Economy & interest rates

• In November 2003 the Bank of England’s monetary-policy committee (MPC) raised interest rates by 0.25%, the first increase in almost four years. With hindsight, it seems a straightforward decision. The economy was growing steadily, unemployment was low, house prices were shooting up and banks were lending freely. Yet at the time there was great anxiety about the change. The fear was that the increased burden of consumer debt would make even a small rise in interest rates bear down heavily on spending.
• That worry is all the greater now, as the bank contemplates a similar move. As The Economist went to press on April 7th the MPC was expected to keep its benchmark rate at 0.5%—but a quarter-point increase seems likely as soon as next month. Debt is worse, relative to incomes, than in 2003 (see chart). Other pressures on household finances are greater now than then. Wage growth is sluggish; inflation is far higher; job prospects are poorer. And taxes are going up. In the circumstances, an increase in interest rates could easily provoke a damaging cutback in spending by nervous consumers. One big, if subtle, reason for concern is the stark polarisation between the cash-rich and the debt-poor.
• If each household had an equal share of the cash and debt held by all, there would be little to worry about. True, personal debt is around 1.5 times post-tax income, which means that a percentage point increase in interest rates, if fully passed on by lenders, would take up 1.5% of income in higher debt-service costs. On the other hand, the income effects of interest-rate changes do not work in only one direction. Households in aggregate also have large cash deposits, and higher interest rates raise the income that is earned on them. The stock of cash is a bit smaller than the stock of debt, so the overall effect of interest-rate increases would be to depress household income. But as long as deposit rates rise in tandem with borrowing costs, the cost of a percentage point rise in rates would be less than 0.3% of incomes.
• That reckoning, however, understates the likely impact. Analysing the debt and cash holdings of all consumers lumped together reveals little about the effect of interest-rate increases on spending. That actually depends on how the aggregate cash hoard and debt burden is divided.
• People typically do not have both large debts and piles of cash, since it would make sense to use the latter to pay off the former. Rather there is a financial spectrum with, at one end, debt-laden householders, usually young, who have recently taken on a hefty mortgage and have little spare cash; and at the other end, older savers who have paid off their mortgages, or who have traded down to smaller homes and banked the proceeds.
• These different sorts of consumers will respond to interest-rate increases in ways that are unlikely to be neutral for the economy. The indebted will cut their spending to free up the extra cash to service their loans. Once rates start to rise, those with the biggest debts might be anxious to save harder to pay down those debts at a faster pace. At the other financial pole, the cash-rich and debt-free (by definition savers not spenders) might well spend little, if any, of the extra income they gain from higher deposit rates.
• Any squeeze on debtors’ incomes might be mitigated if banks chose not to pass on any increase in funding costs stemming from higher base rates. That scenario is optimistic. The gap or “spread” between the Bank of England’s rate and the average interest rate on mortgages (which account for four-fifths of household debt) has narrowed a bit recently, though it is much higher than before the financial crisis. This narrowing owes little, it seems, to banks competing more vigorously for mortgage business. Rather it reflects lower rates for borrowers whose fixed-rate deals had expired and lapsed into cheaper variable-rate mortgages.
• In one sense, this is helpful: it has lifted the incomes of some borrowers at the banks’ expense. But it has also made the economy more sensitive to changes in short-term interest rates. Before the crisis, around half of mortgages were at variable interest rates; by the end of last year, the share had risen to 69%. This greater sensitivity is heightened by the fragile state of Britain’s housing market. Higher rates will crimp the already-weak demand for homes and weigh on house prices—perhaps spurring anxious borrowers to spend less and pay off their mortgages quickly.
• A big enough interest-rate shock would start a downward spiral in debtors’ finances, spending and house prices. Rising defaults would exacerbate the damage. For this reason, the MPC is likely to tread carefully. The “glacial pace” at which interest rates are likely to rise—perhaps 0.25 percentage points every three months or so—is unlikely to be dangerous, reckons Kevin Daly of Goldman Sachs. If spending suffers unduly, “the MPC would be able to deal with it,” he says.
• The polarisation of household finances that makes the impact of a rate rise so uncertain also helps to explain why some MPC members feel the need to act. Debtors are hoping that interest rates stay low, but savers and bondholders need to be reassured that today’s high inflation won’t be allowed to persist. A small rate increase would be a victory for savers. The needs of the economy mean that, overall, monetary policy will continue to favour debtors.

big oil firms are offloading their refineries to different kinds of buyer

• The twinkling lights of an oil refinery at dusk show the potential for beauty in industrial landscapes. But the dramatic silhouettes, part ocean liner, part funfair, disguise the difficulties within. Decades of poor returns from turning crude oil into petrol, diesel and other fuels have convinced the Western oil giants to get out of the business. In their place come mainly state-run oil firms from Asia, the Middle East and Latin America, and private equity
• Essar, an Indian conglomerate, this week paid Shell $1.3 billion for the Stanlow refinery in north-west England. In February, state-owned PetroChina paid $1 billion for a half-share in Scotland’s Grangemouth refinery and in another at Lavéra in the south of France. Many more refineries are for sale in Europe and America. Britain’s BP, which is raising cash to pay the bill for the Deepwater Horizon oil spill, wants to sell two huge ones in America. Valero, an American refiner, may show interest, though it has just bought a plant in Wales from Chevron for $1.75 billion.
• American private-equity firms may also be taking a look at BP’s plants. According to FACTS Global Energy, a consultancy, over the past two years private-equity buyers have snapped up refining capacity of around 1m barrels of crude a day (b/d). State-backed oil companies, such as PetroChina and Russia’s Rosneft, have bought nearly the same amount.
• The refining business has suffered from chronic overcapacity, and thus weak margins, since the 1970s oil shocks, which led to a slump in the use of oil-based fuels for generating electricity and heating homes. A respite came in 2005-07, as a buoyant rich world and increasingly thirsty emerging economies boosted demand. But that was a high point that the rich world may not hit again. Demand for petrol in America has fallen, and may never regain its previous peak. Refining margins, having touched $4.50 a barrel, are down to one-tenth of that and still falling.
• It makes sense for big Western oil companies to get out of such an unprofitable business and put the capital into exploration and drilling. But refineries’ weak margins are not deterring oil firms from emerging economies from buying them. One reason is that they are going cheap. This gives the buyers access to declining but still sizeable rich-world markets. Such access is especially useful for those with ambitions to become global oil traders.
• As they buy refineries abroad, emerging-market firms continue to build them back home, where demand is still booming. For those firms owned or backed by their home governments, there are other considerations besides commercial ones. China, although it is set to remain a big importer of crude, is desperate to become at least self–sufficient in refining. By 2015 it will boost its domestic capacity by 20%, taking the total to 12m b/d. Middle Eastern oil producers are also building refining capacity to add value to the crude that they pump out of the ground.
• All this extra capacity will keep global refining margins under pressure for at least another five or six years, believes Francis Osborne of Wood Mackenzie, a consultancy. That may not bother state oil companies much, but it ought to worry private-equity firms. So why are they buying? First, because prices are so low. Second, because they are looking optimistically to the long term. Martin Brand of Blackstone, a private-equity giant that has bought three refineries in America in recent years, thinks margins will have recovered in ten years’ time, and in the interim there will be plenty of efficiency gains to be made.
• Others are sceptical. The European and American refineries’ new owners will be far less likely to close them than their old ones. In the absence of such a rationalisation of capacity, thinks Gemma Gouldby of FACTS Global Energy, margins will stay poor indefinitely. If so, the Western oil majors will be glad they got rid of them.

sensex struggling to get out of negative bias

• The markets continue to trade volatile in the negative terrain, but above their intraday lows. At 11:05 a.m., the Bombay Stock Exchange’s Sensex was at 19,555.70, down 56.50 points or 0.29% from the previous close, while the National Stock Exchange’s Nifty was at 5,874.30, down 17.45 points or 0.3%.
• Indian shares eased a tad on Thursday as investors were in consolidation mode after a big rally in March, while underlying sentiment remained upbeat following a spurt in foreign fund buying.
• Maruti was trading down 1.3 percent at 1,277.95 rupees after the company said it would recall 13,157 diesel engine cars.
• Foreign funds have pumped around $2.8 billion into equities since the start of March, after being net sellers in the first two months, on hopes a market correction made the market attractive given economic growth was still robust.
• Global demand for dairy products will jump in the next decade, led by surging consumption in China and India, according to Fonterra Cooperative Group Ltd, the world’s largest exporter.
• Oil dropped from the highest in 30 months in New York after China raised domestic fuel prices and U.S. stockpiles climbed, stoking speculation demand may falter in the world’s biggest energy users.
• Gold declined on speculation that investors are locking in gains after the price rose to a record earlier, and as central bank efforts to combat inflation curbed demand for precious metals.
• Asian stocks rose as the yen weakened against all of its most-traded currencies and after gold prices rose to a record for a second day in New York on demand for the precious metal as a hedge against inflation.
• Indian imports of power-station coal rose by 33% to 65.7 million metric tons in the year ending March 2011 from 49.4 million a year earlier, India Coal Market Watch said, citing estimates based on port data.
• World trade will grow faster than the 7 percent long-term average rate for a second successive year in 2011 but fall short of last year’s dramatic rebound, the World Trade Organisation is likely to forecast on Thursday.
• China may be heading for a pause in its half-year cycle of monetary tightening, raising interest rates just once more this year as its moves so far start to slow inflation and economic activity.
• The U.S. economy remains too fragile for the Federal Reserve to begin raising interest rates, the president of the Atlanta Fed, Dennis Lockhart, said on Wednesday.
• Portugal’s decision to seek international aid removes a cloud of uncertainty over the euro zone and has a good chance of ending the spread of debt market crises to fresh countries in the region.
• Chinese economy probably grew less quickly in the first quarter of this year than the final quarter of 2010, dovetailing with the government’s efforts to shift more emphasis to the quality rather than the pace of growth.
• Portugal’s caretaker government, fighting to avoid a bailout, said on Wednesday a political crisis had caused “irreparable damage” after borrowing costs rocketed as it sold a billion euros in short-term debt.
• The euro will steadily lose the recent ground it has gained against the dollar in the coming year as the U.S. Federal Reserve plays catch-up to the European Central Bank’s interest rate hikes, a Reuters poll found.
• India’s record grains output in 2011 may prompt the government to allow wheat exports, Farm Minister Sharad Pawar said on Wednesday, boosting the prospect of overseas sales of the grain from the world’s second – biggest producer.
• Some of Asia’s emerging economies are showing signs of overheating, underscoring the need for further policy tightening and more flexible foreign exchange rates to tackle growing inflationary pressures, the Asian Development Bank said on Wednesday.
• U.S. congressional negotiators on Wednesday raced against a looming deadline to agree on billions of dollars in spending cuts and find a budget deal that keeps the federal government operating beyond Friday.
• Europe has opened flat and is trading mixed. The Indian market is now in the green but still in flat territory with the heavyweights proving to be a drag in today’s trade. Sensex is trading at 19624, up 12 points from its previous close, and Nifty is at 5896, up 4 points.( 01:23 pm,india).
• Leading India Inc representatives today made a strong plea to the Reserve Bank to review its rate tightening policy, saying the high cost of credit is having an adverse impact on growth.
• Cairn Energy and Vedanta Resources on Thursday extended the deadline for a $9.6 billion deal for Cairn’s India assets, reflecting optimism the deal will get done a day after the government deferred a decision. Both companies have extended the date by which all conditions must be completed or waived to 20 May 2011 to accommodate the completion of the open offer for Cairn India shares, Cairn Energy said in a statement.
• Food inflation fell to 9.18 per cent for the week ended March 26, the lowest level in almost four months, on the back of a decline in the prices of pulses.
• The European Central Bank is poised to raise interest rates from a record low 1.0 percent on Thursday and more is likely to follow but, fearful of heaping more pain on the euro zone’s stragglers, it will give few clues about when the next move will come.
• Maruti Suzuki India (MSIL), the country’s largest car maker, on Wednesday said it wouldrecall 13,157 diesel cars manufactured between November 13 and December 4, 2010, to examine a possible faulty engine part.
• The foreign institutional investors (FIIs) were net buyers of Rs 150.85 crore in futures and options segment on Wednesday.According to the data released by the NSE, FIIs were net sellers of index futures to the tune of Rs 117.33 crore, while they sold index options worth Rs 587.96 crore.They were net sellers of stock futures to the tune of Rs 305.01 crore and sold stock options worth Rs 14.77 crore.
• Oil producing countries that have surplus production capacity provided international oil companies with additional quantities of crude, UAE Energy Minister Mohammed bin Dha’en Al Hameli has said.Addressing the 12th International Oil Summit in Paris on Wednesday, Al Hameli said that OPEC members are not the only producers that are providing additional supplies, noting that non-OPEC supplies were expected to reach 500,000 barrels a day this year.
• The Union government has slapped an excise duty of 10% on jute products that constitute about 80% of the Rs 6,000 crore industry and threatens to cripple the fate of 2.5 lakh workers.

Greece, Ireland and Portugal should restructure their debts now are in crisis

• It is a measure of European politicians’ capacity for self-delusion that Angela Merkel, Germany’s chancellor, called the euro-zone summit on March 24th-25th a “big step forward” in solving the region’s debt crisis. Something between a fudge and a failure would be more accurate. The leaders fell short on almost every task they set themselves. They agreed on a “permanent” rescue mechanism to be introduced in 2013, but couldn’t fund it properly, because Mrs Merkel refused to put up money her finance minister had pledged. The Brussels gathering did little to help Greece, Ireland and Portugal, the zone’s most troubled economies. Their situation is getting worse—and Europe’s leaders bear much of the blame.
• Portugal’s prime minister resigned on March 23rd after failing to win support for the fourth austerity package in a year. The country’s credit rating was slashed to near-junk status on March 29th, while ten-year bond yields have risen above 8% as investors fear Portugal will have to turn to the European Union and the IMF for loans. The economies of both Greece and Ireland, Europe’s two “rescued” countries, are shrinking faster than expected, and bond yields, at almost 13% for Greece and over 10% for Ireland, remain stubbornly high. Investors plainly don’t believe the rescues will work.
• They are right. These economies are on an unsustainable course, but not for lack of effort by their governments. Greece and Ireland have made heroic budget cuts. Greece is trying hard to free up its rigid economy. Portugal has lagged in scrapping stifling rules, but its fiscal tightening is bold. In all three places the outlook is darkening in large part because of mistakes made in Brussels, Frankfurt and Berlin.
• At the EU’s insistence, the peripherals’ priority is to slash their budget deficits regardless of the consequences on growth. But as austerity drags down output, their enormous debts—expected to peak at 160% of GDP for Greece, 125% for Ireland and 100% for Portugal—look ever more unpayable, so bond yields stay high. The result is a downward spiral.
• As if that were not enough, the European Central Bank in Frankfurt seems set on raising interest rates on April 7th, which will strengthen the euro and further undermine the peripherals’ efforts to become more competitive . Some politicians are still pushing daft demands, such as forcing Ireland to raise its corporate tax rate, which would block its best route to growth. Most pernicious, though, is the perverse logic of the euro zone’s rescue mechanisms. Europe’s leaders won’t hear of debt reduction now, but insist that any country requiring help from 2013 may then need to have its debt restructured and that new official lending will take priority over bondholders. The risk that investors could face a haircut in two years’ time keeps yields high today, which in turn blights the rescue plans.
• This newspaper has argued that Greece, Ireland and Portugal need their debt burdens cut sooner rather than later.That case is stronger than ever, not only because today’s approach is failing but because the risks of restructuring are falling. The spectre of contagion is receding. Spain, whose bond yields have fallen and whose spreads with Germany have tightened, has distanced itself from Portugal. Behind the scenes, sovereign-debt specialists are devising ways to minimise the impact of an “orderly restructuring” on banks. Most banks in the core of the euro zone can withstand a hit from the three small peripherals.
• The big obstacle is not technical but political. Since many at Europe’s core, particularly the ECB, remain implacably opposed to debt restructuring, the pressure has to come from elsewhere—not least from the peripheral economies themselves. Ireland’s new government is talking about forcing the senior bondholders of its bust banks to take a hit. Greece should stop pretending that it can bear its current debt burden and push for restructuring. But the best hope lies with the IMF. Its economists have the most experience of debt crises. Some privately acknowledge that debt restructuring is ultimately inevitable. It is time the Fund’s top brass said so publicly and, by refusing to lend more without a deal on debt, pushed Europe’s pusillanimous politicians into doing the right thing.

sensex loses 15 points

• The markets were quite volatile today and both the benchmark indices closed flat. Textile, brokerage, midcap banks and sugar remained the star performers of today’s trade and infra stocks also registered strong buying. The Sensex closed at 19687, down 15 points from its previous close, and Nifty shut shop at 5910, up 2 points.
• From the Sensex stocks on the losing side, Tata Power declined by 1.77 per cent, M&M (1.49 %), HUL (1.45 %), L&T (1.34 %), HDFC (1.03 %), Bajaj Auto (1.02 %), REL Infra (1 %), ICICI Bank (0.83 %), RIL (0.47 %) and ITC (0.38 %).However, gainers were Sterlite Ind rose by 2.83 %, REL Com (2.79 %), TCS (2.30 %), Tata Motors (2.04 %), BHEL (1.64 %), Hero Honda (1.61 %) and SBI (1.14 %).Among sectoral indices, BSE-CD firmed up 1.72 per cent, BSE-Metal by 1.33 per cent and BSE-Realty by 0.74 per cent.
• The total market breadth remained strong as 1,985 stocks closed in the green, while 994 ended in the red on the BSE. The total turnover improved further to Rs 3,698.77 crore from Rs 3,212.45 crore yesterday.
• The Indian rupee raced to a five-month high on Tuesday, the first trading session of the new fiscal year, driven by robust dollar inflows, but gains were capped by weakness in most regional peers.
• High oil prices have raised concerns about a higher subsidy bill for the government, inflationary pressures and high interest rates, marketmen said.
• For May delivery, crude oil settled yesterday at the highest level since September 22, 2008 and was close to USD 109 a barrel in New York.
• Selling in heavyweights like L&T, ICICI Bank, HDFC, RIL, M&M, HUL, Tata Power and ITC weighed on the market.
• A recent increase in U.S. inflation is driven primarily by rising commodity prices globally, and is unlikely to persist, Federal Reserve Chairman Ben Bernanke said on Monday.
• The Supreme Court lifted a ban on iron ore shipments from Karnataka on Tuesday, freeing up about a quarter of supplies from the world’s third-largest exporter as strong demand from China keeps prices firm.
• The United States will hit the legal limit on its ability to borrow no later than May 16, Treasury Secretary Timothy Geithner said on Monday, ramping up pressure on Congress to act to avoid a debt default.
• Had there not been a rise in TCS, Tata Motors, SBI, Sterlite Ind and BHEL, the fall in the Sensex would have been much more pronounced.
• “The subdued price action in today’s session was in sync with the lacklustre global cues as investors turned a little wary over rising crude oil prices,” said Amar Ambani, Head of Research (India Private Clients) – IIFL.
• Portugal’s biggest banks will stop buying government bonds and are urging the caretaker administration to seek a short-term loan to secure financing until a June 5 election, business daily Jornal de Negocios reported on Tuesday.
• In Asian markets, China, Hong Kong and Taiwan were closed for public holiday. The key indices from Japan ended down by 1.06 per cent, although Singapore and South Korean markets finished better.
• European stocks, however, were trading lower in their mid-sessions. The CAC was down 0.61 per cent, the DAX and the FTSE by 0.31 per cent each.
• The prospect of a good winter harvest is likely to bring down food inflation in India to about 8 percent by end-March, a senior government adviser said on Monday.
• Sales of small cars raced ahead in March as buyers flocked to more fuel-efficient vehicles, a trend major U.S. automakers expect to persist if gasoline prices continue to rise.
• The United States will hit the legal limit on its ability to borrow no later than May 16, Treasury Secretary Timothy Geithner said on Monday, ramping up pressure on Congress to act to avoid a debt default.
• U.S. inflation is likely to remain low for now, but policymakers will keep a close eye on potentially self-fulfilling consumer expectations for higher prices, a top Federal Reserve official said.
• Japan’s nuclear crisis is likely to lead to one of the country’s largest and most complex ever set of claims for civil damages, handing a huge bill to the fiscally strained government and debt-laden plant operator, Tokyo Electric Power Co.
• Credit rating agency Fitch downgraded Portugal on Friday saying the debt-laden country needed a bailout, while rival agency S&P cut Ireland’s rating after bank stress tests revealed another black hole.
• Nasdaq OMX and IntercontinentalExchange bid $11.3 billion for NYSE Euronext in an effort to trump Deutsche Boerse’s deal, and pushed their case with an appeal to U.S. patriotism.
• European banks heavily supported by the U.S. Federal Reserve at the height of the financial crisis have since weaned themselves off these loans, even as the struggle for funding in Europe gets tougher.
• Standard & Poor’s stripped Ireland of its last major ‘A’ rating on Friday, citing future risks to bondholders, but the 1 notch cut and stable outlook was less severe than feared and gave the thumbs up to the state’s bank bill.

investor’s interest in hedging tail risk is growing

• “TAIL-RISK” hedging was the talk of Wall Street in 2008 after global markets nosedived and traumatised investors tried to figure out how they could protect themselves from extreme or “black swan” events—those well outside an ordinary distribution of outcomes—that cause massive losses. Interest is revving up again as revolutions in the Middle East and Japan’s earthquake have destabilised markets and increased volatility, leaving battered investors searching anew for protection.
• Peddlers of tail-risk products like to compare them to insurance: investors pay premiums every year to avoid financial catastrophe later. Some even get philosophical. Vineer Bhansali of PIMCO, a big fund manager, has likened tail risk to Pascal’s wager—the argument that you’re better off believing in God than suffering the consequences of being wrong. The same is true with drastic dives in markets.
• Tail risk is technically defined as a higher-than-expected risk of an investment moving more than three standard deviations away from the mean. For mere mortals, it has come to signify any big downward move in a portfolio’s value. There are different ways to hedge tail risk, but a popular one is to create a basket of derivatives that will perform poorly during normal market conditions but soar when markets plunge. These include options on a variety of asset classes, such as equity indices and credit-default-swap indices.
• Some banks have started to sell tail-risk products. Deutsche Bank has created the ELVIS index, which generates returns when stockmarket volatility increases. Big asset managers like BlackRock and PIMCO have made a business of advising customers on managing for the worst case. Hedge funds have also got in on the act. Several “tail funds”, which invest in assets that should rise in bad economic times, have started up in the past few years. These funds tend to lose around 15% each year when the market is normal but can return 50-100% when the market dives. Or more: 36 South, a hedge fund, saw its tail fund gain 234% in 2008. According to Gaurav Tejwani of Pine River, which launched a tail-risk fund last year that now manages over $200m, “It costs money in most good years or average years, but it makes you a fairly large return when all your other assets are performing very poorly.”
• Sellers naturally claim it is worth the cost. Mr Bhansali of PIMCO, which offers several tail funds, estimates that it costs investors between 0.5% and 1% of assets to hedge against tail risk, but that investors will break even in three to five years. That is partly because the market does not have to crash in the way that it did in 2008 for hedges to pay their way. PIMCO now oversees around $30 billion in tail-risk products, mostly in separate accounts. Other funds have also seen inflows. Take, for example, Universa Investments, a tail fund advised by Nassim Taleb, author of “The Black Swan”, which has grown from $300m in 2007 to around $6 billion today.
• Even so, Mark Spitznagel, the boss of Universa, complains about complacency among investors. Demand is very uneven. The price of hedging varies, rising when markets are volatile and investors most need it, and declining during bull markets. It is difficult, after all, to keep stomaching losses from hedged positions as markets rise: “The kids outside playing in the snow without sweaters and scarves seemed to have much more fun than those of us who were bundled up,” says Steven Englander of Citigroup.

India losing investors

• Corruption is dreadful in India, as shown by a current “season of scams”—over mobile-phone licences, the Commonwealth games and more. Politicians, notably the ruling Congress party, are now feeling the public’s ire. Worries have also grown that graft is scaring away foreign businesses.
• Circumstantial evidence points that way. A spokesman for a big Western firm mutters into his cappuccino about a recent High Court decision, which if upheld would cost his company billions. It was so strange, he says, it could be explained only by judicial graft. A representative of a British media firm, SIS Live, which broadcast the Commonwealth games from Delhi, in October, is furious—along with other contractors—at being left millions of pounds out of pocket because, he says, payments have been frozen by investigators digging up evidence of corruption at the event.
• Across the board, surveys regularly tell how graft is an unusually heavy tax on Indian business. An annual one published on March 23rd by PERC, a Shanghai-based consultancy, shows investors are more negative than they were five years ago. Of 16 mostly Asian countries assessed, India now ranks the fourth-most-corrupt, in the eyes of 1,725 businessmen questioned. Being considered worse than China or Vietnam is bad enough; being lumped with the likes of Cambodia looks embarrassing.
• Outsiders may get an exaggerated view. India’s democracy, with a nosy press and opposition, helps to trumpet its scams and scandals, more than happens in, say, China. Yet locals tell similar tales. A cabinet minister frets that there is so much ghotala(fiddling), “it tells the world we are all corrupt. It may be a dampener to investment.” Others agree. KPMG this month reported on 100 bosses who were asked about their own experience of graft. One in three said it did deter long-term investment.
• Judging how much difference it makes is tricky. Right now, investors may be spooked as much by the fight against graft as by the corruption itself. Arpinder Singh of Ernst & Young in Mumbai says foreigners, especially those with some connection to America, increasingly hire firms like his to help them comply with America’s Foreign Corrupt Practices Act. Once a foreigner holds more than about 5-10% equity in an Indian firm, it is seen as having some responsibility for how it is run.
• Now even Indian firms, if they want to raise money abroad, or if their bosses want to protect their own professional reputations, are doing the same. As other countries, such as Britain, bring in tough anti-graft laws like America’s, the trend will continue. Yet many Indian firms still fail to comply with higher standards, so deals falter. Mr Singh ticks off a list, “in infrastructure, ports, toll roads, irrigation, microfinance”, of deals he has worked on that collapsed over “governance problems”.
• None of this is enough to prove that graft, alone, is scaring off business. Pranab Mukherjee, the finance minister, insists there is no correlation between corruption and foreign direct investment (FDI). Jeffrey Immelt, the boss of GE, in Delhi last week, cheerily agreed, insisting that a fast-growing market trumps all other concerns.
• But something is keeping investors wary. In 2010 the country drew just $24 billion in FDI, down by nearly a third on the year before, and barely a quarter of China’s tally. There is no shortage of other discouragements: high inflation, bureaucracy, disputes over land ownership, and limits on foreign ownership in some industries.
• Even so, India is home to an unusually pernicious form of corruption, argues Jahangir Aziz of JPMorgan. Elsewhere graft may be a fairly efficient way to do business: investors who pay bribes in China may at least be confident of what they will get in return. In India, however, too many crooked officials demand cash but fail to deliver their side of the bargain. Uncertainty, not just the cost of the “graft tax”, may be the biggest deterrent of all.

another year of living dangerously

• This was supposed to be a stress-free year for the global economy. By January the financial crisis had faded and Europe’s sovereign-debt crisis seemed less acute. America’s economy was resurgent. Investors piled into equities and sold some of the government bonds they’d bought for troubled times. If there was a worry, it was that emerging economies would grow too quickly, inflating commodity prices.
• The year without crisis is not to be. First, Arabian upheaval put oil markets on edge. Then earthquake, tsunami and a nuclear accident clobbered the world’s third-largest economy. How much of a setback to growth do these twin crises represent? And how should economic policymakers react to them?
• Japan’s share of world output has been shrinking for decades, but at 9% it remains large enough for the hit to the country’s growth to subtract noticeably from global output. Then there are the ripple effects on the rest of the world. Japan is a large—in some cases the sole—supplier of intermediate goods to the world’s electronics and automotive industries, from the hardened glass on Apple’s iPad to gearboxes in Volkswagens. Many makers of such parts have had to slow or halt shipments because of damaged roads, power cuts or the loss of components from their own suppliers. The effects have spread well beyond Japan, causing shutdowns from South Korea to Spain. Still, the history of such disasters is that much of that lost production is eventually recovered and reconstruction delivers a fillip to subsequent growth.
• Pinpointing the impact of Arab political turmoil is complicated by the fact that oil prices were already rising thanks to a brighter global economic outlook. Nonetheless, a good portion of this year’s 25% increase seems due to worries over supplies. A rule of thumb holds that a 10% increase in the price of oil trims 0.2 percentage points from global growth. At the start of the year, the world looked likely to grow by 4-4.5%. A crude estimate is that the two crises will subtract between a quarter and half a percentage point from that.
• That may not capture the full effect. Crises by their nature generate clouds of uncertainty . Businesses postpone capital spending and hiring until the clouds clear. Investors seek the safety of bonds and lose their taste for equities.
• Economic policymakers can’t make peace between Arab rulers and their people or stabilise Japan’s nuclear reactors, but they can minimise the collateral damage. The greatest burden is on the Bank of Japan. Its efforts to cure deflation over the past 15 years have too often been timid. That could not be said of its rapid response to the tsunami. It poured cash into the banking system in a pre-emptive strike against panic hoarding. And it expanded its purchases of government and corporate debt and equities. Still more “quantitative easing” can keep bond yields from rising as the government borrows for reconstruction, and help the fight against deflation.
• What should the rest of the world do? In a show of sympathy the G7 joined the Bank of Japan in selling the yen after it spiked dramatically. Such actions should be limited, however. Japan is too dependent on exports and its priority should be stimulating domestic demand and ending deflation, not cheapening the yen. A better way for outsiders to help is to ensure that concerns over radiation in Japanese products do not become an excuse for protectionism.
• Other central banks face a more complicated task. Even as higher oil prices and hobbled Japanese production reduce growth they add to mounting inflation risks (Britain is now fretting over inflation of 4.4%). But most rich-world economies have ample economic slack, and in several countries fiscal tightening will tug at recovery. Britain’s coalition government has reaffirmed its commitment to austerity with this week’s budget , and America has begun to cut spending. Both the Bank of England and the Federal Reserve should resist the temptation to tighten soon.
• The European Central Bank seems intent on raising interest rates next month. That would be a mistake. In the euro zone underlying inflation and wage growth are both subdued and inflation expectations are under control. By raising rates the ECB would strengthen the euro and frustrate the efforts of countries like Greece, Ireland and—the next in line for bailing out—Portugal to grow their way out of their debts.
• There is only so much economic policymakers can do about crises that spring from war or nature. In this case, the priority should be not making matters worse.

will china be happy

• The pursuit of happiness, runs one of the most consequential sentences ever penned, is an unalienable right. That Jeffersonian sentiment seems to have influenced even China’s normally strait-laced, rubber-stamp legislature, the National People’s Congress (NPC), which has just wrapped up its annual session. Increasing happiness, officials now insist, is more important than increasing GDP. A new five-year plan adopted at the meeting has been hailed as a blueprint for a “happy China”. The prime minister, Wen Jiabao, however, appeared downright miserable as he described the challenges he faces.
• At the end of the ten-day meeting, Mr Wen told journalists that his remaining two years in office would be “no easier” than the preceding eight. Keeping the “tiger” of inflation in its cage would be hard enough, he said (the NPC approved a target of 4% this year, compared with inflation of nearly 5% in February). But corruption was the “greatest danger”. A few days before the session began, the railways minister, Liu Zhijun, had been dismissed in connection with a huge bribe-taking scandal.
• The five-year plan called for 7% annual average growth in GDP between now and 2015, compared with a far-exceeded target of 7.5% set in 2006-10. Mr Wen said lowering growth without raising unemployment would be an “extremely big test”. But, he said, China had to change its pattern of economic growth, because it was (using a hallmark phrase) “unbalanced, unco-ordinated and unsustainable”.
• The idea of promoting happiness spread over the country like a huge grin early this year when provincial governments began laying out their own five-year plans. Guangdong province declared it would become “happy Guangdong”. Beijing (which is a province-level administration) said it wanted its citizens to lead “happy and glorious lives”. Chongqing municipality, another province-level area, said it wanted its people to be among the happiest in the country. Officials now often talk of setting up “happiness indices” by which government performance should be judged.
• The word’s popularity among bureaucrats is more an attempt to please leaders in Beijing and show sympathy for the less well-off than a sign of any real determination to change their ways. Many lower-level governments have continued to set investment-driven GDP-growth targets that are far higher than Mr Wen’s. Some of his goals, such as building another 36m subsidised homes by 2015, will require the co-operation of local governments. They are adept at evading such tasks.
• Mr Wen does not see political freedom as having much to do with happiness. In August last year he raised hopes among some liberal-minded intellectuals when he made a flurry of statements about the importance of political reform. Since then, the repression of dissidents has been stepped up. Dozens have been rounded up or put under surveillance in order to prevent them from responding to anonymous internet-circulated calls for an Arab-style “jasmine revolution” in China. To deter any protests, police security during the NPC was even heavier than usual.
• At his press conference, Mr Wen repeated some of the language he had used last August on the need for political reform. This included a warning that China’s economic gains could be wiped out if the country failed to reform politically. He also said people needed to be able to “criticise and supervise” the government. But he offered no guide to how this should happen, and stressed the need for change to be “gradual”, “orderly” and “under the leadership of the party”. He said it would be wrong to draw comparison between the situations in the Middle East and north Africa and that of China.
• The NPC’s chairman, Wu Bangguo, went further, telling delegates that the country faced an “abyss of internal disorder” if it strayed from the “correct political orientation”. He also declared China had achieved its goal of setting up a “socialist legal system with Chinese characteristics”. The Communist Party said in 1997 that it would do this by 2010, but never made it clear how progress would be assessed. China’s struggling band of independent lawyers, who are often spurned by courts and harassed by police for trying to defend victims of official wrongdoing, are probably not celebrating.
• The government’s crackdown on dissent apparently includes a strengthening of China’s internet firewall to make it more difficult to use software to evade blocks on sensitive foreign websites. Some websites in China recently carried a report that 11% of respondents to an opinion poll believed national happiness is boosted when they express themselves freely on the internet. If only they could

Banks,metals will boost sensex further !

• Japan’s government kept its assessment of the economy unchanged in a monthly report on Friday but warned of increasing downside risks to growth such as the strong yen and slowing overseas growth.
• China’s imports leapt in August, boding well for a strengthening of domestic demand in an economy that has become a major driver of global growth.
• Stocks rose and bonds fell on Thursday after stronger-than-expected U.S. data on jobless benefits and trade, raising hopes the tepid economic recovery would accelerate.
• The Basel Committee of central bank and regulatory officials is likely to complete talks on new Basel III capital standards by Sunday or Monday, German Finance Minister Wolfgang Schaeuble said on Thursday.
• There are no signs of a slowdown in India’s industrial output growth, senior finance ministry adviser Kaushik Basu said on Thursday.
• India, the world’s top consumer of sugar, has asked millers to apply for exports of the sweetener against imports of raws in the past, trade and government officials said on Thursday.
• Japan and India agreed on a free trade deal on Thursday which Tokyo said would lead to a 10-fold jump in trade flows as it eyes the fast-growing economy as a low-cost production centre and a market for exports.
• High inflation in India is expected to ease in coming months, reducing pressure on the Reserve Bank of India (RBI) to raise interest rates further.
• India’s wholesale price index in August probably rose 9.6 percent from a year earlier, easing from a rise of 9.97 percent in July. Forecasts from 15 economists ranged from 9.36 percent to 9.84 percent.
• Equity funds posted the biggest weekly inflows in more than a month in early September, reflecting some comfort with the global economic outlook, though fresh cash allocations showed the limits of risk taking, EPFR Global data showed on Friday.
• Asian stocks rose to a four-month high on Friday as some investors were inspired by positive U.S. and Japanese economic data to pick out bargains, with the shift to riskier assets weighing on the yen.
• World stocks kicked off September on a stronger note on Wednesday as data showed a manufacturing rebound in China and stronger-than-expected growth in Australia, while the yen held near recent 15-year peaks against the dollar.
•  India’s tax department has jurisdiction over tax bills in cross-border mergers, a court ruled, dismissing a petition by Vodafone(VOD.L) and setting a precedent for foreign firms looking to buy into Indian companies.
• U.S. President Barack Obama stood firm on Thursday in opposition to a Republican push to extend Bush-era tax cuts for the rich but stopped short of threatening to veto such a measure if passed by Congress.
• Advice may be nice, but backing it up with balance sheet can be key to winning M&A business for investment banks in India.
• Switzerland remains the world’s most competitive economy, while India dropped two places to 51, according to the World Economic Forum’s annual rankings issued on Thursday.

How the euro-zone outs are fighting to retain influence in the European Union?

• One fear of European Union members outside the euro, either by choice or because they are not ready to join it, has been that they will be cut out of the big decisions being taken in Brussels. One hope of many of the euro’s founder members was the obverse: that the club would become more politically and economically integrated. That original tension between wide consultation and tight integration is now bubbling over in arguments over whether the euro-zone heads of government should have regular summits.
• Poland, a leading euro “out”, was horrified when a leak revealed internal German correspondence on the “competitiveness pact” proposed by Chancellor Angela Merkel and the French president, Nicolas Sarkozy. This confirmed the danger of a two-speed Europe that locked out non-euro countries and sidelined the European Commission. Yet Poland sees Germany as its best friend in the EU.
• The Polish prime minister, Donald Tusk, made his dismay thunderingly clear. He has got somewhere as a result. “At the European Council, Tusk never gets angry; he’s trusted and a credible negotiator,” says Piotr Kaczynski of the Centre for European Policy Studies in Brussels. “So on the occasion when Tusk does shout, Brussels stops.” The compromise “pact for the euro” makes concessions, including a role for the commission.
• The Poles will continue to fight plans to move decision-making from the 27 to the 17, accepting the smaller group only for matters directly related to the euro. But they like the competitiveness pact’s structural reforms, such as reforming wage indexation. Jacek Rostowski, the finance minister, says “it’s good if all Europe wants it, not just something for emerging economies.” And there is some scepticism about the ability of 17 very different euro-zone countries to agree on new policies.
• Poland plans in principle to join the euro. The fear of isolation is keener in Denmark and Sweden, which want more say but are unlikely to join the single currency for a while. The adoption of the euro by such new members as Slovenia, Slovakia and now Estonia was a reminder of their dwindling influence. “It really rankles that they can’t get into important policy meetings,” says an Estonian diplomat.
• In fact the centre-right coalitions of Sweden and Denmark, unlike their counterpart in Britain, are eager to adopt the euro. But their voters are not persuaded. The Danes have twice voted against joining, once in a referendum on the Maastricht treaty in 1992 and again when they were asked to reconsider in 2000. Swedish voters similarly rejected the euro in a 2003 referendum. Now the risk of a two-speed EU, with Sweden and Denmark in the outer lane, has led to speculation about fresh referendums in both countries.
• The Danish prime minister, Lars Lokke Rasmussen, floated the possibility earlier this month, arguing that Denmark should ratchet up its European commitment before it takes over the EU’s rotating presidency next January. But the timing could hardly be worse. One opinion poll in February suggested that voters might agree to scrap their opt-outs (from judicial and security co-operation as well as the euro) only if all three were dealt with in a single referendum. And this was a rare positive blip in an anti-euro trend. A December poll by Denmark’s Danske Bank found fully 43.5% were definite noes and only 25.5% certain yeses—an 18-point lead. “I don’t believe the prime minister will call a referendum; the risk of a no is too high,” says Steen Bocian, the bank’s chief economist. Another complication is that Denmark must hold a general election by November—and Mr Lokke Rasmussen is trailing in the polls.
• The travails of the single currency have hardened anti-euro sentiment in Sweden too. Danes fear that without the krone they might have sunk into an Irish quagmire. Swedes are proud that their economy has thrived on the outside. Far from being in the slow lane, in the fourth quarter of 2010 it was the fastest-growing in the EU. For now, Sweden and Denmark will remain out. Their governments will back Poland in resisting a bigger role for the euro group.
• On the face of it, the prospect of regular euro-zone summits is a setback also for Germany. Economic government was a French idea, loaded with dirigiste menace and peril for the independence of the European Central Bank. Mrs Merkel has always been the sworn enemy of class distinctions within the EU. In 2008 she rejected calls for a two-speed Europe when Irish voters rejected the Lisbon treaty. “The unity of Europe is not something we want just for its own sake,” she declared. “It is a great good.” Moves in the direction of a euro-zone economic government look like a climbdown.Mrs Merkel would deny this. No new club is being formed, and any arrangement cooked up by the 17 will be open to the ten non-euro members as well. Far from opening a dangerous new division within the EU, the Germans think they are closing one: between competitive economies and the laggards that threaten the survival of the euro. If they have their way, this euro-zone summit may be the last.
• From Mrs Merkel’s point of view, the alternative was worse. Germany may have as much as €200 billion ($280 billion) of exposure to rescue schemes for wobbly euro members and that figure could climb. So will resistance from voters and some members of Mrs Merkel’s coalition. The euro has become the top political issue, says Frank Schäffler, a hawkish Bundestag member from the liberal coalition party, the Free Democrats. The pact for the euro is supposed to help by breaking euro countries of the bad economic habits that got them into trouble in the first place. “She needs something to take to her increasingly sceptical coalition,” observes Daniela Schwarzer of the German Institute for International and Security Affairs. Not all are reassured. Mr Schäffler sees the pact as a “placebo to quiet the people.” European countries should compete rather than being forced to reform by a central authority, he thinks. Hans-Werner Sinn, a liberal economist, fears that France may use a euro-zone government to force Germany to raise wages.
• Mrs Merkel’s allies are awkwardly positioned between backing her diplomacy and setting limits on German concessions. On February 23rd the three coalition parties laid down conditions for approving a treaty change to set up a permanent euro-zone bail-out fund. One was more economic co-ordination within the zone—in other words, a version of the competitiveness pact and its embryonic economic government. Mrs Merkel may have long opposed a two-speed Europe, but pressure from voters, her coalition partners and other euro-zone countries seems to be pushing her into tolerating it.

Financial crises and property busts go together

• Property’s grip on people is unrelenting. After the worst housing crash in memory, almost two-thirds of Americans still think that property is a safe investment. In Britain ministers hold summits to work out how to get first-time buyers into a market where prices are falling. In China anxious buyers queue to snaffle yet-to-be-built apartments. The world of commercial property is saner, but not by much. A bounceback in office values in London has prompted fears of a new bubble. Cranes dot the Chinese skyline, where more than 40% of the skyscrapers to be built over the next six years will be sited.
• Property is more than just a place to live and work. For many people, it is the biggest financial bet they will ever make. That bet has been disastrous for plenty of homeowners. Over a quarter of mortgage-holders in America owe more on their loans than their homes are worth. House prices there have fallen back to 2003 levels and are still declining—by 2.4% year-on-year in December. A huge pipeline of foreclosed homes is still on its way to market: distressed transactions account for 66% of sales in California. Prices will probably fall again this year, sapping confidence and preventing people from moving to find work. Programmes to modify mortgage payments have been disappointing: for some underwater borrowers it may make more sense for the state to help reduce the principal.
• At least prices in America are back to their long-run average compared with rents. For those with cash, homes are more affordable than they have been for years. In many parts of Europe, prices still have a long way to fall to revert to that sort of value and there is lots of downward pressure. Oversupply weighs on the market in places like Spain, where a construction boom turned to bust. Credit is constrained (a big worry for commercial property, too, given the amount of debt that needs to be refinanced). The threat of rising interest rates looms over the many borrowers with adjustable mortgages.
• In emerging markets policymakers have a different problem: holding prices down. A property bubble, many reckon, is the biggest threat to China’s economy. A succession of measures have been introduced to subdue speculative buying and force developers to increase the supply of homes. There are sound reasons for prices to rise in China, given income growth and huge pent-up demand for decent housing. But policymakers are having to fight to keep things under control.
• The irony is that property’s appeal is founded on its supposed solidity. It is no coincidence that the housing bubble started in the aftermath of the dotcom bust. Out went fantasy business plans; in came a real asset with a proven record. But , property has dangerous qualities.
• One is its size. American households have more of their wealth in real estate than any other asset; it is a similar story elsewhere. So when things go wrong, the consequences are more serious than if there is a slump in equities, say. Worse, property is a magnet for debt. Lenders have to set aside less capital for loans against property because of its security as collateral. Individuals have no other opportunity to take on so much leverage. As prices go up, a deadly feedback loop forms: rising collateral values enable banks to extend more credit, which means prices can be chased higher. Things can spiral very quickly: there was a doubling of mortgage debt in America between 2001 and 2007. It is leverage that explains why property busts have a habit of causing financial crises.
• Property is also an inefficient asset class. It is lumpy: you can offload parts of your share portfolio, but you cannot sell off the kitchen. It is illiquid, which can strand people in their homes even if they are not in negative equity. And it is inefficiently priced, not least because as an asset class it is hard to short: you can’t hedge your exposure.
• So governments should be neutral about home-ownership, whose benefits have been oversold. People will always want to buy houses: they do not need a shove from subsidies. In America plans to wind down Fannie Mae and Freddie Mac, which buy and guarantee mortgages on the government’s account, are welcome. Tax deductions on mortgage interest should go. So should distorting exemptions on capital-gains taxes; it is better to cut the transaction taxes that make it expensive for people to move.
• Politicians will be loth to cut the value of their electorate’s biggest asset, however. Which is why lots of people are now looking to central banks to intervene when property booms get going. That already happens a lot in Asia; Western central banks are also moving in this direction. The Swedes last year imposed a maximum loan-to-value ratio of 85% on mortgages, for instance. Good. Standing idly by is not much of a policy. And central banks have tools at their disposal, including interest rates, that can dampen things down.
• Regulators have failed to spot bubbles in the past, however. And booms can be hard to stop when they get going: just ask the Chinese authorities. Discretionary interventions should be on top of standing rules, not instead of them. There should be no room for the wildest mortgage products—those that do not seek verification of income, say. But the systemic issue is the amount of debt that borrowers take on. Property busts are at their most destructive when borrowers fall quickly into negative equity (one reason to worry less about China is the small amount of debt that homebuyers have). A cushion of equity—10-15% of the property’s value, say—should be required of new borrowers as a matter of course.
• This should be phased in gradually. Unlike getting rid of mortgage interest relief, which is relatively painless when interest rates are already low, a minimum equity provision would hurt the economic recovery (especially in America, where the government is guaranteeing loans with tiny down-payments). And there is also a risk of excluding creditworthy borrowers, particularly first-time buyers and the self-employed. But it cannot wait too long. Asking people to save up for longer is a reasonable price to pay for a safer system.

A complex chain of cause and effect links the Arab world’s turmoil to the health of the world economy

• Two factors determine the price of a barrel of oil: the fundamental laws of supply and demand, and naked fear. Both are being tested by the violence that is tearing through Libya, the world’s 13th-largest oil exporter. The price of a barrel of Brent crude now hovers around $115. On February 24th, however, it rose to almost $120, as traders realised that they might have to do for a while without some or all of Libya’s exports: some 1.4m barrels a day (b/d), or about 2% of the world’s needs.
• The situation in Libya is grim, as the rebels and the forces of Muammar Qaddafi battle for control of the country’s only resource. Brega, the seat of the Sirte Oil Company in the east of the country, has changed hands three times in recent days. Most of the oil workers have fled, and production has fallen by two-thirds. The ports of As Sidra, Brega, Ras Lanuf, Tobruk and Zuetina, which together handle almost 80% of Libya’s oil exports, were all seized by the rebels; two have now been retaken by Colonel Qaddafi’s forces. The rebels remain in control of Africa’s largest oilfield, Sarir, pumping some 400,000 barrels on a normal day. But for how long?
• The history of oil is marked by Middle Eastern strife, supply shocks and global recession, with the Arab oil embargo in 1972, the Iranian revolution in 1978 and Saddam Hussein’s invasion of Kuwait in 1990. To gauge the risks today you need to answer three questions. How vulnerable is the oil market to an interruption in supply? How sensitive is the world economy to oil-price spikes? And how well can policymakers cope with a shock if the worst happens? Take each in turn.

• The troubles in Libya are only the most serious example of the impact of Arab unrest on global oil markets. Prices jumped as Egypt’s citizens took to the streets to oust President Hosni Mubarak. Egypt is an oil importer, but acts as a vital conduit between the huge oilfields in the Persian Gulf and markets in Europe, via the Suez Canal and through the SUMED pipeline. Although it seemed unlikely that protesters would or could disrupt oil shipments, events in Cairo were enough to add more than $5 to a barrel.
• The spread of unrest to Bahrain, Oman and the Gulf has created a whole new dimension of anxiety. North Africa produces 5% of the world’s oil, but the Middle East produces 30%. Moreover, Bahrain’s problems are on Saudi Arabia’s doorstep. These bear on the situation in the eastern Saudi provinces, from which a huge quantity of oil is pumped into global markets.
• Saudi Arabia is therefore the traders’ chief worry. But it is also, in oil terms, the world’s chief hope. It is the only producer with significant spare capacity that could quickly be released if the oil price rose too high. Although OPEC, in which Saudi Arabia is the biggest force, exists to keep oil prices buoyant, it does not want to see them reach a point where the world economy is damaged and demand for oil falls. When prices spiked in 2008, the Saudis said they had capacity to spare. Terrified oil markets doubted its existence, and prices rose anyway, to reach $145. Yet the subsequent collapse in the oil price in the second half of 2008 was only partly caused by the credit crisis and the rich-world recession that resulted. Saudi Arabia also pumped extra oil: nearly 2.5m b/d on top of the 8.5m it was already providing.
• OPEC’s spare capacity now is put at anything between 6m b/d (by OPEC) and 4m-5m b/d (by industry analysts); Saudi Arabia’s share of that excess is perhaps 3m-3.5m b/d. The oil price has retreated from its peak in the past ten days largely because Saudi Arabia says it is pumping up to 600,000 b/d to replace the shortfall in Libyan exports. It has invested heavily in expanding capacity, with plans to spend perhaps $100 billion on wells and infrastructure by 2015. It has also been far more open about letting the world see what it has done. OPEC’s stated aim of stabilising oil prices relies on traders believing that the Saudis really do have the capacity to pump more when prices rise.
• Why, then, are traders still so nervous? The answer is that the long-term trends of supply and demand were already unfavourable when the Arab shoe-throwers intervened. Before the uprisings, a barrel of Brent crude was commanding close to $100 a barrel. World demand grew by an extraordinary 2.7m b/d in 2010, according to the International Energy Agency. It will probably keep growing by another 1.5m b/d this year and the same again next, as the rich world recovers and demand surges in China and the rest of Asia. Net expansion of non-OPEC supplies is likely to be negligible in the coming years. Though the rich world’s inventories are high, with cover of around 50 days, it is not clear that Saudi Arabia can pump much more than it did in 2008; and the speed of oil released from government reserves, such as America’s Strategic Petroleum Reserve, also has upper limits.
• If disturbances hit Algeria and threaten its oil industry too, the buffer of spare capacity would fall below where it stood in 2008. But demand now is much higher, so spare capacity as a proportion of that demand is much lower.
• When oil markets tighten, another set of problems emerges. Saudi oil is generally more dense and sulphurous than the Libyan crude it will replace. Europe’s creaky old refineries will not be able to process the heavier Saudi crude, and fuel regulations there are less tolerant of sulphur content than elsewhere in the world. So the Gulf oil will have to be shipped to Asia’s newer refineries, which are designed to deal with a wide variety of grades of oil. West African oil, a close substitute for Libya’s output which usually goes to Asia, will be sent to Europe instead.
• If the supply situation worsens, opportunities for this type of substitution will be fewer, creating supply bottlenecks, shortages of petrol and spikes within price spikes for different crudes and products, even when spare capacity remains. The price differential of about $15 a barrel that has built up between Brent crude, which more closely reflects global trade, and West Texas Intermediate, the benchmark for oil prices in America, is a good example of how oil markets can become distorted by local patterns of supply and demand. If supply gets even more stretched, oil could fetch a far higher price in some parts of the world than others. If supply problems become really grave, oil companies may even declare force majeure, raising the prospect that, as in 1978, oil markets fail altogether.
• That is still a remote prospect, and the upward march of the oil price seems to have paused for now. The crucial question is how much oil will be lost, and for how long. When oil markets operate at the limits of supply, even the smallest extra disruption has a disproportionate effect. On February 26th, for example, Iraq’s biggest refinery shut down after a terrorist attack. This and other assaults could knock out another 500,000 b/d from the world’s fuel supplies. And if the raids on oil installations in previous elections in Nigeria are anything to go by, the next one, in April, may threaten another 1m b/d of supplies from west Africa. Meanwhile, Saudi Arabia remains far from secure . On March 1st the country’s stockmarket, jittery about the neighbours, plunged by 7%, a worrying sign that confidence is fading.
• All this is a dark cloud on an otherwise bright horizon for the global economy. Few things can short-circuit growth like an oil shock, both because of the fuel’s ubiquity and because of the relative insensitivity of demand. When the oil price jumps, consumers have little choice but to accept it, spending less on something else.
• So how sensitive is the world economy to oil prices? Thus far the rise, and the likely damage, both look modest, in part because many forecasters had expected an increase this year anyway. Since the end of last year the price of Brent has risen by $23 a barrel, or about 25%, and West Texas Intermediate by $10, or 10%. The IMF reckons that a 10% increase in the price of crude shaves 0.2%-0.3% off global GDP in one year. As it happens, crude oil (using a blend of several grades), is now about 10% more costly than the IMF assumed in late January, when it projected global growth of 4.4% this year. That implies that the Fund would now foresee growth of about 4.2%.
• Economists do not expect a repeat of the 1970s, when oil-price rises led to “stagflation” in the rich world. Olivier Blanchard, chief economist of the IMF, and Jordi Galí, of the Centre de Recerca en Economia Internacional in Barcelona, point out that two recent oil-price rises—one beginning in 1999 and another in 2002—were of the same order of magnitude as during those turbulent years. But the effect on both inflation and unemployment in the rich world was much smaller: in America, for example, a rise in inflation of only 0.7 percentage points on average, whereas the 1970s shocks had caused a rise of 4.5 points in the two years after the shocks.
• The rich world is less vulnerable now because it has substantially reduced the amount of oil used per unit of output. America’s economy in 2009 was more than twice as large in real terms as in 1980. Yet over that period America’s oil consumption rose only slightly, from 17.4m b/d to 17.8m. Europe actually used less oil in 2009 than in 1980, even though its economy had grown.
• Other factors may also have helped. Supply shocks generate larger increases in inflation and bigger falls in output when wages are rigid. So oil shocks have smaller effects today, because labour markets in rich countries have become considerably more flexible since the 1970s.
• Emerging economies may be hit harder by a spike, since they use more oil per unit of output than rich countries do. America’s economy, though about three times the size of China’s, uses just over twice the amount of oil that China’s does. But oil intensity in emerging countries has also been falling in recent years, as manufacturing has become more efficient and less energy-intensive service industries have increased their share of the economy. So even these countries are less vulnerable to an oil shock than they used to be.
• Among rich economies America tends to suffer the biggest immediate impact, because its economy is relatively energy-intensive and because its low petrol taxes interpose only a small wedge between crude oil and petrol prices. Goldman Sachs estimates that a 10% price increase trims GDP by 0.2% after one year, and 0.4% after two.
• In Europe the effect is muted by lower energy intensity and high levels of tax. Excise and value-added tax represents roughly 60% of petrol prices and 52% of diesel prices in the euro area, according to the European Central Bank (ECB).
• Emerging Asia is more complicated. Although its economies are more oil-intensive, several also export oil, and many subsidise fuel, limiting the impact on consumers. Thailand has resolved to hold the price of diesel below 30 baht (about $1) a litre until April; without the subsidy, which was raised on February 24th, it would be 34 baht. Citigroup estimates that each $10 increase in the price of oil costs India’s state-owned oil-marketing companies the equivalent of 0.5% of GDP, of which half is absorbed by the budget. An IMF staff study has estimated that emerging and developing countries subsidised fuel by about $250 billion in 2010.
• What can central banks do to protect the economy? Higher oil prices act as a tax on countries that import the stuff, which would normally call for easier monetary policy. But they also raise inflation, which calls for tightening. A one-off rise in prices would not produce a sustained increase in inflation, unless it boosts firms’ and workers’ expectations of future inflation, which can become self-fulfilling. The oil-price shocks of the 1970s rapidly found their way into broader inflation. Central banks had to clamp down drastically to suppress their inflationary effects.
• In recent years, with inflation expectations more stable, central banks have responded more moderately to higher oil prices. But in July 2008 the ECB raised short-term interest rates because it feared that a rise in headline inflation would feed a wage-price spiral. In retrospect, that was a mistake. The global economy was already slowing, and over the next year both headline and core inflation (which excludes energy) fell sharply in the euro zone. Although America’s Federal Reserve did not tighten, it hinted at the possibility, which prompted markets (wrongly) to anticipate a rate increase. These hawkish signals may have compounded the slide in economic activity already under way.
• This year their response is likely to be more subdued. Unemployment is higher in America and Europe than in 2008, and underlying inflation, except in Britain, is lower. At a forum on February 25th at the University of Chicago, officials from both the European and American central banks signalled willingness to hold fire unless inflation expectations grow. On March 1st Ben Bernanke, chairman of the Federal Reserve, said the recent rise in commodity prices would probably “lead to, at most, a temporary and relatively modest increase” in inflation.
• In many emerging markets the risks are greater. Those economies are already operating at capacity, and both overall inflation and core inflation have risen: China’s January inflation rate was 4.9%, well above its official 4% target, and India’s was more than 9%. An increase in the price of energy can cause a steeper jump in inflation in emerging markets, because in many it has a larger weighting in their consumers’ baskets: 15.2% in Indonesia, 14.2% in India and 13.8% in Malaysia, compared with about 9% in America’s. Moreover, energy is a large input in food production, which has an even bigger weight.
• Monetary policy has also been relatively loose in these countries, with real short-term interest rates negative in many of them, including, by some measures, China. Johanna Chua of Citigroup reckons that monetary conditions, including both interest rates and the exchange rate and, in China’s case, credit growth, have tightened already in Asia, but need to tighten further in both China and India.
• The reason for a rise in the oil price is as important as how large it is. An increase forced by higher demand is less dangerous than one driven by constricted supply, because it is evidence of a healthy global economy. If rapid growth means that China and India are importing more oil, they are probably importing larger amounts of other things as well, lessening the pain for slower-growing consumers of oil.
• Nonetheless, whether driven by demand or supply, a large enough spike in the price of oil can do great damage. Economists call such abrupt responses “non-linearities” and they suggest that when the price rises fast enough, consumers and businesses trim their spending and investment plans. This is often because prices are driven by other factors that hurt confidence, such as wide unrest in the Middle East. If another Arab government were toppled, pushing the oil price over $150, the economic impact would almost certainly be larger than the 0.5% to 1% of GDP that simple extrapolation suggests.
• James Hamilton, of the University of California, San Diego, has identified numerous periods since the late 19th century in America when an abrupt rise in the price of oil or petrol coincided with recession. Many of these were caused not by an interrupted supply, but by demand growth colliding with unresponsive supply. That seems to explain the price spike above $140 in mid-2008. Although the financial crisis was the main cause of the recent recession, Mr Hamilton argues that oil explains why the economy had already begun contracting before the worst of the crisis hit that autumn. Robert McNally, of Rapidan Group, a consultancy, concurs, arguing that American consumer confidence fell sharply once petrol went past $3 a gallon . It is now at $3.38, after the biggest one-week increase since Hurricane Katrina in 2005.
• Even if the unrest leaves supply unaffected, significantly higher prices may be only a matter of time. The same dynamic that drove the oil price skyward in 2008 is steadily reasserting itself. Supply is not growing substantially, and global demand, which regained its pre-recession peak last year, is expanding briskly again.

• Given enough time, the rich countries should be able to adjust to higher prices. Jim Burkhard of IHS Cera, a consultancy, notes that OECD oil demand peaked in 2005 and has been slipping since in response to the upward march of prices. In America a shift in consumer purchases towards more fuel-efficient vehicles, ethanol mandates and higher fuel-economy standards have all capped growth in petrol demand. Meanwhile, the higher world price has unlocked new supply within the United States, and elsewhere, which was previously too expensive to exploit.

• Yet it may take years for such trends to dent demand and boost supply by much; and the world may not have a lot of time. “Historians will look back on 2008 as the first time in modern memory that spare capacity ran out without a war in the Persian Gulf, and OPEC failed to cap prices,” says Mr McNally. “Eventually we’ll replay that scenario. If OPEC can’t control the market any more, that means prices will have to swing much more.”