Wednesday, November 28, 2007

Credit Squeeze and Bank Lending in the Eurozone

From the FT this morning:

Credit squeeze fails to dent eurozone borrowing

By Ralph Atkins in Berlin

Published: November 28 2007 15:03 | Last updated: November 28 2007 15:03

The global credit squeeze has had little or no impact on business and consumer borrowing in the eurozone, European Central Bank data suggested on Wednesday, with the effects of the recent financial turmoil yet to feed through into the 13-country economy.

Loans to non-financial businesses grew at an annual rate of 13.9 per cent in October, unchanged from the previous month, and one of the fastest rates since the launch of the euro in 1999, according to the ECB’s credit and money supply figures. Lending to consumers had started to slow before the credit crunch hit in August but in October still grew at an annual rate of 6.8 per cent – also unchanged from the previous month.

That appeared at odds with recent the latest ECB survey on bank lending conditions, released last month, which had reported a significant toughening of credit standards applied by banks.

The conflicting evidence highlighted the quandary facing the European Central Bank. Inflation is rising sharply – November’s figure published on Friday is expected to be far above its target of an annual rate “below but close” to 2 per cent – which would otherwise have strengthened the case for higher interest rates.

But the ECB is still fighting to calm tensions in money markets, where three-month interest rates remain stubbornly high. The large appetite for funds was highlighted in the ECB’s latest regular auction for three-month money yesterday, where banks submitted €132.4bn of bids for the €50bn allotted.

Meanwhile, the extent of the macro-economic impact of the global credit squeeze and the euro’s record strength remain unclear. Robert Barrie, economist at Credit Suisse, argued that October might have been too early to see effects on lending data. But higher market interest rates, and a sharper-than-expected US slowdown added to the threats. “It is very easy to draw up quite a list of downside risks to growth. If they all materialised, growth would slow a lot,” he said.

As a result of the conflicting pressures, the ECB is expected to hold its main interest rate unchanged next week at 4 per cent – and financial markets expect it to remain on hold for much of 2008

The latest data showed annual growth in M3, the broad money supply measure, accelerating to a record 12.3 per cent in October. M3 is watched closely by the ECB as an inflation early warning signal. But its growth might have been exaggerated by a flight to liquid assets as a result of recent financial market turmoil.

The figures on lending to business might also have been distorted by recent events with growth rates exaggerated if loans had built up on banks’ books because they had failed to securitise deals as in past. Nevertheless, Julian Callow, economist at Barclays Capital, argued that the ECB was likely to see the data “as suggesting no discernible impact of the credit tightening on the pace of non-financial private sector credit growth up until the end of October.”

Volatility and the Japanese Yen

From the FT this morning:

BoJ warns of ‘disease’ in world markets

By David Pilling in Tokyo

Published: November 27 2007 20:01 | Last updated: November 27 2007 20:01

The yen hit a two-and-a-half year high against the dollar on Tuesday as Toshihiko Fukui, governor of the Bank of Japan, expressed strong concern about the turbulence in world markets, comparing it with “a serious disease”.

The yen briefly rose to Y107.17 against the dollar, although it fell back to Y108 in Tokyo trading. Before July, when investors began to reverse some so-called yen carry-trade positions amid a retreat from risk, the currency had been trading at above Y120 to the dollar.

Tuesday’s sharp oscillations sent Japanese equity markets gyrating, with the Nikkei index falling 300 points in the morning amid concern about the effects of a strong currency on exporters, before it rallied to close up 87.64 points as the yen drifted down again. Mr Fukui said the volatile movements in financial markets since July suggested global markets were paying the price for “euphoria and excessive risk-taking”. It was the central bank’s job, he said, “to help markets adjust themselves in an orderly manner as far as possible, while keeping markets functioning at all times.”

The BoJ has reacted to the US mortgage crisis by putting an expected interest rate rise on hold, keeping overnight rates at 0.5 per cent. Although the bank has fractionally pared back its growth and inflation predictions for this year, it has stuck to its central thesis that Japan’s economy remains in a virtuous cycle.

Masaaki Kanno, chief economist at JPMorgan in Tokyo, said a strengthening yen clouded the picture. If the yen broke through Y100 or Y90 to the dollar, he said, it could “be a big blow to the economy” and once more raise the spectre of deflation.

“In the past we didn’t worry so much about yen strength as we believed the global economy would grow steadily,” he said. “But if the strong yen is caused by the slowing of the global eco- nomy together with the spread of risk aversion, then probably we should be a bit more worried than before.”

Other economists said concern about the yen comes on top of worries about the domestic economy, partly brought on by a sharp fall in housing starts.

Jonathan Allum, strategist at KBC Financial Products, said the yen was still relatively weak against the euro, a fact that had helped underpin strong exports to European countries.

On Tuesday, the yen, which peaked at Y168 to the euro in early July, had strengthened to about Y160, compared with previous levels of about Y130.

If the yen appreciated further against the euro it could damage exports to Europe, Mr Allum said. But the “knee-jerk reaction that a strong yen is bad and a weak yen is good [for Japan] is probably a bit out of date.”

Japanese politicians have said that a strong yen is not bad for Japan in the long run, but they have warned about the dangers of sharp movements.

From Bloomberg this morning:

The yen climbed against all of the world's 16 most-active currencies as losses at U.S. banks prompted investors to reduce purchases of higher-yielding currencies funded by loans from Japan.

The yen rose against the dollar, rebounding from its biggest decline in three months, after Asian stocks fell and Wells Fargo & Co. announced a $1.4 billion of loan losses. The euro fell after Germany's consumer confidence weakened more than expected by economists in December.

``The subprime crisis isn't over yet by any means,'' said Ryohei Muramatsu, manager of Group Treasury Asia in Tokyo at Commerzbank, Germany's second-largest bank. ``Investors are risk averse, so the bias is to buy the yen.''

Japan's currency climbed to 108.65 against the dollar at 6:50 a.m. in London from 108.97 late yesterday, when it fell more than 1.4 percent. The yen may rise to 108.10 today, Muramatsu forecast.

The euro declined to 160.52 yen from 161.62 yen and fell to a one-week low of $1.4773 from $1.4829, after Gfk AG's index of German consumer confidence fell to 4.3 in December, the lowest since January 2006.

The 13-nation currency also declined after the Economic Times of India today cited European Central Bank President Jean- Claude Trichet as saying he's averse to ``brutal'' shifts in exchange rates.

Growth Outlook

``European officials are worried the euro's gains may be excessive, hurting economic growth,'' said Tsutomu Soma, a bond and currency dealer in Tokyo at Okasan Securities Co., Japan's sixth-largest brokerage by sales. ``It looks like they don't want a rapid rise in the currency,'' which may fall to $1.4785 and 160.45 yen today, he said.

Losses in the euro accelerated after it dropped below $1.4775, where traders have orders to sell, said Shigetake Nakayama, a manager of proprietary trading desk in London at Bank of Tokyo-Mitsubishi UFJ Ltd., a unit of Japan's largest publicly traded lender by assets.

Traders sometimes place automatic instructions to limit losses in case their bets go the wrong way. The euro may fall to $1.46 against the dollar today, Nakayama said.

The euro has gained 2.7 percent versus the dollar in the past month, eroding the competitiveness of European exports. The European Commission this month cut its forecast for euro-area growth next year to 2.2 percent from 2.5 percent. The British pound weakened 0.3 percent versus the dollar to $2.0629, and the Swiss franc declined 0.3 percent to 1.1091.

The yen rose the most versus Norway's krone, a favorite of the carry trade because Norway's key rate of 5 percent is above Japan's 0.5 percent. The krone slipped 0.9 percent to 19.7886 yen. The MSCI Asia-Pacific Index of regional shares fell 0.4 percent.

Carry Trades

``Exporters are taking advantage of the yen's weakness, especially when the outlook of subprime problems is unclear,'' said Akihiro Tanaka, a senior currency dealer in Tokyo at Resona Bank Ltd., Japan's fourth-largest publicly traded lender.

Japan's currency may move between 107.80 and 108.80 per dollar today, Tanaka forecast.

In carry trades, speculators get funds in a country with low borrowing costs and invest in another with higher returns, earning the spread between the two. The risk is that currency fluctuations erase profits between the two rates.

Wells Fargo, the second-largest U.S. mortgage lender, said yesterday it will take a $1.4 billion pretax charge tied to increased losses on loans backed by homes.

The euro may fall to 153 yen after its chart formed a so- called ``double top,'' said analysts at Citigroup Global Markets Inc. Europe's single currency advanced to 167.65 yen on Nov. 7, with the previous peak a 12-week high of 167.74 on Oct. 15. The pattern indicates a currency may decline, triggering a slide in the euro to 153 yen, Citigroup's technical analysts said.

Japanese Exporters

Japanese exporters sold dollars before the end of the month on speculation the Federal Reserve's so-called Beige Book, a compendium of regional reports that will frame policy makers discussions when they meet in December, will today show mortgage defaults are slowing U.S. economic growth.

``The dollar has a downside risk with the Beige Book,'' said Masaki Fukui, senior economist in Tokyo at Mizuho Corporate Bank Ltd., a unit of Japan's second-largest publicly traded lender by assets. ``There are some possibilities the Fed may indicate the correction in housing markets and financial instability will adversely affect the real economy.''

The U.S. currency may decline to 103 yen by the end of March, Fukui said.

There's a 98 percent chance the Fed will cut its key interest rate by a quarter-percentage point next month from the current level of 4.5 percent, according to interest-rate futures traded on the Chicago Board of Trade. Investors saw an 82 percent chance a month ago.

and from Reuters

JGBs rise as quick remedy on credit crunch doubted

Japanese government bonds rose on Wednesday as investors remained doubtful of a quick resolution to global credit problems, with many financial institutions still struggling with losses from the slumping U.S. housing sector.

The housing market slump kept intact concerns about a deterioration in the U.S. economy, which could also weigh on Japan's economy and make the Bank of Japan delay raising interest rates further.

Traders said investors were buying back bonds, particularly in the medium-term sector, as they saw as overdone the previous session's sharp selling on expectations that money may flow into risk assets again from the safety of government debt.

JGBs and U.S. Treasuries fell sharply on Tuesday on news that Abu Dhabi Investment Authority, the world's biggest sovereign wealth fund, will inject $7.5 billion into Citigroup Inc (C.N: Quote, Profile , Research), which has been one of the hardest hit by subprime mortgage sector problems and the consequent credit crunch.

"The move is not sufficient to resolve the subprime loan problem, which has a much wider impact not only on the health of financial institutions but also on the U.S. economy, so selling of JGBs on the news was overdone," said a senior dealer at a big Japanese bank.

The move "soothed excessive pessimism, while few think uncertainties over the subprime mortgage problems have completely diminished," said Tatsuo Ichikawa, a fixed-income strategist at ABN AMRO Securities.

Wells Fargo & Co (WFC.N: Quote, Profile , Research), the second-largest U.S. mortgage lender, said on Tuesday it would take a $1.4 billion fourth-quarter charge largely related to losses on home equity loans as the U.S. housing market deteriorates.

December 10-year futures <2JGBv1> ended the day session up 0.21 point at 137.10, edging towards a 22-month high of 137.53 hit last week.

JGB futures have risen to their highest since January 2006, as turmoil in global financial markets has fuelled investor doubts over whether the BOJ will lift interest rates to 0.75 percent from the current 0.5 percent before the end of Japan's fiscal year in March.

The 10-year yield fell 1 basis point to 1.480 percent, staying well above a 26-month low of 1.395 percent reached last week.

The five-year yield fell 2 basis points to 1.025 percent. The yield slid to 0.995 percent on Tuesday, a 21-month low.

The two-year yield edged down 0.5 basis point to 0.755 percent. The short-term yield struck a nine-month low of 0.715 percent earlier in the month.

Traders expect the Ministry of Finance's offer of around 1.7 trillion yen ($15.67 billion) in two-year JGBs on Thursday to go smoothly, although demand is not expected to be very strong. Traders said the coupon could be set at 0.8 percent.

Weaker Tokyo shares also made investors careful about selling JGBs too aggressively, traders said. The Nikkei share average <.N225> ended down 0.5 percent at 15,153.78.

Japanese retail sales rose a more-than-expected 0.8 percent in October from a year earlier, pointing to firmness in consumer spending, but the data did little to alter the prevailing market view that the BOJ will not raise rates until well into next year. ($1=108.45 Yen) (Additional reporting by Rika Otsuka, Editing by Michael Watson)

Sunday, November 25, 2007

Japanese Investors Quitting the US?

The New York Times reports on a growing trend in Japan among individual investors of reallocating funds invested in the U.S. to faster growing emerging markets. Japanese investors have reduced holdings of domestic mutual funds investing in the U.S. in 16 of the past 17 months. Meanwhile, investment inflows in overseas-oriented funds have consistently grown at a higher clip than the outflow from U.S. funds. An estimated half of Japan's $14 trillion in personal savings is believed to be invested overseas in search of higher returns, especially in terms of yield, given Japan's extraordinarily low returns on deposits and bonds. At the same time, Japanese investors are gradually beginning to diversify their holdings, after having only embraced mutual fund investing about a decade ago. According to data from Daiwa Fund Consulting, Japanese investors have invested the dollar equivalent of $17.5B into emerging market funds over the past year, while reducing holdings of North American funds by $4B. Fund management companies have taken notice, resulting in a 36% increase in the number of emerging market mutual funds to 183 in total (vs. 137 U.S.-focused funds).

TOKYO, Nov. 22 — Many in Japan are starting to speak of “quitting America,” but they are not talking about a rise in anti-American political fervor. Rather, they mean a move away from American investments that is altering global capital flows and helping to weaken the dollar.

The move is seen in decisions of individual investors like Daijo Okudaira, a 66-year-old clerk at a Tokyo consulting company. Like many Japanese, Mr. Okudaira had long limited his overseas investments to the relative safety of securities from developed countries, particularly the United States.

Starting late last year, however, Mr. Okudaira made drastic changes to his portfolio, putting $50,000 into mutual funds focusing on stocks in China and other emerging economies. He said he had been drawn to these countries because they seemed to hold much brighter growth prospects than the United States.

“People say the engine of the global economy is shifting from the United States to emerging countries,” Mr. Okudaira said. “Emerging countries have growth and energy that America and Europe lack. They remind me of Japan 40 years ago.”

Japan’s legions of individual investors like Mr. Okudaira have emerged as a global financial force to be reckoned with, directing almost half a trillion dollars of their nation’s $14 trillion in personal savings overseas in search of higher returns. Until recently, much of this huge outflow of cash, known as the yen-carry trade, had gone into United States stocks, bonds or currency, propping up the dollar’s value.

Now, however, Japanese individuals are diverting more and more of that money away from the United States and the dollar and into higher-yielding global investments, ranging from high-interest Australian government bonds to shares in fast-growing Indian construction companies. Partly this “quitting America” — called beikoku banare in Japanese — reflects an increasing sophistication of Japan’s investors, who embraced mutual funds only a decade ago and are still learning to diversify. But it also offers one more sign that the world does not depend as much on the American economy as it once did.

Recent figures on mutual fund purchases suggest this trend has accelerated since August, when subprime problems shook Wall Street — and along with it, faith in the United States economy. Since early August, the dollar has fallen almost 8 percent against the yen, a decline many analysts here say offers another indication of Japan’s waning appetite for dollar-denominated investments.

“One lesson of August was the failure of American markets to recover,” said Akiyoshi Hirose, head of research at Daiwa Fund Consulting, a research company based in Tokyo specializing in mutual funds. “On the other hand, Asia’s emerging countries did recover quickly. So money is flowing out of the United States and Europe and into these newer markets.”

In October alone, Japanese individuals pulled 33.9 billion yen, or about $300 million, out of mutual funds that invested solely in North American stocks and bonds, according to Daiwa Fund. In the same month, it said, Japanese individuals put 175.2 billion yen, or $1.6 billion, into funds investing in stocks and bonds in emerging countries.

In the last 12 months, Japanese individuals invested 1.97 trillion yen, or $17.5 billion, into emerging market mutual funds, according to Daiwa Fund, and during the same period, they removed 447 billion yen, or $4 billion, from North America-only mutual funds.

Demand for emerging market funds has gone up so sharply that asset management companies added 48 such funds in the past year, bringing the total number to 183, the company said. Meanwhile, it said, the number of United States-focused funds rose by just 3, to 137.

To be sure, some analysts caution that the popularity of emerging markets may prove to be a fad, especially if stock markets in China or India start falling as quickly as they rose. Analysts also say the dollar’s greater familiarity gives it an enduring appeal among many Japanese, who may return once the United States mortgage problems subside.

Some analysts predicted the eventual revival of short-term currency trading between the dollar and the yen, which had been an important support for the dollar’s value before August’s market turmoil.

“A lot of dollar-buyers are just sidelined now,” said Tohru Sasaki, chief exchange strategist in the Tokyo office of JPMorgan Chase Bank. “They’ll be back once currency markets settle down.”

PCA Asset Management, a Japanese arm of a British firm, said that until last year, its most popular product was a United States bond fund. Now, the company says, 80 percent to 90 percent of the investment money it receives flows into its emerging-market funds, all focused on Asia. To meet demand, the company has added five new Asia-focused mutual funds since January 2006. The most popular, a fund investing in stocks of infrastructure-related companies in India, has grown to $1.4 billion in assets in just one year.

Takashi Ishida, head of investment at PCA Asset, said the emerging-market funds have proved particularly popular with investors in their 50s and 60s, an age group that remembers Japan’s period of high growth four decades ago. He said these Japanese now believe they recognize the same sort of heady growth in developing Asian countries like China, India and Vietnam.

“Asian emerging markets appear safe to invest in because they seem familiar to many Japanese,” Mr. Ishida said.

Many individual investors agree, citing vague impressions of cultural affinity in explaining their optimism in Asian emerging markets. Okiko Ebata, one of a half-dozen individuals gathered on a recent afternoon for an investing seminar in Tokyo, said she had invested in overseas stocks for the first time late last year, choosing a mutual fund that focused on Vietnam. She acknowledged it was a riskier choice than United States or European stocks, but said she felt comfortable.

“I’ve heard people in Vietnam resemble Japanese,” said Ms. Ebata, 59, as the rest of the group nodded in agreement. Two others also said they had invested in the last year in mutual funds focused on India or Southeast Asia.

In a separate interview, Mr. Okudaira, the clerk, said his China fund had doubled in value in less than a year. But even if Chinese investments cannot keep up such rates of return, he said, he and other Japanese will continue to diversify where they put their savings.

“I now have money invested in America, Europe, as well as in Asia,” Mr. Okudaira said. “Japanese are learning how to reduce risk.”

Saturday, November 24, 2007

Decoupling and Global Markets

The piece below comes from the FT this morning, if you want to know my take on all this go over here.

Markets unsure if they will decouple from US

Global markets are reflecting unease that a deteriorating US economy, which comprises about 25 per cent of total world activity, could torpedo the notion that Asia and other countries can "decouple" from a sickly North America.

China's Shanghai index fell below 5,000 this week, the first time since August, and is now more than 17 per cent lower since setting a record high in mid-October.

The big fear is that the US consumer, battered by record high energy prices, a collapsing housing market and a growing credit squeeze from banks will have no choice but to rein in spending.

The consumer is responsible for about 70 per cent of US economic activity. Any pullback, argue some analysts, will lower global growth, particularly for those countries that rely heavily on exporting goods to the US.

"As to whether a US recession would spill over to the rest of the world, opinions are split,'' says Marco Annunziata, chief economist at UniCredit Markets. "Some strongly believe in decoupling and look forward to watching the giant collapse, while the rest of the world powers on, while others believe we would all be hurt.''

At this juncture, the outlook for the US economy is for an extended period of much slower growth starting in the present quarter, but not a recession. Lehman Brothers forecast a 30 per cent probability of a recession starting before the end of next year.

The key factor to watch is the labour market, argue economists. So long as unemployment does not rise sharply from its level of 4.7 per cent, the consumer should weather the storm.

Wednesday, November 21, 2007

Dubai Money Going To India?

This one in Bloomberg this morning is interesting:

Damac Properties, a closely held developer based in Dubai, plans to invest as much as $5 billion in India over the next three years as a booming economy spurs demand for real estate.

The developer will construct houses, offices and shops in the Indian cities of Mumbai, New Delhi, Hyderabad and Bangalore, Chairman Hussain Sajwani said in a telephone interview from Mumbai. The first project will be started in 12 months, he said.

Soaring office rents and a shortage of apartments is luring developers including Donald Trump Jr. and Emaar Properties PJSC to India. Damac has built waterfront luxury projects in the United Arab Emirates and is investing in Saudi Arabia and Egypt as it expands outside its home base of Dubai.

``There is a latent demand for high-end and luxury properties as the economy booms and income levels rise,'' said Malvika Chandra, head of India research at Knight Frank in Mumbai. ``The right products are getting lapped up.''

India's 1.1 billion population faces a shortage of 25 million housing units, according to government data. The government is seeking to encourage the purchase of homes by giving tax breaks and ensuring easy availability of bank loans.

``We plan to meet the funding requirement from our internal resources,'' Sajwani said.

Growing Wealth

Demand for property is soaring in the world's fastest-growing major economy after China. India is poised for 9 percent growth in the year to March 31, following an average 8.6 percent average rise in the past four years.

Economic growth and the rising value of stocks and real estate are increasing the number of affluent in India.

The number of Indians with the financial wealth of $1 million or more rose by a fifth, the second fastest in Asia after Singapore, to about 100,000 last year, according to Merrill Lynch & Co. and Cap Gemini SA.

Rising demand is pushing up property prices with houses in south Mumbai doubling in the past two years, according to estimates by Cushman & Wakefield.

``We are on the luxury segment of the market so rising prices in India is not a concern,'' Sajwani said.

Mumbai also has the second-priciest offices in the world after London, according to CB Richard Ellis Group Inc.'s semi- annual Global Market Rents survey.

The city is the headquarters to India's main stock exchanges, companies and the main trading center for gold, diamond and commodities.

Rising Supply

Developers including Emaar MGF Land Pvt., Lodha Developers and Oberoi Constructions Pvt. are seeking to benefit from rising demand from Mumbai, New Delhi, and Bangalore and Hyderabad, the main hub for the telecommunications, software and pharmaceutical industries.

Still, a rise in the supply of high-end houses could hurt their future growth, according to DTZ Research. The number of high-end houses in Gurgaon, adjacent to New Delhi, could triple to 10,500 by 2010, DTZ said.

Most of these are being constructed by DLF Ltd., India's biggest developer, Emaar MGF Land, Unitech Ltd. and Parsvnath Developers Ltd., it said.

``Most of the prudent demand comes from the mid-income segments, and that's where we also see most of the supply also coming,'' said Chandra of Knight Frank.

Venture capital firm Indiareit Fund Advisors yesterday said it plans to invest 1.5 billion rupees ($38 million) in Samira Habitats, a company that's developing luxury villas and apartments in Alibag, on the mainland across from Mumbai, made up of a series of islands.

Houses in the 400-acre Samira Habitats project will cost between 5 million rupees and 100 million rupees when they go on sale at the end of next year, Managing Director Ramesh Jogani said.

Emaar MGF Land, the Indian unit of Emaar Properties PJSC, plans to sell 117 million shares. The Middle East's biggest real- estate developer by market value may raise as much as 60 billion rupees in an initial share sale, the Business Standard reported in September.

Monday, November 19, 2007

Europe's property sector hit hardest

From the FT this morning:

Europe's financial services industry, and especially the property sector, has been hardest hit by the global credit squeeze, a closely watched survey has shown.

Growth in European Union financial services went into reverse in October, with the sector reporting its first monthly contraction since the terrorist attacks of September 11 2001, according to details of purchasing managers' indices published on Monday by NTC Economics.

Within the financial services sector, property-related service companies saw the steepest rate of decline.

The latest data reinforce other evidence suggesting that the global credit squeeze has started to have a significant macroeconomic impact across Europe - although its extent and likely duration remain unclear.

The overall all-sector index for the EU suggested that economic output grew in October at the slowest rate since September 2005. The detailed breakdown of the results suggests that much of that slowdown was concentrated in those industries most obviously affected by the financial market turmoil, such as banking. Financial services had already seen a marked weakening in growth since July.

However, out of eight broad industries surveyed by NTC Economics, only telecommunications and consumer services reported growth in October at rates above that seen a year ago - suggesting that the effects of the financial market turmoil over the past few months had become more widespread. The technology sector saw the weakest growth for more than four years.

"Whether that is contagion from the credit turmoil or whether it is a broadening of the slowdown that had taken place before the summer, is a difficult one to answer ... There might be a little bit of both," said Jacques Cailloux, economist at the Royal Bank of Scotland.

Given London's importance as a financial sector, the UK might have been expected to be particularly affected, but service sector activity has also been hit in the eurozone.

Economic activity across Europe is likely to have been hit by the higher financing costs resulting from the credit squeeze. At the same time, a significantly stronger euro and the delayed effects of higher European Central Bank interest rates since the end of 2005 are also likely to have acted as a brake on growth. More recently, a pick-up in inflation would have eroded consumer spending power.

Dizzy in Boomtoom

From the Economist last week:

Dizzy in Boomtown

Nov 15th 2007 | HONG KONG
From The Economist print edition
The boom in emerging economies and their stockmarkets is not over yet. But some are likely to run out of breath sooner than others.

THE world is experiencing one of the biggest revolutions in history, as economic power shifts from the developed world to China and other emerging giants. Thanks to market reforms, emerging economies are growing much faster than developed ones. There is a widening gap between their growth rate and that of the sluggish developed world (see chart 1). According to the IMF, this year they are growing almost four times as fast.

Emerging economies account for 30% of world GDP at market exchange rates (and over half using purchasing-power parity to take account of price differences). At market exchange rates they already account for half of global GDP growth. And by a wide range of measures, their weight is looming larger. Their exports are 45% of the world total; they consume over half of the world's energy and have accounted for four-fifths of the growth in oil demand in the past five years (explaining why oil prices are so high); and they are sitting on 75% of global foreign-exchange reserves.

The increasing strength of emerging economies has been reflected in their stockmarkets, which have climbed steeply in recent years. Share prices in many emerging economies are showing signs of altitude sickness, with recent sharp falls in China and other markets. Even so, since 2003 Morgan Stanley Capital International's emerging-market index has jumped more than fourfold in dollar terms, compared with an increase of only 70% in America's S&P 500. Top of the mountain has been Brazil, with an incredible gain of 900% (see chart 2). Over the same period, emerging economies' output has grown by 35%; the developed world's by only 10%. More than ever before, emerging economies are being relied upon to help lift the world economy. But can they keep up the effort?

Sounder footings

They may be able to. On many measures emerging economies look sounder than some developed ones. As a group they are no longer financially dependent on foreigners: together they run a current-account surplus, and thanks to large reserves and reduced debts, are now net foreign creditors. They have smaller budget deficits, on average, than rich countries, and inflation rates remain historically low. Unlike so often in the past, most currencies do not appear to be notably overvalued and hence prone to collapse; if anything, many are undervalued.

What is most striking is that this year, for the fourth year running, all of the 32 emerging economies tracked by The Economist show positive growth. This is a remarkable turnabout: in every previous year since the 1970s at least one suffered a recession, if not a severe financial crisis.

But it is dangerous to treat emerging economies as homogenous. This brings back alarming memories of the early 1990s, when investors poured money into any fund with an “emerging market” tag. On April 1st 1994, when buying fever was at its peak, a Hong Kong stockbroker advised clients to buy shares in Bhutan Dry Docks. He immediately received several large orders even though Bhutan is a landlocked Himalayan kingdom which then did not even have a stockmarket.

Investors need to discriminate carefully between countries. Although emerging economies have never before looked so healthy, aggregate numbers conceal some horrors. Table 3 shows The Economist's ranking of 15 of the biggest economies according to potential economic risk. It is based on the size of current-account balances, budget deficits, credit growth and inflation. A country's overall score is arrived at from the sum of the rankings of each indicator. It is obviously only a crude gauge, but it reflects the economic factors that have caused trouble in the past. A similar ranking would have flashed red for Thailand in early 1997 just before the Asian financial crisis.

The riskiest economies, all with current-account deficits and relatively high consumer-price inflation, are India, Turkey and Hungary. Those with current-account deficits are vulnerable to a sudden outflow of capital if global investors become more risk averse. Economies where inflation and credit growth are already high and budget deficits large, such as India, have less room to ease monetary or fiscal policy if the economy weakens.

Being irrational

The nature of capital inflows also matters. Foreign direct investment is much safer than speculative capital. But according to Chetan Ahya, an economist at Morgan Stanley, 85% of India's capital inflows this year have been in the form of debt or portfolio investment, much of which has gone into the stockmarket. India shows dangerous signs of irrational exuberance. It was swept by euphoria last month as the Sensex, India's benchmarket index, hit 20,000 for the first time. India's Economic Times declared, “The first 10,000 took over 20 years. The next came in just 20 months...Superpower 2020?” Instead, India's poor risk-rating should ring alarm bells.

China's economy looks less risky thanks to a small official budget deficit (many reckon that it really has a surplus) and its vast current-account surplus and reserves. The other two members of the so-called BRIC group, Brazil and Russia, also have a better risk-rating than India. Russia's credit boom is frightening, with lending up by 55% in the past year, but the economy is sheltered by large external and budget surpluses, thanks to high oil prices. After running a current-account deficit for most of the previous three decades, Brazil has had a surplus for five years—also thanks to robust commodity prices.

Emerging Europe, however, is flashing red, with widening current-account deficits, rising inflation, soaring bank lending and property bubbles. Indeed, Hungary and Turkey appear prudent compared with the Baltic states. Latvia has a current-account deficit of 24% of GDP, inflation of 13% and property prices rising at an annual 60%. The economy is seriously overheating, but its currency is pegged to the euro, which means it cannot raise interest rates. Estonia, Lithuania, Bulgaria and Romania also have current-account deficits of more than 12% of GDP. If these smaller economies were included in the table they would all rank at the bottom, below India.

A large chunk of bank lending in the Baltics and other parts of emerging Europe has been denominated in, or indexed to, foreign currency. The combination of large external financing needs and private-sector currency mismatches looks suspiciously like Thailand in 1997. These economies are highly vulnerable to a change in investor sentiment: if a rapid outflow of capital caused currencies to collapse, debts would soar in local-currency terms.

At the other extreme, Thailand, Malaysia, Taiwan and South Korea have not only the lowest risk ratings, but also share prices that look less overvalued than elsewhere. In Thailand, Malaysia and Taiwan price/earnings (p/e) ratios are still below their 20-year average.

Emerging stockmarkets now have a higher average p/e ratio than developed markets for the first time since the early 1990s. Stocks used to trade at a discount because these markets were seen as riskier. Now their economies are less wobbly and profits grow faster than in the rich world. This might justify a higher valuation. But the size of some p/e ratios causes concern that a bubble is in the making.

There was a stumble in emerging markets this summer when America's subprime crisis began to unfold. But after the Federal Reserve cut its discount rate in August investors eagerly returned, pushing prices up by an average of 40% in dollar terms by the end of October. Markets that looked cheap in August started to look dear, so it is hardly surprising that some investors have recently needed a breather.

In any case, the average p/e ratio in emerging markets may be distorted upwards because of a different industrial mix. Some types of businesses have consistently higher ratios, and emerging-countries tend to have more of them. When comparing like with like, the average p/e is still lower in emerging economies than in the developed world, according to UBS.

International comparisons can also be blurred by different accounting conventions. It is better to compare a country's p/e ratio with its own track record. Emerging markets' average p/e of 14.7 (based on forecast 2008 profits) is now above its 20-year average of 14, but it is nevertheless still well below previous peaks (see chart 4).

China A shares have been the frothiest this year, up by 104%. Thanks to frenzied buying at its stockmarket debut, PetroChina is now by some measures the world's most valuable company—three of the world's five largest companies are Chinese. A forward p/e ratio for A shares of 40 (again, based on forecast profits) certainly looks bubbly, but it too is much lower than in previous bubbles. The p/e reached 80 in Japan in the late 1980s, while on America's NASDAQ it hit 90 in 2000.

The p/e for Chinese shares that foreigners can buy is a more modest 22, well below the 40 reached in 2000. In contrast, Indian shares, also with a p/e of 22, have never been so overvalued. And while p/e ratios of 11-12 in Russia and Brazil seem like a screaming buy, relative to their historical averages of 7-8 they look generous.
Rolling along

Emerging stockmarkets experienced a similar boom in the early 1990s, until ended by a series of painful crises: Mexico at the end of 1994, East Asia in 1997, Russia in 1998, Brazil in 1999, Turkey in 2000, Argentina in 2001 and Venezuela in 2002. By 2002 the Morgan Stanley emerging-market index had lost almost 60% of its 1994 dollar value. So why should the current boom be any more sustainable?

A common feature of bubbles, such as America's dotcom mania and more recently its housing boom, is that most people refuse to believe they are bubbles until they burst. In sharp contrast, plenty of people have denounced China's stockmarket as a bubble, most notably Alan Greenspan, the former chairman of the Fed. The recent dive in prices makes such warnings seem prescient.

Yet a report by Goldman Sachs argues that many of the common symptoms seen when bubbles are about to burst are missing in today's emerging markets. Not only are p/e ratios much lower than in previous bubbles, but economic and financial imbalances created by rising asset prices, such as widening external deficits, are also absent from many economies. Likewise, before bubbles burst, notably America in the late 1990s and Asia in 1997, profits started to shrink. They are still growing strongly in China and the rest of Asia.

There is also ample global liquidity to fuel further gains. Just as previous interest-rate cuts by the Fed helped to pump up both the dotcom bubble and America's housing bubble, further easing over the next year could inflate emerging markets even more. These economies' domestic monetary conditions are also loose. Over the past year their broad money supply has increased by an average of almost 20%, accounting for a staggering three-fifths of the total expansion in the world's money. The surplus of money growth over and above the growth in nominal GDP (a crude measure of the money available to be invested in financial assets) has been growing at its fastest pace for years.

Several analysts therefore predict that after taking a short breather, emerging-market mania will resume. Bubbles will get bigger before they burst. Chris Wood, a strategist at CLSA, predicts that emerging Asia's forward p/e ratio will peak at twice America's. The premium now is only 5%.

Foreign money seems likely to continue to pour into emerging-country stockmarkets, if only because they lag so far behind the rest of the world. While emerging countries account for 30% of world GDP, they account for only 11% of world stock-market capitalisation.

Over the coming years, faster growth in profits and hence share prices, along with new share issues by companies, will almost certainly boost the value of these markets. According to a recent report by Ernst & Young, China, India, Russia and Brazil accounted for nearly half of all money raised worldwide in initial public offerings in the third quarter of this year.

One risk is that such prospects will attract too much interest from abroad. The surge in emerging-market shares has been a boon for international investors, but large inflows of foreign capital may be less welcome to governments and central banks. According to the IMF, net inflows of private capital to emerging economies have surged to almost 4% of their GDP on average this year, surpassing the peak of the previous wave in the first half of the 1990s. Net inflows to Brazil and Argentina have been running at 5-6% of GDP; and emerging Europe even more.

Vast capital inflows can harm economies in several ways. Not only can they inflate asset bubbles and spur excessive borrowing, but they can also cause a steep rise in the exchange rate, damaging the competitiveness of export sectors. If a country already has a current-account deficit this will make it even more vulnerable to a quick reversal of capital. On the other hand, if central banks intervene to hold down their currencies, the build-up of reserves can lead to excessively loose monetary conditions and rising inflation. This is exactly what is happening in much of emerging Europe.

Many other emerging economies have allowed their exchange rates to rise against the dollar. The Brazilian real has jumped by 23% this year, and by a total of 100% since 2003. In response to rising inflation, the Reserve Bank of India has allowed the rupee to rise by 12% since April. It has been greeted with howls of protest from business, yet the rupee has risen by no more than the Chinese yuan since mid-2005 and by much less than many other Asian currencies, such as the Thai baht.

Could a sudden crash in emerging stockmarkets derail the boom? Most stockmarkets are much smaller in relation to GDP than in developed economies, so the wealth effects of a crash would be modest. The East Asian economic slump in the 1990s was not caused by stockmarkets crashing, but by over-borrowing and the severe currency mismatches which caused the local currency value of debt to explode when currencies fell. This is a serious risk in the Baltics, but elsewhere most economies do not display the same sort of financial imbalances.

A more imminent threat is the impact of an American recession. Economists argue fiercely about whether emerging economies can decouple from the United States, yet by some measures they seem to have done so already. Emerging economies' exports to America slowed markedly this year, but their GDP growth has been supported by robust domestic demand and strong exports elsewhere.

If exports to America weaken further, many governments can support demand by boosting public spending, thanks to more prudent budgeting than in the past. Anyway, America is less important as an importer than it used to be. The share of China's exports going to America (including re-exports through Hong Kong) has fallen from 34% in 1999 to 24% now. China exports more to other emerging economies, which as a group now send more to China than to America. This partly explains why as American imports have slowed this year, the emerging world has continued to boom. So long as China's economy remains robust, it will help to pull other emerging economies along.

Indeed, this year for the first time emerging economies are likely to have bought slightly over half of America's exports, helping to prop up the economy of the United States. Some years into the future, economists may instead ask: “Can America decouple from China?”

Friday, November 16, 2007

Russian Inflation

Inflation in Russia in 2007 could exceed 11%, the director of the Economic Development and Trade Ministry’s macroeconomic forecasting department said Thursday.

Andrei Klepach told journalists that originally, inflation in 2007 was expected to reach 8% attributing the rise to structural factors like price hikes in staple foods, as well as monetary factors. Klepach said inflation in 2008 could exceed the 6-7% forecast. “We are currently specifying the inflation forecast for 2008. It looks like we won’t be within 6-7%,” he said. The ministry official also said the Russian government could restrict grain exports in 2008 to curb inflation. “We may impose a direct ban or introduce an export duty,” Klepach said adding that measures will depend on the market situation. He said grain exports were 3 million metric tons in October and if this trend continues, the government will consider additional measures to restrict exports. According to the economics ministry forecast, GDP growth in 2007 will reach 7.3-7.4%.

Russian consumer prices rose more than expected in October as sunflower oil, dairy products and other foods became more expensive.

Prices rose a monthly 1.6 percent, the most since January, compared with 0.8 percent in September, the Moscow-based Federal Statistics Service said in an e-mailed statement today. The median forecast of 18 economists surveyed by Bloomberg was for a 1.4 percent increase.

Russia, the world's biggest energy exporter, has struggled to curb accelerating inflation as petrodollars flood the country and global food prices increase. The inflation rate may rise to 11 percent this year, surpassing the previous year's rate for the first time since 1998, according to the Economy Ministry.

``The rising costs of basic commodities can no longer be offset by resilient labor costs and soft commodities,'' UralSib Financial Corp. said in an e-mailed research note before the figures were released.

President Vladimir Putin and several ministers said last month the government will be unable to meet their goal of lowering the inflation rate to 8 percent this year from last year's 9 percent.

Food prices increased a monthly 3.3 percent in October, led by sunflower oil which increased 26 percent in the month, the service said. Dairy produce rose a monthly 9.6 percent.

Food Effect

``The Russian government has recently taken a number of measures to control prices on foodstuffs, given that they account for more than a third of Russian CPI index,'' UralSib said.

The government approved a lower import duty on dairy and vegetable oil, sold some grain from the state reserves and instituted an export duty on grain to keep the commodity in Russia to curb consumer-price growth.

Companies including OAO Wimm-Bill-Dann, Russia's biggest dairy producer, and X5 Retail Group NV agreed last month to freeze prices on some milk, vegetable oil, egg and bread products until Jan. 31.

The anti-inflationary measures slowed price growth in the last week of October, probably keeping inflation from spiking until next year, said Yaroslav Lissovolik, the chief economist at Deutsche Bank AG's Moscow office.

Ruble Strength

The central bank may allow the ruble to strengthen at the end of this year or in the first quarter of 2008 to slow price growth, he said.

``The increase in government spending, which will improve the situation with liquidity, will place the central bank in a better position'' to use the ruble as an anti-inflationary tool, Lissovolik said.

Most Russians spend more than half their household income on food, according to the state-run Center for the Study of Public Opinion. Another 29 percent spend at least a quarter of their income on food, according to a survey released on Oct. 31.

Consumer prices increased 9.3 percent in January through October, compared with 7.5 percent in the first 10 months of last year, according to the statistics office.

Tuesday, November 6, 2007

Romania and Italy

From the FT today:

Prodi expands on EU migration

By Guy Dinmore in Rome

Published: November 6 2007 22:07 | Last updated: November 6 2007 22:07

Partial transcript of Financial Times interview with Romano Prodi, Italy’s prime minister, in Rome on November 5:

FT: As president of the European Commission in 2004 you were a strong proponent of enlargement, when directive 38 governing the movement of EU citizens was passed. The Italian interior minister, Giuliano Amato, has criticised aspects of this directive. With the benefit of hindsight do you think the European Union failed to anticipate the consequences of opening its borders in this way to countries like Romania and Bulgaria, and that this was a mistake?

PRODI: No I don’t think it was a mistake because it was a shared view of all the EU countries. Clearly the so called enlargement was not a short term sighted decision. It was a long term historical decision and clearly everybody knew how difficult was the process and I think that this process has been much more positive, taken together, than anyone could think in terms of changing institutions of the new countries and especially in terms of democracy. I think the results we had through enlargement are unique in the world. I used to repeat that is the only way of exporting democracy

FT: It seems that you may have imported democracy given that half a million Romanians have arrived in Italy. Do you think governments like Britain, France and others which have made their own special arrangement governing labour quotas for Romanians have made it more difficult for Italy to cope with this inflow of people?

PRODI: Maybe. But Romanian immigration, especially focused on related countries, say Spain and Italy, is also simply dictated by linguistic similarity and the necessity to have more immigrants. It is not by chance that these are the two countries. Concerning Italy you have to bear in mind there are also 22,000 Italian companies operating in Romania. The Romanian workers working inside Italian companies in Romania are more than 600,000. Nobody knows that. In addition, the only non-Italian office of Confindustria is in Romania, not in Frankfurt, because of the number of Italian companies operating there. So the two countries have always been inter-related since the fall of the iron curtain and so it is not difficult to understand why there was this flow.

FT: Did you anticipate such numbers?

PRODI: The problem is the quantity is beyond expectations. Nobody could expect that. Nobody was expecting the outflow from Romania, not the percentage inflow into Italy. This is a phenomenon that must be studied deeply. A phenomenon that is consistent also with an inflow into Romania from Moldova and Ukraine.

FT: Does the EU not bear some responsibility for not anticipating the biggest movement in almost refugee like conditions since the Bosnian war?

PRODI: The most part of them are working in Italy as normal workers. If you go to any Italian small city or capital you will see the Romanian people going to the Orthodox church, mixing with the Catholic population and working on assisting people or workers in construction. for the most part of them are absolutely normal (workers). Almost the totality. The overwhelming majority are normal workers who work because of demographic reasons inside Italy and substitute a lack of Italian workers in this sectors. Keep in mind that this concept is not clear in Italian papers. Italy has regulated this. The right of circulation is one of the fundamentals. If you talk about the working permit Italy is open to very specific and clearly defined jobs. I can give you the list. It is mainly manual work or night shifts, house keeping for old people, industry special jobs which lack in Italy. But because of free circulation you come and then it becomes difficult to distinguish the two types of people that are inside the country. This is a great problem. This is not a decree for Romanians. I insist on this. Otherwise is seems that Italy is discriminating against Romanians. I think it is the destiny of these two countries to have a flow…. typically a new Italian company does contracting to Romanian workers and they come back. Typically there are more than 1,000 trucks a day from Romania to Italy. Now we have to distinguish people coming here irregularly from the people who have the working permit and are regulated. We are working to enlarge this regulated part and be very vigilant on this small part that is giving strong trouble as we saw in these days. This is a problem concerning all foreigners, not just Romanians, although in this moment statistically the Romanians are higher than any other country. But I want to insist on the fact that first of all there is no deportation order. Each individual decision is based on its merits. No nationality is singled out and the decree is enforced on every immigrant, whatever his nationality, who is engaged in serious criminal activity that gives rise to social alarm and, second, each expulsion would be validated by a judge and can be appealed even if for the reason of the alarm the expulsion is immediately effective. But you can appeal immediately. Three is a right of appeal to a judge. And absolutely there is no big alarm. There are four (expelled) in Milan. A total of 29 decisions. 12 convalidated (by a judge), six already executed. 28 Romanians and one Hungarian. It is very targeted, not only related to Romania, and with the right of appeal and the convalidation of a judge. This is the legal framework. The Italian policy is clearly to demonstrate that you cannot tolerate illegal activities and that also we believe that the problem can be solved only through strict and strong cooperation, as I did with Albania in the previous situation, 10 years ago.

FT: but the difference is that Albania was not a member of the European Union

PRODI: of course. The day after tomorrow (Nov 8 ) the Romanian prime minister will visit with his experts… and we will work together in order to regulate the illegal aspects of this flow of people. But I don’t want absolutely that no workers or citizens be affected by this necessary decision that we have taken. This decision had already been taken in the projected law and was only anticipated in the decree. It was the same wording as in the proposed law. I did not want to change one word.

FT: How would you like other countries deal with this situation to help Italy? To deal with this unexpected situation?

PRODI: We are talking now because this case came out (the beating to death last week of an Italian woman in Rome by a suspected Romanian immigrant) but I think that we need more cooperation in the case of immigration by all European countries.

FT: Would you like Britain to ease its restrictions which might then ease the influx into Italy?

PRODI: They can do what they want. I don’t think in this case it will change definitely the situation for the reasons I gave before. But certainly I prefer to have a Europe which is open to free circulation of all the Union citizens and regulate together all the criminal aspects of it. Certainly there are many cases in which more cooperation would be helpful. Specifically on this case it would not help so much.

FT: Do you know how many Romanians are working in Italy legally and living illegally?

AIDES: December 31, 2006 == residents 342,000 and 278, 582 residence permits

FT: but now WE are a year later. What are estimates for last nine or 10 months? Amato (the interior minister) spoke of 500,000 Romanians arriving in Italy in a year.

PRODI No. No. Nobody knows. I think half a million is an exaggeration. (AIDE: it might be the total)

(AIDE: you can see the trend as at end 2003 there were 177,000 Romanian residents)

PRODI: what I am asking of the European Union is to have common rules in order to have repatriation more effective and to be more cooperative in all the side effects of these movements. But I repeat this is a general request.

FT: So you agree that directive 38 does not give sufficient clarity?

PRODI: It does not give sufficient stimulus to cooperation. It is not per se enough for the degree of this phenomenon. We need more active cooperation. This is what I think clearly about that. I am convinced that this phenomenon of immigration is not temporary. Demography is so clear, simply if you consider I was jogging in the surroundings of Bologna and there were eight or nine cantieri, construction sites, and in I did not see any Italians. No one. Not one. Also the truck drivers were foreign, not only Romanian, mostly from Morocco and Albanian.

FT: You don’t see the need to establish quotas?

PRODI: We are establishing quotas, we decided this year that there would be 278,000 work permits. That is necessary for this year. The employers are pushing for more than 300,000. If you look at he number of immigrants clearly the number one for this year are Romanians but you find now we are not far way from nearly three million immigrants... That for the UK is not a big number but for Italy they came just over six or seven years. There are 100,000 Indians. The Chinese . if you travel though the north of Italy countryside all the milk workers are Sikh. I inaugurated a Sikh temple. There were 4,000 people. 4,000 people.

FT: Do you think Italy is ready for such a sudden change?

PRODI: As a necessity, yes, but psychologically and socially the speed, the impact is incredible. When you think that I saw my first foreigner when I was six years old . We were a country of emigration till less than one generation ago. .. I was maybe the first to write about immigration in the 1970s when the first Egyptian came to my town, a skilled worker for nightshift in mechanical engineering. It was such an event. Nobody had seen a foreigner working in Italy. In answer to your question, for necessity Italy is prepared. And businessmen they press for more immigration. In psychological terms it is an enormous change, an enormous change. Think to the schools…. In my life until university I had never had a non-Italian schoolmate. Never never until I was 18. And in one shot there are some schools in northern Italy where one third of the pupils are not Italian. In 10 years it is a stress for the teachers.

FT: Moving to the related question of security. Many Italians, rightly or wrongly, equate this influx of immigrants with rising crime and less stable living conditions.

PRODI: It is not so different from the debate you had a few years ago in London. I followed it with interest. I remember the Pakistani problems, and then you absorb it.

FT: in connection with organised crime and the mafia. There is a perception in the minds of many Italians that the government is losing this battle, despite the arrest today of the mafia boss (Piccolo)

PRODI: I don’t agree with that, because The arrests of the mafia leaders have not been only today. The leaders have been arrested and then the substitute leaders have been arrested. Today a new wave of leaders has been arrested. No criminal organisation in the long run will resist these arrests. And the progress in Sicilian society has been remarkable. Working together with the judiciary. Not the same in Calabria. I have to make an honest analysis, the progress in Calabria has been less remarkable. But we are absolutely insisting on using a new system of fighting this criminality because they have changed radically. They are much more subtle and much more business minded. I don’t remember who asked the question of what is the mafia but the answer was three words: business, business, business. And we have to fight with them. The way we are fighting against the illegal economy we will make a big success also. Against mafia and camorra (Naples) and ‘ndrangheta (Calabria). All of this year the additional income because of fighting against tax evasion is in the order of 20 billion euros. That is absolutely a huge amount of money and there is not another way of fighting against criminality but day by day analysing with the financial police, the carabinieri, the inspections. Day by day and going into the channels of money, circulation and cooperation of local people. In Sicily there is new cooperation. It is more difficult in Calabria and the area of Campagna and the comorra. There are clusters of criminality on the ground. You have to work on each, one by one in order to have success.

FT: some people in Naples suggest that martial law should be imposed in Naples and that the military should take over. Do you have any sympathy for those views?

PRODI: I already expressed my scepticism on that. You must have strong police and carabinieri. In general you must have a total knowledge of the economic activity of that area. It is similar to the strategy adopted by the United States in the 1930s…. the deep aspect of the economic aspect, the economic blackmail… maybe for some temporary moment when there is a resurgence of visible presence of criminality you can use externally the army – it was done in the past – but in the long run it does not work. I think that serious policy in controlling and checking the illegal economy is much much more effective.

FT…. your coalition has tensions within it. The next two weeks will be a difficult time with voting for the 2008 budget in parliament.

PRODI: you could have put the same question 17 months ago. Every week there is a certain journalist who says the next 15 days will be terrible. My answer is yes but till now since the first day of my government took power we lost one senator and we gained one senator. The votes, thousands of votes, not hundreds, all of them a majority except a few not important cases. If you tell me I have a slim majority, yes,. If you tell me that because of the electoral law everyone has an interest in being vocal I say yes. If you ask me if the government works well, I say yes. We work, we take decisions and until now the majority, except two or four votes. It happens in other countries. …. In the Senate certainly you have to fight every day. And tonight there will be a vote concerning the elegibility of the budget. Honestly if you take the decisions we have made in 17 months ago, this government is really changing the country, in the direction that has been made by many liberal papers, including the FT…. In terms of growth we are approaching the European average. In terms of innovation I think we made strong changes…. If the (2008) budget is approved (by parliament), as I anticipate then the nominal corporate tax rate will be exactly like as in Germany, absolutely the same… I am absolutely convinced that the results for the economy will be positive.

Certainly I do not have the media backing me. My opponent (Silvio Berlusconi) is lord of the news. And in spite of that…

FT: sometimes it is difficult to know who is your opponent. You have so many critics inside the coalition

PRODI. No, they are catalysed till now, the end of the story is always Berlusconi… He dictates the agenda to the opposition and you understand why everyday he says that I will fall next week because he absolutely needs to get results from his opposition and there are clear signs of frustration among the opposition parties because in theory he promised to be in power at short notice and till now this has not happened.

FT: Are you worried that this immigration issue will help the opposition build a case for going into the next elections?

PRODI: No, because I am not responsible for that. Italy opened the door to Romanians when I was not in government. I was president of the European commission but I was not in the government and of course now everybody tries to change the burden of responsibility but time will play in favour of a (serious) judgement.

FT: With the new centre-left Democratic Party being formed, will Italy move back to a more clearly defined polar system?

PRODI: This was already in Italy when Berlusconi changed the (electoral) law. I entered politics 12 years ago for one reason only to put together the different reformists and shape a centre-left coalition. Twelve years ago I was not a politician. I did it. We did it, and last Sunday (with formation of centre-left Democratic Party) we ended the process…. Now there is a law that helps fragmentation. In spite of that there was a merger of DS (Democrats of the Left) and Margherita into a strong Democratic Party. I think that the centre right cannot avoid – I don’t say the same – but something similar. And this is the reason why I have always fought in favour of the DP in spite of that many said Veltroni (mayor of Rome and Democratic Party leader) will push Prodi out. The government will only be helped by having a condensation point of the coalition,, this is the Democratic Party. In spite of all the interpretations, Veltroni and I work together well as we did in the past. Don’t forget he was my vice prime minister in 1996-98 government and I only hope we can change the electoral law. I am working on that. But I announced the electoral law cannot be changed without a large majority… now I am working for that. The results until now are not satisfying… the government in this case cannot push for a specific electoral law… this is a typical work for the parliament. My position is that the country will have a safe and stable government only by a bi-polar organisation of Italian parties.. but I cannot do it in favour of one party as it will only be changed again the next time…

Roma seek Italy’s good life despite hostility

By Thomas Escritt in Avrig, Romania

Published: November 7 2007 19:15 | Last updated: November 7 2007 19:15

Of the nine children Elena Tincu brought into the world, two are dead, two are in a mental health institution and two are in foster care. One daughter was murdered by a jealous lover while her son drowned in a swimming accident.

Another, Romulus Mailat, is sitting in jail in Italy, the main suspect in a murder case which has sparked a wave of concern in Italy about huge numbers of Romanians living in the country. Like Ms Tincu and her son, many of them are ethnic Roma.

But Ms Tincu, who says she was forced to return to Romania after her son’s arrest, wants to return to the country. “In Italy, we had a very good life,” she says. “Anybody who went there came back with more money and could get a better house.”

While Ms Tincu’s partner and her son worked on building sites, she sat on the streets begging with her three-year-old daughter. “People were very merciful, and we never had any problems,” the 45-year-old adds. In Rome, the family’s money ran to paying for a generator to light their squat in an illegal shanty town, a luxury after her hard life in the village of her birth.

Ms Tincu’s Romanian home, in an illegal settlement on the outskirts of the otherwise prosperous village of Avrig, a short drive from the booming tourist destination of Sibiu, is a shed of corrugated iron.

Cars heading down the mud track towards the settlement must wait for herds of grazing cows returning from pasture. There is nothing for her or her family in Romania, she insists. And the same must go for many of the Romanian Roma, 50,000 of whom, Italy’s Catholic church estimates, have made their way to Italy.

Despite an increasingly hostile environment in Italy, which this week passed a law making it easier to deport EU citizens, many are undeterred. “When our bus crossed the border back into Romania earlier this week, there were two packed buses queuing to head back the other way,” Ms Tincu says.

But the Romanian government has clearly been stung by the force of the anti- immigrant backlash in Italy. Anxious to rein in emigration, Calin Tariceanu, the country’s prime minister, has announced a campaign to remind Romanians abroad of brightening prospects back home.

Adrian David, deputy mayor of Avrig, points out that Ms Tincu’s family circumstances are unusually grim. “There are Roma families around here with 100 head of cattle,” he says. Her neighbour in the settlement, Constantin Bloata, insists Roma like him can succeed at home. “You can live perfectly well here,” he says, pointing to his large house and livestock. “It is the people who fail to make money here who go abroad.”

And local wages are on the up. Bucharest is in the midst of a construction boom, which has pushed wages in the sector up 50 per cent over the past year, according to Diwaker Singh, an Indian property developer active in the city. With as many 2m Romanians working abroad, Romania’s labour market is tight. “We are facing a labour shortage, since so many have left the country to work abroad,” he says.

● The prime ministers of Italy and Romania yesterday made a joint appeal to the European Union to tackle the immigration crisis unfolding between their countries, particularly in dealing with the problems of the transient Roma, or Gypsy, communities.

Romano Prodi and Calin Popescu Tariceanu made the appeal in a letter to Manuel Barroso, European Commission president, following talks prompted by the savage murder of an Italian woman in Rome, allegedly by a Romanian immigrant from the Roma community

Japan's Leading Economic Index Drops to Decade-Low 0%

From Bloomberg this morning:

Japan's broadest indicator of the outlook for the economy fell to the lowest level in a decade, signaling growth may stall.

The leading index was zero percent in September, the Cabinet Office said today in Tokyo, matching the estimate of all 28 economists surveyed by Bloomberg News. A reading of below 50 indicates the economy may slow in three to six months.

The Bank of Japan cut its growth forecast last week, in part because of a decline in housing starts caused by a change in building regulations. Industrial production slid in September from a record, summer bonuses dropped for the first time in three years, export growth slowed and the jobless rate rose.

``The toll of the warning bell on the economic outlook just got a lot louder,'' said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong. ``This neatly underscores the complete loss of dynamism and vigor in the Japanese economy.''

Japan has had three recessions since the country's stock and property bubble burst in the early 1990s. The first lasted 32 months from March 1991 to October 1993, and the second dragged on for 20 months from June 1997 to January 1999.

The most recent recession was in the 14 months from December 2000, when the bursting of an information-technology bubble damped exports and capital investment.

Housing starts slumped 44 percent in September to the lowest level in four decades because of stricter rules for obtaining building permits. The Land Ministry last week said it would relax the regulations after industry criticism.

Credit Suisse Group cut its economic growth forecast for Japan twice in the past month, most recently to 1.3 percent, and said unemployment may rise should the housing downturn persist. The jobless rate increased to 4 percent in September from 3.8 percent and the ratio of job offers to each applicant fell.

Weakening labor conditions and wages may sap household buying power and sentiment, undermining the central bank's case for raising borrowing costs, the lowest among major economies. The Bank of Japan maintained the benchmark rate at 0.5 percent on Oct. 31, the same day it cut its growth prediction to 1.8 percent from 2.1 percent for the year ending March 31.