Inflated BRIC -: A Special Report By CapitalHeight 24-02-11

8/7/2019 Inflated BRIC -: A Special Report By CapitalHeight 24-02-11

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INFLATED BRIC!!!

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CONTENTS

Introduction

Inflated BRIC

Inflation and Policy Stance

Brazil

Russia

India

China

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Introduction

Chairman Bernanke's experiment with quantitative easing continues to have unintended

consequences for the global economy, due to the impact of the equation highlighted below:

QE2 = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]

While prices for food and energy have been rising, inflation in the United States has remained

relatively subdued. One common explanation for that phenomenon is that U.S. inflation has

been "exported" to China and elsewhere through the U.S. Federal Reserve's monetary policy.

And given the perennial U.S. balance of payments deficit, it's good to know the country has

found something it can successfully export!

U.S. monetary policy has involved excessive money creation since 1995, fueling asset bubble

after asset bubble. However, it has not produced inflation in the United States because the

dollar is a reserve currency, so excess dollars flow to countries whose economies are more

vulnerable to inflationary pressures. However, the bad news here is that inflation does not stay

exported - and in 2011 it may boomerang back to make life on Main Street miserable.

In the 1990s, the excess dollars flowed to Argentina, whose currency was pegged to the dollar.

The imported inflation wrecked Argentina's sound policies of that decade and contributed to a

debt-fueled collapse in 2001.

Since 2008, the excess money has gone to China, India, Brazil and other fast-growing emerging

markets. It also has fueled a massive growth in foreign exchange reserves among the world's

central banks. Central bank holdings of forex reserve have grown more than 16% per annum

since 1998.











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Inflated BRIC

China, India, and Brazil all currently have massive inflation problems. China, which has

increased its inflation by holding down its currency against the dollar, has been very proactive

in tackling inflation as of late. The People's Bank of China (PBOC) surprised the markets on

Christmas Day by raising its one-year refinancing rate by 52 basis points to 3.85% and increasing

the benchmark deposit rate by 25 basis points to 2.75%.

The PBOC has increased bank reserve requirements five times in the past year and raised

interest rates twice - albeit by a scant 0.25% each time. China's official inflation rate currently is

5.1%, up from 1.5% at the beginning of 2010, but its figures are suspect. The PBOC probably will

have to raise its benchmark rate several more times from its current level of 5.81% before it's

able to bring inflation under control.

India's inflation is about 8.4%, but is expected to rise further since food prices are surging at

double-digit rates. Prices for onions, for instance, are up 33% from last year. The Reserve Bank

of India (RBI) is again raising interest rates, now at 6.25%. But, as in China, sloppiness in official

inflation statistics means Indian interest rates are negative in real terms and the RBI will have to

continue raising rates if it wants to control inflation.

Brazilian inflation was 5.91% in December and is rising fast. Newly elected President Dilma

Rousseff fired the central bank chief and is trying to bring interest rates down from their

current level of 10.75%. Again, inflation seems likely to surge in the near term.

To complete the BRIC (Brazil, Russia, India, and China) picture, Russian inflation is currently

running at 8.8%. That's down from a year ago, but still much higher than the Russian

government would like it to be. With inflation rising in all four BRIC countries and many other

emerging markets, the U.S. holiday from inflation cannot last much longer.











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The Fed's second round of quantitative easing (QE2), which included purchases of $600 billion

in Treasury bonds before July, and the December package of tax cuts are also fueling

inflationary forces. Money growth, which had been low in 2009 after the burst in late 2008, has

once again risen to worrying levels. Over the last four months, the average growth rates of

broad money on the Federal Reserve Bank of St. Louis' Money of Zero Maturity and M2 Money

Stock measures were up 10% and 7%, respectively. That's comparable to their growth in the

1970s.

Furthermore, oil prices are approaching $100 per barrel, and other commodity prices are

strong, as well. So however successful the Fed has been in exporting inflation since 2008, its

success won't last for much longer. At some point in 2011, inflation will be re-imported - and

probably with a roar rather than a whisper. When that happens, the Fed will have to raise

interest rates to fight rising prices. Of course, Federal Reserve Chairman Ben Bernanke will

almost certainly resist this inevitability, fudging figures and producing spurious arguments to

avoid making the right decision. When the Fed does eventually raise rates, it will do so

grudgingly - as it did during the period from 2004 to 2007. That means higher short-term

interest rates probably won't arrive until 2012, and higher long-term rates could potentially be

delayed by more quantitative easing. The result will be an unholy mess that takes the form of

surging inflation in 2011 and a second recessionary "dip" in 2012.

Gold and other commodities will continue to offer protection against the surge in inflation in

2011, as they have in the last few years. At some point, though, the market will start to

anticipate tighter Fed policy and gold and other commodities prices will collapse. If the gold and

commodities markets didn't believe the obviously serious Volcker would stop inflation until

several months after he took decisive action, they certainly won't have confidence in the

actions taken by a reticent Ben Bernanke. So your gold and commodities investments will

probably be pretty safe even if the Fed does eventually start raising rates.











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Inflation and Policy Stance

A brief review of global economic data points highlights struggles with inflation in three very

key countries: China, India and Brazil. While the divergence between each country's responses

reminds us that both inflation and monetary policy are local, analyzing them collectively allows

us to derive the equation laid out on first page.

Country: BRAZIL Policy Stance: Reactive Last fall, Brazil's monetary policy graded out less than favorably due to its relatively late

reaction (compared to China) in fighting inflation. But it appears Brazil is

finally ready to shift the fight into high gear in January,

after raising reserve requirements early last month.

Analysis of Brazilian interest rate swaps suggests

traders are betting bhike in benchmark Selic rate by

50bps to 11.25% in January.

New President Dilma Rousseff, has also joined thefight against inflation by taking action to cut

government spending by $15 billion. However, we see

that the Brazilian Congress just approved an increase

in the minimum salary – a metric that determines

both the nation's minimum wage and transfer

payments.

Given that a broad-based wage hike would augment already-robust

Brazilian consumer demand, we would expect to see more monetary policy tightening and

offsetting fiscal restraint elsewhere in the government's budget over the intermediate trend.











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Brazil's Manufacturing PMI came in at 52.4 for December, a 2.5

increase over November's 49.9 reading. Brazil is in a setup very similar to China: while we have

conviction that growth will continue to slow throughout the first half of 2011, it is robust

enough to continue providing demand-side inflationary pressures.

Country: RUSSIA Policy Stance: Active Russia may need to let its currency rise to curb inflation and that the government should begin

withdrawing its huge fiscal stimulus. A return to a policy of resisting nominal ruble appreciation

could send inflation back to double-digit levels. Monetary policy should focus firmly on inflation

control in the context of a more flexible exchange rate.

Russia’s central bank, which has sharply reduced the

extent to which it steers the ruble to lessen the

effects of currency moves on producers, still

prioritizes exchange-rate stability over inflation.

Also, inflation in the world’s largest energy

supplier shouldn’t exceed 5 percent to 7

percent in the coming three years. Russia

doesn’t have a strategy for the removal of

stimulus and doing so will not be possible

without reinvigorating long- delayed public-

sector reforms. International comparisons

suggest the nation can make significant savings

in health and social protection adding that the

pension system isn’t financially viable without a

comprehensive overhaul, including a gradual increase











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in the retirement age. Russia’s authorities previously expected to start withdrawing stimulus

this year, and to gradually lower the non- oil budget deficit to 9.5 percent of gross domestic

product by 2012, from 13.75 percent of GDP in 2009. However, with the recent supplementary

budget, there is instead a small further expansion in 2010, and the authorities also appear to be

revisiting the planned pace of consolidation over the medium term. Russia’s GDP is projected to

increase 4.25 percent in 2010 and inflation to remain relatively subdued, reaching 6 percent at

the end of the year. Still, with limited prospects for further increases in oil prices over the

medium term, the nexus of strong growth in investment, productivity, real wages, and

consumption that powered the pre-crisis growth is unlikely to materialize any time soon.

Country: INDIA

Policy Stance: Inactive

India continues to lag in its bout with taming inflation, opting instead for the "wait and see"

approach with regard to implementing another rounds of tightening. Having shifted from his

hawkish stance (six rate hikes in 2010 and 1 in Jan 2011) to a more relaxed position. That would

be fine if India had inflation under control.

Unfortunately, the latest wholesale price index (WPI) reading of +8.4% year-over-year suggests

India is far from achieving its target of +4-4.5% inflation. It is, however, a marginal improvement

nonetheless, though expecting an additional +300bps drop from here absent any further

tightening would be reckless at best. Moreover, food inflation continues to plague the 828

million Indians who live on less than $2 per day, with the PPP accelerating to +14.44% year-

over-year in the second week of December.











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Compounding this blatant lack of vigilance is the RBI's decision to add fuel to the fire by buying

back government bonds from Indian lenders with the intention of increasing liquidity in a cash-

strapped banking system that has been struggling to meet demand for loans. In December, the

RBI pumped nearly 414 billion rupees ($9.3B) into India's financial system via sovereign bond

purchases (a.k.a. Quantitative Easing).

Fueling speculation when inflation is running at nearly twice the target rate is not our idea of

prudent monetary policy. We expect further tightening ahead. This is one of the reason, we

expect Indian equities bearish over the intermediate-term trend. we can be bullish on many

commodities like corn, sugar, oil, etc. as countries like China and India look to accelerate

food and energy imports to ease any supply shortages. India's food

price index had risen for the fifth straight

month to 18.3% in late December, its

highest in more than a year, while fuel

prices climbed 11.63%, government data

last week showed. Food makes up a little

over 14% of the wholesale price index,

while fuel contributes about 15%, and a

quickening or softening in these

components will put pressure on the

headline figure in either direction.

Industrial output in November rose a

slower-than-expected 2.7% from a year

earlier, sharply lower than the previous month's

revised annual growth of 11.3%, government data.











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The central bank is expected to raise its key rates by 25 basis points at its policy review on

January 25, in its efforts to squeeze inflation back to its projected level of 5.5% by end-March.

The RBI had raised its key rates six times last year and by another 25 basis points in Jan 2011.

Country: CHINA

Policy Stance: Proactive

On a relative basis, China has been particularly proactive in its fight with inflation of late, hiking

interest rates twice in the last 2.5 months, raising banks' reserve requirements, and announcing

potential price controls and supply rationing in its food market. China has

proactively fought speculation and its latest Purchasing

Managers' Index (PMI) report shows early signs

of success.

Manufacturing PMI, a proxy for demand,

slowed in December to 53.9 vs. 55.2 prior withthe Input Prices component backing off a 29-

month high, coming in at 66.7 vs. 73.5 in

November. Dampening some of the positive

headway made in the report was acceleration

in Non-Manufacturing PMI to 56.5 vs. 53.2

prior, which suggests Chinese monetary policy

has more, tightening to do before growth has

slowed enough to rein in both inflation and

inflation expectations.











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Inflated BRIC -: A Special Report By CapitalHeight 24-02-11