0
20
40
60
80
100
120
0
5
10
15
20
25
30
35
40
Feb-64 Mar-73 Mar-83 Mar-93 Mar-03 Mar-13
US Monetary Indicators
M2 [YoY %Growth]
Base Money[YoY Growth%]
India Economic Outlook
The steep jump in YoY growth of Base Money between 2008 and March 2009 was due to the Federal Reserve’s QE1 where
it started buying Mortgage backed securities and ended up with $1.75 trillion of bank debt, mortgage-backed securities,
and Treasury notes in March 2009 from around $700 billion in 2008. It also resulted in a growth in M2.
Since late 2013, M2 has decelerated due to the Fed’s tapering where it has cut back on its monthly bond purchase
program. This is leading to a contraction of money supply in the economy. The Fed may have to ease off a bit on its
tapering to prevent a total slump of M2. Also the Fed is keeping a close watch on the target 2% inflation rate and 6.5%
unemployment rate in order to hike the interest rate.
Abenomics pillared upon fiscal stimulus, monetary easing and structural reforms which includes a 2% annual inflation
target by boosting monetary growth which has weakened the Yen to counter excessive Yen appreciation. This in turn will
lead to a reduction in fiscal deficit and push asset prices up also increasing real and nominal GDP. But an increase in
consumption tax to 8% in 2014 and an expected 10% in 2015 will have to be met by an increase in the degree of
quantitative easing. Only those expecting a pay rise would be able to spend contributing to the demand. But most will cut
back on spending due to the high consumption tax.
-3
-2
-1
0
1
2
3
4
-9
-8
-7
-6
-5
-4
-3
-2
-1
0
Dec
-01
Dec
-02
Dec
-03
Dec
-04
Dec
-05
Dec
-06
Dec
-07
Dec
-08
Dec
-09
Dec
-10
Dec
-11
Dec
-12
Dec
-13Japan PrimaryBalance (% ofGDP) [LHS]
Japan CPI YoY% [RHS]
Japan CPI coreYoY % [RHS]
QE3 tapering leading
to deceleration of
Base Money and M2
over 2014
QE, monetary growth
weakens Yen;
Higher the inflation,
lower the primary
deficit
With a near zero Fed funds rate, the unemployment rate has fallen below the threshold 6.5% which has
been because of moderate growth in employment. The Fed believes that it needs to run a 2% target inflation
to see a healthy economic revival. Before this the Fed was using the threshold 6.5% unemployment rate to
hold the Funds rate near zero but has switched to inflation as a metric to hold funds rate.
Tax hikes and spending cuts by the Obama led government has reduced the fiscal deficit considerably but
hasn’t eliminated it. Heavy military spending over the last couple of years towards operations in the
unsettled Middle-East region has added to the deficit woes.
On a year by year basis budget deficit isn’t a concern, but if debt as a % of GDP (debt/GDP ratio) reaches a
100% then creditors might fear a rising risk of default. The US has already raised the debt ceiling to $16.7
trillion and debt has risen steeply since the crisis.
0
5
10
15
20
Jan-78 Jan-83 Jan-88 Jan-93 Jan-98 Jan-03 Jan-08 Jan-13
US Federal FundsRate %
Core PCE DeflatorYoY %
Core CPI YoY %
-800
-600
-400
-200
0
200
400
600
Jul-
05
Jan
-06
Jul-
06
Jan
-07
Jul-
07
Jan
-08
Jul-
08
Jan
-09
Jul-
09
Jan
-10
Jul-
10
Jan
-11
Jul-
11
Jan
-12
Jul-
12
Jan
-13
Jul-
13
Jan
-14
Monthly Change in US Non-Farm
Monthly Changein US Non-Farm
Near zero Fed funds
rate, 2% target
inflation not reached
As the monopoly supplier of monetary base, the ECB , is targeting a 2% inflation rate concerns over
disinflation is rising over the Eurozone. There is a possibility that such low inflation rates might lead to a fall
in asset prices, prices of goods and services and wages. People start spending reluctantly and demand falls.
Repayment of loans becomes more costly because a low inflation rate means a high real interest rate
(borrowers lose out). This may become a deflationary cycle which starts feeding off itself. Here, the ECB
might be cornered into using negative interest rates as a tool to stir up inflation.
The YoY growth of the Harmonized Index of Consumer Prices (HICP) as measured by the ECB, harmonized for
the entire Eurozone stood at 0.8% in Jan 2014.
M3 growth has been well below ECB’s 4.5% YoY target. So we might as well see a cut in interest rates which
will follow on from an asset purchasing program (quantitative easing) of the ECB just like the US Federal
Reserve’s.
-40
-30
-20
-10
0
10
20
30
40
50
60
70
80
Jan-04 Jan-06 Jan-08 Jan-10 Jan-12
MoneySupply M3YoY%
Base MoneyEU YoY %
-1
0
1
2
3
4
Dec-01 Dec-05 Dec-09 Dec-13
Euro Interbank Rate(overnight)
EU Harmonized CPI YoY %
M3 still below ECB
target (4.5% YoY);
QE likely to start, may
cut down interest
rates
ECB target 2%
inflation incomplete;
Fear of deflationary
cycle looms
Clearly China’s M2 money supply has risen more than sharply from 2008 all the way into 2014 which is
almost 1.6 times the M2 of the US. Due to heavy social financing prevalent in China, hence more money
supply resulting from the money creation process. Countries with mature financial markets like the US have
lower M2/GDP ratio due to direct financing.
This excess liquidity (money supply) might have gone towards inflating an asset bubble in China. China’s M2
must grow less that nominal GDP in order to prevent the asset bubble from bursting and cut back property
price.
With Social financing expected to slow down in 2014, it is a positive sign to reduce the risk and pressure on
the banking system. Also M2 has grown at a much faster pace than GDP which indicates oversupply of
money.
0
2000000
4000000
6000000
8000000
10000000
12000000
14000000
16000000
18000000
20000000
Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12
EU
China
Japan
US
Money Supply M2 (US$ mn)
0.75
1.00
1.25
1.50
1.75
2.00
2.25
0
20000
40000
60000
80000
100000
120000
Dec
-96
Dec
-98
Dec
-00
Dec
-02
Dec
-04
Dec
-06
Dec
-08
Dec
-10
Dec
-12
Money SupplyM2
SMAVG (4) ofNominal GDP
M2/GDP Ratio
Steep rise in M2:
China;
Rising US M2, result
of QE 1,2,3
High M2/GDP ratio,
excess liquidity;
Concern over inflated
asset bubble bursting
US imports from Asia grew negatively YoY at -29% in 2009 during the helm of the Global financial crisis after
growing positively YoY for a span of 7 years from 2002.
Though Asia exports to the US have rebounded from 2010 onwards, we can notice a slight slump in Asian
exports after 2H FY2012. This can be rightly attributed to the gradual revival of the US manufacturing and its
on-shoring. But Asia’s exports are set to strengthen over the second half of 2014 though new orders haven’t
shown any steady growth as reported by the ISM.
-45%
-30%
-15%
0%
15%
30%
45%
Nov-95 Nov-99 Nov-03 Nov-07 Nov-11
US Imports from Asia-10 (YoY % 3mma)
US Imports fromAsia-10 (YoY %3mma)
0
10
20
30
40
50
60
70
80
Dec-94 Dec-98 Dec-02 Dec-06 Dec-10
US ISM new orders
US ISM new orders
Rebound in US
imports;
Sluggish growth in
Asian Exports due to
US onshoring
We must note that Asia has had consistent current-account surpluses since 1998 (after the Asian Financial
Crisis) and China since 1994.
Along with this Asia has received consistent net positive FDI though FPI and other investments have not
been consistently positive over the years. But the high Current Account surplus has been able to negate the
net FPI and other investments and has kept overall BoP positive.
On observation, China’s Current Account surpluses have been larger, averaging around 8-8.5% and overall
BoP surpluses rose to their all-time high in the period 2008-09.
These surpluses may have aggravated the excess liquidity situation that then went into pushing up asset
prices, especially in a situation where the Chinese Yuan was fixed and not allowed to appreciate against the
dollar.
China’s Forex reserves have risen somewhat steadily over the past 12 years from 1999 until 2011.But over
the period between 2011 and 2013 forex reserves have grown rather sheepishly in anticipation of broader
tightening of policy.
China’s Reserve import cover has risen consistently from around 9 months in Dec 2000 to almost 29 months
in Dec 2009. But fell sharply between Dec-09 and Dec-11 to 19 months.
0
500000
1000000
1500000
2000000
2500000
3000000
3500000
4000000
4500000
Forex Reserves China
Forex ReservesChina
0
5
10
15
20
25
30
35
Jan-99 Jan-02 Jan-05 Jan-08 Jan-11
China Reserve Import Cover (months)
China Reserve ImportCover
In India, a reversal of capital inflows resulting from QE tapering could destabilize the rupee and the country's
equity market. Net capital inflows into the Indian economy totalled $88 billion in 2012, accelerated by global
quantitative easing.
In Indonesia a reversal of the FPI due to tapering could lead to heavy pressure on the BoP in turn weakening
the Indonesian Rupiah.
Also any sudden move by the US Fed could leave a devastating impact on emerging markets assets like the
sell-off and capital flight that was witnessed in May 2013.
Property deflation is a medium-term threat to China. China has seen land-price appreciation since 2002 due
to the excess liquidity that went into pushing up asset prices. Japan has seen its fair share of land price
inflation between 1986 and 1990.
China’s demographic dividend ended in 2013, and its dependency ratio is now rising and working-age
population declining where the numbers of dependents are on the rise which might lead to depletion of
savings. Supply of cheap labour is also reducing pushing the govt. to raise wage rates to compensate for slow
labour growth.
-10
-5
0
5
10
15
20
25
Japan Land PriceInflation YoY %
China Land PriceInflation YoY %
30
40
50
60
70
80
90
100
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
(%)
ChinaJapan
Demographic
dividend
Demographic debt
Gross Fixed Capital Formation refers to the outlays on additions to fixed assets and net changes in
inventories. It includes land, infrastructure and machinery of all kind, investments made by public, private
corporate and household sectors.
Indonesia, China, India, Taiwan and Philippines are the only countries that have had a net positive change in
GFCF over the 7 years from 2004 to 2011. Among these Indonesia and India have had substantial addition to
Fixed capital formation as indicated by the chart. This seems to be a positive sign as domestic investment
from the all three sectors have helped the economy to expand. China’s increase in GFCF can be attributed to
the excess liquidity which has gone not only toward fixed asset creation but also contributed to the
escalation of asset prices.
China’s low cost of capital (and under-valued Renminbi) has resulted in an investment boom, and an
excessively capital-intensive pattern of economic growth. To avoid any imbalances China is expected to
allow the Renminbi to appreciate slightly.
17.83
37.82
-14.60
92.77
13.53
-3.59
-21.02
-4.53
16.67
-3.52
-7.37
-12.92
-9.66
-50 0 50 100
China
India
Singapore
Indonesia
Philippines
European Union
United States
South Korea
Taiwan
Hong Kong
Malaysia
Japan
Thailand
Gross Fixed Capital Formation: 2004 vs. 2011 (% change)
Gross Fixed CapitalFormation: 2004 vs. 2011 (%change)
(8)
(4)
0
4
8
12
Dec-97 Dec-00 Dec-03 Dec-06 Dec-09 Dec-12
Asia-10's current account surplus moderating (as % of GDP, 4Q rolling sum)
Asia-10 US ASEAN-4+Korea
The 10-year moving average of real GDP growth has risen close to 8% – but the 5-year moving average
slumped to 6.2% in Dec 2013, having peaked at 8.9% in FY2006/07, just before the Global Financial Crisis.
Though the pace of 10yr moving average GDP growth rate has slowed down since Dec 2011, the Modi
government’s investment led approach to growth may improve business sentiment which might provide an
incentive for revival in private investment. With inflation hovering around 6%, real GDP is expected to grow
from a low of 4.3% in Dec 2013 to 6.4% by Dec 2015.
The near term challenges for the Indian economy in the next 12 months include El Nino and the recovery of
exports while the US Fed’s QE tapering and consequent change in capital inflows along with global economic
environment are medium term challenges.
Clearly we can notice that a high level of investment since 2001 has been responsible for spurring GDP
growth since 2004. GFCF has also been a major contributor to the increase in real GDP coupled with heavy
government spending.
0
2
4
6
8
10
12
Jan
-80
Jan
-83
Jan
-86
Jan
-89
Jan
-92
Jan
-95
Jan
-98
Jan
-01
Jan
-04
Jan
-07
Jan
-10
Jan
-13
Jan
-16
Jan
-19
Real GDP YoY %
Real GDP (5yr SMAVG)
Real GDP (10yr SMAVG)
0
5
10
15
20
25
30
35
40
0
1
2
3
4
5
6
7
8
9
10
GDP: YoY %(5yr SMAVG)(LHS)
GDI: % of GDP(RHS)
India Real GDP growth:
five and ten year moving
averages
Investment/GDP ratio as
a measure of rate of GDP
growth
India’s GFCF has witnessed a growth from FY 04 due to heavy government as well as private spending. A
good portion of the govt. spending can be attributed towards infrastructure development (roadways, ports
etc.) and employment programs of the Govt. of India such as the MGNREGA among others. The fall in GFCF
from 2011 to 2014 has been due to the Govt cutting back on its spending program especially Capital
Expenditure and Subsidies.
0
5
10
15
20
25
30
35
4019
95-9
6
1996
-97
1997
-98
1998
-99
1999
-00
2000
-01
2001
-02
2002
-03
2003
-04
2004
-05
2005
-06
2006
-07
2007
-08
2008
-09
2009
-10
2010
-11
2011
-12
2012
-13
2013
-14
% o
f G
DP
Gross Capital Formation (% of GDP)
GrossCapitalFormation(% of GDP)
0
5
10
15
20
25
30
35
40
% o
f G
DP
Bank Credit Growth [India]
Bank CreditGrowth
Growth in Manufacturing has not been consistent and has stagnated between 2010 and 2014 causing a
slump in Real GDP. NREGA has successfully boosted rural consumption despite a slowdown in urban
consumption. This implies that any improvement in overall consumption will be driven by rural
consumption.
There are concerns over growth in Agriculture due to the impending fears over El-nino posing a widespread
threat to production. But the new DMIC which is under development and 3 newly commissioned NMIZ’s (1
in AP & 2 in Karnataka) should be instrumental in spurring GDP growth under Modi.
To add to the woes heavy oil and gold imports have also mounted pressure on India’s CAD. The rise in gold
import duty and lower oil imports over the last year and a half should allow the CAD to moderate by the end
of FY 14.
-10
-5
0
5
10
15
20
25
30
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Real GDPYoY %
Agriculture
Industry
0
5
10
15
20
25
30
35
40
45
50
-12000
-10000
-8000
-6000
-4000
-2000
0
1994
-95
1995
-96
1996
-97
1997
-98
1998
-99
1999
-00
2000
-01
2001
-02
2002
-03
2003
-04
2004
-05
2005
-06
2006
-07
2007
-08
2008
-09
2009
-10
2010
-11
2011
-12
2012
-13
Ru
pee
s B
illio
n
Trade balance[Export - Import]
MerchandiseExports YoY %
MerchandiseImports YoY %
-6
-5
-4
-3
-2
-1
0
1
2
3
1970
-71
1972
-73
1974
-75
1976
-77
1978
-79
1980
-81
1982
-83
1984
-85
1986
-87
1988
-89
1990
-91
1992
-93
1994
-95
1996
-97
1998
-99
2000
-01
2002
-03
2004
-05
2006
-07
2008
-09
2010
-11
2012
-13
India CAD as a % of GDP
CAD as a% ofGDP
-5
0
5
10
15
20
25
30
35India Inflation [WPI YoY %]
Inflation - AllCommodities
Inflation - FoodArticles
Inflation - Fuel& Power
Inflation -ManufacturedProducts
Current Account Balance
(CAD) = Trade Balance +
Net Invisibles
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