India Needs a Massive Push in Infra Spending to Attract Private Players
Richard Koo, Chief Economist, Nomura Research Institute
Feb 02, 2018 | Source: ET
Balance sheet recession is not a big risk but we are not completely out of it either. The private sector in the US, Western Europe and Japan is still not borrowing money at zero interest rates because of the balance sheet concerns of the past. It’s not a big problem as before, because people do pay down debt and the balance sheets are becoming cleaner in these economies, but we are not out of the woods either. So governments have to be careful in putting the necessary fiscal stimulus. For example, Japan tried to raise the consumption tax two years ago. Suddenly, the economy decelerated. That shows we are not out of the woods yet. We still need the fiscal stimulus.
India is not in balance sheet recession so I don’t recommend fiscal stimulus as a fundamental proposition. But India is also a developing economy which can use lot of infrastructure spending. If you pick the right infrastructure spending and do it carefully, then lot of private sector people might want to invest in that. Then the total effect of fiscal stimulus will be much larger than the initial spending. Since this is still a developing country and huge potentials, infrastructure spending in India should be pushed very strongly and then that will attract the private sector. If you are talking about fiscal stimulus as just to get the economy going, then I am completely against it because macro economically this is not balance sheet recession.
I am sure there would be some positives following Trump govt’s tax plan. I am not against tax cuts of the kind Trump is pushing but in terms of macro-economic impact, I would have preferred infrastructure spending. The US private sector even today is not borrowing money as a group even with these very low interest rates. You give them a tax cut, chances are high that some of the tax cuts will be used to rebuild their savings and we have that first with the oil price decline. Oil price decline is like a tax cut. A lot of economists thought that oil price decline will get the developed world economy going but it didn’t happen because people used the money to repair their balance sheets and that can still happen this time as well. If the government spends the money, that adds to the GDP right away, whereas tax cut is indirect.
For advanced countries like the US, Japan and Western Europe, return on capital is not very high because wages are so high. Instead of investing in the US, companies like to invest in Mexico, Bangladesh, India and elsewhere. When you are in that kind of situation, you have to increase the return on capital at home to make sure that companies will actually invest at home. If they don’t invest at home, productivity of the workers cannot increase and if that happens, their wages are not going to increase. We have to change that so that the workers will have more equipment to work with. Some of what Trump is trying to do is the right thing to do now that return on capital is high abroad, in emerging economies than in advanced countries.
Jerome Powell always voted with the Chairman which is no-brainer. You can only tell what a person really thinks if he goes against the Chairman in all these central bank meetings. The right thing to do is to stay ahead of the curve on both inflation and asset prices. Inflation to Federal Reserve is still ahead of the curve because US inflation rates are still very low. But on the asset prices, commercial real estate prices are going sky high, far above the previous peak and those suggest that they should continue normalising the policies as quickly as possible. You will probably continue the current path.
There is a chance that a bear market for bonds can happen in 2018 because now they are unwinding the QE, at least the Federal Reserve. Because Fed said it is not selling the bonds, the market has kind of calmed down, complacent. The Fed said it is going to hold on to the bonds until maturity and not going to re-invest. That’s how they are unwinding QE. What happens when the bonds mature in the hands of the Fed? Treasury will have to pay the Fed. Treasury doesn’t have that kind of money. It has to issue redemption bonds to get the money from the private sector to pay the Fed. In redemption bonds, you take the money from the private sector and you use this money to pay the guy in the private sector who owns the maturing bonds. This guy is likely to use the money to buy government bonds again. The money doesn’t really leave the bond market which is why if it is redemption bonds, people are relaxed. If it is a new money bond then people become very uptight because it doesn’t come back to the bond market, which is why it could raise interest rates. What happens when the Fed is holding the maturity bonds? You issue the redemption bonds by name, but this money goes to the Fed and disappears there. It never comes back. Effectively this is new money bonds. We are talking about huge sum of new money bonds this way; $300 billion this fiscal year, $600 billion each in the following two years. $600 billion is one year’s worth of US budget deficit so in 2019, 2020. We are talking about doubling the US budget deficit. That is likely to have upward pressure on interest rates so I don’t think the bond market will do particularly well going forward.
Once more and more people begin to realise, there would be pressure on the bond market and then I think that would then affect the stock market but that’s basically what the Fed wants to do anyways. I don’t think Fed wants to see the asset prices and commercial real estate prices continuously going up because if that continues, at some point this thing will go bust, and then we go back to 2008 all over again.
QE removal is still a challenge because we have never seen anything like this before and we are all finding our way, so things can go wrong somewhere along the line. I hope nothing goes wrong of course but you are talking about huge amounts involved. I hope not we do not see a repeat of 2008. In 2008, there was so much leverage in the system so when things started going then everything started unwinding. This time the leverage is not that high except in maybe commercial real estate.