The hard liner Wolfgang Schäuble, Germany’s finance minister, was explicit again on Tuesday, saying: “If Greece– and this is the will of the great majority– wants to stay in the euro, then they have to accept the conditions. Otherwise it isn’t possible. No responsible candidate can hide that from the electorate.” German Chancellor Angela Merkel and the new French president, François Hollande, were more diplomatic after their first meeting in Berlin, stating that they wanted Greece to remain in the euro area, and that Europe would work to promote economic growth. But they also made clear that the Greek government would have to stick with the agreed IMF program. Even after Hollande’s victory, there was not much sunlight between France and Germany.

Despite the clarity of their warnings, polls in Greece suggest a mixture of wishful thinking and schizophrenia. Voters seem to be flocking to Syriza’s anti-IMF electoral platform while expressing the desire to remain in the euro area. Something will have to give.

As I have described earlier, the new elections take euro area crisis brinkmanship to a new level. But whether euro area leaders succeed in bludgeoning Greek voters into backing the pro-IMF program parties is an open question.

The threats are already producing real economic effects in a way that past warnings to voters in Ireland and Denmark, when they initially rejected a European Union in referendums, did not. The latest threats may not be swaying Greek voters, but they are already swaying Greek bank depositors, who have been withdrawing their bank deposits at an accelerating pace. Indeed, we may not even see Greek elections if Greek bank depositors deliver their own verdict on leaving the euro area before mid-June.

Normally, of course, a bank run is a devastating event. Responsible policymakers do their utmost to avoid one. But an accelerating bank run in Greece might offer opportunities. A bank crisis will likely strengthen the hand of pro-IMF program parties. We should thus expect no letup in the threats from the euro area leadership. Indeed, these leaders may secretly encourage the bank panic as a strategy to expose the hollowness and deceit of the Syriza electoral platform. If Greek bank depositors do not trust Alexis Tsipras’s promises with their own money, would they vote for him?

It is counterintuitive, perhaps, but anyone who wants to keep Greece in the euro area should withdraw money from the banks. Though pro-IMF program politicians will likely keep quiet, PASOK and New Democracy might actually encourage the bank runs. They could even post the lines outside banks on YouTube to send the message!

Make no mistake. This high stakes game of chicken could bring unknown and potentially uncontrollable consequences, possibly leading to an economic collapse in Greece, which could spread to other euro area countries. As I have argued before, euro area leaders should choose this route only if they are prepared to adopt a pan-European bank deposit insurance scheme and have the European Central Bank (ECB) resume massive market intervention if things go wrong.

But the potential benefits from this gamble are also huge. A bank run led by retail depositors– after all, no one really knows how a country technically leaves the euro!– might vindicate the pro-IMF program parties and quell Greek protests against austerity and their flirtation with Tsipras’s populism.

The euro area could then consider several alternative strategies to get a compliant government in Athens. The Greek president could reconvene political leaders to try to salvage the situation, with PASOK and New Democracy seeking several of the previously opposed parties to form a new unity government. These could include the Democratic Left led by Fotis Kouvelis and/or the Independent Greeks led by Panos Kammenos. It might not be strictly constitutional to cancel an election once it has been called, but a legal route could be found if the president and a majority of Greek parliamentarians wanted it.

If the deposit flight continues unabated, the ECB will be in an awkward position, because it will likely be called upon to provide capital to Greek banks to make up for lost deposits. Presumably the ECB would do so only with a mandate from euro area political leaders, perhaps including explicit euro area sovereign guarantees to continue to lend to Greek banks or allow Bank of Greece Emergency Liquidity Assistance (ELA) to continue. Such a demand would echo what the central bank did when it was forced to accept default-rated Greek bonds after the restructuring in March. As Belgian central bank president Luc Coene said this week: “The issue is one for the politicians… It will be a political issue– where is the balance of solidarity– rather than a technical issue about whether the banks have been sufficiently recapitalized or not.” The ECB would of course not want to be seen as pushing Greece, leaving that role to elected politicians.

Euro area leaders would then have to decide what to do. They would probably not want to see the Greek banking system collapse immediately, so they would likely go along with the ECB lending money to Greek banks. But they would probably also demand that Greek politicians sign up to the IMF program, or even that they scrap the elections and form a unity or technocratic government. This may seem terribly undemocratic. Such demands would have to be packaged to make them look like the idea came from Greece. But such things have happened before. Only last November, the EU pushed for the installation of technocrats to run the governments of Greece and Italy. Despite the claim by Merkel and Hollande that they would “listen to the Greek people,” Greek bank depositors may speak louder than Greek voters. If a bank run presented an opportunity to win a Greek agreement to stick with the IMF program, European leaders would almost certainly seize it.

More broadly, a devastating domestic bank run in Greece could strengthen the case for keeping the euro area together while it heads toward a fiscal and banking union. Euro area leaders in Germany, France, and elsewhere know that a euro exit by a member state would be very costly throughout the currency region, making them vulnerable to blackmail from opportunistic populists like Alexis Tsipras in Greece. But now the example of Greece has illustrated a new factor — namely, that the threat of a bank run taking place in any country considering a euro exit acts like the functional equivalent of a preemptive nuclear strike on political forces advocating such an exit. Because of the Greek example, populists across the euro area have awakened to a new political reality– that will be blamed for destructive domestic bank run if they pursue their exit strategies.

By bringing forward the economic costs of a euro area exit to the present– before any voters back a euro exit in their country– a bank run in Greece will not only help produce the “right result” in that country (i.e., a pro-IMF program majority), but prevent such policies from even being articulated by populist leaders elsewhere. Such political neutralization of populism would be a huge prize for euro area leaders.

Utilizing the threat of bank runs does take euro area brinkmanship to a dangerous new level. Euro area leaders should think carefully about proceeding down this road. It should only be contemplated if euro area leaders are willing to proceed to pan-euro area bank deposit insurance and other dramatic integration measures to avoid the spread of contagion and bank runs to other member states. If they are prepared to do so, they can call Alexis Tsipras’ bluff by fomenting a bank run in Greece before the new elections are held.

Copyright © 2012 Peterson Institute.

When faced with this type of electoral upset in small member states, the EU has historically adopted two distinct response strategies, one aimed at voters and the other aimed at recalcitrant political leaders. The first strategy was employed in 2009 when the Irish first rejected the Lisbon Treaty reforming the European Union. Subsequently, when a few meaningless revisions were added to the Treaty, the Irish voters adopted it in a second referendum. It was the threat of economic and political isolation that persuaded them to change their mind. The second strategy unfolded at Cannes last year. It was then that the EU threatened Greek political leaders with economic ruin (in the form of a euro exit) in order to force them to rethink their response. Both these strategies were designed to overcome member state democratic processes and get to the “right answer” for the European Union as a whole.

We are about to see both these strategies potentially applied to Greece, ushering in a period of intense political instability in the euro area as this one or two-stage game of chicken gets under way.

As new elections in Greece now look overwhelmingly likely, we will first see the Irish referendum strategy played out focused on the Greek electorate. Alexis Tsipras, leader of the leftist anti-IMF program Syriza party, which came second in the Greek elections, has clearly articulated that he intends to annul the IMF program and cancel all loan arrangements.² He expects to call the euro area’s bluff by threatening economic ruin on the rest of Europe to force a renegotiation easier on Greece. For several reasons, this strategy is unlikely to work.

Threatening market chaos if its demands are rejected is much less credible than earlier in the crisis, for example. Following the Greek debt restructuring in March, most of the private losses from Greece’s bankruptcy have already been realized. Euro area banks are well funded with ECB 3-year liquidity. The immediate cross-border financial market spill-overs from the end to the current IMF program and another Greek default will likely be smaller today than they would have been last November.

If an outright Greek euro exit were seriously contemplated, however, the euro area would have to take additional institutional measures to protect itself from the risk to its currency. Euro area leaders would have to redouble their commitment to keeping the diminished euro “inseparable and forever”. The euro area would have to accelerate its economic and institutional integration by, for example, introducing a pan-euro banking deposit insurance scheme to prevent bank runs in other peripheral countries when Greek euro deposits are suddenly converted into new drachma. There would also have to be a clear time table for eurobonds. Ironically, by forcing Europe to prepare for threatened chaos, a Greek exit would have a positive impact on the integration of the rest of the euro area.

Euro area taxpayers are increasingly playing the role of sole junior Greek creditor. If one believes that Greece is ultimately not going to be able to commit to its IMF program, it would be in the taxpayers’ interest to cut off funding as early as possible to prevent having to take bigger losses in the future. This is crucial because large transfers to recapitalize Greek banks (€25-50 billion) are otherwise planned in the near future. Ending the IMF program payments to the Greek government early and instead relying on the separate escrow account to continue to pay only Greece’s remaining private bondholders (most of them euro area banks)– while stopping all payments to cover the Greek budget deficit– might appeal to euro area leaders. Even if it chose to stay in the euro, the Greek government would have to balance spending and revenues immediately, ushering in even more austerity than entailed by the IMF program. While the euro area does not want Greece to end its IMF program and even less to exit the euro, it holds a stronger hand than Athens holds in this new round of brinkmanship.

Ahead of Greece’s new elections, the euro area and the Troika (the EU, the ECB and the IMF) will thus employ the Irish referendum strategy by rejecting Tsipras’s bluff and declaring the IMF program non-negotiable– and adding that a failure by Greece to adhere to it will cancel financial support and drive Greece from the euro area.

We are already seeing this strategy put in motion. In March, the IMF noted that “Greece has little if any margin to absorb adverse shocks or program slippages.”³ But it remains unlikely to sanction any postponement of implementation of its program. This reality was acknowledged by IMF managing director Christine Lagarde in a speech on May 7, in which she noted that while balanced fiscal policies are important, “countries under severe market pressure [including Greece] have no choice but to move faster.”⁴ A chorus of voices from Berlin and Frankfurt have been equally clear. Chancellor Angela Merkel has explicitly stated that Greece must carry on with the IMF program to receive financial assistance.⁵ Guido Westerwelle, the German foreign minister, was even more explicit in raising the specter of a euro exit: “We want Greece to stay in the euro area,” he said. “Whether it stays in the euro area is in the hands of Greece.”⁶ Finance Minister Wolfgang Schäuble noted that “If Greece decides not to stay in the euro area, we cannot force Greece.”⁷ Austrian Chancellor Werner Faymann has said that the “exit option” remains on the table in Europe: “Every country can decide to leave the common euro area,” he said. “Of course Greece can as well. You just have to know what it means– and the Greeks will have to consider that.”⁸ The ECB’s Jörg Asmussen has also already been unequivocal, telling Handelsbladt that Greece has no choice but to stick with its IMF program “if it wants to remain a member of the euro area.”⁹ There is also the option that the euro area will– using the escrow account– try to block funding from Greece before the next elections¹⁰ to ram home the message.

Whether this “shock therapy” will influence the Greek electorate is an open question. If cheap rhetoric about the “end of austerity” is the prevailing narrative of the next campaign, Syriza and others may well do even better. But if a second Greek election campaign is about whether to stay inside or outside the euro, the parties committed to the IMF bailout may do better than they did this month and the euro area’s “Irish referendum strategy” will have been vindicated. Opinion polling persistently shows that 60-70 percent of Greeks want to stay in the euro. Implicitly putting the euro on the ballot might also reduce the record high 35 percent abstention rate on May 6.¹¹ One thing is sure, though. Volatility will remain in the weeks ahead. Indeed euro area policy makers are exploiting the chaos to make the choice unmistakable for Greek voters.

If this strategy fails and Syriza and other anti-IMF program parties again win, then the euro area will likely resort to its ultimate strategy from Cannes last year.

It was then that Prime Minister George Papandreou surprised Europe by suddenly calling for a referendum on Greece’s austerity program. That announcement, which occurred just before the G-20 Summit on the Cote d’Azur, forced Papandreou’s rivals in the New Democracy to share the political responsibility with his own Socialist party for implementing the IMF program. Previously, New Democracy and its leader Antonis Samaras had cynically refused to share responsibility for the program with PASOK. Indeed he disingenuously claimed that the program could be renegotiated. Papandreou’s calculation was that a call for a referendum would expose the emptiness of Samaras’s claim and force him to join a national unity government instead.

Later, at the Cannes summit, Papandreou probably got a lot more than he bargained for. Both Chancellor Angela Merkel of Germany and President Nicolas Sarkozy of France made it clear that a rejection of austerity in the referendum would force Greece to leave the euro area.¹² Papandreou’s gambit worked, setting in motion the formation of a national unity government under the technocrat Lucas Papademos only a few days later. PASOK was thus relieved of the sole political responsibility of implementing the IMF program, and Greece won some short-lived but much needed political stability, enabling it to negotiate a new program with the largest sovereign debt restructuring in history in the form of a Greek bond swap in early 2012.

Thus if the anti-IMF parties win the next election, the Greek political establishment will likely wake up and seek ways to expand the parliamentary support base for the tough economic policies it knows are inevitable. Remember that Syriza and the Independent Greeks parties are similar to the political position of Samaras before the New Democracy joined the unity government last year. They claim to be “pro-European” and supportive of Greece remaining in the euro. But they also reject the demands for further austerity and structural reforms that represent the price Greeks will have to pay to follow that path. Only the two most extreme parties in Greece, the hard-core communist KKE with 8.5 percent of the vote on the left, and the extreme-rightwing Golden Dawn with 7 percent of the vote on the right actively advocate the departure of Greece from the euro.

Will the three self-professed pro-European parties come to the same conclusion as Samaras last year when international realities began to sink in? So far, Tsipras and Syriza are talking a good game. They claim that Greek voters have “clearly nullified the [IMF] loan agreement,”¹³ under the assumption that the voting result can force economic concessions. When it is made clear to them that this is not the case, will they change their minds? Or will they stand by these pledges, when the Greek government runs out of cash as early as the end of June¹⁴ and is speeding toward complete economic collapse as a result of a euro exit? Samaras changed his mind when confronted with this question last November. The euro area will be betting as a last option that Greece’s new populists will do the same. They are counting on the parties to stay in Europe and not walking away from history and joining the Levant.

The outcome is uncertain, and Greece may have to enter a more acute phase of ungovernability, perhaps precipitated by a retail customer bank run or other highly visible signs of imminent economic collapse, before people like Tsipras change their minds.

The euro area’s ultimatums are ushering in a volatile new phase of the euro area crisis, increasing the risk of Greece leaving the euro area. Brinkmanship is entering a new and more unpredictable level. But this is a case of the democratic process in Greece coming to terms with the cold facts of the challenges it faces. Greece has now had its “first TARP vote” and must now choose which route to take, but with eyes open toward the consequences of its decision.

Euro area leaders face a similar reckoning. If they let Greece go, they must also make a new quantum leap in economic and political integration for the remaining members of the common currency. It would be reckless to force Greece out without adopting the type of 10-year plan for euro area integration called for by Mario Draghi, the ECB president, including steps like a banking union and a road map toward eurobonds and a common fiscal policy.

Copyright © 2012 the Peterson Institute.

US Emissions Turn the Corner

The official US GHG emissions inventory is published annually by the Environmental Protection Agency. Last month EPA released numbers for 2010, showing a 5% decline relative to 2005 levels, but a 3% increase over 2009. This raised concerns among environmentalists that any progress the US had made towards reaching its 2020 emission reduction commitment was just a byproduct of the recession and that US emissions will continue to rise as the economy recovers.

It takes a while to properly inventory all greenhouse gas emissions, but the Energy Information Administration publishes monthly data on energy sector CO2 emissions, which account for 79% of the US GHG total. According to EIA’s most recent Monthly Energy Review, energy-sector CO2 emissions were 8.3% lower in January 2012 than in January 2010, and 12.9% lower than in January 2005. Power sector CO2 emissions were down by more than 18% from the same month in 2005, almost all of which occurred over the past two years. While this monthly series can be pretty volatile, US CO2 emissions now appear to be on a structural decline – and at a rate capable of achieving America’s 2020 climate change commitment.

What’s Driving the Decline

The US energy sector emitted 480 million tons of CO2 during January of this year, down from 552 million tons during the same month in 2005. Of this 72 million ton decline, 34 million tons came from lower energy demand (Figure 1). In the residential sector, this is mostly due to warm weather. This January was the fourth warmest on record, which lowered demand for home heating (Figure 2). The industrial sector decline is a hold-over from the recession. Indeed, industrial CO2 emissions rose 5% between January 2010 and January 2012 as industrial output picked up. The drop in transportation energy demand, however, is on a more structural thanks to high oil prices and new fuel economy regulations. 

Overall energy demand was down 6% in January relative to 2005 levels and I expect a bit of a rebound in the months ahead. The other 38 million tons of monthly CO2 emission reductions came from fuel switching, however, and that is likely here to stay. Most of this occurred in the power sector, thanks to cheap natural gas and state and federal renewable energy incentives. Coal fueled 38% of US power generation in January of this year, down from 52% during the same period in 2005. Natural gas stole most of that market share, accounting for 27% of generation this January, compared to 15% in 2005 (Figure 3).  And with oil prices above $100 per barrel, petroleum’s share of power generation has fallen to less than 1%, while wind’s has grown to more than 4% (Figure 4). Increased natural gas and wind generation are each responsible for 11-12 million tons of January’s overall emissions decline, with nuclear, biomass and other renewables delivering an additional 5-6 million tons in reductions (Figure 5).   

Sustaining the Momentum

Projected improvements in vehicle and building efficiency will help keep US energy demand in check as the economy recovers. But power sector emissions will need to continue falling for overall CO2 emissions to reach the 17% target by 2020. The rapid growth in wind power generation over the past three years is unlikely to continue absent new policy support from Washington or state governments. Solar power should post some impressive gains in the years ahead, but will make only a limited dent in coal-fired power between now and 2020. Further medium-term electricity sector emission reductions, therefore, depend on a continued switch from coal to natural gas-fired power. Currently forecast natural gas prices combined with EPA air pollution regulations are well positioned to make that happen, allowing the US to achieve its 2020 climate commitments absent cap-and-trade or other economy-wide climate legislation.

The hard part comes after 2020. Stabilizing global concentrations of GHG emissions will require much more than a 17% reduction, and that in turn will require going beyond natural gas fired power. Nuclear, renewables and carbon capture and sequestration (applied to either coal or natural gas) will need to account for a significantly larger share of US electricity generation. And it will take policy to make that happen.

During the 1980s to the 2000s, the price of gold fell steadily in the world market thanks to a strong US economy, but Indians kept buying gold. I calculated that the 20,000 tonnes of yellow stuff that was estimated to be kept under charpoys in Indian households lost a national sum of tens of billions of dollars in value during that time. Capital which, had it been invested in the economy, would have added a percentage or two to the Indian GDP growth story.

Which is the other problem: not only was gold losing value (outside India, at least — the price was holding up inside), it was simply huge mountains of money sitting around doing nothing in a country starved of capital.

Today, of course, the price of gold has soared as the dollar has soured. But I haven’t changed my opinion. The national gold bug is still anti-national to India’s interests.

Mind you, only a handful of Indians are buying gold as a hedge against the dollar. Most are buying it to hedge against domestic inflation, which only makes it worse: buying when the price is high makes it a bigger blot on the national account book.

The consequences are already evident. India’s monthly trade deficit hit nearly $14 billion in March and is only growing. The main culprit for the deficit is oil– India imported over $105 billion last fiscal year– but close behind are record gold and silver imports, totaling $61.5 billion in the same period.

One can easily understand the individual actions of Indian households. With inflation over 10 percent, putting money in a bank account is the equivalent of watching it shrink. Putting it in gold (which, for now, is holding its own in price terms) makes sense. Sure enough, total deposits in bank accounts fell last fiscal year.

But I still wince at the thought of so much money being buried in the ground, rather than building the many things that India needs more than jewelry and biscuits.

Copyright © 2012 the Hindustan Times.

China further built out its net creditor status: China’s net foreign assets reached a record high of $1.77 trillion, cementing China’s status as one of the world’s largest creditor countries. However, the growth of net foreign assets slowed down from last year, due to reduced reserve accumulation, challenges expanding outward investment and solid growth of the foreign investment stock in China.

China’s global investment position continues to be dominated by low-yielding assets: Despite the goal to diversify its global portfolio, China’s international investment position continues to be dominated by reserves and other low-yielding asset classes such as debt instruments, bank loans and cash. Direct investment and portfolio investment in equities remain a small part of China’s global portfolio.

A new momentum for capital account liberalization: The recent push for financial sector reform will give investors greater flexibility to move money in and out of China. The latest measures will particularly boost outward direct investment, inward portfolio investment and cross-border lending. However, reforms will remain gradual and changes in China’s net investment position will continue to be incremental.  

China’s Net International Investment position

In 2011 China added another $600 billion of assets to its global balance sheet, bringing its total assets to $4.72 trillion (Figure 1). However, the pace of asset accumulation further slowed; the 15% year-on-year (y0y) growth rate was the lowest since 2004, the first year PBOC published detailed IIP data. This is mostly due to a slowdown in new investments abroad: a smaller trade surplus meant fewer new reserves for the central bank to manage, and firms’ outward direct investment dropped slightly from the previous year. In addition to a decrease in new investments, the value of existing assets declined due to valuation losses and exchange rate effects.

In the same period, China’s international liabilities – assets owned by foreigners in China — grew by $500 million to $2.94 trillion at year-end 2011, an increase of 21% compared to the previous year. Despite concerns about the health of China’s economy in the second half of 2011, the inflow of foreign capital remained strong on an annual basis, particularly in the form of direct investment and cross-border loans. The value of assets held by foreigners in China was also boosted by the appreciation of the renminbi against the US dollar and other valuation effects.

The faster growth on the liabilities side slowed down the expansion of China’s global creditor position. The country’s net foreign assets (NFA) — international assets minus liabilities – grew from $1.69 trillion in 2010 to $1.77 trillion in 2011, a year-on-year increase of 5%. The pace of net foreign asset growth has come down from an annual average of more than 50% in the years before the crisis (2004-2008) to an average of 6% in 2009-2011. However, China remains one of the largest creditors in the world and is a unique case among non-resource exporting emerging economies (Figure 2).

Despite rhetorical and real efforts to diversify its global portfolio, China’s global assets remain dominated by reserves holdings and “other investments” — trade credit, bank lending and currency holdings. Historically higher yielding asset classes such as portfolio investment in equities or direct investment stakes still account for only a small share of China’s global assets. The picture is reversed on the liability side, which is dominated by foreign direct investment and portfolio investment in equities – assets that historically have higher returns. This explains why China’s investment income balance remains negative despite its significant net creditor status. In 2011, China paid $157 billion in investment income to foreigners while receiving $145 billion in investment income from abroad. This implies an average 3-4% lower effective rate of return on Chinese assets abroad as compared to foreign assets in China (Figure 3).   

Reserves: Slower Growth, increasing attempts at diversification

Reserves managed by the central bank’s State Administration of Foreign Exchange (SAFE) dominate China’s global portfolio. In 2011, China’s already huge reserves grew by another $342 billion to $3.26 trillion. However, this 12% year-on-year growth is the lowest increase of China’s reserve stock in seven years. There are two reasons for the slump. First, accumulation of new reserves fell to $388 billion, the lowest figure since 2006. China’s current account (CA) surplus dropped to $202 billion, or 2.8% of GDP – the lowest since 2005 – due to a lower trade surplus ($244 billion) and a higher services trade deficit ($55 billion) (Figure 4). Second, the difference in reserve accumulation and mark-to-market increase in reserve stock also suggests valuation losses on existing reserves.

The overwhelming majority of China’s reserves are foreign exchange reserves (98%), with the remaining 2% held in gold, special drawing rights (SDR) and deposits at the International Monetary Fund. The composition of foreign exchange reserves by asset class or currency is a closely guarded state secret. SAFE has generally favored greater diversification of these holdings, but the stark reality is that European distress and the risks associated with other currencies have left Beijing with far fewer alternatives to the US dollar than it would like.

In the absence of serious rebalancing efforts, China’s reserve accumulation is expected to continue going forward. The weak external environment and resilience of global commodity prices will keep China’s trade surplus down in the short term. For 2012, the International Monetary Fund (IMF) expects China’s current account surplus to shrink to 2.3% of GDP. In the medium term, however, the surplus is expected to swing back up if progress on structural adjustment policies remains limited. In its newest World Economic Outlook (WEO), the IMF estimates the current account surplus will climb to 4.25% in 2017. While that’s a significant reduction from the 2007 peak of 10.1%, in dollar terms it means tripling the surplus from its current $200 billion to $540 billion in 2017.  

Other Investment: Expanding fast

The second biggest asset item on China’s global balance sheet is the “other investment” category, which consists of trade credit, loans, deposits and currency holdings. With a 33% increase, this was the fastest-growing asset class on China’s global balance sheet, driven by a massive expansion of trade credit (34% yoy) and cross-border lending (90% yoy) assets. Some of these outflows might have been hot money leaving the country amidst fears about a hard landing of the Chinese economy.

At the same time, all sub categories also experienced a massive expansion on the liabilities side in 2011, which pushed the “other investment” balance into negative territory (Figure 5). Trade credit liabilities continued to expand to $250 billion. Inward cross-border loan liabilities expanded by 50% yoy to $372 billion as the credit squeeze in China caused firms to increase borrowing abroad. Amid moderating but still positive renminbi appreciation expectations, currency and deposit liabilities increased by 56%.

The current momentum for accelerated capital account and financial sector reforms will likely further boost cross-border lending flows. Overseas expansion of cross-border lending already enjoys top-level policy support as it allows Chinese banks to lend out abundant foreign exchange at stable interest rates, in many cases with additional political benefits in recipient countries. Policymakers have historically been skeptical toward foreign lending, but recent policies indicate a greater readiness to let foreign loans into the country. In March, the National Development and Reform Commission (NDRC) substantially increased the quota for foreign banks for long-term debt. Export credits are likely to continue to be strong as well, as they not only provide stable returns on FX outflows but also yield other benefits such as export growth and foreign policy leverage. China’s recent commitment to comply with OECD export credit rules could change China’s export credit patterns, but its exporters’ goal to move up the value chain will generate continuous demand for export credits.

Direct investment: Taking a break, but structural growth Ahead

Outward foreign direct investment (OFDI) remains a small part of China’s global assets. In 2011, China’s OFDI stock grew from $317 to $364 billion, an increase of $47 billion. Net outflows in the BOP were slightly higher ($50 billion), suggesting valuation losses on the existing OFDI stock. Overall, the pace of outward FDI has slowed down from $58 billion in 2010 to $50 billion in 2011.

At the same time, inward FDI continued to be strong. According to China’s BOP, foreign firms invested $220 billion in China in 2011 — a slight drop from last year’s record volume of $244 billion, but still more than four times what Chinese firms invested abroad. In 2011, China’s inward FDI stock grew by $235 billion to $1.8 trillion, five times China’s outward FDI stock. The higher figure suggests an exchange-rate related appreciation of foreign assets in China. The gap between inward and outward FDI stock widened further in 2011, to $1.44 trillion (Figure 6). These figures are markedly higher than the FDI figures published by the Ministry of Commerce (MOFCOM) as they include reinvested earnings by foreign-invested firms in China and other flows, such as intra-company transfers. This is common international practice, but China just recently revised its BOP/IIP methodology to account for such flows, resulting in a sharp upward correction of the FDI stock in China.

Firms’ outward investment interests are increasing and further policy liberalization will promote OFDI growth in coming years. Recent reforms include a new scheme in Wenzhou for outward FDI by individuals. Bureaucrats are also reportedly working on a new comprehensive outward FDI regulatory framework. New guidelines by the State-owned Assets Supervision and Administration Commission (SASAC) will force state-owned enterprises (SOEs) to become more prudent in outward investment, but these rules are unlikely to materially impact their outward investment motivations and financial resources. At the same time, private sector investors – Sany, Huawei or Haier, for instance – are gaining importance in the outward investment arena.  The lack of experience and capacity at Chinese firms remain major problems. Looking forward, we see the expansion of outward FDI as structural growth story and expect China to export 1-2 trillion in OFDI by 2020. 

Portfolio Investment: on a tight leash

Portfolio investment – investment in debt securities and equity stakes below the 10% FDI threshold – remains the smallest position among China’s global assets at $260 billion. China’s portfolio investment assets have been virtually flat for the past five years at around $250 billion (Figure 7). Outward portfolio investment is tightly controlled by regulators due to fears of capital flight, and the few private investors with outward investment quotas have been cautious due to the volatility of global equity markets in recent years. After a sharp pullback in 2010, portfolio investment started to flow out again in 2011 ($6.2 billion), but valuation effects dragged down total growth of the portfolio investment stock to only $2.9 billion.

Foreign portfolio investment assets in China increased constantly since 2004, bringing China’s total liabilities to $249 billion in 2011. The expansion of quotas for inward portfolio investment under the Qualified Foreign Institutional Investors (QFII) scheme was on hold throughout most of 2011 due to concerns about speculative hot money inflows. In reaction to the sharp slowdown of foreign exchange inflows in the second half of 2011, regulators have reversed course, boosting QFII quotas from $20 to $25 billion in the first few weeks of 2012. There are reportedly plans to increase this quota to more than $80 billion this year.

The overall portfolio investment position is approaching equilibrium, but the composition of assets and liabilities fundamentally differ. Mirroring the structure of China’s global investment position, China’s foreign portfolio investment holdings are dominated by debt securities (76%), which require less sophistication and risk taking, but have lower returns historically. Foreign holdings in China, on the other hand, are dominated by equity positions (85%). Recent initiatives to reform China’s archaic corporate bond market and lift restrictions for foreign investment in these markets could help push up the share of debt securities in the liabilities position in the medium term.

A number of Indian commentators have protested. India has the same credit rating as Croatia, Barbados and Colombia? Croatia’s economy is in the negative growth zone. Barbados is so small its population could fit in Rashtrapati Bhavan (plus a few gubernatorial homes). And Colombia is largely famous for its prostitutes who boast US Secret Service men as clients.

The credit rating of a government, its sovereign credit rating, is supposed to be a measure of its likelihood of default. Even Standard and Poor’s isn’t saying India will default, though it is saying there’s a one in three chance of a downgrade (to junk bond status), thus indicating a fiscal blowout is in the realm of possibility.

Most of the Indian grumblings against the rating are based on the sheer size of the Indian economy and, perhaps, the fact that much of India’s government debt is held domestically. Mind you, it does have a largish foreign debt that has been growing in recent times — but not as a proportion of GDP.

However, macroeconomic indicators are only part of the basis for such ratings. The other part, though more art than science, is about the credibility of the polity to do the right thing, fiscally or otherwise. A final bit is simply the history of the government concerned: as with individuals, your past behaviour is a key determinant of your present credit standing.

Well, the truth is India has a less than great score in all these categories.

First, though its growth figures are doing well, they are clearly suboptimal. And Standard and Poor’s actually has among the most negative assessments of India’s coming GDP figures — just above 5 per cent. What is more important is that India does poorly in most of the measures that default-watchers would pay attention to: international reserves as part of GDP (India’s figure is good, but not great), domestic public debt (which is horrendous, especially for an Asian emerging market), and the current account deficit (which jumped sickeningly last year to well above 4 per cent of GDP).

Second, the political system could not be in worse shape. There isn’t unrest on the streets and so on. But the ability of the government to do anything seems to be receding almost monthly. The Manmohan Singh government spends the majority of its time finding reasons why it can’t do something. From what I gather, the core problem is not Mamata Banerjee or Sonia Gandhi or the Comptroller Auditor General; the higher up you go, your finger ends up pointed at Prime Minister Singh himself as the biggest obstacle in the road.

That at least Moody’s got right, noting that his seeming indifference to political developments is a big part of what’s going wrong in India.

Third is the past history of India. True, India has never defaulted on its foreign debt. It doesn’t allow more than a few tens of billions of dollars of government bonds to be held by foreign investors, so what’s rolling the Eurozone won’t happen here.

But India does have a sterling financial past. As Bimal Jalan, former governor of the Reserve Bank of India, pointed out, India had balance of payments crises almost every year in the first 40 years of its history. Eventually, it couldn’t keep winning this lottery, and in 1991 its external finances went belly-up.

Put it all together and I, personally, can see why India’s credit rating hovers just above junk bond. Perhaps it should be one notch higher, but that’s the best New Delhi deserves.

Copyright © 2012 the Hindustan Times.

What is the real role of austerity in the region? Why are countries almost volunteering to submit to it?

Some would argue that senior euro area officials and leaders are stupidly infatuated with the euro area crisis as a “morality tale” of the evils of government debt — and that they fail to understand Keynesian economics and its lesson that deleveraging in both the private and public sectors will devastate the economy short term. Paul Krugman (and many others)² advanced this point, deriding the politically disingenuous doctrine of “expansionary consolidation” — the idea that austerity can itself spur investor confidence.  Early in the crisis, the European Commission and the ECB and its president Jean-Claude Trichet mused that such fiscal consolidation would somehow boost private sector demand — as if belt tightening could be pain free. It was always too good to be true. Krugman and others (including the IMF, or International Monetary Fund) were quick and correct to dismiss the argument. Fortunately Trichet’s successor as ECB president, Mario Draghi, has distanced himself from this specious line of thought.³

But just because top euro area policymakers succumbed to promises of what my colleague John Williamson, in another context, once dubbed an “immaculate transfer” does not mean they are all imbeciles or members of the hardcore cult of austerity presided over by retired Bundesbankers. The reality is more nuanced.

In declaring austerity a failure, some American critics on the left are advancing their domestic political agenda, for example. They frankly fear that if austerity works in Europe, it could legitimize the cause in the United States. But even after budget cutbacks, the public sector and social safety net in the euro area will remain larger than in America. Government spending there will still amount to close to half of total GDP in 2012,⁴ compared to 40 percent for the United States (including state and local governments). The fact is likely to be lost in the toxic US political debate, unfortunately. The dangerous and misguided Path to Prosperity budget advanced by Representative Paul Ryan and the Republican House Majority envisions cuts to the federal government that would be unthinkable in the euro area. Small wonder that a large number of American critics want euro area austerity to fail.

Beyond this bias, too many macro economists and market bond strategists are obsessed with the short-term need to get back to trend growth, ignoring the deep political scope of the challenge before euro area leaders. But Europe is mired in the aftermath of the kind of massive financial crisis that Carmen Reinhart and Kenneth Rogoff have identified in their book This Time Is Different as producing sluggish and slow recoveries. Even with the right policies, a quick return to pre-crisis growth levels in the euro area is illusory. Europe is also still an ageing continent plagued by large internal imbalances, too.

My late great colleague Michael Mussa, in one of the last papers he wrote for the Peterson Institute in late 2011, stated as much [PDF] with his trademark lucidity and wit:

I will take a medium-term perspective on growth prospects — the next 5 to 10 years, covering both the United States and Western Europe… The main conclusion of this paper is that both the United States and most of Western Europe, especially the euro area, face significant and persistent problems in significantly and rapidly reducing large existing margins of slack and in restoring their economies to growth paths similar to those that prevailed on average for the quarter century before the great recession.

There are important similarities between the problems facing the United States and the euro area, notably in the need for medium-term fiscal consolidation, but there are also important differences. In particular, wide disparities in the economic problems faced by different euro area members, the constraints implied by a unified currency, and the absence of other powerful policy instruments to address regional disparities, makes the achievement of adequate medium-term economic growth especially difficult. I do not have a magical solution for these difficulties; they exist and to a considerable extent will need to be endured.

More generally, I will argue that sound economic policies can only play a limited role in improving medium-term growth prospects, either in the United States or Western Europe — although it is always possible for bad policy to make matters worse.

As fatalistic as this advice sounds, one must add a note of caution. Simply getting “back to trend” will not suffice for the euro area. Unless Europe reforms its system, it faces a long-term economic decline. Labor markets, for example, must be further liberalized in Spain, Italy, and other countries to scrap a system that has long favored insiders (in unions and guilds) over outsiders (the young trying to break into the economy). Services sectors, even in relatively robust Germany, must be deregulated in order to further deepen Europe’s Internal Market.

The example of Spanish youth unemployment is instructive. Youth unemployment in Spain is at a catastrophic level of 50 percent. Of course the recession has led to this spike. But in early 2008, before the collapse of Lehman Brothers, that rate was already at a devastating 32.7 percent. Even in the false prosperity heyday of the Spanish housing and construction bubble in 2006 it was between 15 and 20 percent,⁵ higher than US youth unemployment today of 16.4 percent.⁶ The main culprit is Spain’s archaic and dual labor laws, which forced young Spanish workers to accept flexible and temporary jobs while older workers enjoyed permanent contracts with generous severance payments. No surprise, then, that when the bubble burst, the young were dismissed disproportionately. Without an overhaul of this system, youth job creation in Spain will never be at an acceptable level. In the absence of change, reflating the Spanish economy is meaningless and the crisis opportunity will be wasted.

By contrast, the United States faces few of these impediments to renewed job creation. Indeed more austerity in an already depressed economy might produce hysteresis effects in the labor market, compounding the difficulties of the long-term unemployed to return to the market and raising new doubts about the effectiveness of short-term austerity in improving the sustainability of long-term US debts.⁷ Accordingly, US policymakers should worry more than their European counterparts about fiscal policy and the fiscal multiplier making the situation worse.

The reforms discussed here will also require an unprecedented surrender of national sovereignty by euro area member states. As started in the IMF’s April 2012 Global Financial Stability Report Box 1.1, [PDF] the process will also “take political determination and time.” Indeed the IMF staff may have underestimated the obstacles by stating that a “credible commitment to a truly integrated EMU [economic and monetary union] would have immediate benefits.” That is not so clear.

Such a “credible commitment” is a deeply political issue, requiring some taxpayers (in Germany and other AAA rated nations) to stand behind the government debt of other euro area members, which the elected leaders in the guaranteeing nations would be undertaking at great political peril. Sequencing of events is key. Despite the wishes of the IMF staff and markets for an immediate introduction of eurobonds, an early announcement of such a step at the next European Union Council in June would lack credibility. Even if it were constitutionally legal (which it is not), skeptics would question the resolve of German taxpayers in standing behind Spanish deficits or Italian debt stocks. Hastily raising such prospects could simply provoke a Tea Party-like political revolt.

What might make German taxpayers willing to stand behind the debts of governments in whose election they have no voice? This is not just a matter of Germany benefiting from the euro. It is about what might make the Swabian housewife say: “OK, I will chip in, too.” Only then can fiscal risk sharing in the euro area become a political reality.

This is where the euro area’s new and numerous fiscal rules become important. For Germans to backstop other people’s debts, every benefiting country must first prove able to sustain their social models and finances within agreed upon fiscal rules. In the words of Doubting Thomas: “Except I shall see in his hands the print of the nails, and put my finger into the print of the nails, and thrust my hand into his side, I will not believe.”

Fiscal consolidation today should be viewed as a political down payment by countries seeking guarantees from German taxpayers. It would be wonderful and much easier if a cooperative solution were available free of moral hazard. But few are so blessed in the real world.

An overly dominant centralized fiscal authority is not a necessity for Europe, though one might be optimal. Europe may be able to prosper under a relatively stable and “functioning” currency union, a legacy of currencies historically dictated by wars, conquests, and taxation of nation states that arose in the 17th century. The euro area, by contrast, results from a voluntary sovereignty pooling by democratic states. As Bordo, Jonung and Markiewicz [PDF] (NBER Working Paper 17380, A Fiscal Union for the Euro: Some Lessons from History, 2011) discerned, the economics profession lacks historical cases to guide policy in novel entities like the euro area. Caution is warranted when contemplating what types of currency unions are feasible.

Obviously, the euro as designed in the Masstricht Treaty of 1992 has not proved viable. Without a federal state, the euro area will remain economically suboptimal. Many economists might thus dismiss the entire project as unworkable and unworthy. But plenty of suboptimal economic entities survive if the political will exists to implement sufficient reforms to prevent their collapse.

The euro area crisis has shown that threatened with disaster, the political will has emerged to sustain the euro. Though European self-identities are not likely to recede, the currency union can function sufficiently. That is why the fiscal austerity and debt and deficit rules under way are important. The new EU fiscal surveillance packages in teh so-called Six-Pack (consisting of five new regulations and one directive), the Two-Pack (the two new regulations under discussion), the Fiscal Compact Treaty, and the austerity in Spain and elsewhere might appear to be doing senseless damage to short-term macro-economic growth. But these steps make sense as laying out a path to new and necessary institutions to sustain the euro area.

Once one recognizes that optimal is not feasible, one can see that the euro area suffers from an acute version of the difficulties that have faced many existing federations and unitary states. For example, Spain at present, and Argentina in the 1990s, have their own troubles controlling the expenditures of politically powerful and independent provinces. The euro area may actually need strong spending curbs for the provinces or state within its member states far more than it needs the fiscal federation across the region. As the current crisis has illustrated, the illusion of a no-bailout clause in a closely integrated modern currency union has not been enough to prevent rampant and instantaneous financial contagion.⁹ Strong fiscal rules have thus attained additional importance.

Of course, the euro area must not be based on austerity alone. But austerity measures must be undertaken to produce euro area integration with the benefits of eurobonds, integrated bank supervision, resolution, and deposit insurance — and a more directly political role for the fiscal rules overseer at the European Commission, perhaps through a directly elected Commission President. Like it or not, fiscal austerity has to precede fiscal solidarity.

Notes

1. http://www.nytimes.com/2012/03/03/business/global/spain-unable-to-meet-goal-for-deficit-cuts-this-year.html

2. Krugman’s Monday column called “Europe’s Economic Suicide” is systematic of this school of thought.

3. See for instance http://www.ecb.int/press/pressconf/2012/html/is120404.en.html

4. 48.8 percent according to the OECD.

5. Eurostat total unemployment rates age group 15 to 24 years of age.

6. BLS March 2012 seasonally adjusted unemployment rate 16 to 24 years of age from CPS.

7. See Delong and Summers [PDF] (2012) for this argument for the US economy.

8. The United States has had the historical advantage that a series of state defaults in the early 19th century created a strong state-level norm for constitutional balanced budget requirements (something the euro area is of course now trying to recreate), which combined with the powerful taxing and spending capacity of the federal government has helped prevent state defaults for more than 150 years.

9. In other words, there are — unlike in the United States in the 1830s and 1840s — not going to be any examples in the euro area to illustrate to everyone just how bad a default is, and thereby why it is important to maintain fiscal sustainability. The euro area will have to develop its fiscal norms without the “power of the example.”

Copyright © 2012 the Peterson Institute.

One might take the view that the new Spanish government and central bank governor are simply not up to managing the crisis or its associated message discipline. They could both have committed terrible faux pas similar to the one by the new Spanish prime minister, Mariano Rajoy, in Brussels a few weeks ago. It was then that he unwisely declared a “sovereign Spanish decision” to renege on the pledge to reach a deficit of 4.4 percent of GDP in 2012. The latest comments come just after the economy minister, Luis de Guindos, announced an additional austerity measure of €10 billion in healthcare-related “efficiency savings,” which are certain to dampen economic growth, roil markets, and raise doubts about debt sustainability. Thus a sense of drift seems to be emerging in Madrid. Or are they really just clueless?

Another interpretation of recent events and utterances is possible, however. It seems doubtful that the audience they are addressing is the financial markets. More likely the Spanish government is sending signals to the European Central Bank (ECB) governing board in Frankfurt. Recall that ECB Executive member Benoit Coeure in Paris recently stated that “we have an instrument, the securities markets program, which hasn’t been used recently but it still exists.” So when the Spanish government this week doubled down with additional austerity measures, the ECB was listening. The central bank has been very consistent in its demands for fiscal austerity. Even if the markets won’t reward Spain for more austerity, the ECB probably will.

As stated by ECB President Mario Draghi last week at his monthly press conference, when asked about the recent rise in Spanish and Italian bond yields in spite of its Long Term Refinancing Operation (LTRO): “I would read the recent developments not so much as an example of market fragility, but simply as an example that markets are expecting reforms. What markets are saying is that they are asking these governments to deliver, i.e., fiscal consolidation, structural reforms, etc.”

Of course it is not just faceless financial markets that are expecting reforms from euro area governments. But it is convenient for an appointed civil servant like the ECB president to blame markets for the tough political demands put to democratically elected leaders. As was the case in August 2011, when the ECB first considered buying Spanish and Italian bonds through the securities market program (SMP), the political quid pro quo from Frankfurt to euro area leaders remains clear: If Spain cuts spending and undertakes structural reforms, the bank will help out. Prime Minister Jose Luis Rodriguez Zapatero understood the message back then. Prime Minister Silvio Berlusconi of Italy did not. The Rajoy government seemingly does so today.

What else might the ECB “request” in return for renewed SMP purchases of Spanish government debt? Appropriately, Draghi was also focused last week on continued labor market reforms and the need to undo Europe’s dual labor markets: “Much of the growth in countries that are now experiencing a fiscal contraction would have to come from supply reforms,” he stated, “and this drives me straight to the labor market issues.” We can therefore hope that Frankfurt will insist that the Spanish government expand the labor market reforms already announced this year.

Then there is the persistent issue of the Spanish banking system. As indicated by Bank of Spain Governor Miguel Ángel Fernández Ordóñez, the system remains vulnerable to a likely further decline of Spanish house prices and is already mostly dependent on the ECB for funding. If the asset quality of Spanish bonds continues to deteriorate, the ability of Spanish banks to borrow from the ECB — even under more lenient collateral requirements — will likely decline, perhaps eventually replaced by “national borrowing” through an expanding Bank of Spain Emergency Liquidity Assistance (ELA) program. However, in light of the ECB’s willingness to push Ireland into the arms of the International Monetary Fund (IMF) in 2010 — when Irish banks relied on ECB loans to stay afloat — one hopes the ECB will insist that the Spanish government deal with the lingering real estate related balance sheet problem in large parts of the banking system.

Given the poor macroeconomic outlook for Spain, significant new private capital for the Spanish banking system will not likely materialize soon. This means that public money will have to be spent. The Spanish government, faced with a dire fiscal outlook, would then have to seek a European Stability Mechanism (ESM) Article 15¹ loan of perhaps €50 billion to €60 billion for the earmarked purposes of recapitalizing its banking system. Such a request would be relatively easily handled by the European Stability Mechanism/European Financial Stability Facility (ESM/EFSF), which would demand conditionality. The treaty setting up the ESM (Article 13.3) states how “the consent of the [conditionality] MoU [memorandum of understanding] shall reflect the severity of the weaknesses to be addressed and the financial assistance instrument chosen.” It is not inevitable for ESM conditionality to be politically onerous for the Rajoy government.

An Article 15 request for ESM funds to recapitalize Spanish financial institutions would have several benefits. First, its targeted and more limited nature seems an appropriate response to the economic challenges facing Spain, which are smaller than those confronting Greece, Ireland, and Portugal. Second, it would keep the Spanish government funded in the markets. This would save the euro area (and possibly the IMF) a lot of financing, since a standard IMF program typically lasts for years. Third, such a step would probably limit market contagion from Spain to Italy. While hardly well capitalized, Italy’s banks are at least not weighed down by a massive real estate collapse.

What effects would additional ECB secondary purchases of Spanish bonds have on Spanish primary market bond issuance? Following the Greek bond exchange, where the ECB was a senior creditor in a restructuring scenario, further SMP purchases might be seen as pushing remaining and potentially new private bondholders further down the credit ladder. But the inability or unwillingness of the ECB to take any credit losses on its SMP portfolio is only relevant in a sovereign restructuring scenario. Spain remains far from such a restructuring, which suggests that the ECB could purchase sizable amounts of Spanish bonds before any serious concerns about subordination surface.

Finally, there is the issue of real yield value in euro area sovereign bonds. It is essentially inconceivable that Spain would be allowed to default. In the end the ECB would bail it out. One must then ask how long it will take for even modestly improved Spanish data to make Spanish bonds a better value than the new 10-year German bonds, which were offered this week with a criminally low, guaranteed wealth destroying (if you are a pension saver) 1.75 percent coupon. In what world, compared to a Spanish bond at yields around 5 to 6 percent, is this German Bund a good safe investment, considering that Germany’s economy looks likely to push wages and inflation rates higher and may be heading into a recession? Which private investors — and €3.87 billion of buyers did — want to help Germany liquidate its debt through pretty much guaranteed negative real interest rates for the duration of this bond? Fortunately, Madrid won’t have to improve that much to offer a better deal.

Note

1. Article 15 in the ESM Treaty stipulates the circumstances under which loans can be granted to member state governments for the specific purposes of re-capitalizing their national banking systems.

Copyright © 2012 Peterson Institute.

Recap: the World Trade Organization provides geographical intellectual property right protection for certain products. Thus it ensures no one can call their sparkling wine “champagne” except those who make stuff in the Champagne region of France.

The Indian and Pakistani Punjab was originally seen as the home of this long-grain aromatic rice. The two countries had once sought to jointly get basmati registered with the WTO as geographically specific to certain parts of their respective countries. Both sides had been rattled by an attempt by a US firm to register a patent for its own hybrid basmati strand.

In the mid-1990s, this joint effort fell apart. I vaguely remember that the Indian side blamed the Pakistanis for trying to tie it to Kashmir or something on those lines. Whoever was to blame, the two went their separate ways when it came to basmati’s geographical protection.

This was unfortunate because it precluded defence through the WTO, easily the most sensible way to do so as it would be global and be defended by a tribunal system with punitive powers.

So basmati protection became and remains a patchwork of local and bilateral agreements, one set by Pakistan and the other by India. It has done well, but India’s Agricultural and Processed Food Export Development Agency spends Rs 40 to 50 million a year defending the sacred name of basmati — most recently against a cafe in Morocco. Presumably some Pakistani agency does the same.

Fortunately the biggest importers of basmati in the world, mainly Persian Gulf Arab states, have local definitions of the rice that all but guarantee most of the global market remains reserved for South Asia.

But this is a piecemeal solution. The WTO would be so much more final. And that would require a common India-Pakistan petition to have basmati listed with the WTO. Also the battle is endless, and you only have to lose once. Tilda, an Indian exporter, nearly lost a case against a Thai firm claiming to grow basmati.

I also think that having a joint definition would help freeze or at least make it more difficult to change the parameters of basmati. Today, at least in India, basmati is said to grow in Rajasthan and Uttar Pradesh. Last year Madhya Pradesh asked for its aromatic rice to be defined as basmati. Bangladesh also claims to grow the stuff.

Adulteration is rampant. A study in the UK in 2005 found half the basmati sampled was, well, not basmati. A new rules regime was put in place, but another survey showed adulteration had only been reduced.

Time for a joint Indo-Pakistani task force to save basmati from others, and each other.

Copyright © 2012 the Hindustan Times.

William Avery was a State Department official when the Indo-US nuclear deal was being put together. Dishing out visas in Chennai, he didn’t have much to do with the deal. However, he was infected by the same geopolitical bug that bit George W. Bush, and it’s stayed with him, though now he’s a corporate merger and acquisitions advisor.

India’s rise is, he argues, “China’s nightmare, America’s dream” in his book of the same name. These different national responses pretty much tell you why a US-India partnership makes so much sense. Avery sees the US as the obvious partner to address the missing pieces in India’s power puzzle. “Building stronger defence ties with the United States, and its allies, is the only way for India to create the weapons industry it needs.” And the economic sinews of a superpower, for him, lie in the creation of multinationals. India is producing them, but it needs to do more, quicker. Again, the US is the model.

This is not a patronising work: Avery’s enthusiasm for India would make the Bajrang Dal blush. “I believe India is capable of being a true world power. The world needs India to become a true global power.” He frets at India’s passivity about taking over its own ocean, the weakness of its indigenous defence industry and its general caution about everything.

Avery wants the rupee to be a global reserve currency by 2025. He even believes India should get off its call centring obsession — “outsourcing can only survive so long as India is poor.”

Understandably, he’s disappointed with the Obama administration and Manmohan Singh 2.0 and the way both have frittered away the Bush momentum. “It turns out the Indo-American relationship could have used a little less professor and a little more cowboy.” India has other good global friends but they don’t have what it takes given the horizons India should be aiming for. France and Russia are nice, but they are too small or declining too rapidly. As for the US, its main international relationship is with China — and it’s “mutually dysfunctional; they sell us junk we don’t need and we fall in love with consuming it.” Pakistan? Easy. There should be a complete Indo-US mind-meld over handling that failing State.

What’s nice about Avery’s book is that he pushes out a big idea that the Indian strategic establishment is still wary to talk about and US strategists still can’t take seriously. He is realistic enough to know that no matter how close they get, India and the US will never have a full-blown alliance.

What’s missing is that Avery doesn’t do a detailed geopolitical and economic nuts and bolts study that would make a classic case for an IndoAmerican alliance. Maybe its because neither country hasn’t worked out how their interests converge. India’s national security thinking is still a work in progress. Avery’s answer: “Don’t overthink Indo-US relations. You have to step back. Once you do, it becomes pretty obvious.”

Copyright © 2012 the Hindustan Times.