Rate Cuts, Trusts, Banks and the Summer of 2001

Saumitra Chaudhuri &= nbsp; &nbs= p; &= nbsp;

Economic Advisor

ICRA Limited = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; = &nb= sp; December 31, 2008

26 K G Marg, New Delhi 110 001

No Fear of Heights In 2009

No longer is there a need to look down. After the vertigo of the massive roller coaster ride last year, things have stopped looking down, even if they are yet to begin to look up. The year 2008, saw = prices all over the place, as too asset markets, currencies and the great names in= the world of finance. The eagle ate crow in a manner never envisaged. Governmen= ts and monetary authorities tried to cope with the chaos as best as they could, while the US Treasury Secretary appeared bent on compiling a record of self= -goals to be the grand finale to Mr. Bush’s eight years in the White House.<= o:p>

Going into 2009, one hopes that this year will lac= k in such seismic character. That of price we can say once again, that they chan= ge, for the most part gradually, with occasional bouts of volatility. That pric= e mostly reflects the net of global excess demand over current supply. That it is negative when prices tend to fall, and in other times positive, when prices tend to rise. That expectation affects the dynamics of price formation modestly, but they do not overwhelm it. That, what went on last year and in= the closing months of 2007, was an anomaly. When crude oil went from $70 per ba= rrel in June 2007, to $90 in Jan 2008, to $147 in July, to $37 in Dec 2008 ̵= 1; it was not about changes in underlying demand, not even about changes in th= e highly cartelised supply.

Such an unnatural phenomenon, was well unnatural, = the unholy offspring of too much liquidity at too low a price, an excess of recklessness and cynicism in financial investors and some major oil produci= ng governments, with regulators playing the deer frozen in the headlights. It was not oil a= lone that saw such obscene upheavals in price. The price of steel went from $600= per tonne to $1,200 and is now down to little over $400. Wheat prices rose from= below $200 per tonne in 2006 to nearly $600 in early 2008, only to fall back towa= rds $200. The price of rice went to $1,000 per tonne in early summer 2008 before collapsing, as did the price of soybean and other edible oil. Many food importing developing countries faced acute distress and even food riots. In= flation raged every where. Central banks worked at cross-purposes, most squeezing monetarily to curb prices, while the US pulled interest rates ever= lower – as they kept saying since Jan 2008 – to avert the recession. =

In dealing with the devastation that the mortgage crisis wreaked on financial institutions, the heavy hands of US authorities were all thumbs, fumbling at every stage in dealing with the fallout of the mortgage crisis, capping it with a curious intervention in the mortgage gia= nts Sallie Mae and Freddie Mac that wiped out a part of the capital of smaller US bank= s. But the piece de resistance was= the decision to let Lehman Brothers go bankrupt, a bailout of AIG that had to b= e entirely reworked twice in as many months, and a 3-page draft bill to buy “toxic” assets from banks presented to the US Congress that was voted out the first time and which after its tortuous passage was used to do something else, namely to provide capital to banks.

The markets in November thought that a coup de grace was imminent, viz. a decision to let Citigroup go bankrupt. Rumour has it that this was averted = by the intervention of the President-Elect as was the executive decision late = next month to provide a lifeline to General Motors and Chrysler. At the rate the former Wall Street hot shot Mr. Paulson was going, there was a real danger = that nothing would be left of the US economy for the Obama administration to work with. If the Russians can do scorched earth, so can I, may have thought the gentleman, who was to receiv= e a stinging and public rebuke in Beijing in November when he went there solici= ting capital for US banks.

Reeling from the bursting fragments of the sub-pri= me bubble, then the commodity bubble, the collapse of Lehman and the consequent freezing up of the world’s credit markets, nearly shattered by the uncertainty about Citigroup, we finally have a recession spanning all of the developed economies – US, Europe and Japan: The one that the US Fed w= as trying to avert starting Jan. 2008 when it slashed interest rates. Only to = let loose the genie of the commodity bubble. Of such unintended, but not unforeseeable, consequences are real tragedies made.

As 2008 drew to an ignominious end in the world’s economic and financial arrangements, there has begun a competitive effort to paint the outlook for 2009 bleak – a hopeless wasteland, the aftermath of the devastation of 2008. Multilateral agencies = and governmental bodies are yet in the process of lowering the outlook for 2009. It is a safe bet for them. If the US and other advanced economies start recovering slowly in the middle of 2009,= which is likely, then why it will be thanks entirely to the fiscal and monetary stimulus, i.e. the brave efforts of heroic governments. Maybe it will help salvage some of the public confidence in the capabilities of government whi= ch has taken such a hard knock last year. Banks and other private economic age= nts have also joined in to forecast the recession running into virtually 2010. = For one thing, the economic analysts who mostly missed anticipating this mess, = have had their convictions shaken and are now playing safe. This does not help to instil general confidence, but such public goods are not their burden.

Eventually people will do what they have to do. Th= ey will at some point begin to raise their consumption and begin to invest. One certain longer term victim of the events as it has unfolded, are some of th= e large banks of yesteryear. They will take a long time to recover from this crisis, which will make the economic recovery harder to achieve and may keep that recovery, when it comes, from being a robust one.

The developing economies – India, China, Bra= zil, Southeast Asia and all of the rest – do not have the peculiar problems that afflict the US and in a different way, Europe. In India, = we have solvent banks who are not sitting on stupid loans and stupider packaged products, manufacturing and service companies have viable economic models, households have more assets than debts and save 20 per cent and more of GDP every year. True, we will suffer from the relapse in global demand for our exportable products, true our companies will find it hard to raise money to= finance their projects. It is also true that the hysteric fear in Western markets h= ave not left our markets and entrepreneurs unaffected and an excess of caution = may well have replaced the excess of euphoria in evidence in 2006 and 2007.

In the depressed global conditions, our growth in 2009/10 will be slower than it might have been otherwise. But we can do a reasonably good job and come out strong when the world begins to recover in= the second half of 2009 and certainly in 2010. It is not the fear of heights th= at will be a problem in 2009. But a lack in confidence will hurt. We must appr= oach 2009 with a combination of common sense, rooted in ground realities, and no= t be swayed by the appurtenances of the purging of collective guilt in a narrati= ve of endless economic suffering coming out of the West today, which would in = that narrative structure, serve to round off the morality tale.

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