August 31, 2013/ Abimbola Hakeem Omotola
As major economies all over the world continue flooding the global economy with easy money in a bid to strengthen the financial system with liquidity necessary to sustain economic recovery, it is meet to note that this exercise should be done with caution and major emphasis should also be laid on correcting structural deficiencies hampering growth.
This unprecedented monetary easing campaign, coming on the heels of an asset bubble that gave rise to downtown in global finance in 2008 has already given rise to “competitive devaluation” as major economies jostle to devalue their currencies to make exports more competitive and imports expensive. These “currency wars” as the Brazilian Minister of Finance tagged it in 2010 have already generated some trade frictions.
Orthodox and unorthodox techniques are being used from Asia to Europe and the United States. The Bank of Japan on its part has been on a major QE expedition since new premier; Shinzo Abe handed reins of the Reserve Bank to Haruhiko Kuroda (pictured above). Having witnessed deflation for the better part of the last 25 years, the Apex bank led by the new Governor has embarked on a unique style of Monetary Easing backed by the Premier who has also been pursuing fiscal expansion to stimulate the ailing economy.
Inflation target has been set at 2% in order to spur growth and a Central Bank balance sheet by the equivalent of over 1% of GDP a month, twice the size of the American Federal Reserve’s is also targeted. Maturities of government bond holdings are being raised from 3 to 7 years to prompt risk averse managers to invest in the real sector or foreign portfolios which will help devalue the Yen thus strengthening export.
The BoE Governor, Sir Mervyn King earlier in February noted that the Bank is ready to tolerate higher inflation rate and went ahead to set a high Inflation target thus raising the expected inflation of the economy. This is to be done by QE though implicitly stated unlike Japan’s case. An orthodox technique, a combination of reducing interest rate; to raise the opportunity cost of investing in the bond market which also reduces a currency’s relative expected return thus spurring growth in the real sector and buying of government securities which will provide the much needed fund for fiscal activities and strengthen the system with enough liquidity is being used. The bank Governor recently lost out on a bid to print more money to bolster the economy. This leaves so many questions to be answered as some might ask if the gains in export won’t be eroded by higher inflation.
The Fed in US has also been engaging in QE probably to mitigate the effect of the Sequestering. Assets are being bought at a massive rate by the Feds which has been driving sentiments in the equity market as the Dow, S&P and NASDAQ keeps gaining points daily.
All these and more are efforts being made by major monetary authorities to consolidate on gains on economic recovery. It has however left emerging economies in a risky position. Should it see the sudden influx of foreign portfolios as a welcome addition or a risky one which can propel the economy into an asset bubble? The capital and money market in Nigeria for example has witnessed huge foreign portfolio inflow amounting to around 60% of the total capitalization in the market.
The Monetary Policy Committee in March had to retain the Monetary Policy Rate at 12% despite a reduction in inflation, citing the need to limit the exposure of the economy to potential risk of asset bubble. The communiqué released after the meeting read, “Yields on FGN bonds have been declining steadily, signalling the impact of increased inflows while equity prices have been trending upwards. Quantitative easing, especially in the US and the EU is already creating a potential new round of asset bubbles globally”. The bulls, backed by foreign funds have been rallying to close at strong positions for the last 3 months at the NSE aside some few corrections. But, can this be sustained?
The major rationale behind this article is to note the need for monetary authorities to be cautious in their easing campaign; the world needs it but not in excess. Competitive devaluation is a zero sum game and the memories of the 1930’s should serve a note of warning to all. Rather, radical reforms should be embarked on by fiscal authorities to remove structural rigidities especially in emerging markets. Structure of an economy being the organizational framework within a given nation should be at the heart of any policy to bring about sustainable growth and development.
The fiscal authorities hold the key to the economy. They control not just the security apparatus but also pass the largest budget. Besides, they are backed by fiat to pursue far reaching reforms greater than what the supposed political independent Central Banks can. Population growth should be curtailed or encouraged where required while political and social rigidities should be dealt with in developing economies. Security challenges should also be tackled head on. Emerging markets should work on opening up their economies to generate substantial foreign investment in sensitive real sectors such as energy and infrastructure. Sustainable institutions should be built; foreign exchange market, law enforcement agencies, efficient credit system, etc, should be strengthened. Strong input market to aid the supply network necessary for industrial development is equally important.
Furthermore, efficient risk management system backed by strong, transparent and accountable cooperate finance practices is needed to sustain growth in the service sector and spur growth in the real sector. The task of consolidating on recent recovery is for all. Individuals and economic managers should all get involved with the fiscal authorities taking charge of the process.
Monetary policies should be reduced to a reactionary role, cleaning up the acts of the often reckless fiscal authorities and complementing its actions where required. It shouldn’t be seen as an end in itself but complementary means to one.