Nervous about the yuan

Sidney Leng in South China Morning Post had a column on Saturday that the chances of the Chinese currency having a go at the U.S. dollar has receded considerably. The title of the article says it all. It is falling apart.

Last month, the euro surpassed the yuan to be the second most active currency in trade finance, according to a monthly report from Swift, a global financial network used by banks to transfer capital, which has tracked the yuan’s progress towards becoming a global currency since 2011.

According to the report, three years ago, when expectations for the yuan to appreciate were high, it rose to be the second most active currency for trade finance with a share of about 8 per cent. Since the yuan started depreciating in 2014, its usage has been decreasing to its current share of 4.6 per cent.

The yuan also slipped by one position in October to become the sixth most actively used currency for international payments, after the Canadian dollar.

The offshore yuan market in Hong Kong is currently shrinking, and the dim sum bond market – bonds issued outside China but denominated in renminbi – is withering.

Two months ago, Eswar Prasad wrote a piece for the Wall Street Journal and he elaborated on it for Brookings Institution. Like a typical academic, he was careful to hedge his bets. But, he must be pleased that he concluded his piece on the following lines:

The only way to convince investors is to match words and commitments with actions on the ground, and to make further progress on reforms. If China plays its cards right by adopting reforms that put its economy and financial markets on the right track, the RMB could one day conceivably become a significant reserve currency, rivaling even such reserve currencies as the pound sterling and the Japanese yen.

Even with such reforms, however, the RMB will soon reach its limits. While the Chinese leadership is pursuing financial liberalization and limited market-oriented economic reforms, it has unequivocally repudiated political, legal, and institutional reforms. Chinese President Xi Jinping’s government has, if anything, rolled back freedom of expression, the rule of law, and the independence of key institutions from government interference.

Financial Times reported today that the Chinese government is considering a proposal to restrict outbound investment. That is a departure from encouraging outbound investment in place until recently as China had too much Foreign Exchange Reserves. Now, evidently, it does not think it has enough.

The State Council, China’s cabinet, will ban outbound investment deals worth more than $10bn or mergers and acquisitions above $1bn if they are outside the Chinese investor’s core business, according to two sources who have seen a draft document outlining the new rules. State-owned enterprises will also not be allowed to invest more than $1bn in foreign real estate, according to the sources, writes Gabriel Wildau in Shanghai. [Link]

This FT article says that mindless acquisitions have led to the crackdown. Could be. But, it is also due to concern over capital flight. Lucy Hornby in FT tracks the methods by which capital leaks out of and leaves China.FT View thinks that fixes such as this won’t work for long. I am not sure about it though.

According to the State Administration for Foreign Exchange (SAFE), Foreign Exchange Reserves were around USD3,120.66bn as of end-October. It was USD3,330.362bn in end-December 2015. That is a drop of USD209.71bn this year. That explains many things.

The path of least resistance for the yuan seems to be lower (weaker) for longer. This is not an investment recommendation. Caveat emptor.

Postscript: FT has a detailed research report (unlikely to be open access) on the rising household debt. It is not alarm bells yet. But, the country is getting there. According to BIS data on non-financial debt, Household (and the not-for-profits sector) debt/GDP ratio was 19% in end-2007. By end-2015, it had more than doubled to 39.5%. All else being equal, that would lower, over time, the current account surplus (may be, even a deficit at some point?) and elevate weakness risks for the yuan.

Demonetisation update 13 – some questions

One of the things that used to be said of Indian sportsmen and women and  teams is that they did not finish off what they started. In simple terms, it was about failing to convert an excellent opening and passses into goals, in football parlance. It could be said of limited over matches or badminton or tennis matches, etc. In other words, we were supposed to be good at plucking defeat from the jaws of victory. May be, it does not apply to Indian sportsmen and women anymore.

But, perhaps, it applies to policymaking. I am not saying that it does. I do not know honestly. But, I just thought that it was worth asking the question.

As this blog tagline says, there are only questions and no answers. I have many questions but no answers.

If 60% of all cash in circulation in the old 500, 1000 rupee notes had come back into the banking system and if it continues to the point that the entire stock of old ‘cancelled’ currency notes are deposited into banks, it means that all the black money had been successfully laundered. Of course, that is a big IF, if all the money would be ‘banked’.

(1) Does it mean that the government’s surprise announcement failed?

(2) If a surprise announcement still could not ‘punish’ illegal wealth, what more steps are needed?

(3) Or, was it worth all the trouble at all, if the money were laundered fully?

(4) But, is it the case that an implicit redistribution had directly happened from the rich to the poor except that it bypassed the government as many would have laundered their old currencies at a discount? In other words, it does not matter that the money had been laundered because they had already paid their dues via the discount at which they laundered it. Will that be the government line?

(5) Or, will the rich manage to collect it back from their servants, housekeepers, laundrymen and women, et al., whom they used to launder this?

(6) If they successfully laundered at a 20% to 40% rebate, why would the government’s new voluntary disclosure scheme succeed? That seems more expensive than what they can get away with. Plus, there are other concerns of being permanently on the radar of tax authorities.

(7) If the banking system were flush with deposits, they would be paying interest on them, even if the rate of interest is tiny. But, with CRR being imposed on the incremental deposit at 100%, their Net Interest Margin on the incremental deposit is negative. Of course, it is supposed to be temporary.

But, if is temporary, would it have been so bad had the call money rate fallen below the reverse repo rate for a temporary period?

(8) After all, banks collectively are not lending much. Non-food credit growth is growing at slightly above double digit rate. But, industrial loans are barely growing or even contracting. Only personal loans have been rising. So, if they were flush with deposits and the call money rate and the banks made some loans at potentially lower cost, would that have been a big problem?

(9) Or, am I violating my own self-discipline and asking too many questions too soon?

(10) Or, is it just that I am clueless or that the government is, or both?


In a recent missive (28 November 2016) to clients, Credit Suisse notes four negatives from the demonetisation exercise. Interesting. Would like to hear more on these.

● Continuing policy uncertainty: The market may continue to be apprehensive about further steps from the government to clamp down on black wealth.
● Lasting black economy currency shortages: The currency in the white economy may normalise in a few weeks. However, for illegal/tax evading transactions currency availability would remain an issue for much longer, likely more than a year. This may slow down the informal lending market as well as real estate demand which in-turn would affect the formal economy as well.
● Moral hazard risk: This exercise is a ‘force majeure’ that individuals/firms can use to renege on liabilities.
● Lasting damage to households/enterprises: Some of these may not be able to survive the stress from the 1.5-2 months of severe currency shortages.

Want to emulate this?

In our little book on India (‘Can India grow?’), Gulzar and I suggest that India should stop obsessing about China. In particular, this paragraph is worth highlighting:

There are compelling reasons to argue that China’s path to growth may not be the
appropriate model for India. First, unlike China, India does not have the requisite
human, physical, and financial capital or state capability needed to sustain such high
growth rates over long durations. Second, the proximate domestic driver of Chinese
growth was its extraordinarily high public investments, in the range of 45–50 percent
of GDP, which India cannot come close to matching. Third, the external counterpart,
export-led growth, was facilitated by favorable global geopolitical and economic structures, which may have turned against continuing Asian growth. Finally, as recent events have shown, such breakneck growth is inevitably distortionary and engenders profoundly destabilizing risks with the potential for long-term damage.

The information below was always available there in the public domain but it just struck me with some force on Sunday. It reinforces the last sentence above:

In the last decade or more, China’s growth has been achieved at the cost of massive debt accumulation. Its nominal GDP in 2005 was USD2.257trn. The figure in 2015 was USD10.866trn. India’s nominal GDP in 2015 was more or less in line with China’s nominal dollar GDP in 2005. As per data from the Bank for International Settlements, China’s non-financial sector debt/GDP ratio was 151.9% in 2005. It has ballooned (or, exploded?) to 254.8% by the end of 2015 – from USD3.5trn in 2005 to USD26.5trn in 2015. GDP up 4.8 times and debt up 7.6 times in a decade. Hence, the quality of growth is low and unsustainable. India does not have to flap its wings. It can and should do better.

Volatility and financial crises

I just finished teaching a course titled, ‘Advanced Quantitative and Economic Analysis’ for students of the Master of Science Programme in Applied Finance at the Singapore Management University, on Friday. I had talked to them in the last two sessions about how long periods of stability breed instability through the risk-taking channel. This is the hypothesis of Hyman Minsky.

I was pleasantly surprised to find a paper published by the Federal Reserve Board in October 2016 on this topic. The paper is:

Danielsson, Jon, Marcela Valenzuela, and Ilknur Zer (2016). “Learning from
History: Volatility and Financial Crises,” Finance and Economics Discussion Series
2016-093. Washington: Board of Governors of the Federal Reserve System,

While the common view is that volatility directly affects the probability of a crisis, this has proven difficult to verify empirically. In what we believe is the first study to do so, we find direct empirical evidence that the level of volatility is not a good indicator of a crisis, but that relatively high or low volatility is. Low volatility increases the probability a banking crisis, both high and low volatility matter for stock market crises, whereas volatility{in any form{does not seem to explain currency crises.

We further use the credit-to-GDP gap as a proxy for risk-taking, and find that low
volatility significantly increases risk-taking. This is very much in line with what theory predicts and provides strong evidence for Minsky’s instability hypothesis and his famous statement that \stability is destabilizing”. Low volatility induces risk-taking, which leads to riskier investments. When those turn sour, a crisis follows.

Finally, we find that the relationship between volatility gap and the incidence of a crisis becomes stronger over time, consistent with the observation that stock markets have grown in importance over the 211 year sample.

What they say on page 6 about stock markets, low volatility and crises is very interesting:

Third, since our 211-year sample contains a variety of economic systems, market structures, and technological developments, it is of interest to examine the volatility-crisis relationship over key sub-periods of the sample. The relationship between financial market volatility and the incidence of a crisis becomes stronger over time – not surprising considering that prior to World War I, stock markets, and hence market volatility, played a much smaller role in the economy than they would later. The relationship weakened again during the Bretton Woods era when financial markets and capital flows were heavily regulated, and became especially strong since.

The emphasis above is mine. The policy implications are obvious. We need to regulate capital flows. Keynes was dead right in that respect. That is why it was both surprising and disappointing that Vijay Kelkar and Ajay Shah, in their advice to the government on managing the aftermath of demonetisation, batted for capital account convertibility. Not only was it unrelated to the issue of demonetisation but it is also counter to the mounting evidence that it does not add to but subtracts from economic welfare.

Indeed, India should consider not only retaining the short-term transaction tax in financial markets but think of expanding its scope and enhancing the rate of such taxation!

Mortality and trade with China

Pierce and Schott have updated their working paper on mortality and trade. Their conclusions from their earlier version (Nov. 2015) remain unaltered.

Their two concluding paragraphs:

We find that exposure to PNTR is associated with an increase in mortality due to suicide and related causes, particularly among whites. These results are consistent with that group’s relatively high employment in manufacturing, the sector most affected by the change in trade policy. We find that these results are robust to various extensions, including an alternate empirical specification that places no restrictions on the timing of the effects of the policy change as well including controls for changes in state health care policy ad exposure of other counties in the surrounding labour market.

While the results in this paper do not provide an assessment of the overall welfare impact of PNTR, they do offer a broader understanding of the distributional implications of trade liberalisation.

PNTR stands for Permanent Normal Trade Relations. America granted PNTR to China in October 2000 – towards the end of Bill Clinton Presidency.

The revised version can be found here.

While this paper focused on mortality, the outcome is a consequence of the rapid loss in manufacturing employment that US experienced after the granting of PNTR to China in the year 2000. The paper that examines the loss in manufacturing employment in the United States can be found here.

Demonetisation update 12- Dr. Singh’s scoot and thunder

One of the important lessons of ageing is to appreciate the virtue of silence. There is dignity in that. Some not only do not appreciate it but travel in the opposite direction.

I read the text of Dr. Manmohan Singh’s speech in Rajya Sabha as reported in ‘Indian Express’. He got a few things right and many things wrong.

He was right to focus on the short-term travails and chaos. That is where the government’s vulnerability lies. Well, the government is actually paying the price for the lack of capability of the machinery of the Indian state to pull something off like this on a national scale at short notice.  Back in 2003, Dr. Arun Shourie had lamented that the Indian state got the odd big project right (Kumbh Mela, for example) but did not sustain it. This one is even more challenging. No surprise that there is chaos and hardship. There will be some economic costs to the nation and to the people. Hope it is negligible.

He was right not to criticise the demonetisation exercise itself. He focused on the process. That is about it. He got the rest of his speech wrong.

If he did not disagree with the objectives and if he did not wish to favour ‘this side or that side’, then why did he characterise it as organised loot and legalised plunder? Strong words but what is the basis? Did he mistakenly think that we were in 2010 when there was organised loot and both legalised and illegal plunder of national resources?

He is right that even 50 days is too long for the poor to suffer. But, in that case, was it right to let them suffer for 1830 days between May 22, 2009 and May 26, 2014? Annual average consumer price inflation was 10.1% in that period (based on CPI-IW) and food inflation was 10.5% per annum. The poor suffered enormously. The rupee plunged 50%. Businesses collapsed. Telecom licenses were handed out to cronies. Supreme Court cancelled them. Mining licenses were allotted arbitrarily. Supreme Court banned mining. Economic growth, which was flying high due to the global boom pre-2008 collapsed to 5% to 6%, thanks to UPA missteps and loot and plunder. The 50-days that the current Prime Minister is talking about must be seen in this perspective.

Let me try another argument. The suffering of the people is incremental to the suffering that the State has been inflicting on an ongoing basis. Further, if the issue of corruption remained untackled, how could even one compute the suffering that would endure for much longer? By definition, that is harder and even almost impossible to estimate. Isn’t it?

Dr. Singh invoked John Maynard Keynes. Well, most economists know the context in which Keynes talked about the long run. It was in the context of the great economic depression of the 1930s and the advocacy of government remaining passive by the Austrian school. He advocated government intervention. Keynes may have been right (or wrong). It is hard to find out for it is impossible to construct the counterfactual. Indeed, many think that the non-intervening UK recovered better and faster than the American economy despite (or, because of?) Roosevelt’s interventions.

Be that as it may, in India, the situation has arisen out of government action (and not inaction) and it is handling the implementation challenges by responding to them immediately. So, Keynes’ analogy does not apply in this context at all.

Indeed, the long-run arrived for India in 2014 and the economy was nearly dead when the present government took office. It has been a struggle for it to breathe life into the economy left comatose by Dr. Singh’s government.

Dr. Singh is right that there will be economic impact in the short run and the long-run benefits are not easily identifiable or quantifiable, at this stage. That does mean that they are unlikely.

Indeed, much of India’s present economic fragility is traceable to UPA’s errors of omission and commission. Certainly, the public sector banks’ Non-Performing Assets is a UPA legacy. That is just one of many legacies of his government that India could have done without, some of which I have recounted above.

If the economic fragility persists longer, political uncertainty will follow in its wake and the Indian economic revival will end even before it began.

The government faces a very tough challenge. It has to keep up with structural reforms if it has to shut further avenues for corruption and, at the same time, mind economic growth and job creation. Not easy. Dr. Singh cannot be blamed for not offering any advice to the government in this regard, despite his impressive economic credentials. Unfortunately for him and for India, under his leadership, the government neither carried out structural reforms nor facilitated economic growth. So, he has no experience of either. Those were the dark ages.

Both this government and India need all the luck they can muster to avoid a return to those times in 2019. Palms folded or fingers crossed.

[Postscript: Here is Keynes’ full quotation on the issue of long-run. It is easily located in the Internet:

But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again. Source: A Tract on Monetary Reform (1923), Ch. 3, p. 80.

Keynes was addressing some economists. In the case of India, no one is advising the government not to address the short-term issues nor is the government being indifferent to them.]

Merkel, Liberals and Liberalism

When I saw the story that Ms. Merkel would seek a fourth term as German Chancellor my mind went back to a comment that Professor-Philosopher John Gray made about her in a brilliant article after the Brexit vote:

A country whose pre-eminent leader condones the prosecution of a comedian accused of insulting a foreign head of state – as Angela Merkel did earlier this year – cannot be relied on to protect freedom of expression.

It appears that she is so out of touch with the reality in Germany that she thinks she can win. This letter in FT poses the right question about her seeking a fourth term.

This is what Wolfgang Streeck, political economist and Leftist wrote about her decision to let refugees in:

Once again, a decision ‘that will change our country’, as Merkel herself put it, was made without regard for democratic process or, for that matter, constitutional formalities. When Merkel declared the German borders open, there had been no cabinet decision to this effect and no official statement in the Bundestag. Since the opposition didn’t ask, as Merkel knew they wouldn’t, nobody knows to this day what sort of order, legal or not, by whom and when, was given to the police. The Interior Ministry is still refusing requests from leading figures (including the former president of the constitutional court, who was preparing a legal opinion on the matter for the Bavarian government) for access to the ministerial decree that should have been issued to the border authorities. [Link]

Incidentally and interestingly, Wolfgang Streeck wrote this as part of his review of a book by Martin Sandbu (of FT) on Europe. To understand why it tickles me, see below.

She is the icon of the Liberals. So much for liberalism – one of the biggest frauds on earth. It is the same as perfect competition in economics. It exists in textbooks. There is no capitalism without competition, as a friend said – capitalism means free entry and exit and no barriers/resistance to both. What we have today is a parody of capitalism. That is how it has become progressively (pun intended) in the last thirty plus years. Similarly, what we have today is a parody of liberalism. There are no liberals though many proudly call themselves such. To understand what I mean here, read Michael Skapinker’s article today on why (so-called) moral companies do immoral things.

For some genuine liberal stuff, watch this six-minute rant by Jonathan Pie. I stumbled upon it when I checked out the Twitter handle of Jonathan Haidt. Read Mark Lilla’s ‘End of Identity Liberalism’ and read Jonathan Haidt and Ravi Iyer’s joint piece in Wall Street Journal on Nov. 10 as to transcend tribal politics (or,instincts?). I am almost done reading Jonathan Haidt’s ‘The Righteous mind’ (recommended by Nitin Pai of Takshashila Institution).

When I read Mark Lilla write the following:

The media’s newfound, almost anthropological, interest in the angry white male reveals as much about the state of our liberalism as it does about this much maligned, and previously ignored, figure. A convenient liberal interpretation of the recent presidential election would have it that Mr. Trump won in large part because he managed to transform economic disadvantage into racial rage — the “whitelash” thesis. This is convenient because it sanctions a conviction of moral superiority and allows liberals to ignore what those voters said were their overriding concerns. It also encourages the fantasy that the Republican right is doomed to demographic extinction in the long run — which means liberals have only to wait for the country to fall into their laps. The surprisingly high percentage of the Latino vote that went to Mr. Trump should remind us that the longer ethnic groups are here in this country, the more politically diverse they become.

I was reminded of the horrible piece that Martin Sandbu wrote soon after the elections were over, expressing a similar sentiment identified and highlighted above. I had blogged on it here. You can find his piece here.

Although not general, Frank Bruni has a specific message for Democrats which goes along similar lines as the earlier links.

Given how FT has covered Merkel’s announcement, it is very unlikely that FT gets it at all or ever will.