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The Bulletin
October 2016
Vol. 7 Ed. 9
Monetary to fiscal
Point of inflection
FOCUS on Frankfurt’s new path
Charles Goodhart, Geoffrey Wood on QE risks
Kingsley Chiedu Moghalu on African democracy
Vicky Pryce on Germany and the G20
Ignazio Visco on the euro policy mix
William White on zombie banks and companies
Global Public Investor 2016 is the third annual report by OMFIF on public
sector asset management and ownership. The increased detail and
coverage builds on analysis in the 2015 and 2014 editions.
GPI 2016 is focused on two fundamental developments on the world
investment scene: the use of a rising number of currencies in world asset
management; and the growth of low-carbon investment, part of a general
upgrading of the importance of sustainable investment.
Selected media coverage
GPI 2014
GPI 2015
GPI 2016
The march of the
sovereigns
The Economist
17 June
Global state investors shift
into property
Financial Times
20 May
China’s central bank remains
world’s top public investor
China Daily
29 June
Heimliche Strippenzieher
der Finanzwelt
Die Welt
27 June
Sovereign funds risk inflating
global property bubble
South China Morning Post
21 May
Central banks lead fall in
GPI’s assets in 2015
The Business Times
29 June
To order your copy visit www.omfif.org/shop
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Contents
October 2016
- Vol. 7 Ed. 9
COVER STORY: Monetary to fiscal
Monthly Review
October 2016
Frankfurt forges
European path
6-7 Briefings – OMFIF meetings, Advisory Board
International monetary policy
8
FRANKFURT
Limits of ‘low-for-long’ interest rates
Stijn Claessens, Nicholas Coleman, and Michael Donnelly
10 Merkel’s tasks for divided continent
III Enhanced prowess and responsibilities
Ben Robinson
11 Global liquidity under pressure
V Formidable springboard for the future
FrankfurtRheinMain
Vicky Pryce
Ben Robinson
12 Fed holds off amid election campaign
VI Promising real estate pipeline
FrankfurtRheinMain
Darrell Delamaide
13 Quite erroneous policy
VII Combining lifestyle and performance
Stefan Bredt and Armin Winterhoff
Charles Goodhart and Geoffrey Wood
Sustainable investment
7
14 Market approach to climate change
Flavia Micilotta
Europe
15 A suboptimal policy mix
Ignazio Visco
16 Italy’s ‘doomsday’ scenario
Steve H. Hanke
17 Cyprus, Greece and ‘whatever it takes’
Panicos Demetriades
18 Costs for financial system
Peter Warburton
Emerging markets
19 Renminbi payments show limited gains
Ben Robinson
20 Three headwinds for Brazil
Danae Kyriakopoulou and Bhavin Patel
22 Directing policy to growth sectors
Donald Mbaka
23 African democracy: work in progress
Kingsley Chiedu Moghalu
Book review
26 Best chancellor New Labour never had
William Keegan
OMFIF Advisory Board poll
27 ECB expected to extend QE to new asset classes
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22
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C O NTE NT S | 3
OMFIF
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www.omfif.org
@OMFIF
Board
John Plender (Chairman)
Jai Arya
Jean-Claude Bastos de Morais
Pooma Kimis
Edward Longhurst-Pierce
David Marsh
John Nugée
Peter Wilkin
Advisory Board
Meghnad Desai, Chairman
Phil Middleton, Deputy Chairman
Louis de Montpellier, Deputy Chairman
Frank Scheidig, Deputy Chairman
Songzuo Xiang, Deputy Chairman
Dialogue on world finance and economic policy
The Official Monetary and Financial Institutions Forum is an independent platform for
dialogue and research. It serves as a non-lobbying network for worldwide public-private sector
interaction in finance and economics. Members are private and public sector institutions
globally. The aim is to promote exchanges of information and best practice in an atmosphere
of mutual trust. OMFIF focuses on global policy and investment themes – particularly in
asset management, capital markets and financial supervision/regulation – relating to central
banks, sovereign funds, pension funds, regulators and treasuries.
Analysis
OMFIF Analysis includes research and commentary. Contributors include in-house experts,
Advisory Board members, and representatives of member institutions and academic
and official bodies. To submit an article for consideration contact the editorial team at
[email protected]
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under the OMFIF Rules, where the source of information shared is not reported. A full
list of past and forthcoming meetings is available on www.omfif.org/meetings. For more
information contact [email protected]
Membership
OMFIF membership is comprised of public and private institutions, ranging from central
banks, sovereign funds, multilateral institutions and pension plans, to asset managers, banks
and professional services firms. Members play a prominent role in shaping the thematic
agenda and participate in OMFIF Analysis and Meetings. For more information about OMFIF
membership, advertising or subscriptions contact [email protected]
Advisory Board
The OMFIF 168-strong Advisory Board, chaired by Meghnad Desai,
is made up of experts from around the world representing a
range of sectors, including banking, capital markets, public
policy and economics and research. They support the work of
OMFIF in a variety of ways, including contributions to the monthly
Bulletin, regular Commentaries, seminars and other OMFIF
activities. Membership can change owing to rotation.
Mario Blejer, Senior Adviser
Aslihan Gedik, Senior Adviser
Norman Lamont, Senior Adviser
Fabrizio Saccomanni, Senior Adviser
Ted Truman, Senior Adviser
Editorial Team
Danae Kyriakopoulou, Head of Research
Angela Willcox, Production Manager
Julian Halliburton, Subeditor
Ben Robinson, Economist
Darrell Delamaide, US Editor
Wendy Gallagher, Marketing
Strictly no photocopying is permitted. It is illegal to reproduce, store
in a central retrieval system or transmit, electronically or otherwise,
any of the content of this publication without the prior consent of the
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The Bulletin
September 2016
Vol. 7 Ed. 8
Official monetary and financial institutions ▪ Asset management ▪ Global money and credit
Modi and the market
India passes a milestone
The Bulletin
July-August 2016
Vol. 7 Ed. 7
Official monetary and financial institutions ▪ Asset management ▪ Global money and credit
March of female power
The Bulletin
Storm-tossed currencies
Steering through volatility
A referendum and its consequences
FOCUS on Luxembourg’s role in Europe
Darrell Delamaide on Obama’s legacy
Mar Guðmundsson on financial integration
John Mourmouras on debt sustainability
Wang Yao on Chinese green bonds
Caroline Butler on Big Data and markets
Kevin L. Kliesen on the slow US economy
Patrick J. Schena on Saudi sovereign fund
Boris Vujčić on central bank independence
Harald Walkate on impact investment
HISTORICAL REVIEW: SEVEN AGES OF GOLD
June 2016
Vol. 7 Ed. 6
Official monetary and financial institutions ▪ Asset management ▪ Global money and credit
The Bulletin
May 2016
Vol. 7 Ed. 5
Official monetary and financial institutions ▪ Asset management ▪ Global money and credit
Fed and the election
Elusive American dream
Efraim Chalamish on China investment in US
Richard Koo on European self-financing
John Mourmouras on negative interest rates
Michael Stürmer on the geopolitics of oil
Marsha Vande Berg on stagnating wages
Claudio Borio on dollar dominance
Mojmír Hampl on activist central bankers
George Hoguet on Fed political pressures
Ravi Menon on Beijing's debt vulnerabilities
Gary Smith & John Nugée on reserves growth
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EDITORIAL
Monetary point of inflection getting closer
C
entral bankers responded to the global financial crisis with a mix of unconventional policies, including negative rates and asset purchases.
Addressing September’s OMFIF main meeting in Rome, Banca d’Italia Governor Ignazio Visco noted that such policies helped cushion the
initial shock, and that both subsequent GDP growth and inflation would have been lower without them. But they have hardly provided a
panacea. As Visco also noted, such policies have distorted markets and created risks for financial stability.
Extraordinarily loose policies have not only failed to boost growth substantially, but have also created dangerous debt overhangs in many
economies. There have been some collateral effects too, examined in this month’s Bulletin. Charles Goodhart and Geoffrey Wood argue that
these measures have hurt bank profitability, while Stijn Claessens and Nicholas Coleman of the Federal Reserve Board of Governors, and Michael
Donnelly of MIT, consider evidence on the effect on banks’ net interest margins. Ben Robinson presents the findings of an OMFIF report, produced
with BNY Mellon, showing that unconventional policies have reduced the supply of liquid assets for collateral. Panicos Demetriades, former
governor of the Central Bank of Cyprus, highlights the negative consequences for central banks’ credibility and the notion of their independence.
The good news is there are signs that monetary policy is reaching an important inflection point. This might not be apparent at first sight. The
US Federal Reserve defied expectations that it would raise rates at its September meeting. But as Darrell Delamaide argues, this was driven more
by politics than economics – a December rate rise is now a virtual certainty. Meanwhile, the Bank of Japan’s decision to refrain from a rate cut
and introduce yield curve controls in asset purchases confirms a shift to a more flexible approach. Some monetary alchemy will still be needed to
help Japan exit its debt trap without pain – the subject of OMFIF’s latest report, published in September, by John Plender. The case of the Bank of
England is more worrying, maintains Peter Warburton, who argues that even a shock as big as Brexit did not warrant the Bank’s August rate cut.
Yet escaping from this unconventional quicksand dragging down central bankers will not be easy. As Luiz Pereira da Silva of the Bank for
International Settlements told an OMFIF City Lecture in September, central bankers face a ‘singular dilemma’: continuing with such policies
carries dangers in the long run, but exiting also risks market panic. One way to exit is to use more fiscal policy to ease the pain of tightening the
monetary screws. With borrowing rates at historical lows, it is now time for governments to invest and they are not doing enough of it. This
is not just a feature of developed markets: Donald Mbaka of the Central Bank of Nigeria echoes Visco’s warnings of a ‘suboptimal policy mix’.
Despite these risks, the central bank that was the slowest to join the QE party may still find it hard to leave. A third of responses to our
Advisory Board Poll expect the ECB to expand its QE programme into new asset classes instead of letting it expire in March 2017. This could
bring the economics back into the spotlight, but for now Europe’s biggest headache remains its politics. As Vicky Pryce highlights, divisions
across the euro area have risen and anti-euro movements are gaining ground in many countries. Steve Hanke alerts us to a doomsday scenario
for Italian banks – even though the well-publicised problems of Deutsche Bank may provide Italy with a welcome distraction. There may be
some silver linings for the European economy however, as Brexit creates an opportunity for financial centres on the continent. This month’s
edition includes the second in OMFIF’s series of Focus reports, examining the case for Frankfurt. We round off with William Keegan’s review
of an account of his time in politics by Ed Balls, the UK Labour party’s shadow chancellor who lost his parliamentary seat in the 2015 election.
Perils of fiscal policy in disguise
Zombie banks, zombie companies: the reckoning
U
William White, Organisation for Economic Co-operation and Development
nconventional monetary policies – as the bond-buying programmes by central banks in Japan, the US and continental Europe have been
baptised – are really fiscal policy in disguise. As a result of central banks’ transgression into the political sphere, the 40-year period of
central banking independence is now effectively over. We will discover whether this puts the world on to a more or less stable footing.
Current policies foster financial instability. By squeezing credit and term spreads, the business models of banks, insurance companies and
pension funds are put at risk, as is their lending. The functioning of financial markets has changed dramatically, with many asset prices bid
up dangerously high, threatening future growth. Resources misallocated before 2008 have been locked in through zombie banks supporting
zombie companies.
The insidious effects of persistently ‘easy money’ policies can be seen in the alarming slowdown in global growth. Two vicious circles are at
work, with a wounded financial system contributing to both. On the demand side of the economy, accumulating debt creates headwinds that
slow demand, leading to still more monetary expansion and yet more debt. On the supply side, misallocations slow growth, again leading to
monetary easing, more misallocation and still less growth.
There is a route out of the impasse – reliant on government action rather than that of central banks. We need to adopt precepts from
both Keynes and Hayek. To please Keynes, governments should use whatever room they have for fiscal expansion, with an emphasis on
infrastructure investment in concert with the private sector. Into the Hayekian category fall measures to address excessive debt through careful
debt write-offs and restructuring; this might require recapitalisation or closure of those financial firms that made the bad loans. Structural
reforms to raise growth potential and the capacity to service debt will pay longer-term dividends.
A paradigm shift in thinking about how the economy and policy actually work is required – and then the political leadership to bring
about well-balanced and judicious solutions. One way or another, the bill for accumulated debts will have to be met. If we do not marry
the approaches of Keynes and Hayek, the bill will be paid by Greek taxi drivers and German taxpayers – in a fashion that would not only be
profoundly unsatisfactory but also highly disorderly. I hope that this is not the path we end up taking.
William White is Chairman of the Economic and Development Review Committee at the OECD.
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M O NTH LY RE VI E W | 5
Advisory Board
OMFIF has appointed Jenny Corbett to the Advisory Board. For the full list of members, see p.24-25.
Professor Jenny Corbett is distinguished professor in the Crawford School of Public Policy at the Australia National University.
She is reader in the Economy of Japan at the University of Oxford, a Research Fellow of the Centre for Economic Policy
Research and a Research Associate of the Centre for Japanese Economy and Business at Columbia University. She was formerly
the executive director of the Australia-Japan Research Centre. She has been a consultant to the Asian Development Bank, the
Organisation for Economic Co-operation and Development, the World Bank and the European Commission.
‘Clouded outlook’ for Europe and euro
T
he clouded outlook for Europe and the euro following the UK vote to leave the European
Union, and the need for flexible and innovative fiscal and monetary policies to lift growth
and employment, topped the agenda at an OMFIF Economists Meeting at the National Bank
of Hungary on 29 September.
There was a general discussion about the impact of the UK vote on faultlines in Europe,
and agreement that this had caused great political uncertainty in all 28 member states, with
UK doubts and questions about how to go forward compounding the problems. On a more
optimistic view, the meeting heard, the UK would become associated with the EU through
some form of ‘satellite relationship’ that would allow the City of London to maintain business
through modified ‘passporting’ arrangements.
On a more pessimistic reading, delegates discussed how the EU was heading towards a
painful period of transition, with heightened tensions both within and between members and
non-members of the euro. The meeting also heard how the National Bank of Hungary was adjusting to increased vulnerability and pressure
on GDP growth with a new monetary policy approach using a more flexible set of instruments. This policy balanced financial and monetary
stability with the bank’s inflation target and credit initiatives under ‘funding for lending’.
Search for better policy mix in Rome
T
he ever more urgent search for a better mix of European fiscal and monetary policies
was a guiding theme at OMFIF’s Seventh Main Meeting in Europe at the Banca d’Italia on
22-23 September in Rome, against a background of slowing growth, high debt and political
fragmentation in many countries.
The overall mood was sombre, with a widespread perception that political risk – from the US
presidential election to an upsurge of anti-European political parties – had increased. One wellknown political speaker said Europe’s leaders were unable to resolve their difficulties because
the continent’s time-honoured recipe of dealing with crises through emergency action forged
in the heat of upheaval was no longer working.
According to another top-line speaker, ‘Not even in the global financial crisis have the
problems been more difficult… There has been an erosion of the mutual trust on which 2008
co-operation was based,’ he said, listing as the main European problems migration, Brexit, the
rise of ‘nationalist and populist’ movements, financial and macroeconomic imbalances, and
banking fragility.
Several speakers underlined the need for innovative thinking on Europe, including the possibility of co-operation between blocs of
countries, placing different degrees of emphasis on political and economic integration. There was a broad discussion throughout the
meeting on the support for ‘populist’ polices in the US and Europe, with opinion divided about the validity and longer-term effects of this
development. For Banca d’Italia Governor Ignazio Visco’s speech see p.15.
Japan’s economy on ‘the edge of a shock’
J
apan’s monetary and financial system is living on the edge of a shock, with the potential to rock a global financial
system still worryingly fragile in the aftermath of the global financial crisis, according to an OMFIF report by John
Plender, published in September.
Almost four years after the launch of ‘Abenomics’ – Prime Minister Shinzo Abe’s three-pronged programme aimed at
reviving Japan’s economy – Japan remains stuck in an atypical debt trap. The country’s aging demographic profile and
history of excessive rates of corporate saving lie at the heart of an unsustainable build-up of debt that has necessitated
increased public spending and caused the government to borrow as a substitute for tax receipts. Abenomics has failed
to reverse this reality radically. Plender identifies three potential scenarios out of the debt trap, all of them problematic,
and concludes that all encompass significant risks of financial stability that could spill over to the rest of the world. For
more details contact [email protected].
6 | M O NTH LY RE VI E W
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At the edge of the shock
Japan’s problematic monetary future
John Plender
21 September 2016
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Canuto: Structural reforms key
O
taviano Canuto, executive director of the
World Bank and member of the OMFIF
Advisory Board, gave a City Lecture on 20
September in London on global imbalances.
These have recently re-emerged as an
important topic for policy-makers, with current
account positions across economies diverging
again after a narrowing of imbalances
following the global financial crisis. A
rebalancing of internal and external objectives
across countries would help support global
growth, but it is not a panacea: country-specific agendas of structural reforms are key to help
economies overcome ‘income traps’. Canuto also touched on the economic outlook of his
home country, Brazil. While he admitted that the economy is suffering from a double malaise
of productivity anaemia and ‘fiscal indigestion’, he argued that a reduction in the risk premium
for businesses, more competition in the private sector, and improved efficiency in the public
sector should all contribute to a stronger economy.
Rules ‘unevenly enforced’
F
inancial globalisation provided ‘freedom’ for
advanced economies to run large current account
deficits that amplified the effects of the crisis on
emerging markets, Luiz Pereira da Silva, deputy general
manager of the Bank for International Settlements,
told an OMFIF City Lecture on 19 September in London.
Pereira da Silva drew attention to challenges facing
emerging markets such as the uneven enforcement
of rules in the international system. On advanced
economies, he highlighted the ‘singular dilemma’ faced
by international monetary policy-makers, between
continuing with risky and decreasingly effective monetary policies and entering tightening that
could cause market panic.
Asia meetings
OMFIF Singapore office opening reception
A reception to mark the opening of the
OMFIF office in Singapore in the presence
of Lord (Meghnad) Desai, chairman, OMFIF
Advisory Board, Prof. Kishore Mahbubani,
Dean, Lee Kuan Yew School of Public Policy
and Mr Ravi Menon, managing director of
the Monetary Authority of Singapore.
16 November, Singapore
Positioning Asia for growth in a challenging
global economic environment
The gathering brings together senior
representatives of official and private sector
institutions from Singapore, the Asia Pacific
region and beyond to discuss critical policy
and investment issues facing the region.
Co-hosted by the Monetary Authority of
Singapore.
17 November, Singapore
Financial stability in an uncertain global
environment
The goal of the seminar is to have candid,
interactive discussions of the most significant
current threats to financial stability, what
needs to be done now to mitigate the most
significant risks, what potential spillovers
might occur, and whether crisis management
arrangements are sufficient.
23 November, Kuala Lumpur
For details visit www.omfif.org/meetings.
Governments ‘should move on stimulus’
G
overnments globally must place greater emphasis on fiscal stimulus and systemic reform to
raise growth in view of low interest rates and diminishing effectiveness of monetary policy,
Carolyn Wilkins, Bank of Canada first deputy governor, told an OMFIF City Lecture in London on
14 September.
Wilkins outlined the dangers of slow growth, caused by structural factors such as weak
demographics and decelerating productivity. The effects include threats to financial stability,
as lower neutral rates raise the risks for indebted households and impede the effectiveness of
monetary policy. To address these concerns, Wilkins argued for promoting a sound global financial
system through greater use of macroprudential tools, and stressed the importance of pro-growth
policies, particularly on the fiscal side.
Greater coordination needed in Beijing
Election influence on Fed rate decision
On 3 October, the first day for markets following the renminbi’s
inclusion in the special drawing right, OMFIF held a telephone
briefing which discussed the need for greater coordination between
economic and financial reforms in Beijing. Ben Shenglin,
executive director, Renmin University International
Monetary Research Institute, moderated the
call between Alain Raes, chief executive, EMEA
and Asia Pacific, SWIFT and Linda Yueh, fellow in
Economics at St Edmund Hall, Oxford University.
Nick Verdi, senior foreign exchange strategist at Standard Chartered
Bank, and Joseph Gagnon, senior fellow at the Peterson Institute for
International Economics, told an OMFIF telephone briefing on 20
September that the US Federal Reserve was unlikely
to raise rates the following day, reflecting the
influence of the electoral cycle. The discussion also
covered the Bank of Japan, with speakers agreeing
that more monetary policy action was needed to
support growth in the Japanese economy.
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M O NTH LY RE VI E W | 7
Limits of ‘low-for-long’ interest rates
How fluctuating economies affect bank margins and profits
Stijn Claessens, Nicholas Coleman, and Michael Donnelly
W
hile overall bank profitability in banks are reluctant to lower interest rates.
advanced economies, measured by As they must pass on lower rates on assets
return on assets, has recovered from the linked to contractual repricing terms (such as
worst of the global financial crisis, it remains floating rate loans) to borrowers with other
low. Many banks are facing profitability financing choices – and have an incentive
challenges related to low net interest to do so – bank margins compress as rates
margins, typically measured as net interest decline.
income divided by interest earning assets,
and weak loan and non-interest income
growth.
Net interest margins
While NIMs across many banks in
are lower when
advanced economies have been trending
interest rates are low –
downwards over the longer term, they have
fallen more sharply since the financial crisis –
banks must pass on lower
in part, it appears, because of lower interest
rates on assets linked to
rates.
In many ways, banks can benefit from
contractual repricing terms.
low interest rates both directly (such as
through valuation gains on securities they
hold) and indirectly (for example, levels
Analysing a sample of 108 relatively large
of non-performing loans will be lower as international banks, many from Europe and
borrowers’ debt service is less burdensome). Japan, and 16 from the US, Claudio Borio,
On the narrower question of the effects of Leonardo Gambacorta and Boris Hofmann, in
low interest rates on banks’ NIMs, however, their 2015 paper ‘The influence of monetary
Chart
Advanced economies
most onby bank
low yields
analytics
and1: empirical
findings suggest affected
that policy
profitability’ (BIS Working
NIMs are lower when interest rates are low.
Paper 514, October 2015), documented the
and median
of short
yields,negative
%, and loweffects
interest of
ratelow
boundary
LowRange
short-term
interest
rates can -term
depress
interest rates (and
bank margins. For many types of deposits, shallow yield curves) on banks’ NIMs and
“
profitability, concluding that effects were
stronger at lower interest rates.
Evidence from the US supports this
conclusion, though the direct effects of
low rates are relatively small. Analysis for
Germany suggests normally small long-run
effects of interest rate changes on NIMs, but
large effects in the recent, low-interest rate
environment. Evidence for other countries
has been more scarce.
New analysis: data and methodology
Our new cross-country analysis confirms
and expands on these findings. A database
was assembled with 3,418 banks from 48
countries for the period 2005-13. Countries
were classified each year as being in either
a low- or high-rate environment, based on
whether the interest rate on their threemonth sovereign bond was below or above
1.25% (other cut-offs were also tested and
yielded similar results).
Chart 1 shows the sample of countries
covered and the range and median of the
short-term yields in each country. The
variations in rates are large for a number of
countries, with many both in the high- and
low-yield environment for some time (the
25
Chart
1: Advanced economies affected most by low yields
Range and median of short-term yields, %, and low interest rate boundary
20
15
10
5
Jamaica
Turkey
Greece
Venezuela
Indonesia
Romania
South Africa
Colombia
Hungary
Mexico
Portugal
India
Lebanon
New Zealand
Russia
Lithuania
Philippines
Australia
Poland
Croatia
United Kingdom
Peru
Brazil
Norway
Israel
South Korea
Bulgaria
United States
Thailand
Austria
Ireland
Slovakia
Denmark
Canada
Finland
Netherlands
Italy
Spain
Belgium
France
Germany
Sweden
Czech Republic
Hong Kong
China
Singapore
Switzerland
Japan
0
Interest rate range
Boundary for low interest rate (1.25%)
Median three-month sovereign yield
Source: Bloomberg, FRB staff calculations. Values used are yearly averages of the implied three-month rate published by Bloomberg.
8 | I NTE RN ATI O N A L M O N E TA RY P O L I CY
Source: Bloomberg,
Federal Reserve
staff calculations
omfif.org
O c to b e r | © 2 0 1 6
Net interest margins and return on assets, %
median provides a sense of how long each
country has been in each environment).
Particularly advanced economies faced
low yields after the global financial crisis –
19 such countries in 2009 as opposed to just
two in 2005. These shifts help to estimate
the differential impact of low rates on banks’
NIMs.
Chart 2 shows that average NIMs are higher
in the high-rate environment than in the lowrate environment. Profitability, measured by
return on assets, is higher too in the highrate environment. This is likely to reflect both
higher NIMs and concurrent better overall
economic and financial environments.
To isolate effects, we regressed the NIMs
for all banks for each year on the average level
of the three-month sovereign rate in that year
(a common proxy for banks’ marginal funding
costs) – controlling for the bank’s own lagged
NIM, other time-varying bank characteristics,
and a bank fixed effect, as well as GDP growth
and the spread between the three-month
and 10-year sovereign rates. The sample was
then split into banks in low- and high-interest
rate environments.
The results show that a decrease in the
short-term interest rate lowers NIMs in
both low- and high-rate rate environments,
with effects symmetric for an interest rate
increase. But, all other things being equal,
effects are statistically greater in a low-rate
environment.
Chart 3 summarises the regression results.
For a representative bank, a one percentage
point decrease in the short-term rate is
associated with a 0.09 percentage point
decrease in NIM in the high-rate environment
versus a 0.17 percentage point decrease in
the low-rate environment.
Chart 2: Negative impact when rates fall below 1.25%
Net interest margins and return on assets, %
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Net interest margins
Low-interest rate environment
Return on assets
High-interest rate environment
Source: Bankscope, Federal Reserve staff analysis
We also analysed separately the effects
of movement in interest rates on changes in
Source: Bankscope, Federal Reserve staff analysis
interest expenses and interest income.
The more pronounced effects on NIMs in
the low-rate environment are largely driven
by the greater pass-through of low rates
on interest income rather than on interest
expenses.
Specifically, a one percentage point
decrease in the short-term rate is associated
with a 0.63 percentage point decrease in the
ratio of interest income to earning assets
in the low-rate environment, and only a
0.35 percentage point decrease in the highrate environment, a 0.28 percentage point
difference. The equivalent difference is
Chart 3: Short-term rates drive bank returns
impact on bank
margins
in low bank
and highreturns
interest rate environments (bps)
Chart Estimated
3: Short-term
rates
drive
Estimated impact on bank margins in low- and high-interest rate environments (bps)
0
-10
-20
-30
-40
-50
around 0.20 percentage points for the ratio
of interest expense to liabilities.
In other words, at low rates, banks have
greater difficulty reducing their funding rates.
Moreover, they still largely have to pass the
lower rates on to their borrowers.
This is likely to be due to greater
competition, including from non-bank
lenders, and lower demand for loans.
Economic activity is lower in times of low
interest rates, causing NIMs to decline more.
Overall effects and conclusions
While there are caveats, our findings strongly
suggest that NIMs are low when interest
rates are low.
An important issue then is how banks can
adjust their activities and cost structures to
offset adverse effects on profitability and
capital. Although institutions are making
adjustments, such efforts take time, with
limited immediate pay-offs when facing
weak cyclical conditions and deleveraging
pressures.
This poses a challenge for banking systems
in many low-interest rate countries. Until lost
income can be offset through other actions,
lower profitability will reduce financial
institutions’ ability to build and attract capital.
This increases their vulnerability to
shocks and declines in market confidence,
undermines their ability to support the
real economy, and potentially weakens the
transmission channel of monetary policy.
▪
-60
-70
Net interest margin
Interest income margin
Low-interest rate environment
Interest expense margins
High-interest rate environment
Source: Federal Reserve staff analysis
Source: Federal Reserve staff analysis
O c to b e r | © 2 0 1 6
omfif.org
Stijn Claessens and Nicholas Coleman are Economists at
the Board of Governors of the Federal Reserve System.
Michael Donnelly is a Masters student at MIT. The views
expressed are those of the authors and should not be
attributed to the Board of Governors of the Federal
Reserve System.
I NTE RN ATI O N A L M O N E TA RY P O L I CY | 9
Merkel’s tasks for divided continent
Taking responsibility for unachievable G20 pledges
T
Vicky Pryce, Advisory Board
he G20 leaders’ communiqué on 5
September following their summit
in Hangzhou, China, was the last before
Germany takes over the G20 leadership on
1 December. It was, as would be expected,
a positive one, full of good intentions –
geopolitical stability, solving the refugee
crisis, containing environmental damage,
fighting terrorism, and so on.
On the economic front, the leaders
acknowledged that although the world
recovery was ‘progressing’, this was not
happening fast enough. Investment and
trade remain sluggish, unemployment is still
too high in many countries, and volatility in
commodity and financial markets provides a
threat to stability.
The threat of protectionism emerges when
economies do less well. At times the threat
is realised, backed by populist movements,
before unravelling over time. But the damage
can be significant.
The G20 leaders called for protectionist
trends to be curtailed and restated their
commitment to reducing trade barriers
further, setting themselves firmly against
competitive devaluations. The fear of
protectionism and its negative impact on
world trade were also highlighted by the
International Monetary Fund in its latest
World Economic Outlook published in early
October.
A tide of nationalist fervour
But this is hard to achieve against a tide
of increased nationalist fervour, in both
economics and politics. Despite the rhetoric,
a World Trade Organisation report on G20
trade restrictions, published in June, found
that around 70% of restrictive measures were
instigated by G20 economies.
The campaign slogan ‘Taking back control’
was instrumental in convincing the majority
of British voters to support ‘Brexit’ on 23 June.
Donald Trump’s presidential campaign in the
US has protectionism, even isolationism, as
its core message.
Europe, severely shaken by the British
vote to leave the European Union, has yet to
decide in a cohesive way how to respond –
something that the divisions evident at the
conclusion of the EU’s Bratislava summit on
16 September made very clear.
Meanwhile, nationalist parties are gaining
ground in France, Italy, the Netherlands,
Austria and Germany. Countries such as
Poland, Hungary, and Slovakia protest that
their voices are not being heard. Hungary’s
2 October referendum overwhelmingly
1 0 | E U ROPE
Angela Merkel, Chancellor of Germany
rejected European refugee-sharing proposals,
although turnout was below the threshold
for validity.
Southern Europeans are increasingly
united and vocal about the unfairness, as
well as the negative economic and social
impact, of policies often perceived as being
imposed by supranational European policymakers. This creates the strong impression of
a divided Europe.
One of the G20 leaders’ main pledges
clearly is not being met, namely the need for
well-designed and coordinated monetary and
fiscal policies to achieve ‘strong, sustainable,
balanced and inclusive growth’.
Rhetoric and reality
The European Central Bank is doing what it can
on the monetary front, but this alone will not
guarantee balanced growth. That requires
other policy elements, including fiscal.
The G20 sets down a high standard: ‘We
are using fiscal policy flexibly and making tax
policy and public expenditure more growthfriendly, including by prioritising high-quality
investment, while enhancing resilience and
ensuring debt as a share of GDP is on a
sustainable path.’
The reality is somewhat different. Spain
and Portugal narrowly escaped being fined
for missing their deficit targets. Southern
European countries’ debt to GDP ratios
remain unsustainable – not only Greece’s
188% but Italy’s 137%, Portugal’s 130%, and
Spain’s now nearly 100%.
At the opposite extreme, Germany has
ignored bodies including the Organisation
for Economic Co-operation and Development,
the European Commission and the
International Monetary Fund by running
a budget surplus and a current account
omfif.org
surplus of some 7% of GDP. The current
account surplus this year is expected to be
even more, 9% of GDP
The popularity of Angela Merkel, the
German chancellor, is falling following last
year’s significant influx of refugees. This led
to her suffering setbacks in recent regional
elections.
In Italy a constitutional referendum on
4 December could result in Prime Minister
“
The threat of
protectionism emerges
when economies do less
well. At times the threat
is realised, backed by
populist movements, before
unravelling over time. But the
damage can be significant.
Matteo Renzi’s downfall, though Renzi has
stated that his government will remain in
place irrespective of the result.
There is still no firm government in Spain
after two elections – a third is expected
in December – and increasing talk of new
elections in Greece.
Merkel must be wishing that another
country could head the G20 from 1 December.
Taking responsibility for unachievable G20
pledges adds one more task to her list of
unenviable challenges.
▪
Vicky Pryce is a Board Member at the Centre for
Economics and Business Research and a former Joint
Head of the UK Government Economic Service.
O c to b e r | © 2 0 1 6
Global liquidity under pressure
OMFIF report highlights role of Global Public Investors
G
Ben Robinson
lobal liquidity – a vital ingredient in
the factors driving markets and growth
worldwide – has been under severe strain in
the eight years since the financial crisis. This
is underlined by periodic disruption in even
the most liquid market of sovereign bonds,
as well as limits on some fund redemptions
and less frequent trades and lower turnover
for some assets. As an OMFIF report
published on 11 October demonstrates,
global public investment institutions have
contributed to this situation, but sovereigns
show a growing willingness to play a role in
mitigating the challenges.
Low interest rates from central banks led
to an expansion of high-yield and ‘junk’ bond
issuance, while large public purchases of safe
and liquid assets reduced yields for investors,
pushing them towards these riskier assets.
A second cause of lower liquidity – the
tightening of banking regulations which have
raised the cost of balance sheet-intensive
activities such as market-making – has meant
banks have become less able and less willing
to stabilise markets. In the past, banks and
securities firms helped smooth the market
when an immediate buyer or seller could
not be found, by using their balance sheet
to become the counterparty to trades.
However since 2008 they have lowered
their inventories by over 80%, reducing their
ability to play a stabilising role.
Substantial dangers
The result is a large growth in primary market
issuance despite a lack of secondary market
depth, making assets vulnerable to rapid
price corrections when monetary policy or
market sentiment changes. The speed with
which this may happen has increased as
market participants have changed, including
the growth of ‘shadow banking’ institutions,
mutual funds and high-frequency traders,
adding to complexity over counterparty risks
and trade strategies.
The dangers are substantial. If liquidity in
financial markets and the ability of corporate
and sovereign bond issuers to raise funds at
affordable prices are reduced, second round
effects could emerge which set off a series of
bankruptcies and insolvencies.
As seen after the financial crisis, when
trust in financial markets evaporates, along
with confidence in the quality of assets and
the ready availability of funds on which
liquidity depends, the reverberations can be
deep and long-lasting.
The prospect of divergent monetary policy
between different central banks brings these
O c to b e r | © 2 0 1 6
risks to the fore, as many emerging economies
are highly leveraged, many mutual funds offer
open-ended daily redemptions, and large
amounts of post-crisis debt issuance remain
outstanding. Future US rate hikes risk asset
price deflation, a decline in new issuance and
an increase in short positions.
In this context, compensating for the lack
of liquidity-enhancing but balance sheetintensive activities of banks, stabilising
markets to prevent investor runs, and
ensuring access to wholesale market funding
are vital to avoiding a liquidity shock. As
underlined by an OMFIF survey of sovereign
institutions with $4.74tn in assets under
“
Compensating for
the lack of liquidityenhancing but balance
sheet-intensive activities of
banks, stabilising markets
to prevent investor runs,
and ensuring access to
wholesale market funding
are vital to avoiding a
liquidity shock.
management, sovereigns are willing to meet
these challenges, particularly via increased
capital markets activities such as securities
lending and direct funding of less-liquid asset
classes including private debt and equity.
Among other palliatives, sovereign
investors suggest widening collateral eligibility
for repo transactions, increasing sovereign
participation in wholesale funding markets,
‘renting’ their balance sheets, and directly
funding some assets and projects to offset
some of the issues of bank disintermediation.
Obstacles to overcome
Reforms to market infrastructure
and practices can offset some of these
challenges, including via better collateral
valuation rules and margining policies, as
well as increased counterparty risk
management. The tri-party repo reform in
the US, and the European Markets
Infrastructure Regulation which places a
central clearing counterparty between
traders, have helped to tackle some of
these concerns. They have, however, raised
costs and increased demand for high quality
collateral. This raises the importance of
collateral management and reuse facilities
from custody banks.
Scope for sovereign involvement
The desirable level of sovereign institutions’
involvement in capital markets is contested,
with some survey respondents arguing that it
is not the role of official institutions to price
risk or make markets, and should instead act
as asset managers with a long-term view.
However more than 40% of institutions
believe there is an increased capital markets
role for sovereigns as a result of bank
disintermediation.
The potential benefits are significant:
not just an increase in market liquidity and
resilience to destabilising shocks, but also
the rewards of higher yields to offset the
disbenefits of low or negative interest rates
on high-quality liquid assets.
Ben Robinson is Economist at OMFIF. This is an
edited version of ‘Mastering flows, strengthening
markets: how sovereign institutions can enhance
global liquidity‘. For a copy of the report, please
contact [email protected].
Mastering flows
Strengthening markets
Obstacles need to be overcome, however,
including regulations on banks and dealers, a
lack of coordination between regulators and
sovereigns, and a lack of coordination among
sovereigns themselves.
Some GPIs need to overcome internal
rules that prevent them from pursuing a
more active role in securities lending or repo
markets. They need to manage the implied
counterparty, credit, collateral and cash
collateral reinvestment risk involved in these
expanded activities.
How sovereign institutions can
enhance global liquidity
omfif.org
I NTE RN ATI O N A L M O N E TA RY P O L I CY | 1 1
In association with
Fed holds off amid election campaign
December rate hike likely after 8 November vote
D
Darrell Delamaide, US editor
espite the protests to the contrary, it was
never likely that the US Federal Reserve
would raise interest rates in September, just
weeks before the presidential election. Even
less so in November, just days before the
vote.
Fed chair Janet Yellen sought to emphasise
at the press conference following the late
September meeting of the Federal Open
Market Committee that the US central bank is
not political in any way, shape or form.
‘I can say, emphatically, that partisan
politics plays no role in our decisions about
the appropriate stance of monetary policy,’
she said in response to a question. ‘We do not
discuss politics at our meetings and we do not
take politics into account in our decisions.’
But that affirmation means it could not
take any action with uncertain consequences
so close to an election.
Raising rates could have a negative impact
on stock prices. Making the move just as the
last voters are making up their minds would
bring a barrage of criticism from the staff of
Hillary Clinton, who is campaigning on the
steadiness of the economy under her fellow
Democrat, Barack Obama.
‘Fed doing political things’
Of course, not taking action can also be
interpreted as political, and Donald Trump
did not hesitate to level this charge in the first
presidential debate.
‘We are in a big, fat, ugly bubble,’ Trump
said, commenting on the US economy. ‘And
we better be awfully careful. And we have a
Fed that’s doing political things. This Janet
Yellen of the Fed. The Fed is doing political –
by keeping the interest rates at this level.’
The controversial candidate continued in
his colourful, stream-of-consciousness way:
‘And believe me: The day Obama goes off,
and he leaves, and goes out to the golf course
for the rest of his life to play golf, when they
raise interest rates, you’re going to see some
very bad things happen, because the Fed is
not doing their job. The Fed is being more
political than secretary Clinton.’
Some Fed officials themselves have voiced
concerns about asset bubbles forming after
the long period of low interest rates, so
Trump’s critique is not outlandish.
But his personalising the criticism and
directing it at Yellen puts her in an awkward
position if Trump wins the election – which
cannot be ruled out. Some analysts have
gone so far as to suggest that Yellen would
step down in the event of a Trump victory,
even before the December FOMC meeting, if
1 2 | I NTE RN ATI O N A L M O N E TA RY P O L I CY
only to take the heat off the other Fed policymakers.
That may sound somewhat far-fetched,
but it indicates that the Fed cannot help
but be drawn into the political quicksand of
this bizarre election. It does not necessarily
mean, however, that the Fed’s explanation for
leaving rates unchanged in September is just
so much window-dressing.
‘The Committee judges that the case
for an increase in the federal funds rate
has strengthened but decided, for the
“
Esther George, President, Kansas City Fed
Some Fed officials
have voiced concerns
about asset bubbles forming
after the long period of low
interest rates.
time being, to wait for further evidence of
continued progress toward its objectives,’
the consensus statement read. ‘The stance
of monetary policy remains accommodative,
thereby supporting further improvement in
labour market conditions and a return to 2%
inflation.’
could provoke a negative market reaction
that would give the Fed pause.)
In a widely noted speech the week before
the FOMC meeting, Fed governor Lael
Brainard signalled decisively that the Fed
would wait on action. She said in Chicago that
‘the costs to the economy of greater than
expected strength in demand are likely to be
lower than the costs of significant unexpected
weakness.’
Brainard, who many think could become
Treasury secretary if Clinton wins, concluded:
‘This asymmetry in risk management in
today's new normal counsels prudence in the
removal of policy accommodation.’
Dissent among the FOMC
Restless regional bank chiefs
However, there was an unusually high level
of dissent. Three of the five regional bank
heads who are voting members – Esther
George of Kansas City, Loretta Mester of
Philadelphia, and Eric Rosengren of Boston –
said they would prefer to raise the target rate
for federal funds a quarter point to 0.75%
right now. Only James Bullard of St. Louis and
William Dudley of New York supported Yellen
and the other four in the Washington-based
board of governors.
Could a decision come in November, she
was asked at the press conference. ‘Every
meeting is live, and we will again assess as we
always do incoming evidence in November
and decide whether or not a move is
warranted.’ Don’t hold your breath.
But Yellen also said that ‘most participants
do expect that one increase in the federal
funds rate will be appropriate this year, and I
would expect to see that if we continue on the
current course of labour market improvement
and there are no major new risks that develop
and we simply stay on the current course.’
This seems to make a rate hike in December
a virtual certainty, barring any unexpected
bad news. (A Trump victory, for instance,
omfif.org
But the regional bank chiefs are restless. In
an unusual move, Rosengren, usually a dove,
issued a statement defending his dissenting
vote: ‘The economic progress since the last
tightening in December might, by itself, be
sufficient to justify a further increase in the
rate target. However, it is in considering
the implications of current policy for the
sustainability of the expansion that the case
for raising rates has now become even more
compelling.’
Another dove, San Francisco Fed chief
John Williams, indicated that the dissenting
voters have support for their arguments from
the seven regional bank heads who currently
do not have a vote.
‘It is getting harder and harder to justify
interest rates being so incredibly low given
where the US economy is and where it
is going,’ he told Reuters in an interview.
‘I would support an interest rate increase.
I think that the economy can handle that. I
don’t think that would stall, slow or derail the
economic expansion.
▪
Darrell Delamaide is a writer and editor based in
Washington.
O c to b e r | © 2 0 1 6
Quite erroneous policy
Bond-buying has little impact on real economy
Charles Goodhart and Geoffrey Wood
A
t a time when interest rates, throughout
the yield curve, are at an all-time low,
it could be argued that the public sector,
the biggest debtor, should be trying to
lock in such rates by shifting to ever longer
maturities and duration.
However, if one adjusts for central
bank swaps, under which central banks
effectively buy longer-dated government
debt in exchange for sight deposits, the
overall maturity of public sector debt in most
countries practising quantitative easing has
been going down, not up.
We are told that such central bank deposits
need not, indeed should not, ever get repaid.
That they are, or should be, the equivalent of
Consols (a type of British government bond
redeemable at the option of the government)
– quasi-permanent debt.
Jeremy C. Stein, professor of economics
at Harvard University, argues that satisfying
liquidity needs enhances financial stability
and that monetary policy can continue by
varying the interest paid on central bank
deposits.
He adds that enlarged central bank
balance sheets should remain a permanent
feature. But as such reserve deposits are now
interest-bearing, the huge volume of central
bank deposits increases the public sector
interest rate roll-over risk just as much as if
the Treasury had issued a similar amount of
Treasury bills.
Chart 1:
Despite QE,
If liquidity needs are satiated in this way –
at a time when debt ratios have been climbing
at a rate hitherto unparalleled in peacetime –
why are there still claims that interest rates
are being held down by excessive demand for
“
Negative interest rates,
a flat yield curve, and
substantial fines on the
banking institutions are
hardly conducive to greater
profitability.
‘safe’ assets? Is this claim consistent with the
narrowed risk premia now being observed?
Furthermore, if the demand for liquidity,
and reserves, by banks is to remain satisfied,
what then constrains, and determines, the
aggregate money stock, mostly consisting of
commercial bank deposits, and bank lending
to the private sector? The answer, we would
presume, is the availability of bank (equity)
capital. But capital will be made available
only if the business is sufficiently profitable to
earn a competitive return (unless the public
sector injects the capital itself).
In the banking sector, negative interest
rates, a flat yield curve, and substantial fines
on the banking institutions (rather than the
bankers who perpetrated, or failed to prevent,
the misdeeds) are not conducive to greater
profitability. Profitability is procyclical.
Has policy been actively damaging bank
profitability and hence growth of money
and credit? In most academic studies of
the efficacy of monetary policy, all that
appears to matter is the direct link between
riskless official short-term rates, and future
expectations thereof, and the real economy.
In David Reifschneider’s 2016 Federal
Reserve Board paper, ‘Gauging the ability of
the FOMC to respond to future recessions’,
the words ‘bank’, ‘money supply’ and ‘credit’
do not appear. The same official insouciance
about the profitability of financial
intermediation goes wider than just banks.
Insurance companies and pension funds are
pressured to hold matching assets against
their liabilities. Policy then serves to reduce
the availability and yield of such assets.
If the effect of monetary policy has been
to weaken the profitability of financial
intermediation, might this help to explain why
the massive monetary expansion measures
undertaken by central banks have had so
little impact on the real economy? Perhaps
QE has now become ‘Quite Erroneous’.
▪
Charles Goodhart is Professor Emeritus at the London
School of Economics and Political Science. Geoffrey Wood
is Professor Emeritus of Economics at the Cass Business
School.
Despite QE, inflation remains subdued
Annual consumer
pricesubdued
inflation, %
inflation
remains
Annual consumer price inflation, %
6
Fed QE
Nov 2008
5
ECB QE
Mar 2015
BoE QE
Mar 2009
4
3
2
1
0
US
UK
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
-2
2006
-1
Euro area
Source: US Bureau of Labor, ONS, Eurostat, OMFIF analysis
O c to b e r | © 2 0 1 6
omfif.org
I NTE RN ATI O N A L M O N E TA RY P O L I CY | 1 3
Market approach to climate change
Necessary transition to more sustainable economies
Flavia Micilotta, Eurosif
T
he 21st UN Climate Change ‘Conference
of the Parties’, held in Paris in December
2015, ended with the milestone agreement
for countries to reduce their greenhouse gas
emissions sufficiently to keep the increase
in global temperatures well below 2°C this
century.
The agreement established a system for
measuring individual countries’ commitments
and contribution every five years. A progress
assessment is set for 2018.
Although it is too early to determine
whether the agreement has been drafted
sensibly or whether it will deliver on its
commitments, it sets the tone for policies
and businesses.
Investors now have a number of options
to contribute to the transition to a more
sustainable economy. In this context, the
best-case scenario is a race to the top for
both investors and companies to take part in
the fight against climate change.
Policy push
The strongest policy push following the
Paris conference came from France, where
the government encouraged the financial
community to adopt Article 173 of France’s
law on energy transition and green growth.
By asking investors to disclose how they
factor environmental, social and governance
criteria, as well as carbon-related aspects,
into their investment policies, the law points
the way towards more sustainable patterns
of investment.
The Paris agreement also led a number of
investors to reconsider their investments in
oil. Mark Carney, the governor of the Bank
of England, declared in September 2015 that
investors faced potentially significant losses
as a result of climate change action. Following
this, even investors who did not think of
“
Asking investors to
disclose how they factor
environmental, social and
governance criteria, as well
as carbon-related aspects,
into their investment policies,
points the way towards more
sustainable patterns of
investment.
themselves as particularly ‘pro-environment’
began to reconsider the viability of investing
in oil companies. Now they are pondering
the real costs of the carbon bubble.
The European Commission demonstrated
an understanding of the various issues of
relevance to different stakeholders, as well
as strong willingness to support this change.
ESG market indices outperform market counterparts
Growth of S&P 500 and ESG variant of index, %
300
250
200
150
100
50
S&P 500 ESG
S&P 500
S&P 500 ESG Index
Looking to the long term
Embedding these criteria into investment
analysis and portfolio construction across
a range of asset classes is the underlying
principle of sustainable and responsible
investment. According to Eurosif’s definition,
socially responsible investment ‘is a longterm orientated investment approach which
integrates ESG factors in the research,
analysis and selection process of securities
within an investment portfolio. It combines
fundamental analysis and engagement with
an evaluation of ESG factors in order to better
capture long-term returns for investors,
and to benefit society by influencing the
behaviour of companies.’
ESG incorporation In ESG incorporation, investment institutions
complement traditional quantitative analysis
of financial risks and returns with qualitative
and quantitative analyses of ESG policies,
performance, practices and impacts. Asset managers and asset owners can
incorporate ESG issues into the investment
process in a variety of ways. Some may
actively seek to include companies that have
stronger ESG policies and practices in their
portfolios, or to exclude or avoid companies
with poor ESG track records.
Others may incorporate ESG factors
to benchmark corporations to peers
or to identify ‘best in class’ investment
opportunities based on ESG issues. Still other
responsible investors integrate ESG factors
into the investment process as part of a wider
evaluation of risk and return.
Regulators have come a long way in
pushing the socially responsible investment
industry forward. But much can still be
done to help SRI become a significant
factor in the transition to more sustainable
economies.
▪
Flavia Micilotta is Executive Director of Eurosif, the
European Sustainable Investment Forum.
Source: S&P 500 ESG Index
1 4 Source:
| S U STA I N AB L E I N VESTM E NT
2016
2015
2014
2013
2012
2011
2010
2009
0
In the last six months, it has launched two
key consultations. These have examined how
companies can increase their transparency,
following up on the new directive on nonfinancial reporting, and how investors can
improve their standards in respect of longterm and sustainable investments.
Both pieces of the same puzzle, the
consultations have sent a strong message
about the importance of those ‘intangible’
criteria, most often referred to as economic,
social and governance criteria.
omfif.org
O c to b e r | © 2 0 1 6
October 2016
Frankfurt forges
European path
FRANKFURT FOCUS
A growing centre with European and global reach
T
“
his second report in the OMFIF series on European financial centres after the UK European
Frankfurt and its
Union vote goes beyond the issue of financial innovation and capital markets discussed in
hinterland provide
September’s Luxembourg analysis.
We focus on the crucial juxtaposition of the real economy and Europe’s financial sector, giving the crucible for fastFrankfurt and the surrounding Rhine-Main area – known as the FrankfurtRheinMain region – a
developing financial
pivotal place in the overall European economy.
As the heart of European manufacturing, Germany provides traditional emphasis on financing technology companies,
larger and smaller businesses, including the legendary Mittelstand category of smaller, often familyowned firms that form the country’s economic backbone. Frankfurt is a nexus for this interplay as well as expanding
between finance and industry, as well as an important regulatory, financial and monetary policy- foreign investment and
making centre. The city is home to the European Central Bank and the Deutsche Bundesbank, the
trade.
ECB’s most important and often most vocal shareholder.
Frankfurt and its hinterland provide the crucible for fast-developing financial technology
companies, as well as expanding foreign investment and trade that
have been one of the mainsprings of German growth since the 19th
century. Benefiting from roots in German industry, Frankfurt has GFCI financial centre ranking table
global reach, seen in the international activities of Deutsche Börse Top 10 EU performers
and the growing role of renminbi clearing and settlement, as well as
the city’s experience in connecting start-up companies to European
EU
Financial
GFCI 19
and international investors.
ranking
centre
ranking
The potential for interlinked EU projects such as the Commission’s
1
London
1
strategic investment plan and capital markets union points to
further possible extension of Frankfurt’s role in raising funds and
2
Luxembourg
14
mobilising capital. Brexit vicissitudes provide opportunities for
3
Frankfurt
18
Frankfurt expansion, not least its ability to attract international
financial institutions and regulatory bodies, including those which
4
Munich
27
may move from London. This is not a zero sum game; there is plenty
5
Paris
32
of room for growth- and revenue-generating co-operation between
Frankfurt and London, as the planned merger of Deutsche Börse
6
Amsterdam
34
and the London Stock Exchange (whatever the post-UK-referendum
7
Stockholm
37
uncertainties) demonstrates.
Germany and the Frankfurt region have a vital position bridging
8
Dublin
39
the needs of European households and businesses and the
exigencies of dynamic banking and financial markets. In the new
9
Vienna
40
structures emerging after the UK vote, Frankfurt looks set to forge a
10
Warsaw
48
still more important European path.
CONTENTS
Source: Global Financial Centres Index 19 (March 2016),
examining financial centres’ global competitiveness, based on
profiles, ratings and rankings for 86 centres.
II A growing centre with global reach
III Enhanced prowess and responsibilities
Ben Robinson
V Formidable springboard for the future
FrankfurtRheinMain
VI Promising real estate pipeline
FrankfurtRheinMain
VII Combining lifestyle and performance
Stephan Bredt and Armin Winterhoff
‘Frankfurt Focus’ forms part of the OMFIF Bulletin for October 2016. It is not to be distributed separately without permission of OMFIF. The
same disclaimer applies as on p.4 of the Bulletin.
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Enhanced prowess and responsibilities
Ben Robinson
G
“
ermany is Europe’s largest economy, leading exporter, biggest creditor and the base for euro
Euro clearing and
area financial, regulatory and monetary policy-making institutions. Frankfurt is at the heart
settlement activities,
of this activity, as Germany's largest financial centre and a pivotal location for European capital
markets.
the majority of which take
As the home of the European Central Bank and the Bundesbank, Frankfurt is a key location for
non-EU companies and banks, particularly from China, seeking access to European policy-makers place in London, may
and regulators as well as financial market operators across many sectors. This role has become still move within the euro area,
more significant since 2014 when the ECB assumed supervisory responsibility for banks operating
in the euro area, under the Single Supervisory Mechanism. Frankfurt is home to the European again potentially providing
Systemic Risk Board, responsible for macroprudential regulation. The European Insurance and a boost to Frankfurt.
Occupational Pensions Authority is based in the city, as is the European Banking Federation, the
main body for the European banking sector.
Post-Brexit this concentration of institutions, prowess and responsibilities could be strengthened
further. The European Banking Authority, which regulates the European banking sector, is based in London. After the UK
voted to leave the EU the EBA argued that this can no longer continue, placing the institution in search of a new home
within the EU. Though Frankfurt faces competition from Paris, the city’s powerful presence in housing other EU supervisory
and regulatory bodies puts it in a strong position.
Euro clearing and settlement activities, the majority of which take place in London, may move within the euro area,
again potentially providing a boost to Frankfurt. In 2015 the ECB lost a court case seeking to move euro clearing within
the euro area and away from London, on the basis that it would discriminate against an EU member. London may now
be vulnerable to a second attempt. Some industry observers however say that no other EU centre will gain the clearing
business, maintaining that the only financial metropolis with sufficient economies of scale to play this role lies outside the
EU – in New York.
Whether or not various Frankfurt overtures are successful, the uncertainty surrounding the UK’s access to the single
market and to ECB liquidity once it leaves the EU means banks may pre-emptively move at least some of their operations to
the euro area. As unquestionably the euro area’s central banking hub, Frankfurt is well positioned to attract this business.
A European base for Chinese banks
Among the financial institutions that have been attracted to Frankfurt are Chinese banks, including the People’s Bank of
China, which maintains its euro area base in the city, along with the five largest Chinese commercial banks, which have used
the city as a focal point for expanding their European activities. In 2014 Frankfurt was chosen as the location for the first
renminbi clearing and settlement centre outside Asia, following the establishment of a currency swap agreement between
the ECB and the PBoC in 2013, and the granting of Renminbi Qualified Foreign
Institutional Investor status to Germany in 2014.
Access to renminbi
Frankfurt offers a wide range of renminbi products and services to
companies based in the euro area, so long as their bank maintains an account
liquidity facilitates
at the Bank of China in Frankfurt. These include renminbi trading and hedging;
trade between Chinese
opening and processing letters of credit; issuing bank guarantees; processing
and euro area companies
capital transfers in China; and active currency management, via onshore
renminbi hedging and offshore currency swaps.
by removing currency
Access to renminbi liquidity facilitates trade between Chinese and euro
risks, time delays and
area companies by offsetting currency risks, time delays and exchange rate
costs. The share of euro area-China trade denominated in renminbi, currently
exchange rate costs.
around 20%, is expected to double within the next few years, putting Frankfurt
at the centre of an important financial development.
“
Market infrastructure and new technologies
Frankfurt has expanded its role beyond Europe, becoming an important player in global capital markets. It is home to
Eurex, the third-largest derivatives exchange in the world (by contract volume), and the largest futures and options market
in Europe. It has been investing in market infrastructure and new technologies, resulting in it winning many awards for
excellence in European exchange and clearing house performance.
Frankfurt-based Deutsche Börse, one of the leading global stock exchanges, has increased its activities, purchasing
important index providers and trading platforms, including the 360T currency trading platform, contributing to expanded
trading and investment on the Frankfurt exchange.
In response to the opportunities and disruptive repercussions of digitisation sweeping global banking and finance,
Deutsche Börse has invested heavily in fintech. Between 2013 and 2015 German investment in fintech companies increased
more than fivefold, to €580m. This is far ahead of France but still slightly below the UK, the biggest fintech investment
centre in Europe with just over €700m in 2015.
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Vital outcome of Deutsche Börse negotiations
Frankfurt is establishing an incubator for fintech and other financial start-up companies, centred
on the cluster of Goethe University, the Technical School of Darmstadt and the Frankfurt School
of Finance and Management. The stock exchange has established the ‘Venture Network’ platform
to increase interaction between investors and start-ups, as well as providing free space to start-up
companies around the business district, to enhance the city’s role in fintech innovation.
The shape of the planned merger between the Frankfurt and London stock exchanges has not
been completely clarified following the Brexit vote. The structure of the new group, assuming the
merger goes ahead, is still under discussion. Deutsche Börse wants it formed as a joint holding
company, rather than a London-based holding company as was initially planned. This would see
the legal domicile of the company based in London, with the exchange itself remaining in Frankfurt.
The outcome of these negotiations is vital, as losing its globally important stock exchange would
strip Frankfurt of an important string to its financial bow.
“
The shape of the
planned merger
between the Frankfurt and
London stock exchanges
has not been completely
clarified following the
Brexit vote.
Areas for potential growth outside Europe
Frankfurt has diversified its activities and focus over the last few years and some of the main areas for its potential growth
lie outside Europe. In 2015 it opened the China Europe International Exchange, in partnership with the Shanghai Stock
Exchange and China Financial Futures Exchange.
CEINEX was the first platform for authorised renminbi-denominated trading
outside mainland China, helping to establish Frankfurt as a major centre for
As part of a broader
European investors and traders seeking to access Chinese markets. It allows
strategy by Beijing
international investors to buy shares in exchange-traded funds that hold
renminbi-denominated assets, providing access to the Chinese economy that
to internationalise the
was previously subject to restrictions imposed by the Chinese authorities.
renminbi and improve
As part of a broader strategy by Beijing to internationalise the renminbi and
improve access to international investors, Frankfurt benefits from potential
access to international
for further product development and service offerings, providing significant
investors, Frankfurt
growth in renminbi bonds, ETFs and derivatives.
While both Eurex and CEINEX are either owned or partly owned by Deutsche
benefits from potential for
Börse, both have told OMFIF that, even if the planned Deutsche Börse-London
further renminbi product
Stock Exchange merger goes ahead, all activities will remain in Frankfurt.
“
development.
The challenges of benefiting from Brexit
Attracting activities necessary to make Frankfurt a beneficiary of Brexit presents
challenges. It has a less well-established tradition of financial innovation than
other locations, and it has been less active in marketing its services than Paris, Luxembourg or Dublin.
Competition with other financial centres requires substantial investment in new capabilities, infrastructure and skills to
maintain Frankfurt’s edge. The question marks over the EU’s future are weighing on business and investment sentiment
across Europe. So too are, in a specific Frankfurt setting, the difficulties burdening Deutsche Bank and (to a less severe
extent) Commerzbank, the county’s premier two banks. However, many of the causes – including global banking regulations,
low and negative interest rates, worries over excessive debt, and the sluggish euro area economy – are exacting a toll on
Germany’s rivals too.
Väth: ‘Frankfurt cannot and does not want to replace London’
“
The exact role Frankfurt plays as a financial centre may be limited by factors outside its control.
These two diverse
Yet the city prides itself on its solid foundations, its efficiency and technological development, as
well as its linkages with Europe’s strongest real economy. As Hubertus Väth, managing director of
yet complementary
Frankfurt Main Finance, has said, Frankfurt cannot and does not want to replace London. Instead
cities play interlocking
it hopes to play to its strengths and improve its position in core areas.
As the global financial system evolves, Frankfurt is gaining over other European financial centres roles in wholesale
in its commitment to fintech and improving financial market infrastructure. While it is unlikely banking and trading,
to replace London as ‘the central financial centre’, Frankfurt could become an important bridge
linking London, China and other fast-growing economies to the euro area. All of these developing international asset and
country partners will in time become platforms for capital market activities on both the asset and wealth management and
liability side of western firms’ and asset managers’ balance sheets.
Against this changing international background, with the gravitational centre of world finance corporate deal-making.
moving gradually yet inexorably toward Asia, there is abundant potential for beneficial linkages
between London and Frankfurt. These two diverse yet complementary cities play interlocking
roles in wholesale banking and trading, international asset and wealth management and corporate deal-making.
There is no reason why these twin metropoles – a Continental financial nucleus embedded in the real economy and a
globally connected, multivalent money centre close to, yet outside, the EU – cannot co-exist on highly favourable terms for
all involved.
▪
Ben Robinson is Economist at OMFIF.
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Formidable springboard for the future
FrankfurtRheinMain
T
“
he UK’s vote to leave the European Union has prompted much discussion of possible
Even without
alternatives to London. Some companies and banks with a presence in the City, and Britain
more broadly, may be required to extend their European footprint. Some may decide to leave
concrete indications
the UK altogether to protect their European market share.
of Brexit’s eventual shape,
Frankfurt is taking a different approach to many of its European and global competitors
for foreign direct investment. The city and the surrounding region are not aiming to convince companies in both the
businesses to leave the UK. Rather, FrankfurtRheinMain is positioning itself as a powerful and UK and Germany are
dynamic alternative for companies that are required for any reason to seek a continental solution
drawing up scenarios and
for future growth.
Frankfurt’s financial sector and international airport – comparable in size to London’s contingency plans.
Heathrow or Charles de Gaulle in Paris – are well known. The mutually reinforcing benefits of the
FrankfurtRheinMain region are less immediately evident, but all the more relevant for businesses
taking a longer-term view.
Large numbers of foreign businesspeople visit Frankfurt each year to participate in international
trade fairs. This benefits both the city and the surrounding region, which has a centuries-old record of welcoming,
accommodating and integrating travellers to this traditional European hub for carry out trade, finance and commerce.
FrankfurtRheinMain hosts more than 100 foreign consulates, as well as the headquarters of around 20% of the largest
foreign companies in Germany. It is home to more than 1,000 US companies and the largest Korean business community in
Europe. There is a growing contingent of Japanese, Chinese and Indian companies.
A combination of a service and industry-driven economy
Frankfurt is home to the largest concentration of banks and financial service providers in Germany. But there is much
more than finance: FrankfurtRheinMain contributes around 10% of German manufacturing output. Major life science, ICT
and automotive clusters provide an attractive combination of a service economy mixed with forward-looking 21st century
industry.
Part of the appeal lies in plentiful opportunities for a desirable life-work balance. The region has more than 30
international schools. Around 40% of FrankfurtRheinMain is unspoiled, often gently undulating countryside threaded by
rivers and studded with alluring towns and villages. Frankfurt’s compact size and modern transport system allow easy
access to airports and other cities as well as recreational and cultural highlights, often no more than half an hour away by
car, train or tram.
Depending on the outcome of Brexit negotiations, FrankfurtRheinMain is well equipped to absorb a substantial influx
of foreign professionals. While quality office space is readily available, newcomers seeking apartments and houses for
rental or purchase may – as in other buoyant German cities – face pockets of rising residential property prices, requiring
additional forward planning for those seeking a base in the conurbation.
FrankfurtRheinMain has always been open to international business and trade. The region is reacting with relish to the
challenges of Brexit; whatever happens, the UK will remain one of Germany’s largest trading partners. Companies in the UK
and Germany are drawing up contingency plans to secure best possible outcomes from the UK’s withdrawal negotiations.
By providing sensible and efficient options for corporate relocation and expansion, Frankfurt and the FrankfurtRheinMain
region offer a formidable springboard for the future.
▪
For more details contact Iassen Boutachkov, Director Europe, on +44 (0) 20 3769 0741 or [email protected].
Frankfurt - The Financial Centre
€3.5tn
balance sheet of
Frankfurt’s banks
196
banks based
in Frankfurt
€1.7tn
listed companies’
market capitalisation
100+
research institutions
based in Frankfurt
62,700
people employed in
the financial sector
155
foreign banks
in Frankfurt
Source: Frankfurt Main Finance
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Promising real estate pipeline
FrankfurtRheinMain
“
B
usinesses and banks should be aware of the substantial merits of FrankfurtRheinMain in
The promising
offering attractive and competitively priced office accommodation and commercial real
estate. Particularly compared with other European regions with major international airport
real estate
hubs, the area provides significant location benefits. This is borne out by a positive environment
pipeline will strengthen
for investment projects and a string of real estate initiatives that could well be further enhanced
FrankfurtRheinMain’s
by the impact of the UK’s EU vote.
The promising real estate pipeline will strengthen FrankfurtRheinMain’s position in the global position in the global
market – a self-feeding development promoting and sustaining the area’s drawing power. For
discerning pursuers of real estate opportunities, there is no shortage of availability. With 12.4m market – a self-feeding
square metres (sq.m) of total office space, Frankfurt has a vacancy rate of around 11%, or roughly development promoting
1m sq.m.
Monthly rents for prime properties have increased slightly over the past year to €38.5 per sq.m and sustaining the area’s
and are expected to remain stable in the near term. Average rents of €15.5 per sq.m have also drawing power.
risen slightly. But there is substantial office space in central and other attractive locations at much
lower prices.
For warehouse and logistics space in the greater Frankfurt area, building completions have
shown the best results for years, reaching 350,000sq.m last year. Monthly prime rents for 5,000
sq.m warehouse and logistics space around Frankfurt airport are unchanged at about €6 per sq.m.
For less extensive spaces, under 5,000sq.m, rents can be more than €7 per sq.m. Compared with
the previous year, rents for warehouse and logistics space have stabilised.
A combination of an impeccable status quo and an enticing pipeline makes FrankfurtRheinMain a hub of real estate
opportunities for companies building a continental base.
▪
©Fraport AG
For more details contact Iassen Boutachkov, Director Europe, on +44 (0) 20 3769 0741 or [email protected].
Luxembourg
Sep 2016
Frankfurt
Oct 2016
A series of specialist monthly reports examining the
post-Brexit opportunities for European financial centres
To discuss marketing opportunities contact Wendy Gallagher
+44 (0) 20 3008 5262 or [email protected]
VI | FO C U S : F R A N KF U RT
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Combining lifestyle and performance
Stephan Bredt and Armin Winterhoff, State of Hessen
“
A
mid considerable uncertainty over the economic, financial and political implications of
Europe, its
the UK vote to leave the European Union, one thing is clear: Europe, its economy, and
the financial services sector in particular require a reliable and stable framework to remain
economy, and the
competitive internationally. London’s role as a provider of financial services to the EU is unlikely
financial services sector
to persist. Frankfurt is prepared to strengthen its role as a pivotal partner for global financial
in particular, require
market operators, in the best interests of the European economy and European development.
Banks, insurance companies and other global financial services providers have a presence in a reliable and stable
London and Frankfurt. The major German banks and 155 foreign banks are present in Frankfurt,
where a broad set of other financial services is offered, including by leading capital market service framework to remain
providers, Deutsche Börse and Eurex Deutschland.
competitive internationally.
Many other business services – legal, consulting, analytical – are readily available. Frankfurt will
remain an attractive environment for financial technology enterprises, providing an environment
that facilitates start-ups and new developments while encouraging established businesses to
maintain a long-term presence.
Frankfurt is the EU’s leading internet hub. Relatively low costs for companies and employees make it a magnet for
other businesses, particularly associated with financial services. Frankfurt is home to financial regulators, including: the
European Central Bank, the Single Supervisory Mechanism, the European Systemic Risk Board, the European Insurance and
Occupational Pensions Authority, Deutsche Bundesbank, Bundesanstalt für Finanzdienstleistungsaufsicht, Bundesanstalt
für Finanzmarktregulierung and the Global Legal Entity Identifier Foundation. Following the UK vote, Hessen is applying for
the European Banking Authority to be located in Frankfurt.
Flexible and effective German labour law
German labour law, an important factor in business location, is flexible and effective: 66% of disputes are resolved within
three months, while redundancy payments are regulated by law. In practice, payments of between 50% and 200% of
annual salaries are the norm. A study by the Federal Statistical Office found the number of actions filed involving labour
law in 2011 (three years after the financial crisis) was only 60% of the 1995 level.
Overall tax levels in Germany are much lower than often presumed. With a corporate tax rate of 15% and a business tax
rate of 10-16%, financial companies in Frankfurt pay generally a total marginal tax rate of 25-31%.
The German economy offers business growth opportunities and political stability. Compared with other prominent
euro area countries, Germany – taking up 15th position – is the highest-ranked country in the World Bank’s ‘ease of doing
business’ index (ahead of Ireland at 17, France at 27, and the Netherlands at 28).
Frankfurt is part of the FrankfurtRheinMain region, with 5.6m inhabitants and GDP of €216bn, profiting from steady and
sustainable growth. The region is second-ranked in the EU in terms of GDP per capita.
The city provides high-quality lifestyles, with the population benefiting from an excellent work-life balance, efficient
public transport, and a lively cultural scene. According to the Mercer 2016 ‘quality of living’ survey, helping governments
and companies with employees on international assignments, Frankfurt ranks as No.7 internationally, compared with
rankings of Amsterdam at 11, Dublin at 33, Paris at 37 and London at 39. Frankfurt’s international workforce and wellintegrated expatriate community testify to its global appeal. All these ingredients make Frankfurt well placed to become
the EU's leading international financial centre following Britain’s withdrawal.
▪
Dr. Stephan Bredt is Director General Economic Sector, Financial Services, Exchanges at the Ministry of Economics, Energy, Transport
and Regional Development of the State of Hessen ([email protected]). Armin Winterhoff is Head of Financial
Centre Frankfurt at the Ministry ([email protected]).
Official financial institutions based in Frankfurt
Six regulators located in Germany’s financial hub
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FO C U S : F R A N KF U RT | VI I
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A suboptimal policy mix
Why Europe needs fiscal measures and growth reforms
V
Ignazio Visco, Banca d’Italia
ery low inflation and the persistent risk of
a de-anchoring of inflation expectations
continue to dominate the economic
outlook for the euro area. The policy mix is
suboptimal: there is no common fiscal policy
and many countries lack sufficient room for
manoeuvre.
Bank profitability remains weak and
several intermediaries may need to
strengthen their balance sheets against a
background of subdued economic prospects
and continuing regulatory reform.
The governing council of the European
Central Bank has acted boldly to encourage a
return to price stability. Official interest rates
have been reduced repeatedly, bringing the
deposit facility rate to negative levels. New
longer-term refinancing operations have
been introduced, with conditions rewarding
banks which provide more credit to the
economy. The Asset Purchase Programme
has been progressively expanded.
Effective action
Central bank action has been effective.
Without
these
measures,
economic
conditions would have been much worse,
possibly leading to a deflationary spiral.
Credit supply conditions, particularly tight
in 2011-12, have loosened gradually. The
cost of credit to the economy has fallen and
financial fragmentation in the euro area has
eased. The weak credit dynamics still being
observed in the euro area mainly reflect
subdued demand.
The measures have fostered a decline
in yields and bolstered the prices of a wide
range of financial assets. This has had a
positive impact on consumption, through
wealth effects, and on investment, through
a fall in the cost of capital. Business and
household confidence have been buoyed.
According to ECB estimates, without the
wide range of monetary policy measures
introduced between mid-2014 and the first
part of this year, annual inflation and GDP
growth would be more than half a percentage
point lower in the euro area in 2015-17.
This highly expansionary monetary policy
stance is the result of well thought-out
decisions and a response to the weakness of
the economy and the risk of deflation.
Low inflation is undoubtedly in part a
global phenomenon. It reflects developments
in oil prices; deflationary pressures from
the Chinese economy; and possibly also
technological change. But it depends too on
domestic developments that should not be
underestimated.
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Domestic factors operate both via
expectations and via economic activity. In
both respects conditions in the euro area
differ from those in other main advanced
economies.
Since the end of 2014, the risk of a
de-anchoring has increased notably in the
euro area, where expectations have fallen
“
Nominal rates that
are low or negative
for too long may hurt
the profitability of some
institutions. But a less
accommodative monetary
policy in the current
circumstances would harm
everyone.
further than in other advanced economies. In
addition, there is evidence of a stronger link
between low inflation and economic slack.
In Italy, France and Spain, nominal wages
became more reactive to unemployment
after the crisis.
Low interest rates
The ECB is conscious of the potential for
negative collateral effects from a long period
of very low interest rates.
In the euro area as a whole there is
currently no evidence of risks to financial
stability related to an excessive increase
in the prices of shares, corporate bonds or
houses.
Growth in lending relative to the cyclical
position of the economy is moderate.
Risks that may arise in specific sectors
can be addressed with carefully targeted
macroprudential instruments, as has already
happened in some countries, without
interfering with the monetary policy stance.
Nominal rates that are low or negative
for too long may hurt the profitability of
some institutions. But a less accommodative
monetary policy in the current circumstances
would harm everyone.
Strengthening the economy is key to
ensuring a return to price stability, as well
as mitigating risks to financial stability. In
the current cyclical conditions, the main
risks to financial stability, the profitability
of banks and firms, and even to household
income, continue to stem from the uncertain
omfif.org
macroeconomic outlook and the persistence
of exceptionally low inflation.
The ECB will continue to monitor
economic and financial market developments
very closely and, if warranted, act again by
using all the instruments available within
its mandate. The purchase programme is
intended to run until the governing council
sees a sustained adjustment in the path
of inflation consistent with its inflation
objective. The relevant committees have
been tasked with evaluating the options for
ensuring its smooth implementation.
But monetary policy cannot pursue
a return to price stability and a more
sustained growth rate in isolation. It must be
accompanied by fiscal policies consistent with
cyclical conditions, and by reforms designed
to achieve a permanent return to higher rates
of growth potential and job creation.
The fear of continued weak demographics
and modest productivity growth is the likely
real cause of very low real interest rates.
Structural reforms
Important structural reforms have been
adopted in several euro area countries and
these efforts must continue. Their benefits
are beginning to be felt, but it will take time
to exploit their full potential. Each country
has its own problems, and solutions are
difficult to standardise.
Reforms imply short-term costs, both
economic and political, and we should guard
against the risk of unintentionally introducing
obstacles. For example, excluding some
countries from advances in fiscal and political
union until they have achieved sufficient
convergence would make their reform efforts
more difficult.
Reducing uncertainty is one of the most
pressing challenges facing European policymakers. It not only requires adequate
institutions and policy tools, but above all true
leadership capable of restoring a common
sense of purpose and defining a clear vision
for the future of the European project.
This is the only possible response to rising
populism and the risks it poses to the future
well-being of European citizens.
There are many short-term challenges.
But we must continue to emphasise the need
for a longer-term perspective.
▪
Ignazio Visco is Governor of the Banca d’Italia. This is an
edited extract of a speech given to OMFIF’s Seventh Main
Meeting in Europe on 22-23 September. A full summary of
proceedings and other details of the Rome meeting can be
viewed at www.omfif.org/analysis/reports/.
E U ROPE | 1 5
Italy’s ‘doomsday’ scenario
Storm clouds on horizon for banking sector
By Steve H. Hanke, Advisory Board
O
n 23 June UK voters gave a collective
thumbs-down to continued membership
of the European Union, shocking the
establishment and temporarily unsettling
the markets. The outcome increased the
possibility of an Italian – as well as a euro
area – ‘doomsday scenario’.
The results of stress tests for European
banks, published on 29 July, showed that
Italy’s Banca Monte dei Paschi di Siena was
the only European bank out of the 51 tested
whose capital was wiped out in the stress test
scenario.
The bank subsequently announced that it
would raise capital by issuing stock, while the
Italian treasury indicated that there would
not be a bail-out of Italian banks. Fabrizio
Viola, Monte dei Paschi’s chief executive, was
dismissed and replaced by Marco Morelli,
setting the stage for the bank to raise €5bn in
new capital and dispose of around €30bn in
non-performing loans.
New capital
Nevertheless, storm clouds remain on the
horizon. Monte dei Paschi has used up €12bn
of capital raised since 2008, and there are
no guarantees it would not use up a further
€5bn. Questions remain too over the ability
to raise new bank capital in Italy, where
banks are loaded with non-performing loans
(around €200bn) and bank shares are trading
below book value. If new private capital for
Monte dei Paschi is not raised, and raised
quickly, Italy and the EU will butt heads, and
therein lies the potential storm.
Without new capital, Monte dei Paschi
bondholders will be forced to take losses
(a bail-in) before any government bail-out
money could be deployed under EU rules.
However, a bail-in would be politically highly
problematic for Prime Minister Matteo Renzi
as retail investors, making up a powerful
portion of the electorate, hold a big chunk of
Italian bank debt (bonds).
Suffering losses from a bail-in, bondholders
would be likely to vote against Renzi’s
proposed changes to Italy’s constitution in
December, though this will not prompt a
change of government – Renzi has said his
administration will remain in place regardless
of the referendum result.
The monetary approach posits that
changes in money supply, broadly determined,
cause changes in nominal national income
and the price level. Sure enough, the growth
Growth in Italian money supply hit by bank weaknesses
Money supply (M3) and credit to private sector, annual % change
25
20
15
6.53%
5
4.42%
0
-5
Total money supply - annual growth rate
Total money supply - average (2003-16)
2016
2015
Credit to the private sector - annual growth rate
Credit to the private sector - average (2003-16)
Breaking down the contribution to the
money supply growth, state money produced
by the European Central Bank accounts for
only 17% of Italy’s M3. The remaining 83% is
bank money produced by commercial banks
through deposit creation. As such, Italy’s
banks are an important contributor to the
money supply and the economy.
However, banks have been struggling and
any contraction of their loan books – which
would cause the money supply and credit to
the private sector to slow – would produce
another recession.
Monte dei Paschi is not the only problem
child of the Italian banking system: all the
country’s big banks could benefit from some
additional capital.
But issuing new shares is unattractive
because bank stock is trading below
book value (at the time of writing, Intesa
Sanpaolo’s price-to-book ratio was 0.77; that
of UniCredit 0.27; UBI Banca 0.24; Banco
Popolare 0.22; and Monte Paschi 0.07).
Without new private capital, an Italian
state rescue is the most attractive source for
the recapitalisation. Otherwise, the banks
will be bailed-in by the bondholders, Renzi’s
constitutional changes will go down in flames
and the government will collapse.
With that, the populist Five Star Movement
is most likely to form a government, raising
the threat of a serious initiative to leave the
euro. If the EU does not bend and allow one
of the loopholes in its rules to be used, it risks
setting in motion an Italian and euro area
‘doomsday’ machine.
▪
Steve H. Hanke is Professor of Applied Economics at Johns
Hopkins University.
Source: ECB, ONB, calculations by Steve H. Hanke
16 | E U ROPE
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2003
2004
-10
-15
“
Monte dei Paschi is
not the only problem
child of the Italian banking
system: all the country’s big
banks could benefit from
some additional capital.
State rescue
30
10
of broad money and nominal GDP are closely
linked. Italy’s money supply (M3) growth rate
since 2010 has been well below its trend rate
(6.53%) for most of the period (see Chart).
Unsurprisingly, nominal GDP growth rate in
2010-15 was only 0.4% per year.
omfif.org
O c to b e r | © 2 0 1 6
Cyprus, Greece and ‘whatever it takes’
Political threats to central bank independence
W
Panicos Demetriades, University of Leicester
hen Mario Draghi, president of the
European Central Bank, declared in
July 2012 that the ECB would do ‘whatever
it takes’ to save the euro, financial markets
reacted positively. The intention was fleshed
out in the Outright Monetary Transactions
programme, which had as its declared
aim to eliminate what the ECB viewed as
‘unacceptable re-denomination risk’ in
Italian and Spanish bonds.
OMT was never used, though its
announcement achieved those objectives
at the time. However, the programme on its
own could never have addressed the weakest
links in the chain: Greece and Cyprus.
Significant steps were taken subsequently
towards establishing a banking union,
including the creation in November 2014 of
the single supervisory mechanism, better
placed than national supervisors to tame
excessive risk-taking by big banks. This is
a problem of particular relevance to small
countries, as I quickly discovered when I
became governor of the Central Bank of
Cyprus in May 2012.
Too big to fail
Cyprus’s crisis was very much a tale of two
banks becoming too big to fail, too big to
save, and too big to regulate. Between 2005
and 2011, the domestic banking sector
doubled in size to 9.5 times GDP, while risks
were largely ignored.
The two largest banks had assets
equivalent to 400% of GDP. Parliament rarely
asked the national supervisor, CBC, to explain
how these rapidly growing banking risks,
which represented a contingent liability for
the taxpayer, were being managed.
Important steps have been taken in fiscal
policy coordination that should help prevent
a Greek-style build-up of public debt in future.
Both the Cypriot and Greek crises could have
been prevented had all these improvements
been in place before 2012.
At the time, addressing legacy problems
in banks and public finances remained n
the hands of political leaders. The ECB could
do little to influence bail-out negotiations,
other than to warn that, in the absence of
agreement at the political level, it would be
forced to cut off or freeze liquidity support.
Since 2012 those warnings have been
made openly twice: in Cyprus in March
2013 and in Greece in June 2015. In both
cases bail-out negotiations had come to a
standstill, and the ECB’s actions resulted in
banks shutting down for several days. Faced
with the prospect of banks remaining closed
O c to b e r | © 2 0 1 6
indefinitely or euro exit, political leaders
in both countries came to their senses –
temporarily at least.
In Cyprus, politicians protested about
the ECB’s ‘blackmail’. In his testimony to
a judicial inquiry, Nicos Anastasiades, the
Cypriot president, said the ECB had ‘put a
gun to his head’, otherwise he would never
have accepted the write-down on bank
deposits. That gun, he explained, was the
supply of emergency liquidity assistance.
The ECB of course was alluding to its own
legal constraints. If the Cypriot government
became bankrupt, it could not continue to
supply Cypriot banks with euros.
Taxpayers could not bail out banks
The agreement with Cyprus involved
imposing losses on bondholders and
depositors because, as the International
Monetary Fund’s debt sustainability analysis
showed, Cypriot taxpayers could not bear the
burden of bailing out the big banks.
The much criticised bail-in that was finally
agreed (after parliament turned down the
broad-based levy on insured and uninsured
deposits proposed by the government and
agreed by the Eurogroup) affected only 4%
of uninsured depositors, and reduced the
total bail-out bill by around 33% of GDP. And
it spared Cyprus from Greek-style austerity,
which goes some way towards explaining the
economy’s recovery.
Other upfront banking reforms, including
restructuring credit co-operatives and ringfencing the Cypriot banking system from
Greece, were instrumental in restoring
confidence and allowing capital controls to be
lifted early. However, the reforms resulted in
considerable toxic fallout for the central bank.
Political attacks were soon followed by
legislative changes to the Central Bank of
Cyprus governance. These not only eroded
the bank’s independence but undermined
its decision-making processes – much as
predicted by an ECB legal opinion published
in June 2013 (which legislators ignored).
Greece: not on track
In Greece, public debt is expected to reach
185% of GDP this year, notwithstanding
seven years of austerity (and the private
sector involvement of 2011), compared with
127% at the outset of the crisis in 2009. No
wonder programme legitimacy remains
a huge concern. The long-awaited first
review of the Greek programme suggests
that it remains ‘broadly on track’, but that
‘significant implementation risks’ remain.
omfif.org
September’s programme review remains
incomplete, with a number of key reform
deliverables outstanding. The Greek
government has submitted a bill with reforms
to parliament that will need to be passed for
the next tranche of bail-out funds, amounting
to €2.8bn, to be released by the creditors.
It includes reforms to Greece’s electricity
market, measures to speed up privatisations
and cuts to state pensions.
Prime Minister Alexis Tsipras’ slim majority
in parliament may be sufficient to pass the bill
this time. However, government officials are
pledging to resist labour reforms that could
lead to further wage cuts and job losses.
While such political uncertainty persists,
the risk of ‘Grexit’, which has subsided since
the heights of 2015, could resurface in the
near future, even if macro downside risks do
not materialise.
The return of bank deposits – a key
barometer of confidence in ‘Gremain’ – has
been virtually non-existent. Capital controls
remain in place and Greek banks continue to
be largely funded by the ECB.
A risky strategy
When it came to the crunch, the ECB may
have helped to keep the euro intact. But
can the same be said of its key institutional
foundation – central bank independence?
Since 2012 attacks on euro area central
banks and their governors have become
common. Some appear to follow actions that
involve imposing losses on bank creditors.
Others have been politically motivated.
There have been legal challenges to the
ECB (as well as associated political attacks)
over its unconventional policies from within
Germany. They have focused primarily on
the Bundesbank’s allegedly unlawful role in
the ECB’s outright monetary transactions and
quantitative easing programmes.
These developments have shown that
‘whatever it takes’ is a risky strategy, not
just for Eurosystem institutions but for
individuals taking critical actions for the
euro’s survival. But if EMU is to survive the
storm that appears to be brewing – involving
Brexit, Italian banks, geopolitical risks and the
slowdown in China – the ECB can ill afford to
relax its guard. Doing ‘whatever it takes’ will
remain on the agenda.
▪
Panicos Demetriades is Professor of Financial Economics
at the University of Leicester and Fellow of the Academy of
Social Sciences. During 2012-14 he served as Governor of
the Central Bank of Cyprus and Member of the Governing
Council of the ECB.
E U ROPE | 1 7
Costs for financial system
When lowering interest rates does more harm than good
Peter Warburton, Economic Perspectives
I
t is hard to imagine the possible benefits of
the August cut in the UK bank rate.
If lower interest rates impart stimulus to
the UK economy, is it the case that the lower
the rate, the greater the stimulus? And if
lower positive interest rates boost aggregate
demand, would negative rates have an even
more pronounced effect?
Analytically, it is possible to assert that
a lower discount rate will bring forward
household consumption, that a lower cost of
capital will boost fixed capital formation, and
that higher property and financial asset prices
will inflate the net worth of households and
businesses, inducing them to save less and
spend more.
But when interest rates are extremely,
abnormally and persistently low, other
possibilities must be considered.
The risk of concussion
When interest rates fall out of bed, there is
a risk of concussion. Concussion is difficult
to incorporate into analytical models, but no
less of a reality.
The flip side of very low borrowing rates
– for example, the 4.1% personal loan rate
and the 2.3% lifetime tracker mortgage rate
– is extraordinarily low saving rates. These
are exemplified by instant access deposit
rates (less than 0.05%) and fixed rate bond
Interest rates trend persistently lower
deposits
of 0.85%.
There comes a point at which borrowing
rates are no longer a material obstacle
to borrowers. They may fail to qualify for
loans based on their disposable income,
credit score, postcode or other criteria,
but the rate is immaterial. Consumer debt
is motoring along at growth of 10% per
“
The wider impact of
falling returns in a
complex, leveraged, financial
system could easily overturn
the expectation of a net
economic stimulus when
rates are abnormally low.
annum and in no obvious need of assistance.
Older savers, on the other hand, are
perplexed by the persistence of low rates.
Fearing penury in their latter years, senior
citizens are prone to save more of their
non-interest income to top up their
capital.
Banks typically suffer a squeeze of their net
interest margins as interest rates approach
zero, occasionally leading them to raise
borrowing rates to restore profitability. The
systematic compression of the government
Selected UK household interest rates,
%
Interest rates trend persistently lower
Selected UK household interest rates, %
0
2016
0
2015
1
2014
2
2013
2
2012
4
2011
3
2010
6
2009
4
2008
8
2007
5
2006
10
2005
6
2004
12
2003
7
2002
14
2001
8
2000
16
1999
9
1998
18
Sterling unsecured personal £10k loan rate (left scale)
Sterling instant access deposit rate
Sterling fixed rate bond deposit rate
Lifetime tracker mortgage rate
Source: Bank of England
Source: Bank of England
1 8 | E U ROPE
omfif.org
yield curve makes it harder for insurance
companies to deliver promised returns to
policy-holders, and threatens the solvency of
the weaker companies.
Pension fund injections
Actuarial adjustments based on lowered
bond yields have a profound effect on
pension deficits.
With 80% of company-sponsored funds
in deficit, many businesses will be required
to inject funds into their schemes at the
expense of investment spending. Defined
contribution pensions will project lower
retirement incomes.
There is a generalised cost to the financial
system when liquidity is hoarded within
financial institutions and large corporations,
rather than pooled for the benefit of all.
A zero interest rate equates to zero
incentive to offer surplus liquidity into the
market. The wider impact of falling returns
in a complex, leveraged, financial system
could easily overturn the expectation of
a net economic stimulus when rates are
abnormally low.
Capital spending
Business investment in structures, plant and
equipment has been a serial disappointment
to policy-makers over the past seven years
and, if anything, the trends are worsening.
This raises a number of questions. Has
the capital spending decision been soured by
ultra-easy money and quantitative easing?
Are decision-makers unsettled by the fresh
doubts cast by policy easing on the economic
outlook? As policy uncertainty increases,
perhaps the option value of cash rises to
offset its lower return?
Other questions include whether largescale asset purchases crowded investors
into the securities of cash-rich companies,
persuading them to distribute income
rather than commit to fixed investment.
And while bond yields may be lower, has the
hurdle rate for business capital expenditure
risen?
There are ample grounds to suspect
that the effectiveness of lower rates as a
policy stimulus has been overtaken and
overwhelmed by other considerations. In the
Bank of England and the Treasury, as well as
further afield, it is time to rethink monetary
policy.
▪
Peter Warburton is Director of Economic Perspectives and
a Member of the Institute of Economic Affairs Shadow
Monetary Policy Committee.
O c to b e r | © 2 0 1 6
Renminbi payments show limited gains
Challenges for reserve status after SDR inclusion
Ben Robinson
T
he renminbi was the world’s fifth largest
payments currency by value at the end
of August, according to latest data from
international interbank telecommunications
provider SWIFT. This accounts for 1.86% of
world payments. However, while this is a
significant improvement from ninth position,
which the currency held in August 2013, the
internationalisation of the renminbi remains
limited.
With the currency still protected by
capital controls, a managed peg to the
dollar saw the renminbi appreciate by more
than 33% in real terms against China’s
trade partners between January 2010 and
November 2015, a leading factor behind its
improved ranking in payments value. Over
the same period the yen fell by more than
26% and the Canadian dollar by 17%. The
Hong Kong and New Zealand dollars rose,
but not as much as the renminbi. These
figures have however narrowed this year,
reducing the renminbi’s lead and causing it to
fall back behind the yen after its August 2015
devaluation.
While the renminbi’s share of global
payments has grown, it has been uneven,
led predominantly by the Asia Pacific region.
Between January and end-August 2016, Asia
Pacific was responsible for 47% of all trade
with China, of which 45% was denominated
in renminbi, followed by Europe with 31%.
By contrast, the Americas accounted for
23% of all trade with China, of which only
3% was denominated in renminbi. Even
within the two largest renminbi payment
regions, just two centres – Hong Kong and
the UK – are responsible for the majority of
these transactions, indicating a relatively
limited uptake. Other centres are catching
up, however – the Middle East is the fastest
growing region for renminbi payments.
Substantial gains
Despite these caveats, the currency has
made substantial gains in recent years. This
partly reflects China’s dominant presence in
international trade. As the largest import and
export partner for many countries, the logic
of converting local currencies into dollars and
then into renminbi has weakened, while the
costs, exchange rate risks and time delays of
doing so have grown.
To facilitate renminbi payments China has
rapidly expanded the presence of clearing
banks in global financial centres, including
Hong Kong, Singapore, Frankfurt, London,
Paris, Luxembourg, Doha, Toronto, Buenos
Aires and Zurich.
The PBoC also has a growing number
of currency swap agreements, with more
than 30 countries, to facilitate smooth
transactions, lower costs and ensure access
to renminbi liquidity.
Renminbi overtakesfour currencies by payment value since 2013
Value ofovertakes
global payments
by currency,
index figures
Renminbi
four
currencies
by payment value since 2013
AUD
CAD
CHF
CNY
HKD
Aug 2016
Aug 2015
Aug 2014
Aug 2013
Value of global payments by currency, index figures
JPY
SEK
Source: SWIFT
Source: SWIFT
O c to b e r | © 2 0 1 6
China is seeking to move beyond a trade role
for its currency towards a more sophisticated
use in international investments. Beijing has
opened up the domestic market, albeit in
a limited form, to foreign investors. Strong
economic growth, an appreciating renminbi,
and low yields and weak growth elsewhere
have contributed to international demand for
renminbi-denominated A-shares and Chinese
corporate and sovereign bonds.
However as an investment currency the
renminbi faces challenges: stock market
volatility in mid-2015 and at the start of 2016
have reduced confidence in Chinese shares.
Fears over a bond market bubble, as well as
concerns about the economy, are growing, as
indicated by rising yields.
While higher risks and a growing number
of bond market defaults may partly reflect
a natural rebalancing of the market, the
country’s growing debt over the last few
years raises concerns over a ‘hard landing’.
Reserve status challenges
In addition to becoming a global trade and
investment currency, a long-term goal of the
Chinese authorities is for the renminbi to
become a global reserve currency. Despite
its inclusion in the International Monetary
Fund’s special drawing right reserve currency
basket, this status remains a long way off.
China’s SDR share is 10.92%. While
countries can sell SDRs to access renminbi
liquidity if needed, especially if they are
facing balance of payments pressures with
China, the relatively low share of overall
trade conducted in renminbi, as highlighted
by the SWIFT data, suggests this will be only a
minor consideration.
Boosting the currency’s role as a reserve
asset first requires a larger use in trade and
investment, for which greater confidence
in the Chinese economy, more marketbased pricing, clearer risk signals, and less
intervention are all prerequisites.
The SDR move, meanwhile, raises
questions for the IMF on the acceptable
spread between the onshore and offshore
rate, on the risk of large movements in the
renminbi’s value, and on how the Fund will
monitor the currency’s move towards a more
market-based rate.
Now that the renminbi has entered the
SDR, observers will be paying close attention
to gauge its further progress towards
internationalisation and reserve currency
status.
▪
Ben Robinson is Economist at OMFIF.
omfif.org
E M E RG I NG M A RKE T S | 1 9
Three headwinds for Brazil
Potential shock for economy after investor flurry
Danae Kyriakopoulou and Bhavin Patel
A
look at the fundamentals suggests that
Brazil’s recent investor rally has been
overdone. The country faces a rising stock
of debt, which will become increasingly
expensive to service as monetary policy
remains on a tightening track. Global macro
risks, such as the slowdown in China and the
commodities market, are creating further
vulnerability exacerbated by domestic
political uncertainties. After years of
partying culminating in the Rio Olympics,
Brazil is now suffering a hangover.
Brazil’s financial markets have seen a
flurry of inflows in 2016 as investors bet
on economic recovery. The Bovespa equity
index has risen by 34% this year, the best
performance of equities globally.
The real has appreciated by more than
22% since January, making it the highest
performing major currency in 2016. Brazil’s
finance ministry projects GDP growth of 2%
in 2017 against an expected 3% contraction
in 2016.
the retirement age have proved popular with
investors, they have been much less so with
the broader electorate.
Brazil’s population has enjoyed a
substantial boost in living standards over the
past decade, with GDP per capita between
2006 and 2016 rising by 11%, the biggest
increase in Latin America. This was partly
financed by the commodities boom, but
“
Brazil’s pension
spending is among
the highest in emerging
markets, second only to
Turkey: at 8% of GDP, it is
higher even than that of
Sweden, an economy with
a much older demographic
profile.
Messy politics, bullish investors
Running out of steam
Political change has driven investor
momentum. Markets have anticipated an also by credit expansion, mainly through the
economic turnaround, bullishly tracking the highly leveraged public sector.
impeachment of Dilma Rousseff, unseated as
Continued credit-fuelled growth is
president by the senate in August.
unsustainable. For example, Brazil’s pension
Michel Temer, who has taken over, has spending is among the highest in emerging
pledged to restore market confidence by markets, second only to Turkey: at 8% of
reining in fiscal spending, spurring job GDP, it is higher even than that of Sweden,
creation, in a bid to stabilise debt levels and an economy with a much older demographic
re-establish Brazil’s credit rating.
profile. Sharp rises in borrowing tend to result
However,
while
the markets
previous vice in an inefficient allocation of investments.
Chart 1: Brazil’s
growth tracks
commodity
president’s policies of limiting budget
Brazil’s high inflationary stance implies
Annual S&P commodity indexreturn, %, and Brazil’s real GDP, annual % change
increases in line with inflation and raising that the monetary tightening course pursued
Chart 1: Brazil’s growth tracks commodity markets
Annual S&P commodity index return, %, and Brazil’s real GDP. annual % change
GDP (RHS)
Source: S&P, Brazilian Institute of Geography and Statistics, OMFIF
Source: S&P, Brazilian Institute of Geography and Statistics
2 0 | E M E RG I NG MA RKE T S
omfif.org
2016
2015
-8
2014
-80
2013
-6
2012
-4
-60
2011
-40
2010
-2
2009
-20
2008
0
2007
0
2006
2
2005
20
2004
4
2003
40
2002
6
2001
60
2000
8
1999
80
1998
10
1997
100
Commodities
by the country’s central bank is here to stay.
Rising interest rates in turn will put further
pressure on the cost of servicing an already
high debt pile, raising further questions over
debt sustainability.
This situation cannot be maintained in the
long run, but implementing policies that will
put Brazil on a more sustainable fiscal path
requires huge levels of political capital. While
Temer remains popular among the public,
this could change.
History may repeat itself. Rousseff enjoyed
similar approval ratings during her presidency
before corruption charges saw her officially
impeached. Temer is also being investigated
over corruption allegations in connection
with the Petrobras scandal. He could quickly
lose cross-party support, putting current
political stability at risk.
External conditions are adding to Brazil’s
headache. Growing trade and investment
links with China served the country well
during the boom years – China is Brazil’s
largest trading partner, according to the
latest data from 2015, in contrast to the
majority of economies in the region which
are more connected to the US. Foreign direct
investment from China into Brazil soared
between 2005 and 2015, from around $8m
to $232m.
But China’s economy is slowing. From
double-digit growth in 2005-10, annual
GDP growth has now eased to just over
6%, according to the latest official data.
Alternative measures of the strength of the
economy estimate growth at 3%-4%.
More important for Brazil, though, is not
that China’s economy is slowing, but rather
the nature of the slowdown.
The fact that China’s previously rapid
expansion is running out of steam is not a
surprise. Beijing is rebalancing its economy
away from exports and manufacturing to
focus on domestic consumption and the
services sector.
Demand for industry-heavy commodities
such as iron ore and steel has collapsed,
but commodities such as sugar or petrol
have brighter prospects as China’s middle
class develops a greater appetite for richer
foodstuffs and car ownership.
Although
this
creates
important
opportunities for Brazil (vegetable products
and other foodstuffs make up around 30%
of the country’s exports), the downturn in
the commodity price cycle acts as a third
and final headwind to the Brazilian economy
O c to b e r | © 2 0 1 6
Real may depreciate after rally as US-Brazil inflation differential widens
Nowhere has the recent investor flurry into Brazil been
more pronounced than in the performance of the real. After
depreciating by 33% in 2015, the currency has recouped 47% of
last year’s losses and is the best-performing currency in 2016.
This volatility, driven by market sentiment related to political
developments, obscures the fundamental drivers of the currency’s
valuation. With a floating currency such as the real, the exchange
rate will be determined by the economy’s links to international
markets through international trade and capital flows.
Trade plays an exceptionally small role in Brazil’s economy.
Yet with commodities making up roughly half of Brazil’s exports,
investors in the foreign exchange market tend to associate Brazil’s
performance with that of commodities.
Commodity currency
Brazil’s economic fortunes may be so tied
to the commodities market because of the
close association in investors’ minds between
Brazil and commodities – resulting in capital
outflows and a bearish attitude each time the
commodities market turns down. This seems
to be supported by the data to an extent,
Chart2:
S&P
commodities
total
index
return
, $,and
dollar
per real
2: Brazil’s, percentage
exchange
rate
driven by inflation
points
, and
real per
dollar
Chart 3: Brazil’s ‘commodity currency’ challenge
S&P commodities index total return, $, and dollar per real
1.5
2
1.0
0
0.5
-2
0.0
Real per dollar (RHS)
Source: Central Bank of Brazil, US Bureau of Labor, Brazilian Institute of
Geography and Statistics, OMFIF analysis
8,000
0.4
6,000
0.3
4,000
0.2
2,000
0.1
0
0
Dollar per real
2016
4
0.5
2015
2.0
10,000
2014
6
0.6
2013
2.5
12,000
2012
8
0.7
2006
3.0
2016
10
2014
3.5
2012
12
2010
4.0
2008
14
2006
4.5
2004
16
2002
5.0
2000
18
2011
Brazil-US inflation rate differential, %, and real per dollar
Source: Central Bank of Brazil, US Bureau
u
of Labo
O c to b e r | © 2 0 1 6
▪
2010
Chart
Brazil
-
with the real also performing as a commodity
currency (see Chart 3).
The recovery in commodities and the
possibility of a Chinese soft-landing has seen
Brazil benefit. Investment has flowed into
the region, and the outlook for a Brazilian
recovery appears positive.
The question now is how long the positive
trend will last. Brazil’s financial market
recovery could be generating bubbles –
recovery of fundamentals have lagged
behind the growth in assets. If the Fed raises
interest rates more quickly than expected,
market sentiment could change abruptly,
capital inflows could turn into outflows – and
Brazilian investors could be in for a shock.
Danae Kyriakopoulou is Head of Research and Bhavin
Patel is Research Assistant at OMFIF.
Chart: Brazil’s
3
‘commodity currency’ challenge
2009
At first sight, this strong dependence appears
paradoxical. Commodities play a relatively
small role in Brazil’s economy: rents from
natural resources comprise around 5% of
GDP, close to the global average. In the boom
years this figure was higher, peaking at 8% in
2007.
While they have greater weight in exports
(agricultural and mineral products alone
make up around half of Brazil’s exports),
exports on the whole play a very small role
in Brazil’s economy, accounting for less than
15% of GDP – the fifth lowest ratio in the
world, according to the World Bank. Only
2008
Dependence paradox
Sudan, Afghanistan, Burundi, and Kiribati
have a lower contribution of exports to GDP.
To put this further into context, the
exports to GDP ratio can be well above 100%,
as is the case in city states such as Hong Kong
and Singapore, or even countries such as
Ireland. Even emerging markets of a similar
size to Brazil such as India, Russia, or Mexico
tend to have a substantially higher share of
exports in their economies.
2007
in the short term. As Chart 1 shows, Brazil’s
economic performance traditionally has
been closely tied to the commodities market.
To assess the fundamentals-implied exchange rate, economists
usually rely on the ‘law of one price’ – the principle that exchange
rates correct so that any product should cost the same wherever
it is purchased.
As a result, changes in inflation tend to drive changes in the
exchange rate. This seems to be supported by the data for the
real/dollar exchange rate (see Chart 2).
The inflation differential between Brazil and the US looks set
to widen: the Federal Reserve has hesitated to raise interest rates
once again, and any rate rise will be very modest. Meanwhile,
the Central Bank of Brazil remains on a tightening schedule to
combat high inflation. The fundamentals point to depreciation of
the real over the long term.
Commodity index total return (RHS)
Source: S&P, Central Bank of Brazil, OMFIF analysis
Source: Central
S&P, Bank, of
OMFIF
Brazilanalysis
, OMFIF
analysis
omfif.org
E M E RG I NG M A RKE T S | 2 1
Directing policy to growth sectors
Nigeria seeks better monetary-fiscal coordination
I
Donald Mbaka, Central Bank of Nigeria
n its quest to keep price increases within
defined limits, the Central Bank of Nigeria
has consistently ensured that Nigeria’s
banking system – the key platform for
transmitting monetary policy impulses –
remains sound and stable, with low threats
from systemic risks.
However, the central bank has grappled
with the effects of low levels of domestic
economic activity, particularly their impact
on the exchange rate. This can be attributed
largely to widespread dependence on
receipts from crude oil sales, resulting in
the neglect and stifling of other economic
sectors.
It has not always been this way. Nigeria
was noted in past decades for the large-scale
production of high-value agricultural exports
such as cocoa, groundnuts and palm produce,
among others. These generated substantial
foreign exchange resources and formed the
bedrock of the country’s economic growth in
the early years after independence in 1960.
But while the discovery and commercial
exploitation of crude oil continues to yield
additional and significant inflows of foreign
exchange, which account for around 75% of
government revenues, this has yielded worse
than expected outcomes.
Large-scale imports
Nigeria’s domestic resources – both human
and natural – have not been adequately
exploited. This has resulted in large-scale
imports to meet numerous domestic and
industrial requirements, large outflows of
foreign exchange to pay for these imports,
and resulting problems with exchange rate
management.
As the warehouse for official crude oil
receipts – which account for around 90% of
foreign exchange inflows – the CBN by default
is the major supplier of foreign exchange to
satisfy in-country demand. It does this at
the expense of its stock of foreign exchange
reserves, which has been consistently
depleted over time.
The global financial crisis, coupled with
the subsequent collapse in crude oil prices,
highlighted the need for adequate domestic
capacity to cushion the effects of negative
external developments.
In particular, widespread dependence on
imported products accounted for a major
proportion of the consumer price index, and
was a significant contributor to domestic
inflation.
Given these challenges, the CBN decided
to provide monetary stimulus to the
2 2 | E M E RG I NG MA RKE T S
economy, as was the case in several other
jurisdictions where unconventional monetary
policies were implemented. The underlying
goal was to precipitate real sector activity
and generate domestic economic activity to
support local capacity and reduce imports.
Several
intervention
funds
were
established to provide low-income financing
to economic sectors with the potential to
galvanise an economic revival – key sectors
include micro, small and medium-sized
“
While there is no doubt
that the design and
implementation of monetary
policy should always be
the central bank’s primary
preoccupation, domestic
economic factors have
necessitated some ingenuity
on the part of monetary
authorities.
enterprises, agriculture, and power. Leverage
for this venture hinged on powers granted to
the Bank to facilitate development functions,
as enshrined in its enabling statutes.
The funds undoubtedly have opened
up newer channels to satisfy the financial
resource requirements of various business
ventures as against prohibitive bank loans.
However, adopting such an unconventional
monetary policy tailored to development
financing has inevitably prompted concerns in
Nigeria over the design and implementation
of monetary policy – the prime responsibility
of central banking.
Monetary interventions
These interventions were quasi-fiscal in
nature and increased money supply to the
economy. This naturally translated into an
upside risk for inflation where a single-digit
rate had been targeted.
As a result, and in addition to other fiscal
measures with implications for prices, the
inflation rate has significantly breached the
single-digit target. There have also been
claims that the Bank has gone beyond its
monetary policy remit and ventured into
broader economic policy.
While there is no doubt that the design
and implementation of monetary policy
should always be the central bank’s primary
omfif.org
preoccupation, domestic economic factors
have necessitated some ingenuity on the part
of monetary authorities.
The Bank of Japan has committed to
increasing the monetary base annually by
a given amount to pull the country out of
prolonged recession.
The US Federal Reserve, the Bank of
England and the European Central Bank
have adopted the purchase of financial
instruments (including government bonds).
These jurisdictions have well-organised
and vibrant economies, and financial markets
provide the only feasible avenue for nonstandard measures.
The same may not necessarily apply to
a less developed country like Nigeria. Here,
the financial system is thriving but still
developing, while economic activity remains
far below potential.
Monetary interventions should target
points likely to produce greater impact.
The CBN has directed its unconventional
monetary policy towards sectors that are
more likely to boost domestic economic
activity and enhance productivity.
Price stability
Such concerns are nevertheless valid.
Central banks should focus on achieving
and maintaining price stability, to create a
macroeconomic environment conducive
to sustainable economic growth. Keeping
inflation within specified targets should be
their primary goal.
In this regard, the CBN – which follows a
monetary targeting strategy and has adopted
the corridor system for implementation
of monetary policy – may need to isolate
the various unconventional measures
while providing adequate guidance and
supervision, and re-focus on price stability.
Fiscal authorities, on the other hand,
should provide the direction and incentives
for structural efficiency. Economic growth
and development are within this jurisdiction.
Monetary policy cannot succeed when
the economy is comatose, and fiscal policy
cannot push through with economic growth
measures while other significant monetary
(and macroeconomic) indicators perform
poorly.
Healthy coordination between monetary
and fiscal policy can produce beneficial
results. This must be the aim for Nigeria’s
policy-makers.
▪
Donald Mbaka is Economist at the Central Bank of
Nigeria.
O c to b e r | © 2 0 1 6
African democracy: work in progress
Moving to better governance and inclusive growth
O
Kingsley Chiedu Moghalu, Advisory Board
bserving the presidential election
campaign in the US, a more than
200-year-old democracy, provides a
reminder of the need for some perspective
when assessing the progress of democracy
in Africa.
That a vast majority of Africa’s 54 nations
are now democracies is a good thing. This
represents a radical shift away from the
military dictatorships that dominated the
continent just a quarter of a century ago.
The shift has come about partly in
response to the innate urge for individual
human freedom and free societies, and
partly in response to the hegemonic forces
of globalisation as the cold war ended in
the late 1980s and the struggle between
the Soviet and US superpowers ended on
American terms.
Moreover – as a result of this – it has also
come about in part in response to the felt
need in African nations to meet the evolving
minimum requirement for legitimacy in a
global order increasingly based on democratic
norms (even if the main international
institution that spread these norms, the UN,
is not fully democratic).
Democracy has been broadly good for
Africa, but not because the dictatorships it
replaced could not have created progress.
Those military regimes failed largely because
they were self-serving, and lacked a world
view of economic transformation.
Mixed election outcomes
Elections in Africa in 2015-16 have pointed
to progress and challenges, as well as the
evolving maturity of pluralistic political
spaces.
In Nigeria, an opposition party led by
Muhammadu Buhari, a former military
leader, defeated Goodluck Jonathan,
the incumbent president, in a national
presidential election in 2015. Even more
remarkably, Jonathan conceded defeat and
oversaw a peaceful transfer of power to the
new government.
In South Africa, the majority African
National Congress’ hold on political power has
slipped significantly this year as opposition
party candidates make significant inroads in
mayoral races in important urban centres.
In east and central Africa, Tanzania held
successful presidential elections in 2015.
However, polls in Uganda were marred by
controversies over allegations of political
repression by Yoweri Museveni, president for
the past three decades. Burundi descended
into civil conflict in 2015 as President Pierre
O c to b e r | © 2 0 1 6
Muhammadu Buhari, President of Nigeria
Nkurunziza sought to extend his hold on
power by removing constitutional term limits.
In Rwanda, the country’s parliament in
2015 voted to remove term limits to the
“
It is clear that the
rituals of democracy
such as voting by themselves
do not constitute the sum
of real democracy. More
important – and needed in
Africa – is a deepening of
the democratic ethos.
leadership of Paul Kagame. In some ways
reminiscent of Singapore’s Lee Kwan Yew,
Kagame has led his country from an age of
genocide in 1994 to a new era of development
and undeniable economic progress, even as
western governments question his human
rights record.
Democratic ethos
It is clear that the rituals of democracy such
as voting by themselves do not constitute
the sum of real democracy. More important
– and needed in Africa – is a deepening of the
democratic ethos.
Acquiring power through the ballot box
needs to be accompanied by a sense of the
limitations imposed by the real meaning
of democratic governance, including the
strengthening of independent institutions
and the tolerance of dissent. There is a need
to guard against ‘democratic despotism’ – a
omfif.org
‘licence’ conferred by winning elections to
quash the voices of opposition.
Additionally, democracy in Africa needs
to be organised around ideas that can lead
to real progress. Such ideas incorporate
inclusive economic growth that will make
the popular notion of ‘Africa rising’ more
real than the media- or investor-led hype
that has soured of late, even as the continent
remains a business destination of today and
tomorrow.
Too often, elections are still contests
for control of power and patronage
resources by ethnic and religious identities.
Zambia’s presidential elections in August
point to a regression towards these
motivating forces. These atomistic definitions
of self-interest have blocked the emergence
of more unifying national visions that create
real progress.
Third, an important lesson of Africa’s
democratic trajectory is that, to create
real wealth for Africa’s nations, democratic
contests will require the participation of
technocrats skilled in the art and science
of leadership, economics, public policy and
management, engineering, and innovation.
This trend is already taking root in a few
countries such as Ghana. In many other
countries, the old guard of ‘chartered
politicians’ still holds sway, conflating the
longevity of their political careers with their
perceived ability to take their citizens into the
future in a competitive world. Africa’s citizens
and voters must be educated to recognise
the difference.
▪
Kingsley Chiedu Moghalu is Professor of International
Business at The Fletcher School at Tufts University and a
former Deputy Governor of the Central Bank of Nigeria.
E M E RG I NG MA RKE T S | 2 3
Philip Middleton
Deputy Chairman
Louis de Montpellier
Deputy Chairman
Frank Scheidig
Deputy Chairman
Songzuo Xiang
Deputy Chairman
Mario Blejer
Senior Adviser
Aslihan Gedik
Senior Adviser
Robert Johnson
Senior Adviser
Norman Lamont
Senior Adviser
ECONOMIC & INDUSTRY
EDUCATION & RESEARCH
PUBLIC POLICY
CAPITAL MARKETS & INVESTMENT
BANKING
EDITORIAL & COMMENTARY
Meghnad Desai
Chairman
24 | A DVI SO RY BOA RD
omfif.org
O c to b e r | © 2 0 1 6
OMFIF ADVISORY BOARD
Kingsley Moghalu Fabrizio Saccomanni
Senior Adviser
Senior Adviser
Niels Thygesen
Senior Adviser
Ted Truman
Senior Adviser
EDITORIAL & COMMENTARY
1. Peter Bruce, Business Day
2. Reginald Dale, Center for Strategic and International Studies
3. Darrell Delamaide, Market Watch
4. Jonathan Fenby, China Research, Trusted Sources
5. Stewart Fleming, University of Oxford
6. Harold James, Princeton University
7. Roel Janssen, NRC Handelsblad
8. William Keegan, The Observer
9. Joel Kibazo, formerly African Development Bank
10.Thomas Kielinger, Die Welt
11.Jürgen Krönig, Die Zeit
12.Willem Middelkoop, Commodity Discovery Fund
13.Brian Reading, independent economist
14.Janusz Reiter, former Polish Ambassador to US
15.Anthony Robinson, formerly Financial Times
16.David Smith, formerly United Nations
17. Michael Stürmer, WELT-Gruppe
18.David Tonge, IBS Research & Consultancy
CAPITAL MARKETS & INVESTMENT
1. Andrew Adonis, National Infrastructure Commission
2. Bahar Alsharif, formerly International Finance Corporation
3. David Badham, World Platinum Investment Council
4. Stefan Bielmeier, DZ BANK
5. Mark Burgess, formerly Future Fund
6. Caroline Butler, Walcot Partners
7. John Campbell, Campbell Lutyens
8. Stefano Carcascio, formerly Banca d’Italia
9. Hon Cheung, State Street Global Advisors
10.Peter Gray, Berkeley Capital
11.Trevor Greetham, Royal London Asset Management
12.George Hoguet, CFA Research Foundation
13.Frederick Hopson, formerly Hessische Landesbank
14.Matthew Hurn, Mubadala Development Company
15.Paul Judge, Schroder Income Growth Fund
16.Mumtaz Khan, Middle East & Asia Capital Partners
17. Celeste Cecilia Lo Turco, Italian Ministry of Foreign Affairs
18.George Milling-Stanley, formerly World Gold Council
19.Paul Newton, London & Oxford Capital Markets
20.Saker Nusseibeh, Hermes Fund Managers
21.Robin Poynder, formerly Thomson Reuters
22.Colin Robertson, formerly Aon Hewitt
23.Olivier Rousseau, Fonds de réserve pour les retraites
24.Marina Shargorodska, formerly Quantum Global Group
25.Gary Smith, Baring Asset Management
26.Soh Kian Tiong, DBS Bank
27.Marsha Vande Berg, formerly Pacific Pension Institute
28.Jack Wigglesworth, formerly LIFFE
EDUCATION & RESEARCH
1. Iain Begg, London School of Economics
2. Harald Benink, Tilburg University
3. Gottfried von Bismarck, Körber Stiftung
4. Michael Burda, Humboldt University, Berlin
5. Nick Butler, King’s College, London
6. David Cameron, Yale University
7. Forrest Capie, CASS Business School
8. Jenny Corbett, Australia National University
9. Mark Crosby, Melbourne Business School
10.Jeffry Frieden, Harvard University
11.Haihong Gao, Institute of World Economics and Politics
12.Hans Genberg, SEACEN
13.Steve Hanke, Johns Hopkins University
14.Elliot Hentov, State Street Global Advisors
15.Ludger Kühnhardt, Center for European Integration Studies
16.Mariela Mendez, Escuela Superior Politecnica del Litoral
17. Rakesh Mohan, International Monetary Fund
18.José Roberto Novaes de Almeida, University of Brasilia
19.Michael Oliver, ESC Rennes School of Business
20.Danny Quah, London School of Economics
21.Richard Roberts, King’s College, London
22.Paola Subacchi, Royal Institute for International Affairs
23.Shumpei Takemori, Keio University
24.Maria Antonieta Del Tedesco Lins, University of São Paulo
25.Daniel Titelman, ECLAC
26.Linda Yueh, BBC
O c to b e r | © 2 0 1 6
omfif.org
BANKING
1. John Adams, China Financial Services
2. Yaseen Anwar, Industrial & Commercial Bank of China
3. Marek Belka, formerly National Bank of Poland
4. Consuelo Brooke, Alliance Trust & BlackRock
5. Moorad Choudhry, formerly Royal Bank of Scotland
6. John Chown, Institute for Fiscal Studies
7. Michael Cole-Fontayn, BNY Mellon
8. Christian Gärtner, DZ BANK
9. José Manuel González-Páramo, BBVA
10.Akinari Horii, formerly Bank of Japan
11.Korkmaz Ilkorur, Business & Industry Advisory Committee to OECD
12.Philippe Lagayette, Fondation de France
13.Andrew Large, formerly Bank of England
14.Oscar Lewisohn, Soditic
15.Wilhelm Nölling, formerly Deutsche Bundesbank
16.Athanasios Orphanides, formerly Central Bank of Cyprus
17. Francesco Papadia, formerly European Central Bank
18.Philippe Sachs, formerly Standard Chartered Bank
19.Nasser Saidi, formerly Bank of Lebanon
20.Fabio Scacciavillani, Oman Investment Fund
21.Miroslav Singer, formerly Czech National Bank
22.José Alberto Tavares Moreira, formerly Banco de Portugal
23.Jens Thomsen, formerly Danmarks Nationalbank
24.Pasquale Urselli, formerly Crédit Agricole
25.Makoto Utsumi, Japan Credit Rating Agency
26.Tarisa Watanagase, formerly Bank of Thailand
27.Ernst Welteke, formerly Deutsche Bundesbank
PUBLIC POLICY
1. Antonio Armellini, former Ambassador, OSCE
2. Franco Bassanini, formerly Cassa Depositi e Prestiti
3. Frits Bolkestein, formerly European Commission
4. Laurens Jan Brinkhorst, University of Leiden
5. Colin Budd, formerly UK Diplomatic Service
6. Otaviano Canuto, World Bank Group
7. Desmond Cecil, Areva UK
8. Natalie Dempster, World Gold Council
9. Hans Eichel, former German Minister of Finance
10.Jonathan Grant, Policy Institute at King’s
11.François Heisbourg, Fondation pour la Recherche Stratégique
12.Karl Kaiser, Harvard Kennedy School
13.John Kornblum, former US Ambassador to Germany
14.Ben Knapen, Dutch Senate
15.Ruud Lubbers, former Dutch Prime Minister
16.Bo Lundgren, formerly Swedish National Debt Office
17. Denis MacShane, former British Minister for Europe
18.Kishore Mahbubani, Lee Kuan Yew School of Public Policy
19.Boyd McCleary, former HM Diplomatic Service
20.Luiz Eduardo Melin, formerly Brazilian Development Bank
21.Célestin Monga, African Development Bank
22.Murade Miguigy Murargy, CPLP
23.David Owen, House of Lords
24.Jukka Pihlman, Standard Chartered Bank
25.Poul Nyrup Rasmussen, former Danish Prime Minister
26.Paul van Seters, Tilburg University
27.Christopher Tugendhat, House of Lords
28.John West, Asian Century Institute
29.Paul Wilson, formerly De La Rue
ECONOMICS & INDUSTRY
1. Irena Asmundson, California Department of Finance
2. Robert Bischof, German-British Chamber of Industry & Commerce
3. Eduardo Borensztein, Inter-American Development Bank
4. Albert Bressand, European Commission
5. Shiyin Cai, Business Adviser
6. Efraim Chalamish, New York University
7. Vladimir Dlouhy, former Czech Industry Minister
8. Brigitte Granville, Queen Mary, University of London
9. Graham Hacche, National Institute of Economic and Social Research
10.Hans-Olaf Henkel, University of Mannheim
11.Hemraz Jankee, formerly Central Bank of Mauritius
12.David Kihangire, formerly Bank of Uganda
13.Pawel Kowalewski, National Bank of Poland
14.Gerard Lyons, Greater London Authority
15.Stuart Mackintosh, Group of Thirty
16.Winston Moore, Moore Asociados
17. Vicky Pryce, formerly UK Department for Business
18.Edoardo Reviglio, Cassa Depositi e Prestiti
19.Pedro Schwartz, CEU San Pablo University
20.Vilem Semerak, Charles University, Prague
21.Song Shanshan, SDIC CGOG Futures
22.Gabriel Stein, Oxford Economics
23.Takuji Tanaka, Innovation Network Corporation of Japan
24.Jorge Vasconcelos, New Energy Solutions
25.Obindah Gershon nee Wagbara, Georgetown University
26.Volker Wieland, German Council of Economic Experts
A DVI SO RY BOA RD | 2 5
Best chancellor New Labour never had
Back to hinterland for political retiree
E
William Keegan, Advisory Board
d Balls is one of the most interesting
British politicians of modern times. But
at the age of 49 he is no longer a member
of parliament and his political career is over
– or is it?
It certainly looks like it. In the general
election of 2015, Balls not only witnessed his
party’s defeat but lost his own parliamentary
seat. He has not put his name down for
another constituency and would be unlikely
to be selected to stand in another seat. One
of the messages that comes across from this
engaging memoir, Speaking Out: Lessons in
Life and Politics, is that he has no appetite for
another five years of opposition politics.
The great British political commentator
Alan Watkins was fond of saying, ‘Politics is a
rough old trade.’ The fact that a man of Balls’
calibre should have been propelled from
the scene so unceremoniously is a classic
illustration of the Watkins dictum.
It is a crying shame. Balls played a major
role on behalf of his mentor Gordon Brown in
fashioning ‘New’ Labour’s economic policies,
an achievement for which he has not received
the recognition he deserves.
The Conservatives under David Cameron
and George Osborne in 2010 managed to
persuade more gullible voters that Labour
had been responsible for the global financial
crisis, and perpetuated the myth throughout
the 2010-15 parliament. Slogans like ‘Labour
cannot be trusted with the nation’s finances’
were still a factor in the 2015 election.
The fact that Labour was not responsible
for what went wrong in the US or the euro
area was neither here nor there. Enough
British voters were convinced that Labour’s
public spending plans had caused the crisis.
However, there has been widespread
acknowledgement that Labour was right to
make the Bank of England independent and
keep the UK out of the euro.
And although the state of the National
Health Service is once again a source of
concern, a determined effort to save the
service in one of Brown’s early budgets as
chancellor received broad support.
2 6 | BO O K RE VI E W
Balls’ role and influence was crucial in all
three of these key decisions. This was when
he was a Treasury adviser, before embarking
on his political career by winning a seat in the
2005 general election.
Balls is best known for his economic
expertise, and confesses in the book that he
now regrets never having been chancellor.
The possibility of moving to the Treasury
arose on several occasions during Brown’s
“
The possibility of
moving to the Treasury
arose on several more
occasions during Brown’s
premiership, but something
always got in the way.
2007-10 premiership, but something always
got in the way. Balls was the best chancellor
New Labour never had.
In addition to taking up a fellowship at
Harvard University and becoming a visiting
professor at King’s College, London, Balls
has produced this book just over a year after
losing office.
‘A trying relationship’
He admits that, although he was as close
to Brown as anyone, it could be a trying
relationship.
One revelation is Balls’ firm assertion
that, although the press was always replete
with stories about disagreements between
Tony Blair and Brown, the two were much
closer on policy than most people were led
to believe.
On the other hand, having worked happily
with Ed Miliband at a more junior level, Balls
found himself more or less isolated when
Miliband became Labour leader.
This did not help Labour’s election
chances in 2015, when Miliband abandoned
a fundamental New Labour insight – that we
omfif.org
live in a market economy and it is electorally
dangerous to come across as anti-business.
The book is beautifully written, in
conversational style, and divided into themes
such as ‘Decisions’, ‘Ambition’, ‘Mistakes’.
Balls is an admirer of the great Labour
politician Denis Healey, whom he met shortly
before Healey died.
Healey made a great thing about how
politicians should always have a cultural
‘hinterland’ to shield them from the slings
and arrows of political life.
Balls certainly has one. He is happily
married to the politician Yvette Cooper; he
is an enthusiastic footballer and marathon
runner; plays the piano; and has become a
national figure through popular television
programme Strictly Come Dancing.
Political career over? He concludes: ‘I’ve
had my chance in politics and – while you
should never say never – I don’t expect
that chance to come again.’ Alas, given the
potentially terminal state of the Labour party,
he may well be right.
▪
William Keegan is Senior Economics Commentator for The
Observer.
O c to b e r | © 2 0 1 6
ECB expected to extend QE to new asset classes
Despite monetary expansion, inflation to remain subdued in euro area
T
his month’s poll focused on the outlook for the European Central Bank’s quantitative easing programme and euro area inflation. Members
of the Advisory Board were asked two questions. First, ‘What changes, if any, do you expect the ECB to make to its quantitative easing
programme before it expires in March 2017?’ with five possible options (respondents were invited to select as many or few as appropriate)
– expand into new asset classes; lower or abolish the minimum yield requirement; change the capital key governing ECB QE purchases; raise
the issue limit on bonds; and no change – let the programme expire. The second question asked members for their prediction for the euro
area annual inflation rate, on the ECB’s measurement, in 2017 and 2018.
Of the responses received, 32% expected the bank to expand the QE programme into new asset classes. A further 20% each subscribed to
options three, four and five – that the bank would change the capital key governing QE purchases, the ECB raising the issue limits on bonds, and
‘no change – let the programme expire’, while 8% expected the bank either to lower or abolish the minimum yield requirement.
Estimates for euro area inflation in 2017 and 2018 were wide-ranging – at the lower end for 2017, 0.6%, with an upper estimate of 2%.
Respondents broadly expected inflation to be higher in 2018. Estimates ranged from 0.6% to an upper estimate of 2.5%.
Option 1
‘While I don’t expect the ECB to change the capital
key that governs QE purchases in its current ordinary
programme, it could if one or several countries ask
for activation of the ESM. But one could imagine a
redesigned programme with some sort of yield
targeting whereby the ECB purchases fewer expensive
bonds and more higher-return bonds. This would
drive German and French yields higher and could
be welcomed by the Bundesbank and the German
government, as it would reduce the rate of saver
pauperisation so dreaded by future retirees.’
Olivier Rousseau, Fondation de reserves pour les
retraites
‘Market-based inflation expectations in the euro area
have recently hovered around lows and have been
trending down more markedly after the Brexit vote.
Until the ECB sees a sustained adjustment in the path
of inflation consistent with its aim, the most likely
scenario is that it will extend its QE beyond March 2017.
However, QE’s technical restrictions will become an
issue, with each option having its share of drawbacks.
There are also risks of re-opening rifts within the ECB
with QE extension, with Germany sceptical of moves to
prolong asset purchases.’
Hemraz Jankee, formerly Central Bank of Mauritius
ECB expected to expand into new asset classes
Percentage of responses
Lower/abolish
minimum yield
requirement
8%
No change
– let the
programme expire
20%
New asset
classes
32%
Raise the issue
limit on bonds
20%
Change the
capital key
20%
What changes, if any, do you expect the ECB to make to its
quantitative easing programme before it expires in March 2017?
Wide-ranging inflation expectations
Estimates for euro area inflation, OMFIF Advisory Board
‘QE is now more contentious as the negative impact
has become more evident. A fall in risk assets, leading
to hits to Central Bank balance sheets, would further
damage support for this policy.’
Colin Robertson, independent asset allocation
consultant
These additional statements were received as part of the September
poll, conducted between 9 and 24 September. It calculates the results as
a percentage from a total of 25 responses coming from 17 respondents.
A respondent can choose more than one option to the question.
2017
2018
Lowest estimate
0.6%
0.6%
Median
1.0%
1.4%
Highest estimate
2.0%
2.5%
What is your prediction for the euro area annual inflation rate,
on the ECB’s measurement, in 2017 and 2018?
November’s question
Will China’s economy experience a hard landing or recession over the coming five years?
Will the renminbi's inclusion in the IMF’s SDR basket make an essential difference for the international monetary system, or is it largely
a ceremonial seal of approval?
O c to b e r | © 2 0 1 6
omfif.org
A DVI SO RY BOA RD P O L L | 2 7
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