The US Fed reserve did something unprecedented on Tuesday by publicly stating that it will keep interest rates at near zero until 2013. Fed chief Ben Bernanke even indicated that a third instalment of quantitative easing was possibly on its way. No central banker in recent history would have announced a full two year policy of keeping interest rates at near zero! It shows partly a sense of resignation that nothing would change over the next few years.
Bernanke has displayed extreme growth pessimism by making such a stunning pronouncement. By suggesting that interest rates will be near zero in the medium term, Bernanke has given further comfort to those?largely commodity hedge funds?who have been profiting largely from speculative activity these past few years. This has given rise to what many economists describe as ?financialisation of commodities?. This has not been good for India and other emerging economies who are net commodity importers and are suffering from consistently high inflation, which is wreaking untold havoc on their political economies.
No wonder, the Brent crude prices jumped back to its earlier level, immediately after Bernanke?s announcement that interest rates will remain near zero until 2013 along with the possibility of another stimulus package.
After the global stock market crashed last week, commodity prices too had come off their peaks quite a bit. Crude prices also showed a fairly big correction, prompting India?s finance minister Pranab Mukherjee to observe that the fall in commodity prices will help ease domestic inflation and even ?give me some relief in managing our subsidies and the overall fiscal situation.? Clearly, the finance minister was counting his chickens prematurely. Bernanke put paid to this sense of relief and optimism among the Indian policymakers. It must be stated that just oil and fertiliser subsidies account for nearly 2% of GDP, or about a third of the Centre?s total fiscal deficit. So, a 20%-plus fall in crude prices improves India?s fiscal situation substantially.
There was also a premature celebration among the industry players that Indian authorities might be forced to consider easing interest rates in view of the possibility that the world was going into another mini recession, triggered by the debt problems in the US and EU. However, Bernanke?s pronouncement and the crude prices coming back so quickly to earlier levels will make RBI wary of easing monetary policy any time soon.
No wonder Indian authorities have been quick to sound a note of caution that inflation in India may remain at elevated levels in spite of the world economy slowing this year (IMF has lowered growth forecast for advanced economies from 3% last year to 2.2% this year). The authorities are obviously hinting at the deleterious effects that a third round of quantitative easing (QE3) might have on the conduct of domestic monetary policy.
The first two rounds of quantitative easing by the US authorities since 2008 ended up pumping over $2 trillion into the system. A Financial Express analysis published on Wednesday shows that crude prices went up by 64% between November 2008 and March 2010 following QE1. Subsequently, the effect of QE2 translated in terms of crude prices going up further by 47% between August 2010 and June 2011. It is anybody?s guess what a QE3 would do to crude prices over the next two years that Bernanke promises to give the world a liquidity wash! India will have to brace for this unprecedented situation with its own innovative set of policies. For everything that is happening around us has not occurred before. So, central bankers in the emerging part of the world will have to think on their feet.
Global economics has become deeply political now. One part of the world (the US, EU and Japan) is in deflationary mode and is pumping more and more money to revive their economies. The other part (emerging markets) has fundamental growth impulses intact but are threatened by too much global money playing havoc with their political economies through sustained inflation. The only instrument now left with emerging economies like India to rein in inflation is to substantially moderate their GDP growth. Even that may not ensure adequate lowering of inflation if the US comes up with a third round of quantitative easing in the near future.
India and other emerging economies must strongly focus on the possible impact of QE3 on commodity importing nations at the G20 forum to be held next month in France. It is ironical the French are hosting the meet, considering there is near consensus that France is the next candidate for a rating downgrade, one notch below AAA, on the lines of the US. There is some consensus among G20 nations that curbs must be imposed on speculative trading in soft commodities such as wheat and other food items. A G20 analysis shows that speculative volumes in daily wheat trading had been 30 times the actual global wheat production. In crude oil, speculative volumes had been 16 to 18 times actual demand on the ground. In normal times, speculative volumes are 6 to 8 times the actual demand on the ground. But easy money has led to ballooning of speculative trades in recent years.
Commodities-dedicated hedge fund money on Wall Street was about $50 billion in 2003. This grew to about $250 billion at the peak of the 2007 bubble. After the 2008 crash and the big monetary stimuli that followed, this corpus further doubled to about $500 billion! What after QE3? God alone knows.
mk.venu@expressindia.com