Tough times ahead for central banks

Tue, 23 Mar Pre-Open

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The road ahead looks tough for the developed nations. The subprime crisis may have laid bare the excess debt on the books of companies but this disease has now spread to governments as well. What is more, John Lipsky of the IMF is of the view that advanced economies face 'acute' challenges in tackling high public debt. Further, he opines that unwinding existing stimulus measures will not come close to bringing deficits back to prudent levels.

In fact, it is expected that all G7 countries, except Canada and Germany, will have debt-to-GDP ratios close to or exceeding 100% by 2014. Stimulus measures have obviously lent a hand in widening the deficit but the consensus is that even if governments choose to withdraw the same, it will not have much of a meaningful impact on the overall debt position of countries.

And if you thought that this problem is contained only within the rich world, that appears not to be the case. Lipsky says that government debt in some emerging nations has also reached 'worrisome' levels. While inflation is not the chief concern in the developed world for the time being since most countries are yet to come out of the slump, it could be a bigger problem in the longer term. This would be especially so if the governments stick to their expansionary monetary policies for a much longer time and print more money to counter the recession.

In the emerging nations, higher inflation has already made its presence felt and have kept central banks on their toes. Emerging nations, more specifically BRICS, have not been hit hard by the crisis as the rich world has. As a result, a deadly cocktail of stimulus measures, relaxed monetary policies and abundant liquidity has jacked up the prices of many asset classes. Indeed, it is obvious that whatever be the circumstances, central banks all over the world will see their mettle tested in the coming months.

China could roll back stimulus

Just as US and China are exchanging heated words due to the latter's policy of pegging the yuan to the dollar, China seems to be considering a gradual rollback of its gargantuan stimulus package of US$ 586 bn last year. Having said that, the dragon nation has not set any deadline with respect to the same. It may be noted that the global financial crisis hit China's exports sector very hard and lowered the economy's growth rate. The impact was greater as compared to India simply because China's economy did not have the benefit of strong domestic consumption as India. In addition to the massive doses of liquidity into the country, Chinese banks also resorted to indiscriminate lending to spur consumption. The latter especially proved poisonous as this easy money began to find its way into stockmarkets and real estate the prices of which have reached unjustifiable levels.

The Chinese government as a result resorted to raising the reserve requirements of banks to cool down its economy. Little wonder then that concerns of the Chinese bubble bursting is making the headlines every other day. And while China has a lot of issues to deal with, the US is beginning to breathe hard down China's bank to make the latter let its currency appreciate against the dollar. Whether China will choose to comply given the precarious state that the country's exporters are still in is anybody's guess. But it does seem that the country will have to take some serious steps in preventing its economy from overheating.