Inflation round-up

The Reserve Bank of India is officially an inflation targeter. The agreement between the Ministry of Finance and the RBI was signed on February 20, and published a few days ago. The target is to "bring inflation below 6 per cent" by January 2016. For financial year 2016-17 and subsequent years the target will be 4±2%, so the acceptable inflation band will be 2%-6%. That would represent a significant reduction from the typical inflation rates in India since 2008.

RBI governor Raghuram Rajan has de facto followed an inflation target since the start of 2014, but the monetary policy framework was not official. Prior to inflation targeting, the RBI's policy target can be described as flexible, as it included, besides inflation, the rupee exchange rate and banking sector stability.

Amol Agrawal, at Mostly Economics, doesn't like the agreement.

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Eurozone inflation expectations are sinking, say researchers at the New York Fed. Survey-based inflation expectations have been falling at the one, two, and five-year horizons. They're particularly worried that the whole distribution of inflation expectations is shifting down, not just the median, or the lower percentiles.

A report by Generali, however, shows that inflation expectations measured by inflation swaps have picked up during 2015.

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Inflation, relatively: The following map shows inflation relative to each country's own history (the 10-year z-score), as of 2014-Q4. Despite abundant talk of Russian inflation, prices are increasing slightly more than they have, on average, over the past ten years, adjusted for standard deviation (z score of 0.13).

The highest inflation rates, relative to their own medium-term experiences, are for Argentina, Bolivia, Venezuela, Japan, and Gabon. The lowest inflation rates, relative to their own experiences, are in Greece, United Kingdom, Hungary, and Poland, in that order.

The eurozone is pretty green (meaning low inflation), but if you squint you'll notice that Sweden and Switzerland are experiencing relatively less deflation than their European neighbors. Even the U.S. is deviating more from its own history than Switzerland.

One-year inflation rate, 2014-Q4, 10-year z-score, relative to own country's history. Source: FactSet data, gunnmap.herokuapp.com, author's elaboration.

What caught my eye

1. Labor under-utilization: We keep thinking, long and hard, about how much slack there is in the job market. Gavyn Davies brings our attention to a timely conference put on by the Peterson Institute. The "consensus" --at least as gauged by Davies-- is that the unemployment rate in the U.S. under-represents the true amount of slack, due to the effect of the participation gap and involuntary part-time employment. Moreover, because of long-term unemployment and the potential rise of productivity growth, a decline of labor slack need not be as inflationary as it normally would. Everybody, however, acknowledges the "great uncertainty" around these assessments.

The Peterson Institute has posted the videos and ppt files of all the conference presentations here.

2. "Grapho-tainment": Twenty-two maps and charts that will surprise you, by Vox.com. I love these: #1, #3, #7, #10, #15, #17, and #19.

3. Speech by Vítor Constâncio, vice-president of the ECB, on "understanding the yield curve." I liked this [emphasis mine]:

Moreover, high sovereign spreads in the euro area have raised the question of what is the appropriate yield curve to monitor. In an article in the July Monthly Bulletin we discussed this issue in the context of measuring the euro area risk-free rate. Should we use Bund yields, euro area average AAA rates or OIS rates, or does it depend on the matter at hand?

Incidentally, an intriguing question in a currency union is the following: if it is difficult to identify a risk-free rate in a currency union, this means that there is no risk-free asset either, besides the central bank's own liabilities, the currency. 

4. David Keohane at FTAlphaville shares a report by HSBC, on the uneven conditions for growth across states in India.

5. From this week's batch of NBER working papers [emphasis mine]:

We employ a model of precautionary saving to study why household saving rates are so high in China and so low in the US. The use of recursive preferences gives a convenient decomposition of saving into precautionary and non precautionary components. This decomposition indicates that over 80 percent of China’s saving rate and nearly all of the US saving arises from the precautionary motive. The difference in the income growth rate between China and the US is vastly more important for explaining saving rate differences than differences in income risk. We estimate the preference parameters and find that Chinese and US households are more similar in their attitude toward risk than in their intertemporal substitutability of consumption.

I find the statement in bold very, very hard to believe, given this.

The paper is by Horag Choi, Steven Lugauer, and Nelson Mark, and here's an ungated version.

Links 20130729: Argentina property market; India's macro situation; China's gov't debt

• Housing bust in Argentina, via Bloomberg News. Plus evidence of real estate bubbles in Chile and Colombia.

“The main issue in Argentina is that the real estate market has historically been transacted in dollars so when you make it impossible for people to source dollars liquidity gets disrupted,” said Bret Rosen, managing director of research at Jamestown Properties LLC in New York.Fernandez’s foreign-currency curbs effectively put home purchases out of reach for many Argentines because they would be forced to buy dollars on the black market for 60 percent above the official rate. Sales in Buenos Aires plunged 34 percent in the first five months, the biggest decline since the 2001 financial crisis that culminated in the government’s $95 billion bond default, according to the Buenos Aires Notary College.

• A little overview of India's short-term macroeconomic situation, via Bloomberg News.

• China's National Audit Office to audit government debt, via BBC News. I wonder what the NAO will publicly say, once the audit is finished. Not the whole truth, of course.

20130606 Links

1. Top ten contributors to global growth; 2. Reorienting China; 3. Will India get downgraded to junk status?

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1. Emerging and developing economies already make up about 50% of the world's GDP at purchasing power parity. Their large size, and continued higher rates of growth than in advanced economies, have catapulted EMs to the top of the chart of main contributors to world growth. For the period 2012-17, the top contributors to world GDP growth are projected to be (in brackets, rank in 2002-07):

1. China (1)

2. U.S. (2)

3. India (3)

4. Russia (4)

5. Brazil (6)

6. Indonesia (11)

7. South Korea (9)

8. Mexico (10)

9. Japan (5)

10. Turkey (8)

Canada and U.K., which were in the top ten in 2002-07, get dropped.

Source: Financial Times, accessed on June 5, 2013.

2. IMF paper by Lee, Syed, and Xueyan on consumption and investment in China. Abstract:

This paper proposes a possible framework for identifying excessive investment. Based on this method, it finds evidence that some types of investment are becoming excessive in China, particularly in inland provinces. In these regions, private consumption has on average become more dependent on investment (rather than vice versa) and the impact is relatively short-lived, necessitating ever higher levels of investment to maintain economic activity. By contrast, private consumption has become more self-sustaining in coastal provinces, in large part because investment here tends to benefit household incomes more than corporates. If existing trends continue, valuable resources could be wasted at a time when China’s ability to finance investment is facing increasing constraints due to dwindling land, labor, and government resources and becoming more reliant on liquidity expansion, with attendant risks of financial instability and asset bubbles. Thus, investment should not be indiscriminately directed toward urbanization or industrialization of Western regions but shifted toward sectors with greater and more lasting spillovers to household income and consumption. In this context, investment in agriculture and services is found to be superior to that in manufacturing and real estate. Financial reform would facilitate such a reorientation, helping China to enhance capital efficiency and keep growth buoyant even as aggregate investment is lowered to sustainable levels.

I am not surprised that the authors find evidence of excessive investment, but the insight that private consumption is heavily dependent on investment in the western provinces is new to me. And this has an important implication: if eventually investment growth slows down, as almost certainly it will, total domestic demand will slow down, regardless of how much rebalancing occurs away from investment and towards consumption.

3. S&P revised India's outlook to 'negative' on April 25, 2012. Fitch did the same in June of the same year. Moody's keeps the outlook as 'stable.' All three major agencies give India the lowest of the investment-grade ratings: BBB- (Baa3 in the case of Moody's).

As key drivers of the revision and possible future downgrade, the analysts at S&P wrote in June 2012: "The outlook revision reflected at least a one-in-three chance of a downgrade in the next two years if India's external position continues to deteriorate, its GDP growth prospects diminish, or if progress on fiscal reforms remains slow." I was not able to read Fitch's report, but in an April 2013 interview of CNBC with Art Woo, the agency's director of sovereign ratings, he said it was more likely than not that India would be downgraded, citing slower growth and the deterioration of public finances.

The odds are against India, I'm afraid. Since 2012:Q1, GDP growth has slowed further, the current account deficit has become wider, and the government deficit has shrunk only marginally. The IMF projects GDP growth (p. 153) to rise from 2012 to 2013, but so far we have not seen this improvement. The IMF also projects the government primary deficit to shrink marginally in 2013, but the total deficit to remain unchanged, as a % of GDP. The current account balance, at -4.1% over the 12 months to 2012:Q1, has declined to -5.1% as of 2012:Q4. And, although there are some big changes underway, but I get a sense that the latest wave of reform will amount to a marginal change, rather than a Big Bang, as it has been dubbed.

In my opinion, the most likely scenario is: at least one agency downgrades India by the end of 2013. Second most likely scenario: the downgrade happens in 2014.