Turmoil at twenty: World Bank report on crisis in ECA region

The KSE and the World Bank are organizing the presentation of the report "Turmoil at Twenty". It covers the current situation and discusses how ECA countries deal with the current crisis and what are the next steps required to restore economic growth.

The main lesson I draw from the report is that a sound macroeconomic policy helped to soften the impact of the crisis on countries like Czech Republic relative to countries like Latvia or Ukraine. Here, the emphasis on the exchange rate stability in Ukraine came at a large cost of inability of the NBU to fight high inflation and lack of independent monetary policy. As a result, forced exchange rate adjustments created a panic and led to the severe banking crisis leaving the NBU unprepared to fight the crisis more effectively.

Also, the degree of integration to the world economy was not the cause of the crisis but the channel through which market and governance imperfections amplified their negative impact. For example, a housing market bubble was developing because of highly inelastic supply due to the monopolization in the construction market and poor government regulations in the sector but it would not blow out of proportions without easy access to credit. An increasing concentration of exports in just a few commodities (metals and basic chemicals) was developing due to low competitiveness of firms in other sectors but would never reach 40% of total export without the commodity demand boom caused by overinvestment in China and other rapidly growing economies.

As a result, access liquidity and commodity price boom distorted the market incentives and led to the current situation. Hence, conditional on domestic imperfections that can not be fixed in the short run; there is a need for tools that would allow putting restraints on capital inflows and some sort of countercyclical fiscal stabilizers.

Last quick remark, I felt that the authors of the report are too soft on the financial institutions that failed spectacularly due to underestimation of the risks and provision of excessive credit. Also, the authors claim that the countries in the region have necessary tools and legislation to deal with non-performing loans. I feel, however, that at least in Ukraine, the procedure of bankruptcy is not clearly specified and the borrowers are poorly protected from unilateral changes by the financial institutions of the terms of borrowing.

Level of protectionism is rising

According to the Global Trade Alert, Basic metals and basic chemicals are two industries most affected by the protectionist measures. These are two industries in which Ukraine exports the most.
The top three countries that have the most protectionist measures imposed are Russia, India, and US. However, the EU would come first if one include groups of countries.
In terms of product lines that are affected, the top three countries are Russia, Ukraine, and China.

Vote for me! I am in favor of all good things and against all bad things!

Thanks for the tip to Tom Coupe, who is also a professor at KSE.

Top 10 most strange promises of candidates to President’s post

1. Victor Yanukovych: “My aim is 50 million citizens of Ukraine in year 2020”.

2. Inna Bogoslovska: “Ukraine will make “Kyiv initiative” concerning carrying out in Kyiv the negotiations of the world community on new world order topic”.

3. Volodymyr Lytvyn: “Key task – is providing correlation of minimal and maximum wage in proportion 1 to 5”.

4. Petro Symonenko: “ The minimum share of salaries in the product prime cost will be set at 60%.

5. V. Yushchenko: “A hryvnia will become the only payment means in Ukraine. There will be no foreign currency transactions and prices in the home market”.

6. Oleg Tyagnybok: “European Ukrainian-centrism – strategic course of the government”.

7. Anatoliy Hrytsenko: “I will make an official to speak with people in the language, he/she is addressed”.

8. Oleksandr Pabat: “The state monopoly on main land resources will be renewed and the state will take the land on long-term lease”.

9. Yulia Tymoshenko: “Immediately after the crisis we will resume a long term housing mortgage loans at 2-4% per annum for 10-30 years”.

10. Lyudmyla Suprun: “The schools will turn to multimedia scientific-cultural centers of education and development of personality”.

http://www.unian.net/eng/news/news-351640.html

My personal favorites are the promises number 1 and number 9. I am not sure which one is more difficult to make true.

Technologies will save the country, or will they?

Александр Кендюхов, (Chair of All Ukrainian Union of economists) advocates for creation of state-owned corporations that will be export-oriented and work in biotechnology and pharmaceutical industries. To boost their development he suggests:

- get rid of all taxes on businesses including VAT

- introduce a sale tax of 5%

There are several passages that are truly amazing:

"Высвобождаемое в результате сворачивания устаревших индустриальных производств трудоспособное население, не способное к переобучению, получая от государства стартовый капитал, легко включается в малый бизнес" -- it could easily win the prize for the stupidest economic policy ever suggested! An unemployed who can not find a job and who can not be retrained, presumably because he is either a) stupid or b) too old, will supposedly start his own business using taxpayers' money and  become a successful businessman.  Questions: don't you need at least some very specific ability to develop your own business? what is the likelihood of you having this ability  if  you can not be retrained to do other job?

"Продукция высокотехнологичного сектора, представленного преимущественно крупным бизнесом, должна быть ориентирована прежде всего на экспорт, малый бизнес — на внутренний рынок. Стимулируется рост внешнего и сокращается рост внутреннего потребления, что увеличивает накопления населения. Аккумулированные населением денежные средства направляются на покупкуакций создаваемых высокотехнологичных предприятий."  Very interesting: I save money because the consumption is very expensive and there is nothing there to buy, and the government takes my savings and gamble with it by purchasing stocks in some state-owned biotech company that has uncertain chances of succeeding in its venture.

It is really sad that "ALL Ukrainian economists" suggest these kind of economic policies

China as the source of global imbalances

Martin Wolf on China: Why China’s exchange rate policy concerns us

Investment in Ukraine are down by 43.7%

Investments in Ukraine in January-September, 2009 are 43.7% down relative to the same period of 2008. Here is the regional numbers:

Macro: liquidity trap and money supply

Charles Goodhart comments on the collapse in the money multiplier and advocates continuing quantitative easing. The discussion nicely illustrate the difficulties that the central banks face now in an attempt to increase liquidity:

Insight: Deflating the bubble By Charles Goodhart

Published: November 30 2009 16:35 | Last updated: November 30 2009 16:35

Between the failure of Lehman Brothers in September 2008 and March 2009 asset prices in financial markets, world trade, confidence and real output dropped faster than in 1929.

Since then there has been an, almost miraculous, recovery in financial markets and confidence, and a stabilisation and incipient recovery in trade and output. The turning point coincided with the aggressive adoption of quantitative easing (QE), especially in the US and UK. The most common explanation of this recovery in financial markets is that it has been due to the abundant provision of liquidity; and liquidity is exactly what QE generates.

Yet QE has not worked as many had first expected. A now defunct theory of the supply of money had the central bank controlling this by operating to adjust the reserve base of the banking system. Banks were expected to maintain a reasonably stable ratio of reserves to assets/deposits so, if the authorities should raise their reserve base, primarily their deposits with the central bank, then total assets/deposits should rise by the same level.

Since total assets/deposits are normally a large multiple, say 25 times or more, of the reserve base, this relationship appeared to enable the central bank to adjust total bank assets/deposits by a multiple of their open market operations to affect the reserve base, the “money multiplier” as the theory was known.

From June 2008 to June 2009, reserves held by commercial banks with their central bank doubled in the eurozone, and increased by an even greater percentage in the UK and US, yet bank deposits and total bank assets barely changed, so the multiplier collapsed to zero. Banks, in aggregate, just absorbed the additional reserves by allowing their ratio of reserves to deposits to balloon, without any attempt to use their greater liquidity/reserves to expand their balance sheet. Why?

This may appear to have been a purely passive response to cash injection, but nevertheless commercial bank treasurers will have consciously decided that accumulating vast cash reserves was preferable to using them in any other way. This may be partly insurance against uncertain future needs to roll-over wholesale funding. At a time of tightening bank capital requirements, and rising prospective defaults, the limitations on lending to private sector borrowers, except on most favourable terms, are obvious.

But why not buy safe public sector debt? Lower yields on short-dated government bonds, pushed down by QE, as well as interest rate risk, enhanced by rising debt ratios, may make public sector debt appear less attractive compared to the safe remuneration on deposits at the central bank. This is a condition for a typical liquidity trap; hence my proposal for applying a negative return, a charge, on such deposits. Perhaps a lesson that should be learned is that the relativities between the interest rate on bank deposits with, and borrowing from, central banks gives each central bank another degree of instrumental freedom, on top of their control over the official short-term rate.

Despite the total collapse of the money multiplier, QE has, I believe, been a major factor in the recovery of financial markets and confidence. The scale of asset purchases has been so large that it has led to a huge injection of liquidity, and to portfolio rebalancing, on a large scale amongst non-bank financial intermediaries and financial market participants more widely. Bond yields have come down quite sharply, more so in riskier corporate debt than in government debt, as risk premia also get reduced. Equities rise, and exchange rates fall in countries pursuing QE more aggressively (USA and UK) relative to those doing less (eurozone and Japan). The rise in asset prices and fall in yields, has allowed large corporates, including banks, to refinance themselves in capital markets; with fixed and inventory investment still low, such fund raising allowed repayment of bank loans. It is ironic that QE may have facilitated a reduction in bank lending and deleveraging.

So if QE has been such a success, and the prospective recovery still looks anaemic, why not continue it? Partly because the money multiplier has been defunct, QE has operated primarily via a restoration of prices, confidence and capital gains in financial markets rather than impinging directly on the access to credit and expenditure decisions of small and medium enterprises and households, where the real problems remain. If the authorities go on blowing up financial markets too much, at some point yet another bubble will develop. The last time the financial bubble burst, the taxpayers got soaked. There will not be a next time for this support mechanism, since the taxpayer neither can, nor will, repeat it. Central banks need to check their proclivity for generating a further bubble to overcome the effects of the previous bust. Certainly, we can never get the timing exactly right, but now does seem the moment to declare victory for QE and withdraw.