Daily Archives: November 16, 2011

The recent assessment of China’s financial stability by the International Monetary Fund highlights increasing vulnerabilities stemming from the government’s role in the lending process, and an inflexible interest rate policy. Those who regard weaknesses in the banking sector as a likely trigger for a financial collapse have railed against China’s negative real interest rates and the speculative activity this has spawned.

But focusing on emerging financial risks is a case of treating the symptoms of the problem, rather than its origins. With its responsibilities for providing a broad range of services for a mixed socialist economy, it is surprising how small China’s budgetary footprint actually is. Beijing has been using the financial system to fund public expenditure needs – many of which are not commercial in nature and would normally be undertaken through the budget. While this was unavoidable in the earlier years, it has turned out to be a politically attractive and effective option in dealing with the volatility of the global economy over the past decade.

As such, these hidden banking losses are actually quasi-fiscal deficits, rather than traditional non-performing loans. While on paper China’s does not run major budgetary deficits, these quasi-fiscal deficits in the banking system have been accumulating over the years, awaiting the time when the non-performing loans are formally recognised and written off. While one cannot dispute that China needs to act on financial reforms, the real challenge is for Beijing to recognise the importance of strengthening its fiscal system to undertake expenditure requirements in a more transparent and potentially less destabilising fashion.  Read more

Japan’s 1.5 per cent rise in output in the third quarter was met with a yawn by the markets. Was this the right reaction? Even though it was 6 per cent on an annualised basis, and therefore impressive compared with the 2.5 per cent growth in the US, and even more so compared to the lower-than one per cent in the eurozone, the markets may be right.

These latest gross domestic product figures will probably encourage analysts to stick with the current broad outlook for next year. It is quite remarkable that on average forecasters expects Japan to be stronger than either the US or the eurozone. In essence, the consensus – as well as depressed equity markets and low bond yields for the G7 countries – expect a “Japanisation” of these countries’ economies. The markets are assuming Japan’s post-tsunami recovery is nothing other than a recalibration for lost GDP, and that the rest of the G7 will join Japan in years of dull, or worse, growth.

I am not so sure about a number of aspects of this outlook. Japan is still recovering following the 2008 global financial crisis and the tsunami. Its equity market is cheap and attractive. But the Yen needs to weaken, which it will do as soon as markets realise America isn’t going down Japan’s path. Read more