
Credit crunch, did someone use the expression credit crunch?
No-one Gets Left Behind
"I especially underline the importance of passing amendments to the budget to increase the wages of government employees and military personnel," Zubkov said in a speech before the State Duma lower house of parliament in Moscow today. "We should strictly fulfill all our promises to citizens,'' he told the Duma's opening session in remarks broadcast live on state television. Higher-than-anticipated inflation this year has made it necessary to budget extra funds for salaries, he said.
The Russian government's "massive additional spending'' this year is pushing up inflation, according to the OECD. The OECD raised its forecast for Russian inflation up to 11% for this year and 9.5% for next year, from an earlier 7.5% for 2007 and 6.5% for 2008 as a result of the country's relaxed monetary conditions and tightening labor market, according to their twice-yearly economic outlook published earlier this month.
"The government's attempt to damp inflation by imposing artificial restrictions
on retail prices, both at the federal and regional level, appears to be
ill-advised," the OECD said. "Such steps create new distortions without
addressing the underlying roots of inflation."
The OECD identified private consumption and fast rising real wages together with credits to households as the main engine of growth., noting that massive net capital inflows, which aren't sterilized, and an unemployment rate that has fallen below the historic low of 6.0%, have played as big a part as food prices in boosting inflation.
So today's statement by Viktor Zubkov only pours additional oil onto already troubled waters. Russian wages have increased considerably in recent years, and the average monthly dollar wage (see chart below) has increased from around 175$ a month in 2003 to approxiamtely 500 dollars a month at the end of September 2007, including a 31 percent increase in the first nine months of 2007 as the rouble continued appreciating against the US dollar. The current trends suggest that the average monthly dollar wage at the end of December 2007 may exceed USD 520.
According to Rosstat, average real wage and disposable income increased by 16.2 and 12.9 percent, respectively during the first nine months of the 2007 (see chart below). Increases in real wages continues to be well above growth in GDP - and evidently well above productivity growth - in most sectors of the economy. Almost all sectors of the economy are now reporting increases in nominal wages well above 20 percent during 2007.
And there is no immediate end to this in sight. Conceptually we could think of Russia being about to have a very large version ofthe "Baltic problem" (the canaries down the coal mine). All you need to do is make a mental switch and replace capital inflows from oil lying under the ground for the people working out of the country in the Baltic (or Bulgarian, or Romanian, or Polish, or Ukranian) case. Both mechanisms produce a large inflows of funds, which go to work in domestic sales and construction. Since we are short of people in each case, then this surge in demand naturally squeezes up wages and then rapidly makes exports non-competitive. As a consequence the country involved becomes more and more dependent on imports.
Call this the Baltic syndrome if you will, and plagiarising an old adage, we might say that once the Baltics sneeze it is the global economy which catches the cold.
Amazingly, we are brought to the conclusion that if inflation continuies at this pace, and the rouble does not fall to compensate, then Russia could eventually have a trade deficit, even with all the natural resources she has in play, and at the rate we are going this point may not be too far away. What we need to bear in mind is that while global oil prices may drop back slightly (depending on whether and to what extent there is a slowdown in global growth in 2008), they are unlikely to continue to rise at the same pace as they have been (imagine a US consumer facing oil at $200 a barrel) and so since Russian oil capacity is, at best, more-or-less constant (due to depletion issues), Russia cannot continue to rely so heavily on oil exports for continuing growth (and as living standards rise oil revenues will gradually and inevitably come to consitute a declining share of GDP). And this will become doubly the case if the rouble is allowed to rise (as it must be at some point) since the roublevalue of the oil revenue will become accordingly less.
Really, if you want to understand more about this very important problem, my lengthy analysis of Russia in Too Much Money Chasing Too Few People is a must read.
Wholesale price inflation has been preforming even better:
So to go to the start of our story, back in September 2006, I post a piece on the India Economy Blog entitled "Uncharted Water" where I argued precisely the following:
What is clear is that the Indian economy is currently gathering steam,
and this at a time when there is a general consensus that the political will for
reform isn’t what it used to be. Strange isn’t it?
My meaning here isn’t that reforms aren’t necessary, but that there are other
factors at work, and in particular demographic ones. The importance of these
demographic factors generally can be seen from the fact that it is now the newly
developing countries (China, India, Brazil, Chile, Thailand, Turkey) who are
pulling the global economy (and in the process pushing up energy and commodity
prices). The developed world - which makes up say 50% of global GDP is growing
much more slowly than the developing world - and some of this for ageing related
demographic reasons. Global GDP is forecast to grow at a 5% annual rate this
year, yet the US is growing at around 3.5%, Japan 2.5% and the eurozone around
2%. So you tell me, who is pulling who here?
And this is why I say we are moving into uncharted territory. Economists
used to have a little model which worked on the assumption of each economy
having a certain growth capacity in any given moment. But could any one tell me,
what *is* the growth capacity of China or India? I certainly have no idea, and I
haven’t seen anyone else make a convincing case on this topic. The magnitude of
the growth we are now seeing in the developing world is beyond all historical
precedent.
I am even brazen enough to believe that trend growth may well
have moved up beyond 8.5% going forward, and that indeed within 5 years we may
well see India overtaking China in terms of average quarterly growth rates (of
course this may well vary from one quarter to another, a phenomenon known as
volatility, and of course 5 years from now the Chinese economy may not still be
sustaining the very high growth rates we see today).
Since this time of course, the whole recoupling/decoupling issue has really taken off as a live debate. My latest thoughts on this can be found here, and Claus Vistesen's post - The Global Economy, Compass and Charts Needed - follows up on and continues the "uncharted waters" theme.
Now for the Economist. What I said in my response to them was as follows:
To The Economist
Well, at the risk of having to assume some kind of modern "j'accuse" mantle (for which of course there are ample precedents in the early origins of your own magazine) I am going to put up yet another comment. Maybe this is because I would like to participate in that "severe contest between intelligence, which presses forward, and an unworthy, timid ignorance obstructing our progress" which your contents page so boldly announces.
Maybe it is also because I want to pin down quite clearly for future reference just what the issues are, and just why it isn't "absurd" to suggest that the Economist currently systematically fails to factor-in the demographic components in economic growth (or the lack of it). Well, saving the best (or should that be the worst) to the last, I would like now to come to the case of your India correspondent. This gentleman (and I sincerely hope that despite his evident predilection for strong Vindaloo curry he is one of these) has been systematically re-adjusting upwards India's potential trend growth rate in recent months. In fact his estimate seems to have shot up from 6.5% in November 2006 to 7% in February 2007, to 8% in June 2007. Now that's an upward adjustment of around 25% in trend growth in roughly 8 months. Quite an achievement, especially since he offers absolutely no explanation whatever for these adjustments, but what he does not fail to tell us - oh, he never lets a moment rest without beating this drum - is that: "India's economy, like Delhi this week (or Vindaloo curry perhaps, EH), remains far too hot."
Now just in case what I am suggesting here is questioned I would like to quote chapter and verse, since the issue is an important one.
In November 2006 the Economist's India correspondent estimated capacited growth for India at around 6.5%.
23 November 2006 Too Hot To Handle
INDIA'S curries can be even hotter than the fieriest of Chinese hotpots; likewise the temperature of the two economies. Despite widespread claims that China's economy is overheating, actually India's shows more signs of boiling over.By February 2007 the estimate had risen to "not much above" 7%.
In the year to the second quarter, India's GDP grew by an impressive 8.9%, while China's more up-to-date figures show even more breathtaking growth of 10.4% in the year to the third quarter. But to judge whether an economy is too hot, one needs to compare this expansion in actual demand with potential supply, ie, the sustainable rate of growth. Despite India's growth spurt in recent years, its sustainable pace is still much lower than China's, which puts its economy more at risk of overheating and rising inflation.
India's trend growth rate has almost certainly increased but it is still
nowhere near as high as China's. Mr Prior-Wandesforde estimates that it is now
around 6.5%, up from 5% in the late 1980s. But India's recent acceleration
largely reflects a cyclical boom, thanks to loose monetary and fiscal policy.
The Reserve Bank of India has raised one of its key interest rates by one and a
half percentage points to 6% over the past two years, but inflation has risen by
more, so real interest rates have fallen and are historically low. This makes
the economy more vulnerable to a hard landing.
"But the problem is that this new speed limit is almost certainly lower than the government's one. Historic data would suggest a figure not much above 7% - well below China's 9-10%......If something is not done, then a hard landing will
become inevitable."
"This is not to deny that India's economic speed limit has increased, to perhaps 7-8%, thanks to stronger investment and economic reforms. But growth has
exceeded that limit. The economy still shows alarming symptoms of overheating"
Many Indian economic commentators say that further structural reforms, though desirable, are not essential to keep the economy growing at 8% or more because
of the "demographic dividend". A fast-growing working population and a falling
dependency rate (thanks to a lower birth rate) will ensure more workers, more
saving and hence more investment." "India's demographic structure is indeed
starting to look more like that in East Asia when its growth took off. But this
mechanistic view of growth assumes that demography is destiny and that economic
policies do not matter. In fact, open markets, education and investment,
especially in infrastructure, were the three chief ingredients of East Asia's
success. Population growth by itself does not add to prosperity, unless young
people are educated and new jobs are created. India needs to reform its absurdly
restrictive labour laws which hold back the expansion of manufacturing
particularly."
The rupee's rise may be less dramatic than that of the Philippine peso, Brazilian real or Turkish lira. But it is uncomfortable nonetheless.
This vigour is due to a strong inflow of foreign capital, some of it enticed by India's promise, the rest disillusioned by the rich world's financial troubles. The net inflow amounted to almost $45 billion in the year to March, compared with $23.4 billion a year earlier.
Over the seven weeks ending November 2, 2007, India’s foreign exchange reserves have increased by US$34 billion (annualized inflow of US$250 billion). Indeed, the trailing 12-month sum of FX reserves has increased to US$100 billion. This compares with the average annual increase of US$38 billion over three years prior to these seven weeks. With the current account still in deficit, the increase in reserves is being driven largely by a spike in capital inflows and to a very small extent because of conversion of non-dollar reserves into dollars. During the last seven weeks in which FX reserves have shot up, we believe that capital inflows would have been US$35 billion. Out of this, not more than 10% has been on account of FDI inflows. Non-FDI inflows including portfolio equity and external debt inflows form a major part of these inflows.
While the inflows are pouring in at the annualized run rate of US$250 billion, in our view, currently the country can absorb only about US$40-50 billion of capital inflows annually without causing any concern on attended risks of overheating. The key question policy makers are grappling with is how to manage these large capital inflows. As the strong growth in domestic demand has resulted in overheating of the economy recently, the central bank does not want to leave such large capital inflows fueling the domestic liquidity. Not surprisingly, the central bank has accelerated the pace of the sterilization by way of issuance of market stabilization scheme (MSS) bonds and an increase in the cash reserve ratio (CRR). Over the last 12 months, the RBI has sterilized about 58% of the foreign inflows. The sterilized liquidity (excess liquidity) stock including reverse repo less repo balances, MSS bonds, government balances with the RBI and the increase in the cash reserve ratio has shot up to US$77 billion as of end-October 2007 from US$19 as of end-October 2006.
Statistics Lithuania reports that, according to the labour force survey data, the number of the unemployed in the country in iii quarter 2007 was 63.5 thousand, i.e. The lowest over the recent 5 years. As compared to iii quarter 2006, the number of the unemployed decreased by 27.3 thousand persons, or by one-third. Over the year, the number of young unemployed persons (aged 15-24) decreased from 15.2 to 13.4 thousand.