Quantitative Easing in the US - Some Thoughts

Quantitative Easing or QE refers to massive programme of buying bonds with newly printed money. This QE was initiated in the wake of sub prime crisis of 2008 when Lehman Brothers collapsed and there were serious question marks on other financial institutions. Liquidity had dried up from the market, as even banks were vary from lending to each other, as they doubted others net worth.

Over the past five years, the Fed has invested bought more than $3 trillion in the US Economy in its effort to encourage job creation According to Mr. Ben Bernanke, the programme was “well on its way to meeting our economic objective of putting economic recovery on a path to sustained improvement.”

The Fed began its current, that is third round of QE in September 2012, and unlike previous rounds, made it open ended that is, it would continue until the labor markets outlook had clearly improved.

Starting Jan 14, the Fed will trim its monthly pace of bond purchases for $85 billion to $75 billion. Thereafter the Fed will likely reduce the pace of asset purchases in further measured steps at future meetings. Bernanke expects QE would come to a halt by late 2014, but he emphasized this was contingent on growth of 3% and fall in unemployment to around 6.5%.

More importantly, tapered QE was coupled with a stronger commitment to keep the short term interest rate target at zero. The Federal Open Market Committee had previously said it would stay at zero at least until unemployment had fallen below 6.5%. On 18^th December it said it would stay there “well past the time” that unemployment drops below 6.5%, especially if projected inflation continues to run below its 2% target. That, according to FOMC member’s projections means until 2015 or later.

Current GDP growth stands at around 2.2% and inflation are at 1.5%. Bernanke indicated he thought the drop in inflation was due to transitory factors, such as a slowing rise in health costs, and that it would drift back to 2%.

 Though the overall sentiment has improved in the last five years, notwithstanding the crisis over the budgetary allocations which shutdown the US govt temporarily, yet the key question which needs to be answered is:

Was QE resulting in the flow of money to other emerging markets, and increase in the prices of precious metals such as gold and silver?

Well, the immediate reaction after the announcement regarding the tapering QE seems to suggest the same.

While Fed’s decision would be determined by two key parameters viz the GDP growth rate and the unemployment levels, yet it would be a Herculean effort determine the extent of correlation between QE, and these two key indicators of the US economy.

According to some media reports, it is entirely possible that the tapering decision will prove premature.

The Fed terminated two previous rounds of QE, only to restart them when the economy faltered and deflation fears flared.

Consider the following:

• The number of Americans filing new claims for unemployment benefits rose in week ending 15^th December, to the highest level in nine months, casting a shadow on the labor market. Initial claims for state unemployment benefits increased 10,000 to a seasonally adjusted 379,000. that was the highest level since March and marked the second straight week that claims have risen,
• Given the need for overcoming the fiscal cliff and standoff between the Republicans and Democrats over the need to enhance the overall spending limits of the current US administration to accommodate Obamacare, and other populist measures of the Govt, can the Fed by cutting down and hopefully eliminating the QE by end of 2014, expect the US economy to achieve the desired results?
• The US govt shutdown over October 1-16 after the US Congress failed to clear a new budget. About 800,000 workers were furloughed and another 1.3 million workers worked without any set pay dates. Total loss was estimated at $24 billion and 0.25% shaved off from US’s GDP,
• A huge debt burden forced Detroit to file for bankruptcy after struggling to provide even the most basic needs – like police, fire and medical services to its 700,000 citizens. At $ 18.5 billion, it was US’s largest municipal bankruptcy
• $300 billion in packages committed to Japan, and
• President Obama’s pet healthcare overhaul was nearly derailed by an unresponsive site healthcare.gov. Problems arose after it went live on Oct 1, forcing President Obama to apologize. It cost over $1 billion to set the website right.

The above facts leave no room for doubt that the overall spending by the US govt, has to increase notwithstanding Fed’s decision to begin tapering next month, and ending QE by end 2014.

This essentially means that nevertheless, the overall fiscal deficit will keep bloating, resulting in an increase in the money supply in the US economy. Even if Fed were to put an end to QE3 by end 2014, the flow of money within the US economy cannot ebb until the key issue of fiscal deficit, primarily resulting from the above factors is not addressed by the US govt. If the global jitters witnessed last December, over the standoff on fiscal cliff are any indication, one wonders if there is any other way out for the US administration, other than to keep printing dollars for quite sometime, as it just cannot lose sight of the above facts.   

             

This leads to the following questions:

• Are the key indicators of the health of US economy – unemployment rate and GDP growth rate, solely dependent upon its monetary policies,  or do its fiscal policy and other factors such as the state of its key trading partners also have a role to play?
• Then, while attempting to remedy a serious situation like the one confronting the US in 2008, was it not appropriate for the Fed and US state treasury to go hand in hand?

My take on the above two questions are as follows:

Firstly, the key to an economy’s revival is increased internal and external consumption (local consumption and exports), of domestically produced goods and services, followed by increased employment levels of its citizens. It is here that the role of fiscal policy assumes significance, by providing a strong impetus to domestic industry through various incentives, both direct and indirect,

Secondly, the US administration should have ensured that a major portion of the $3 trillion which Fed has invested over the past five years through QE, was spent on creating long term infrastructure, to make the US economy more competitive and resilient, as compared to its most formidable economic rival China,

Thirdly, as European Union and Japan are still struggling with their economic revivals, it would be a good idea for the US Fed to buy bonds issued by the European Central Bank and the Bank of Japan with the condition that the use of  money would have either  direct or indirect linkages to the US economy.  It is expected that the $300 billion aid to Japan has either direct or indirect linkages to the US economy,

And finally, as part of its efforts to boost local employment levels, which would be the key to boost aggregate demand in the economy through increase in private consumption thereby leading to multiplier effects in the economy, the US govt could make the incidence of corporate taxes in inverse proportion, to the aggregate tax contributions by a corporate’s employees who are US citizens or at least green card holders.         

            

    

Nirbhaya Case Verdict - Challenges Ahead

Quite expectedly and welcomingly, the learned judge in the Nirbhaya case pronounced  “death to all” found guilty of committing an act that shook the entire nation, akin to the incidents like attack on our Parliament and the Mumbai attacks.

Quite expectedly again, there were voices from foreign office of UK, and from the EU, besides from Amnesty International which expressed their reservations against this sentence. But, we can choose to ignore the same, as our judicial process is not subservient to international opinion.

With due respects to the Hon’ble Court which pronounced this sentence, which has satisfied the collective conscience of our society, as was evident by the reactions of crowds eagerly awaiting the judgement, one wonders if this sentence would eventually be carried out?

To quote the learned Additional Sessions Judge, “Inhuman acts of torture before her death had not only shocked the collective conscience but calls for withdrawal of the protective arm of the community around these convicts. Accordingly, the convicts be hanged by the neck till they are dead.”

In its twenty page order, the Hon’ble Court said that the criminal justice system needed to instil faith in women by adopting a zero tolerance policy. The “severity” of the injuries and the “unprovoked” suffering inflicted upon the “defenceless” victim were also relied upon by the Hon’ble Court while handing down the Capital punishment.

Going by the past precedents in two cases involving a similar crime, it is observed that while Dhananjay Chatterjee was executed in 2004 for committing a similar crime, Santosh Singh a lawyer by training was spared the gallows by the Hon’b’le Supreme Court, and was made to serve a life sentence. He was held guilty of raping and then murdering Priyadarshini Mattoo. He had even disfigured her face beyond recognition.

In both the cases, the offence was identical with two key differences:

a)     Dhananjay Chatterjee was a security guard while Santosh Singh is a trained lawyer, and

b)    Dhananjay Chatterjee appeared to be unrepentant later, on while the Honb’le Supreme Court was convinced that Santosh Singh can be reformed.

One wonders, if a well educated person like Santosh Singh who was trained to aid the judicial process can commit such a heinous crime can be spared the gallows, ostensibly because of his so-called good behaviour in jail later on, then isn’t there a possibility that these four men do stand a chance of being spared the noose, if they too are perceived to be repentant later on, and on grounds of their young age, poverty, clean antecedents and other mitigating circumstances?

 Secondly, on a technical issue. The facts of the case clearly indicate that the intention of these four men was to inflict severe injuries on Nirbhaya and not to kill her. Else, they could have killed her before leaving the scene of crime, as in the two cases mentioned above. That she was left on the road with severe injuries is a vital fact that cannot be overlooked. This fact contrasts significantly to the Priyadarshini Mattoo case where the victim was killed later by her tormentor, who also disfigured her face beyond recognition before leaving the scene of crime. Going by the acts of savagery and cruelty inflicted on the victim, the depravity of this crime is no less significant as in Nirbhaya’s case.

My objective of highlighting these facts is not to plead for a lighter sentence to the four accused, but to caution the Special Public Prosecutor Dayan Krishnan and his team, of the challenges which lie ahead of them before death sentence is carried out. Yes, they certainly deserve our standing ovation for such a professional job which has earned them plaudits from across the Nation, but this is not the time for them to rest on their laurels.

And finally, according to the Hon’ble Court, for a case to fall under the “rarest of rare” category, perception of the society towards the offence was important. “The Court has to look into factors like society’s abhorrence, extreme indignation, and antipathy to certain types of cases.”

If this yardstick were to be applied to Priyadarshini Mattoo’s case, and to those life convicts who have been held guilty of similar crimes involving minors, then it would appear that the ends of justice have not been met in these cases. That would be really disturbing.         

                                        

Respected Chidambaram ji

Respected Chidambaram ji,

 The budget making exercise always challenging, especially at a time when the overall economy is not its pink of health, there exists a real threat of being downgraded to junk status by the international credit rating agencies due to high fiscal deficit, and to cap it, this being a pre-election year. Even though the budget is not the only instrument for effecting overall economic development by the government in the forthcoming financial year, as there could be ‘n’ number of announcements time to time which can have significant bearing on our economy, yet it is the most important instrument to steer the economy in the financial year ahead.

 Even though you had very little elbow room to avoid presenting a populist budget, yet you deserve full marks for gambling on good economics, in the expectation of reaping political dividends later on. You have pegged the fiscal deficit to 5.2% of GDP in this financial year, and 4.8% in the next financial year, and yet you have been bold enough to provide for a 29% increase in plan spending in the the forthcoming financial year. Certainly, this rise in the plan spending is based upon the assumption of very high tax collections to fund the proposed plan spending. To be specific, against a nominal GDP growth of 13.4% it is hoped that the tax revenues will rise by 19 %, a very optimistic estimate indeed. Let’s leave it for the next year to evaluate the actual outcome.

 While there can be no budget which can please each and every segment of our country, and despite doing an excellent job given your constraints, yet I find it tempting to make the following observations for your kind consideration and implementation as and when you deem appropriate:

 Widening the tax base

  You had stated in your budget speech, “When I need to raise resources, who do I go to except those who are relatively well placed in society?” According to your estimates, there are 42,800 individuals in the country whose taxable income is Rs. 1 crore or more per year. You have levied a temporary surcharge of 10% for a year for such super rich.

Theoretically, there is no dispute over the principle, that better-offs should contribute more as compared to others to the state’s exchequer. But, let’s not forget that such super rich also have the privilege of eliciting the services of some of the best tax planners who can bail them out through some creative accounting techniques, thus negating the very idea of such surcharge. Besides, this figure of 42,800 is debatable if we were to include the rural sector as well.

 There could be equal number of such super rich in the rural sector, who do not contribute a single rupee to the state’s exchequer, but are enjoying all the subsidy related benefits. It’s high time that we expanded our tax base by getting such individuals within the ambit of income tax. To make it politically saleable, may I suggest that a Rural Development Fund be created, and all the tax contributions by such super rich farmers, be pooled in that fund with a matching grant from the relevant states and a proportionate percentage by the Centre? This entire corpus should then be exclusively used to create the required infrastructure in the deserving rural areas.

  Employment Generation

 This surcharge of 10% has also been levied on those companies whose annual taxable income is Rs. 10 crores and above. Corporate income tax, the largest contributor to the exchequer fell nearly 4% short of the target set by your respected predecessor Shri Pranab Mukherjee. In rupee terms, this shortfall amounted to Rs. 14,353 crores. What saved things to an extent were taxes on individual incomes and services, which narrowly crossed the estimated targets.

To manage the fiscal deficit target, plan spending had to be slashed in a big way, thereby worsening the quality of the deficit. Given this scenario, it would have been worthwhile to reduce the corporate income tax in inverse proportion to the amount of TDS generated by a company through its regular employees’ salaries.

This would have been an excellent way of boosting employment across industries, something which our economy is struggling to achieve at present. Yes, you have provided an incentive to spend for some manufacturing units by allowing 15% of spending over Rs. 100 crores on plant and machinery in the next two years, qualifying as a deduction. But this benefit can be obtained only by those corporates who have deep pockets and most importantly, can justify the same commercially.

 Indigenization of Military Hardware

  Our defense budget has been raised to over Rs. 2 lakh crores, as we cannot afford to compromise on the overall security of our nation. But considering the fact that we are the biggest importer of military hardware, having spent around $50 billion in the past decade on such imports, it is indeed surprising that no serious thought has been given to boost our own military hardware industry to acceptable international standards, thereby saving such mammoth outgo of foreign exchange, and some years down the line transforming ourselves from the biggest importer to one of the leading exporters of military hardware.

 Specifically, what was required in this budget was a five year tax holiday for all companies engaged in the production of military hardware, besides creating a sizeable corpus, from which highly subsidized loans could be granted for R&D related activities to such entities. If such a move yields the desired results, then some years down the line we could rival China, where foreign exchange reserves are concerned. This would boost the value of the rupee which in turn would cut down our crude oil imports bill in rupee terms thereby further extending us benefits in terms of manageable fiscal deficit.

 Setting up of Cold Storages etc for our Agro based Industry

  Your government staked its survival over the issue of FDI in multi-brand retail, and your spokespersons sold the idea on the basis of a pressing need to plug the estimated 40% wastage of fruits and vegetables due to inadequate cold storage and other facilities in the entire supply chain, besides ensuring a fair price to the farmers and the end consumers by removing as many intermediaries as possible.

 It is a great idea indeed. But what has surprised some of us is the absence of any tax related concessions to our own entities desirous of entering into such businesses.

 Women Welfare

  Nirbhaya Fund to the tune of Rs. 1000 crore has been proposed for the security and improvement of women, besides an all women Public Sector Bank with a corpus of Rs. 1000 crore especially to cater to various needs of our womenfolk While there is no dearth of Public Sector Banks in our country, there are also some women cooperatives banks as well which cater to the desired objectives.

 Hence, it would have been better if the same total corpus of Rs. 2000 crores had been allocated for strengthening our judicial system to dispense quicker justice, which would have been a better way of ensuring security and empowerment of our womenfolk.

 Alternate fuel based technologies

  Given our heavy dependence on imported crude as well as our commitments towards reducing global warming, there is a pressing need to develop automobiles on a large scale which use renewable energy. As a thrust on the same, tax holidays for such companies which are currently producing cars which can run on electricity or any other alternate fuels, and a substantial corpus be created through which loans on highly subsidized rates for such R&D can be dispensed to such entities.

 Disinvestment

  Your government has set up an ambitious target of mopping up Rs. 56,000 crores from the sale of PSU shares, pointing to increased reliance on disinvestment to bridge the deficit. This target is for the next financial year, and is more than double that the government plans to mop up during the current fiscal. It includes the residual stake in Balco, Hindustan Zinc, besides MMTC and BHEL. All these are blue chip companies. Is it necessary to “sell family silver for covering one's debt”?

Certainly, this deficit once bridged through stake sale is likely to resurface some years down the line, given the competitive populism which is hall mark of our polity. Kindly explore ways to make such blue chip PSUs more profitable thereby generating more dividends for the government, which then can be used to bridge the deficit gradually. Removing unnecessary government interference in their functioning besides the requisite autonomy and accountability to its senior management could be among some of the measures you might consider for all the PSUs and the dividends so generated would be amazing indeed.

Misuse of Subsidies

 And finally, every year huge amounts are being earmarked for various subsidies. While reduction in subsidies is politically sensitive, yet a strict monitoring of its end use is fiscally prudent. In this connection, may I draw your attention to the decision of IFFCO Board to grant a special incentive of two of its prime properties in Delhi with 40-50 crores each as per media reports to two of its top honchos. According to the news item, IFFCO's 2011-12 annual reports, it received Rs. 14,464 crores or 57% of its turnover of Rs 25,600 crores as government’s subsidies for fertilizers.

According to a press released by the company the following day, IFFCO maintained that the government had no stake in IFFCO and hence those two properties did not belong to the government. As for the lavish subsidy amount of over Rs 14,000 crores or 57% of its turnover that it gets from the government, IFFCO said this was only as per the government policy of compensating fertilizer companies for selling at a loss. If that be so, then how come the company was so generous to gift two of its prime properties worth a combined 100 crores or so to two of its honchos?

This is just one classic case of gross misuse of subsidies by entities like IFFCO. This may also be just tip of the iceberg waiting to be discovered by your administration. Why should we tax payers pay a portion of our hard earned money to facilitate such generous payouts by such irresponsible entities?

 Kindly consider these observations accordingly, and wishing you all the very best in your endeavours.

Respectfully,

Navneet Dhawan