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20 Sep, 2010 07:00

Excess liquidity casts spectre over future growth

The phrase “credit crunch” has entered the daily lexicon after the liquidity crisis sparked an economic downturn. But economists are saying the government may have gone too far in pumping money into the system.

Since the onset of the global financial crisis in late 2008 the Russian government has allocated vast sums of cash to keep the banking system afloat. But few companies are borrowing right now, and many banks prefer to earn a low but safe return from the government – rather than risk investing in companies.

Chris Weafer, Chief Strategist from Uralsib, believes Russia – like other
governments – has created much more money than the economy needed.

“When you look at what Russia did during the crisis, it was out of sync with the rest of the G20, when G20 countries, or G19 shall we say went into quantitative easing, Russia did the opposite and it tightened up in order to stabilize the economy.""

The evidence is clear – Central banks continue to issue huge amounts of money, hoping that banks will lend to industry. However, the money is mostly recycled back into government bonds, while the real economy has largely stopped borrowing.

Treasury Bond yields are falling around the world. A sign of enormous buying demand – as banks seek safe havens for their cash. Elina Ribakova, Chief Economist, at Citibank fears a Japanese style lost decade.

“Well, the lost decades can occur if you have a long period of no credit. That means there is a demand for credit, and at the same time the banking system is jammed with poor quality assets. We see that there are some risks in individual banks, that have not fully cleared up their balance sheets from restructured loans.”

The long term fear is hyperinflation – if central banks don’t act fast enough to withdraw the excessive liquidity if consumer prices start to rocket. But Edward Parker, Senior Director at Fitch Ratings, is confident the central bank of Russia won’t take risks with inflation.

“The central banks always have to be vigilant about maintaining the right balance of liquidity in the economy, and we have seen quite strong growth in the money supply in the last few months. But, I think, that really reflects a return to normalization after the sharp falls during the recession.”

Beyond raising interest rates, the government could introduce measures similar to the car voucher scheme, which causes people to spend – thus removing money out of the economy. But there are limits to what one country can do – if inflation becomes a global problem.