the PSDB’s pre-candidate for president, which has bolstered his visibility among voters in recent weeks. Until the campaign starts in July, the scenario should continue to favor the government’s candidate, in light of the Lula administration’s high approval ratings. The March Datafolha poll showed that the administration’s “excellent/good” rating rose from 73% in February to 76% in March, the highest level in the time series (Exhibit 2).

An increase in voter intentions for Rousseff will depend on the government’s ability to transfer to its candidate the votes of those appraising the administration as “excellent/good.” In March, 45% of voters appraising the administration as “excellent/good” indicated they would vote for Rousseff in a possible second-round election dispute with Serra (Exhibit 3). Thus, a substantial increase in voter intentions for Rousseff would require an increase in this percentage.

Rise in median market forecast for IPCA inflation in 2010, from 5.10% to 5.16%.The Market Readout released yesterday (29 March) points to a rise in the median market forecast for IPCA inflation in 2010, for the tenth week in a row, this time from 5.1% to 5.16% (Exhibit 4). The higher expectations for IPCA inflation are explained mainly by the revisions in projections for short-term inflation, from 0.44% to 0.48% for the March IPCA index and from 0.39% to 0.40% for April. Conversely, after rising for two straight weeks, the median forecast for IPCA inflation in 2011 remained stable at 4.7%.

In our opinion, the upward revision in market expectations for IPCA inflation in 2010 was caused primarily by higher-than-expected consumer inflation in Q1 2010 and in April. While the median of expectations for cumulative inflation from May to December 2010 fell from 2.76% on 8 January to 2.69% on 26 March, expectations for cumulative inflation from January to April rose from 1.74% to 2.43% in the period. These results suggest that the majority of market participants merely incorporated the higher-than-expected inflation in Q1 2010 into their projections for 2010 inflation (Exhibit 5). We believe that the fact that the rise in inflation in the first few months of the year was mostly the result of higher prices of a seasonal nature (e.g., increase in tuitions) or a temporary nature (e.g., higher inflation in fresh food prices) means that the higher-than-expected inflation in the short term has not raised inflation expectations for longer horizons.

We do not expect market forecasts to increase significantly over the next few weeks. Our projections for IPCA inflation in March (0.45%) and April (0.40%) are near the median market forecast. Although the recurrently higher-than-expected inflation in recent months has increased uncertainty as to the dynamics of inflation in the short term, we think a reduction in consumer inflation is very probable in the coming weeks, especially because of the reversal of the price hikes that caused the higher inflation in Q1 2010.
Among the expectations for other economic indicators in 2010, we highlight the stability in the median forecast for the Selic basic rate at the end of 2010 at 11.25%, which assumes five consecutive 50bps increases in the Selic rate starting in April.

President Obama: Masterful politician

March 28, 2010


Soaring the fray.  Source:  Google Images
Soaring above…well…in the fray. Source: Google Images

I don’t agree at all with the Economist’s leader this week, which suggests that Barack Obama’s presidency was headed for failure until his health care victory last week.  The health care victory was the icing on the cake, coming fourteen months into Obama’s first term, after he rescued the planet from an economic meltdown in a cooperative effort with other G-20 leaders, pulled the Security Council behind him in a tougher stance toward Iran, negotiated nuclear arms reductions with the Russians, and improved America’s image in the world.  Bravo, Mr. President!

Politically, this fella is no slouch.  Obama may well avoid what happened to Bill Clinton in ’94, a massive mid-term reversal, with the likes of Newt Gingrich snickering in the hall, John Boehner today looking  like a dim photocopy of the Newt.  Sure, the president has been aided by the Republican victory in Massachusetts.  Yes, that’s right — aided by the Republican victory, a wake-up call that came ten months before the mid-term elections, just in time to deflate the egos of many in the West Wing, to cobble together a realistic health care victory, and to lay the foundation for a multi-month comeback to a mid-term election victory, or at least a less-nasty defeat.   Such a Democratic upset this November seems more likely now, given the current state of the know-nothing Republican Party, as hamstrung by their defunct ideology and mediocre leadership now as they were in October 2008 when they couldn’t understand that capitalism would be saved by government intervention.

Let’s not underestimate the dimensions of this political success.  I, not knowing much about Barack Obama in 2008, underestimated the mettle of this (at the time) inexperienced, leftish, mediocre legislator with barely any time outside the Illinois legislature.  He is one of those lucky bets that is paying off.  

Obama, his advisers, and dare I say it, the Democratic leadership of Congress, played this thing like a symphony.  Right on the heels of the Mass. election, which I wrote about in January, it would have been highly unpopular to ram health care reform through, utilizing the funky procedures they are employing right now.  Steny Hoyer had to button his lip in January.  Now, the country has barely noticed how the Democrats are passing this thing.  The Dems realized that not passing health care reform would be worse than stealing it in the middle of the night.  President Obama can claim that he has done something for the American people, something big, and yes, controversial.  But this accomplishment will be remembered as such, and everyone will forget how it was done.  Brilliant insight on the part of the Democratic leadership.

Even better, the president held that mock-bipartisan discussion with the Republicans right after the Mass. election, providing fodder for his future argument on the hustings, that “I reached out to them and they bit my hand.”  Now, he can dispense with the facade of bipartisanship (something he has never really exhibited), just when you want to dispense with bipartisanship, that is, in the run-up to an election.  The gloves are off, folks, and the Democrats are towering over a party in disarray, drifting to the right, and sipping tea.

Now, what do you do with this victory?  This is the question the Economist asks.  Undoubtedly, the Obama people will answer, “Get re-elected.”  And for starters, this means doing as well as possible in the mid-terms, to allow for a legislative foundation to pass more of the Obama agenda, though no one is quite sure what that is.  Then, run in 2012 as the early 21st century’s FDR, the remnant of the right quivering in their jack-boots.

To keep up the momentum, the President just jaunted off to Afghanistan, to underscore his key foreign policy priority and to make indelible his new-found image of toughness.  Having sustained criticism for dithering and allowing others to lead him, whether Democrats in Congress or foreign leaders, Obama is in pursuit of a victory abroad to match the massive, bloody victory he just won on the homefront.

I opposed health care reform in this blog.  Not that I oppose health care reform per se.  In fact, I am for it.  It is the fair and right thing to do in America, and one of those important actions, so intangible yet so necessary, that underpins social peace and the fabric of our society. However, I oppose health care reform, an expansion of government entitlements, at this time.  I still feel that America’s gravest fiscal crisis in history — the one we are in, which is set to get worse —  is no time to expand entitlements.  Entitlements — unemployment insurance, medicare, medicaid, social security, health care, etc. — could undermine America’s finances, if a medium-term fiscal plan is not put forward that puts government debt (now approaching an unhealthy 90% of GDP) on a downward trajectory.  On this, I concur with the Economist.

I was impressed that the CBO found a way to fully fund health care reform, albeit with uncertainty that the revenues will be there.  Cost containment is another uncertainty.  Hats off to the Democrats for seeking a way to expand entitlements without further busting the budget.  I do feel that some credit for this is due to those of us who put pressure on the party in power to respect fiscal rectitude, including many in the party of “no”.  Democracy works.  

I was a country risk analyst for fifteen years.  Country risk analysts are a breed that understands what is at stake with a deterioration in America’s public finances.  Country risk analysts assess the likelihood that a sovereign government will pay back its debts in full and on time.  Rating agencies, where I was a managing director for sovereign ratings for much of the past decade, assign letter ratings — AAA, BBB, BB, etc. — that rank countries by their sovereign credit risk.  Alas, the US is now in danger of losing its cherished AAA rating — the highest rating, the lowest risk — if the deterioration is not reversed in public finances (not to mention the trade deficit, which is driven in part by government deficits).  I wrote on these matters last fall — a piece on fiscal policy and one on trade — and earlier this year on the prospect of the US losing its AAA.

Americans are spoiled.  Never having experienced a real sovereign debt crisis, similar to what was experienced in Mexico after 1994, in Thailand, Korea, Indonesia and Russia after 1997-98, and in Argentina after 2001, Americans don’t worry about their governments’ finances.  Most argue today that the US, wealthy as it is, can afford health care reform.  But they don’t want higher taxes to pay for it.  There has never been a worry about the safety and soundness of US government bonds.  There have not been lines in America outside of defunct banks of depositors seeking their money since the Great Depression.  This is why the backlash against the bank bailout last  year was so strident…and so ill-informed.  Country risk analysts know better and understand that America has bought some time with its stimulus package and bank rescue, but had better balance its books in short order.  My worry is that the president and his inner circle are not as on top of these risks as the average country risk analyst is.  Hopefully, Geithner and Summers and others will bend the president’s ear regarding fiscal rectitude, if they are allowed to remain in power.

America’s economy remains strong and large.  The US dollar remains the world’s reserve currency. American competitiveness in high-technology, education, services, agriculture, defense and other industries remains intact.  It would take some serious further mismanagement for the US economy to lose its position of number one.  In 1905, Argentina had one of the leading economies in the world.  Through over a hundred years of mismanagement, Argentina became the number one sovereign financial pariah, with a massive sovereign bond default in 2001.

The US has a ways to go before becoming Argentina, or even Greece or Britain, the latter more likely to lose its AAA than the US.  But, such intangibles as credibility of the US dollar and US assets could evaporate quickly.  Right now, those with cash in the world do not have a lot of options better than US dollar investments — euro investments look dodgy at best, yen investments are not so attractive, and other currencies do not provide the depth and safety to handle multiple trillions of investment dollars that pour into US, European and Japanese markets.  Not yet at least.  Watch this box on the Rising Powers to learn more about the risks and opportunities in the major Emerging Markets. 

The US economy and US power are in decline, for sure.  Don’t gnash your teeth or get panicky.  We’re talking about relative decline, which is inevitable.  With $45,000 in per capita income, versus China’s $3,500, America will not grow as fast as China.  The Chinese economy will overtake America’s in a matter of decades.  US power too — that is, America’s ability to influence events in the world — will also decline in relative terms. 

It is not time to move to Beijing.  What is critical is the manner and speed of America’s decline.  If America ensures that the Rising Powers remain cooperative members of the liberal interational world order — characterized by free trade, currency convertibility, market economies, democratization, the generally peaceful resolution of disputes, and cooperation among the world’s great powers — then America can decline with peace of mind.  Moreover, if America’s declining economic position does not occur suddenly and rapidly, producing dislocation and popular anger at home, then America can maintain its still-powerful, yet diminished position in the world with grace, proud of having led the most prosperous, fairest, least-bloody world order since humans stopped swinging from trees.

The surest way to protect the world’s liberal institutions and to co-opt the Rising Powers is for America to stay strong.  So, American policy makers must see every policy option through the lens of American power.  Balance must be sought between achieving a more equitable American society and reinforcing the pillars of American power.  That is why I opposed health care reform at this time, while I fully understand the political imperative of doing it now.  Those Democratic majorities won’t last forever.   

Flush with his health care success, President Obama’s first priority no doubt will be to win elections — first in 2010 and then in 2012.  To that end, he will attempt to chalk up victories in his chosen priorities.  He will seek tangible victories in Afghanistan, some movement in the Arab-Israeli conflict, and progress on jobs and financial re-regulation.  Nothing wrong with these priorities.  The only thing missing perhaps is this lens of American power.  Will such-and-such a policy bolster American power over the longer-term or not?  If not, do not expend political capital on it.  Is there anyone in the White House looking through this lens?  I hope so.    

Restoring fiscal soundness, which means cutting spending and raising taxes, should be priority number one, Mr. President.  The president, who has sought to recast his leftish record as a centrist, should embrace centrism — and its centerpiece, sound finances — wholeheartedly.  But he won’t.  No one believes that centrism wins elections.  I suspect if he did embrace centrism, he might be surprised that it could win elections.  As the first truly centrist American president, Barack Obama would be on his way to achieving another first, following his most recent first — health care reform.