U.S. monetary policy brings down the Indian rupee?

The Indian currency has again reached a record low on Tuesday. Like other developing countries, it suffers including expectations of investors who expect a shift from the Fed. The Indian giant shuddered. With the collapse of its currency, returns the specter of a crisis it had known early in 1991. Prime Minister Manmohan Singh had himself risen, claiming that this new crisis was not of the same order. Moreover, the crisis of the rupee displays India is experiencing a slowdown - albeit relative - its growth. In this context, the question of advancing the general elections before the month of May 2014 was again discussed among the members of the Indian political class. How to explain this monetary crisis going to translate into political crisis? The Indian currency Monday reached its lowest level. On Tuesday, the dollar traded as against Rs 64.11 earlier in the day. The day before, she had gone through the floor dropping to 63.22 rupees to the dollar. More broadly, in two years, the country's currency has lost more than 40% of its value since July 2013. Main reasons given by most analysts: the fear of expected monetary tightening of U.S.

 The impact of a possible end of the buyback of bonds by the Fed is already being felt in the last two months. Capital hesitates between the United States and emerging countries. When the shift in U.S. monetary policy was announced, the capital flows are rerouted to the dollar. The Indian stock market actually costs, “there is still a month; the SENSEX index exceeded 20,000 points," points out the researcher. He thus lost 7% in three days, falling below 18,000 points before rising slightly at the close on Tuesday. In India the deficit of current account is the source of all problems. The deficit amounted to about 4.5 % of gross domestic product, according to a note from the Bureau of Economic Analysis of BNP Paribas. To this must be added a context of relatively slow growth. For the 2012-2013 year, India's central bank has lowered its growth estimate from 5.8% to 5.5%. Well below the 9 % increase in GDP experienced by the country during the previous years.


 In addition, “even in the field of foreign direct investment, we feel a hesitation. Whenever the election is tight, investors may worry about a shift," says economist Center Future Studies and International Information. Faced with this situation, the Reserve Bank of India (RBI) would have little leeway. This is “very embarrassed because political control of the money supply can have a negative impact on growth and investment. It is therefore obliged to act in short strokes. The RBI has, for example tried to halt the decline of the rupee e.g. preventing imports of gold, limiting to $ 75,000 per year instead of 200,000 the amount that can leave the Indians in the country but also in controlling purchases estates abroad. India is not alone in feeling the effects of investor expectations about the U.S. monetary policy. Other emerging market currencies were also affected, such as the Brazil and Indonesia. Finally, more broadly, the crisis itself could amplify these phenomena. India has no role in driving the region since this has the effect of weakening the economy, there is however a risk of indirect contagion in other emerging countries, especially China.

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Record low for the Rupee, The Stock Market Collapses!

The IMF said Thursday that economic "vulnerability" of India had recently worsened, while refusing to "speculate" on the possibility of an application for financial assistance in the country. "The combination of large budget deficits and current account balance, the persistence of high inflation and dependence namely capital inflows are the old vulnerabilities that have increased" recently said Gerry Rice, spokesman for the international Monetary Fund. Faced with the prospect of a tightening of U.S. monetary policy, India has seen foreign capital flowing back, plunging the value of its currency against the dollar. On Wednesday, the rupee fell to a record low before recovering Thursday. According to Rice, the deterioration of the Indian economy "clearly affected market confidence" and is a "challenge" to the authorities. "This is also an opportunity for the Government to continue its political efforts on a number of fronts," he said at a press conference in Washington, without giving further details. Wednesday evening, the Reserve Bank of India (RBI) has announced it will provide dollars directly to oil companies, via a separate establishment, to calm the volatility in the foreign exchange market. Asked about a possible Indian request for financial assistance, IMF spokesman, however, declined "to speculate." India had appealed to the Fund in 1991 to deal with a crisis in its balance of payments, which measures including the influx of foreign capital.

The European Sovereign Debt Crisis!

The financial crisis of 2007 caused a wide deleveraging among private agents developed and pushed the savings rate to rise, tipping the global economy into recession. Governments and central banks then intervened to prevent the collapse of the banking system and relaxed their cyclical policies to restore aggregate demand. The economic slowdown and the reaction of the public authorities have widened sharply public deficits, even though levels of public debt in the developed countries were already considered excessively high. This further deterioration of public finances has raised serious concerns about the ability of states to maintain their debt on a sustainable path. This is especially the countries of the euro zone that have crystallized concerns. Greece between the budget crisis in autumn 2009, and the sovereign bond yields rise sharply in Spain, Italy and Portugal in late 2010. Thus, interest rates, which had been a convergence in the past ten years with the European integration, begin to diverge, market making clear the distinction between state-member groups: on the one hand, those the "periphery" undergoing unsustainable increase in sovereign risk and on the other, those "core" that benefit from historically low interest rates. Countries experiencing the strongest market turmoil in sovereign debt have increased the fiscal austerity measures to restore confidence and reduce sovereign spreads.

 Other Member States have also adopted fiscal consolidation efforts to contain the contagion and prevent their own solvency are in doubt. In some countries, the change in sovereign risk premiums can however hardly be explained by changes in economic. If the debt and the deficit actually reached unsustainable levels in Greece, the fiscal situation in other countries threatened by the debt crisis was not more disastrous than that of the United States or the United Kingdom. In 2009, Spain respected the main Maastricht criteria for fiscal policy, since its public debt represented less than 60% of GDP. Italy certainly requires a budget adjustment to service its debt, but it should make the effort appeared modest as interest rates remained at a low level. Several authors have developed the idea that the sovereign debt crises, particularly the European countries could result from self-fulfilling expectations. In other words, the sustainability of public debt does not only depend on fundamentals (including the amount of the debt, the primary balance, etc. When investors fear for one reason or another the state has difficulties to cope with the burden of debt, they divest their sovereign bonds. These sales push interest rates higher and then the government could more be able to refinance its debt other than prohibitive rates. The liquidity crisis can then quickly degenerate into a solvency crisis. Indeed, the states will try to consolidate their public finances to restore market confidence. If the economy were initially in recession, austerity measures further depress activity, so they are likely to lead to a further increase in the debt to GDP ratio. With rising interest rates and contraction, states are finally forced to default on their debt. Thus, a State may become insolvent simply because investors fear default. They act indeed in such a way that the probability of default rises, even if their concerns were initially unfounded. If it happens, the default validates initial fears: expectations are proven "self-fulfilling." Ultimately, public debt is sustainable as creditors consider it as such. The economic literature formalizes this idea by emphasizing the existence of multiple equilibrium. These are particularly unstable in the presence of self-fulfilling expectations: a simple reversal of expectations is likely to tip the economy a good balance bad. However, a State may in principle difficult to use the central bank to reduce the risk of a liquidity crisis.

 Therefore, the member countries of the euro area, in essence, a greater chance to experience a crisis of sovereign debt that countries into debt in their own currency, even if they have more degraded public finances. The member states of the monetary union can indeed rely on a central bank to provide liquidity if it is missing. As such, they share the same vulnerability to crises of sovereign debt that developing countries that emit denominated in a foreign currency usually the U.S. dollar debt. When a liquidity crisis occurs in a monetary union, countries that lose market confidence the peripheral euro area countries meet in a bad equilibrium characterized by high interest rates and capital flight, as investors seek safer investments in the world. These countries are then capable of falling into recession as the high interest rates encourage their government to implement austerity plans. Conversely, countries that retain the confidence of the bond the core countries are maintained in a good balance: they receive cash flows from the periphery. These inflows exert a downward pressure on their interest rates and thus stimulate the economy. They find that increases in risk premiums that were observed in 2010 and 2011 occurred independently of changes in the ratio of public debt to GDP. Greece, however, is an exception, since the increase in the spread on its debt actually due to the deterioration of public finances. By cons, countries that do not belong to a currency area and that borrow in their own currency appear immunized against liquidity crises. They have indeed crossed the Great Recession without knowing a significant increase in their spread, even though some of them had ratios of public debt to GDP higher than in the euro area. .

So finally endorsing its role as lender of last resort to the States, the ECB seems to have managed to "break" the expectations and bring savings to a good balance. The announcement also seems to have been credible enough that the central bank did not have far to intervene in bond markets to stabilize interest rates. Since the crisis of sovereign debt in the euro zone is mainly due to the self-fulfilling expectations, the reaction of fiscal authorities appear absurd, dictated only by the emergency. The turmoil in the bond markets led all governments of the euro area to focus on fiscal consolidation at the expense of supporting the activity. While the public sector should continue spending to allow private agents to reduce debt, otherwise he immediately sought to consolidate its own balance sheet, which was subjected to powerful euro zone recessionary pressures.

Countries that have experienced the largest increases in spreads have implemented the most severe austerity measures. They then switched to a vicious spiral where the contraction and deterioration of the fiscal balance are mutually maintained. However, if there is a disconnection between risk premiums and the fundamentals, a policy aimed exclusively at improving fundamentals that is to reduce the burden of public debt may not be sufficient to contain the spread. The intervention of the ECB is against proved crucial in stabilizing the bond markets. Thus, not only the macroeconomic shock therapy that have inflicted the peripheral countries is very vain, but it has mostly contributed to the deterioration in public finances deteriorate the growth potential of their economies. However, economic growth is a key factor in the sustainability of public finances. The ECB intervention has certainly reduced the risk of self-fulfilling expectations, but the fundamentals are perhaps now sufficiently weakened that fears about the solvency of public finances are now justified.

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Liquidity Trap

During the Great Recession, many central banks reduced their interest rates to historically low levels. However, the interest rate was good to be its zero point, it remained higher than the natural rate, that is to say, the nominal interest rate which closes the output gap and ensure price stability. However, once the zero lower bound is reached, the central bank may further cut its key interest rate, which exposes the economy to deflationary pressures and an increase in its unemployment rate. In such a situation called liquidity trap, where monetary policy is proving excessively restrictive fiscal authorities must necessarily intervene to counteract deflationary pressures. The finance managers adopt their next steps "unconventional" to make them more effective monetary policy. However, the Great Recession is different from previous episodes of liquidity trap, including the lost decade in Japan, that the phenomenon of liquidity trap this time has a global dimension. The United States, UK and the other Euro countries are the countries most closely linked by trade and financial linkages that have experienced the largest slowdown in crisis, bringing their monetary authorities to fix the interest rate to the nearest zero.
According to famous Economist, the appearance of liquidity traps in a context where markets for goods, services and capital are integrated internationally gives a new dimension to the dilemma highlighted by the literature in finance International (also called "impossible trinity" or "impossible trinity"). The traditional interpretation of this phenomenon, a country cannot simultaneously ensure the opening of capital markets, fixed exchange rates and monetary policy autonomy. If achieved two goals, the third becomes unattainable. However, even if the exchange rate is flexible and fully opens capital markets, monetary policy loses its effectiveness in a liquidity trap. If the domestic economy is a powerful external shock depressing domestic demand, the zero lower bound is likely to constrain its own monetary policy. Financial markets play a key role in the spread of the phenomenon of liquidity trap a country to another.
The economic literature have suggested that the introduction of capital controls to reduce the risk that a country will suffer destabilizing capital inflows: inflows are indeed likely to fuel an unsustainable credit expansion, the formation of bubbles assets and excessive currency appreciation, especially in emerging countries. The introduction of capital controls makes monetary policy more effective in reducing the risk that the economy switches into a liquidity trap.

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Aggressive stimulus efforts by Abe given strong boost to Japan

The expected increase of 3.6% after 4.1% annualized GDP and the private consumption expected to have risen 0.5% Reversal expected business investment. The growth of the Japanese economy is expected to reach 3.6% annualized in April-June, a Reuters survey showed a third consecutive quarter of expansion that would reflect the impact of increasing net policies "reflationary" Prime Minister Shinzo Abe. The figure released on Monday morning in Tokyo should also strengthen the government's desire to raise the VAT next year, even if the implementation of this project politically sensitive involves many other factors, economists note. The second quarter should certainly have marked a slight slowdown in growth after the 4.1% annualized from January to March, driven mainly by household consumption, but the April-June statistics should show a recovery in exports and business investment, they add. "The growth is balanced with a strong domestic demand and external demand. This is a sign that the impact of political Abe is becoming wider," said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute in Tokyo. Compared to the first quarter, gross domestic product (GDP) is expected to have risen 0.9% in April-June, foreign demand are contributing 0.2 shows the Reuters survey.

Private consumption is expected to grow by 0.5% a quarter to the next, which would mark a slowdown after growth of 0.9% in January-March. But business investment, which fell by 0.3% in the first three months of the year, is expected to rebound by 0.7%. Abe's government plans to raise the VAT rate of 5% to 8% in April and 10% in October 2015, as part of efforts to try to contain the public debt, which exceeds 200% of GDP, the highest ratio of the major industrialized countries. This doubling in a year and a half, which is the most ambitious reform of the Japanese taxation engaged for decades, obviously poses risks to the consumer and more broadly for the recovery, as it may curb spending. Abe said he would adopt in the fall a final decision on the matter, in particular according to the changing conditions. Until then, it will be especially aware of the revised second quarter GDP, which is scheduled for publication on September 9. A Reuters survey shows that most private sector economists are in favor of raising the VAT according to the original schedule, considering that the economy can now absorb the impact.

On Monday, the International Monetary Fund (IMF) has called Tokyo to implement the project, considering it was a "necessary first step" to solve the fiscal problems of Japan. But even if GDP figures are as strong as expected and confirmed next month, Shinzo Abe will take a decision after studying the findings of several studies it has commissioned on the expected impact of the reform explain several sources. Careful, the prime minister also asked his staff to consider alternatives to this reform. "A good GDP figures could reinforce the scenario of a VAT increase in the initial project. But the final decision rests with Abe and he alone, “said Yoshiki Shinke. "It will be more important than past GDP figures is how the economy will react if VAT increases indeed. At this stage, it is very difficult to predict."