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Why the global economic slump refuses to end

By Rahul Jacob
February 19, 2016 12:00 IST

A stock traderThe contagion of panic about banks spread last week to Europe and even the US, where banks have deleveraged substantially since the great financial crisis in 2008, rues Rahul Jacob

There may never be a letter to shareholders quite like it.

When Martin Taylor, the highly successful hedge fund manager at Nevsky Capital, announced he was shutting down the hedge fund at the beginning of this year, he showed both an uncanny ability to foretell the future and to make us afraid of it.

Mr Taylor, who has by a wide margin consistently outperformed the Morgan Stanley emerging markets index over the 15 years he ran the Nevsky Fund, said he was closing it in part because trying to decipher what was happening in China and India was increasingly difficult and also because companies were also releasing as little data as they could get away with to avoid excessive scrutiny by investors and regulators.

“Currently, stated Chinese real GDP growth is 7.1 per cent and India’s is 7.4 per cent.

"Both are substantially over stated,” Mr Taylor wrote in a letter released in early January.

“This obfuscation and distortion of data, whether deliberate or inadvertent, makes it increasingly difficult to forecast macro and hence micro as well, for an ever-growing share of our investment universe.”

Right on cue, Beijing made Mr Taylor’s decision to call it quits seem eminently sensible by beginning the year with incomprehensible missteps in its management of China’s currency and stock market, sending both tumbling and the world markets with them.

We had barely caught our breath and it was time for Bank of Japan Governor Haruhiko Kuroda to cut interest rates to negative 0.1 per cent.

This desperate attempt to fight deflation in Japan, and to force its companies to give employees larger raises in wage negotiations in the spring, skidded off-track when the yen rose in response instead of falling -- putting both the Abenomics goals of sparking inflation and boosting corporate growth in peril.

This week, Japan announced that its fourth-quarter gross domestic product had shrunk by 1.4 per cent.

The move to negative rates territory by such a bellwether as the Bank of Japan and expectations of further cuts in the euro zone have sent bank share prices across the world into a frightening downward spiral.

Negative or very low interest rates and the unprecedented flattening of the yield curve have made the business of running a bank very difficult.

In Japan, yields on 10-year bonds turned negative last week for the first time, falling to as low as negative 0.0007 per cent, though they are now positive -- barely.

Publications like Euromoney might consider instituting a most baffling central bank governor of the year award in 2016 instead of celebrating the best one.

The bizarre lurches in decision-making by Mr Kuroda and China’s Zhou Xiaochuan have made this a miserable year for investors.

US Fed Chair Janet Yellen’s  thinking in raising rates in December and contradictory comments last week were equally puzzling.

At least Mr Zhou has the excuse of not really being in charge; until an interview to a Chinese business magazine published Saturday, he had been seen just once in public since the poorly handled widening of the trading band of the Chinese currency in August.

Imagine for a moment being in the war-room of the Bank of Japan ahead of that fateful decision to move to negative rates on January 29. What were they thinking?

Did anyone raise the concern that Japanese banks would have a difficult time passing on negative interest rates to their consumers?

That ratings agencies and bank analysts would quickly compute that bank operating profits would slump eight to 15 per cent, as Standard & Poor’s has estimated, as a result of negative interest rates?

Japanese bank shares have duly plunged 30 per cent in the past few weeks.

The contagion of panic about banks spread last week to Europe and even the US, where banks have deleveraged substantially since the great financial crisis in 2008.

After US banks’ share prices had tumbled 20 per cent this year, Jamie Dimon, the charismatic chief executive of JP Morgan, stepped in to buy $25 million of his bank’s shares to demonstrate his bank was on a firm foundation.  

Back on terra decidedly infirma, which is to say China and India, the bewildering lack of economic logic is everywhere.

On Tuesday, China’s lending data for January showed that lending had increased to 2.5 trillion renminbi ($385 billlion) -- an increase by more than 1 trillion over the same period last year.

Some of this is because Chinese corporates and banks are rapidly retiring foreign currency debt after being singed by the depreciation of the currency; foreign loans declined by 859 billion renminbi in the last seven months, according to the Financial Times’ James Kynge.

But almost half of the new loans appear to be going towards infrastructure, which suggests that Beijing is unwisely opting for fast growth instead of reducing debt, which is more than 250 per cent of GDP.

By contrast to the economic behemoths Japan and China, India is a sideshow, but what a show.

Who could have predicted that members of Prime Minister Narendra Modi’s party and its supporters would conspire to push the successful if irrationally exuberant Make in India summit off the front pages by first accusing university students of sedition and then physically attacking them, even in court?

Or that a tax inspector in the revenue department would go after Vodafone again, even while the issue is in arbitration?

Again, Mr Taylor deserves the last word.

“Obviously we accept politics can trump economics and political analysis has always been a very big part of our process, but surely never has so much of the world been governed by leaders where the logic of that peculiarly parochial yet multi-headed beast -- nationalism -- trumps all,” he wrote, pointing at China, India, Russia and Turkey.

“Almost by definition, the path of logic within nationalism is difficult for ‘outsiders’ to follow with any confidence, leading to highly unpredictable and potentially dysfunctional modelling outcomes.”

Rahul Jacob
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