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Monday, September 1, 2008
A Balance OF probability

We are not alone. Others share our dilemma of rising inflation, weaker growth, concern about capital flow exposure and currency attacks.

“But some countries are taking radically different decisions. Which role model should we follow, if any?” asks Cees Bruggemans, Chief Economist FNB.
“For me the choice is between copying India or New Zealand, or doing our own thing. If this doesn’t quite sound cricket, hear me out.”
Recently India raised interest rates by a surprisingly large (for them) quantum of 0.5%, with accompanying strong indications of more hikes to come.
Yet nearly the same time New Zealand cut rates by 0.25%, also accompanied with much noise about more cuts to come. Kiwi started cutting rates at 8.25% and hopes to be down to 6% in 2009, also hopefully weakening the Kiwi Dollar, favouring exporters.  Kiwis are passionate about not having an overvalued currency. Their trial at the hands of Japanese housewives carrying on has been rather trying for far too long.
He says this is quite a choice, as radical as they get. To still raise, and raise some more, like the Indians; Or to cut, and cut passionately, like Kiwi. Who should we copy?
Both India and New Zealand, like South Africa, face the peak of their respective inflation cycles with some uncertainty as to what happens to inflation in 2009. But when it comes to growth, the situation differs radically between the three countries.
India was gunning for 10% GDP growth until the inflation bogey appeared and they started raising rates. The Indian GDP growth outlook is now down to 7%-8%, depending on who you want to believe. The Indian Reserve Bank is taking its current 12% inflation rate very seriously. With 900 million very poor people, high inflation attacks their margin of existence.
“Politically this is suicide,” he comments. “With a general election looming, just like us, the priority is to address the inflation evil. Besides, the beauty of high growth is that one can sacrifice a bit while attending to more pressing priorities. So India is in full cry, raising rates, addressing second-round expectation effects, hoping to prevent a runaway wage train for long enough until the unwinding commodity price shock becalms inflation again.”
Also, their external capital flow has reversed from $108 billion positive last year to $25 billion annualised negative since May 2008. Such reversals tend to concentrate monetary sensibilities, India wanting to prevent too much of a Rupee slide, worsening its inflation problem. This, too, encourages a higher interest rate defence.
There could not be a greater contrast with New Zealand, with 1Q2008 at -0.3% recession quarter, more weakness in 2Q2008, and 3Q2008 remaining recessionary. The Kiwi Reserve Bank has decided to be brave, look through the coming peak of the commodity-driven inflation cycle aiming for 5%, hoping for the best about what comes next year (oil, food), focusing on recessionary growth.
So what are we supposed to do?
Explains Mr Bruggemans, “We are also above 11% inflation, like India, and we are sensitive about our current account exposure. But unlike India we have already used up most of our growth momentum, though not yet as far as Kiwi has. Projecting to early 2009, our economy could also be weak, even brushing recession, like Kiwi today. Surely we don’t want to go there if it isn’t strictly necessary?”
Unlike Kiwi, we were lucky to have our growth cycle progress longer before the guillotine fell. We may be able to prevent unacceptable low growth before it takes hold, if only inflation could peak shortly. Also unlike India, we didn’t start late sacrificing growth through rate increases. We have been at it for two years. And we don’t have 900 million angry democrats ready to change political goalposts shortly. With us it is an order of magnitude different.
But unlike either India or New Zealand, we don’t have a small or reducing current account deficit. What makes us stand out like a sore thumb is a 9% of GDP gap. That makes us exposed to currency attack and the disturbances these could bring in their wake.  So what model does that suggest for us?
“Well, no longer India,” he says, “because our growth sacrifice is well advanced, and there is now growing hope that the global inflation cycle may be approaching peaking territory, already running off next year.”
But also not quite Kiwi. We aren’t as yet in recession, while our balance of payments makes us exposed, indeed sensitive to the global credit playout.
That’s no argument for raising rates further (India), but also not yet cutting them (Kiwi). For now, we fall between these two stools.
But as growth weakness progresses, inflation peaks, global inflation turns more favourable (here’s hoping) and the global credit crisis abates, the Kiwi example comes into view.
So August no change. Perhaps October no change, building up needed Dutch courage. But December 2008 could see the first 0.5% rate cut, prime dropping to 15%, if events play our way, especially if global credit crisis and commodity virulence could abate.
That would also nicely short-circuit the credibility problem of what to do in election month 2009.

Copyright © Insurance Times and Investments® Vol:21.8 1st September, 2008
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