Emily Dunbar and Mary Holdener
Reality Check

Doing It Wrong

By, 09/04/2013
Ratings343.897059

What do India’s monetary policy, France’s job creation scheme and some Japanese lawmakers’ suggestions for easing a sales tax hike’s potential impacts have in common? All are policies whose outcomes could potentially run counter to their aims—which can have real consequences for stocks. Political factors are potentially key drivers of stock returns—and key to analyzing these are the unseen impacts. If unintended consequences prevent policies from meeting investors’ expectations, that’s a negative surprise, and something worth watching globally. These three examples, while not necessarily bearish for global stocks, provide timely lessons for investors everywhere. 

India’s Inverted Yield Curve

India’s in a hot spot—and not just temperature-wise. The rupee is down double-digits since May, and foreign investors are retreating. To ease liquidity pressures, the Reserve Bank of India (RBI) is trying a number of unusual measures. Last week the RBI even announced it would buy citizens’ gold to cushion the blow—a failed tactic from the ‘90s. But probably the move with the biggest punch will be the RBI’s buying back 80 billion rupees worth of long-term bonds to support liquidity—unfortunately, the “punch” may do more harm than good.

Just earlier this year, the RBI hiked the overnight rate to stem a falling rupee. But in doing so, policymakers inverted the yield curve, and the rupee continued falling—and banks came under pressure. To inject liquidity, the RBI launched a small quantitative easing program, thereby increasing short rates and depressing long rates—further inverting the yield curve.

Your typical, healthy yield curve has a positive slope, with long-term rates exceeding short-term. Positive yield curves support economic activity overall—the steeper the better—but an inverted curve discourages it. Central banks globally agree with this, so that a bank would deliberately invert the yield curve—and then compound matters with measures that further widen the negative spread—is headscratching and likely to create uncertainty for investors.

Moreover, none of the country’s recent policies address the long-running structural issues that made India sensitive to capital swings in the first place, including a decades-long legacy of high barriers to foreign investment. Spooking investors with misguided monetary policy likely only encourages more capital outflows—which probably weighs on both overall growth and stock prices.

France Attempts to Reduce Unemployment

France’s unemployment has ticked up, and Socialist President François Hollande’s approval rating has hit an all-time low. To combat this, he recently announced government plans to create over 500,000 short-term contracts—mostly in the public sector. Additionally, he’s proposing reducing the workweek from 35 hours to 32. If employees can’t work as long, employers will have to hire more to maintain productivity, right?

Well … not necessarily. For one, all of these public contracts will be funded by taxpayers—and they’ve already been hit with several tax hikes recently. Yet there is little way around higher taxes should Hollande’s plan come to fruition, given the government is simultaneously trying to cut deficits to meet EU targets. Considering the private sector’s long record of directing funds more efficiently than governments, simply keeping money in private hands could very well accomplish Hollande’s goal quicker than his scheme.

Shortening the work week doesn’t make sense to us either. It is true hiring more employees will decrease the unemployment rate, but probably not in a way that benefits the labor market in the long run.  Hiring more workers to do the same amount of work increases costs for employers without a corresponding increase in revenues. It takes capital to hire and train new employees, provide equipment and pay for additional benefits—capital that no longer gets spent elsewhere—like endeavors that would support expansion and boost shareholder value. In the end, it isn’t a net benefit to the economy or to the workers who’d see their hours (and, likely, pay) cut to make way for others.

For investors weighing options in France, a key positive driver would be long-term labor market reforms—reforms that are a boon for economic and market growth—not quick fixes that temporarily rejigger the unemployment rate and weigh on the private sector. The proposed policies probably don’t do much to improve France’s labor market—and likely weigh on investor sentiment and stock prices.

Japan’s Taxing Stimulus

Japan’s currently debating doubling its consumption tax to reduce its 16-figure debt. But because hiking sales taxes could drag on economic growth, some lawmakers suggest simultaneously boosting fiscal stimulus to “protect” Japan’s nascent economic recovery. Yep … increased public spending. Confused? So are we.

Taking a trip back to elementary school math, something doesn’t quite add up here. Parliament passed the sales tax hike to increase revenues to pay down its debt—math-wise, that’s a plus. Hiking spending counteracts this since it increases debt. The logic behind these offsetting measures escapes us.

It seems the easiest—and obvious—answer is to not raise the sales tax to begin with. As we’ve written countless times before, incentives matter. When taxes go up or new taxes are implemented, people generally find a way to get around them and reduce their tax liability. Increasing the consumption tax is an incentive against purchasing as many goods and services as folks otherwise would—a burden for markets as less money circulates through the economy. In turn, lower sales tax revenue could result—which, if paired with fiscal stimulus, may have the completely unintended effect of increasing Japan’s government debt load.

Investors should recognize sticking with these policies probably hurts rather than helps the respective economies in the long run. Understanding this—and closely monitoring future developments—should be on your checklist if you’re evaluating Japanese investment options.

 

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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