eco TV

EcoTV – June 2021

6/10/2021

TRANSCRIPT // EcoTV – June 2021 : June 2021

FRANÇOIS DOUX

Hello everyone, and welcome to the June 2021 edition of EcoTV, the video magazine from BNP Paribas economists. In our focus this month, we’ll be talking digital currency with Laurent Quignon. We will look at central bank digital currencies, an area at the meeting point of economic theory and digital innovation. This is a topic that raises a lot of questions, and some countries are already a fair way along this path. In The Chart of the Month, William De Vijlder, our Chief Economist, will discuss eurozone growth with a particular focus on a correlation. The correlation is between bond yields and the mood of economic actors. We will finish with Three Questions to Johanna Melka, where we will be talking about India. We’ll be looking at that country’s economic prospects after a particularly deadly second wave of Covid-19 in the second quarter.

 

FOCUS

FRANÇOIS DOUX

The People’s Bank of China, Sweden’s Sveriges Riksbank, the Fed in the USA, the European Central Bank in the eurozone and even the Banque de France are all looking closely at central bank digital currencies, or CBDCs. To examine this topic, we are joined by Laurent Quignon, Head of Banking Economics at BNP Paribas.

FRANÇOIS DOUX

Hello Laurent.

LAURENT QUIGNON

Hello François.

FRANÇOIS DOUX

We read a lot in the press about these central bank digital currencies and also about cryptocurrencies. We hear about bitcoin, libra, ethereum...  What is the difference between what we call “central bank digital currencies” and these cryptocurrencies?

LAURENT QUIGNON

Allow me to begin, François, if I may, with a quick terminological detour. I prefer to talk about “cryptoassets” rather than “cryptocurrencies”, as these are not currencies in the legal sense. These cryptoassets are issued and circulated via a distributed ledger based on blockchain technology and are not, therefore, issued by an identifiable institution. They do not, therefore, represent a claim on  someone, unlike official currencies, which represent a claim on the central bank, whether we are talking about the coins and notes in our portfolios,  or a claim on a commercial bank, such as our bank deposits. Another difference between cryptoassets and official currencies is that the various forms of currency can be converted into notes and coins, which are legal tender, which is obviously not the case for cryptoassets.

FRANÇOIS DOUX

Particularly as these cryptoassets, bitcoin and the like, are very volatile, as we have seen in the news. But, despite these fundamental differences, Laurent Quignon, is there a risk of competition between these cryptoassets and traditional central bank currencies?

LAURENT QUIGNON

Central banks do indeed see CBDCs as a possible, official alternative to private cryptoassets. But in reality, and depending on the approach taken, a CBDC is not simply an official version of a private cryptoasset. It is something different. And this offer is likely to have relatively substantial effects, again depending on the approach taken, on the operation of the banking system, the financing of the economy and the transmission of monetary policy.

FRANÇOIS DOUX

So at the point, if I dare say it, that central banks are moving into the digital sphere, what exactly will this change for monetary policy, Laurent Quignon? Could scriptural money and fiduciary money also be transposed into digital form?

LAURENT QUIGNON

Well, in the current state of affairs, the only form of central bank currency accessible to the general public is notes and coins, which represent less than 10% of total money supply. The remaining 90% is created by commercial banks in the form of bank deposits. So in the future, if a new form of central bank money was available in digital form, on top of notes and coins, this would tend to increase the use and holdings of central bank money by the general public, which would probably affect the structure of money supply.

FRANÇOIS DOUX

What would be the effect, in the end, if Joe or Josephine Public turned to the central bank? Would the financing of the economy be changed?

LAURENT QUIGNON

Again, the devil is in the detail. If we consider a fairly simple instrument that would in effect be a sort of banknote 3.0, the use and holding of this would remain limited as is now the case for notes and coins, for fiduciary money. Ultimately, this would provide an alternative but with limited consequences. However, if the approach was to open up access to the central bank balance sheet to everyone, with the opening of accounts with the central bank, this would have a substantial effect on the equilibrium and sharing of tasks between commercial banks and the central bank.

FRANÇOIS DOUX

In concrete terms, for second tier banks, for commercial banks, could this result in lower levels of deposits?

LAURENT QUIGNON

Yes, indeed. Bank deposits are created within the framework of lending transactions. This is the process of money creation. If in future a significant share of these bank deposits – which also represent a very important resource for banks in the financing of the economy – was converted into a CBDC, this would mean a corresponding reduction in bank resources and reserves at the central bank for commercial banks. In the same way that a flight of bank deposits and commercial bank reserves to fiduciary money results in a fall in the credit multiplier and the ability of banks to lend to the economy, we would see a fall, in a similar process, in the credit multiplier and the ability of banks to lend with this central bank digital currency.

FRANÇOIS DOUX

Laurent Quignon, would commercial banks not be able to offset the fall in deposits by raising resources on the markets?

LAURENT QUIGNON

In reality such a solution would prove largely illusory, as long-term resources raised by financial and monetary institutions are a negative counterpart of money supply. In other words, the issuance by banks of long-term securities requires a debit in the account of the subscriber, and thus an additional reduction in bank deposits. So, we can say that these two resources, negotiable securities and bank deposits, are substitutes for each other rather than complementary. In the final analysis, although a CBDC offers a possible response, with greater security for the saver, to private cryptoassets, the details need to be very carefully considered if we are to protect the financing of the economy and the effectiveness of monetary policy.

FRANÇOIS DOUX

Protecting the financing of the economy and the effectiveness of monetary policy feels like a good place to end. Thank you, Laurent Quignon for this update on central bank digital currencies. Coming up, the Chart of the Month with William de Vijlder.

 

THE CHART OF THE MONTH

FRANÇOIS DOUX

In our Chart of the Month this month, we’ll be discussing expectations of economic growth. William De Vijlder joins us, and has identified a correlation. We will compare bond yields to the economic confidence index.

FRANÇOIS DOUX

Hello William.

WILLIAM DE VIJLDER

Hello François.

FRANÇOIS DOUX

Tell us first a bit more about this famous economic confidence. What is it?

WILLIAM DE VIJLDER

It is one of my favourite indices. It is prepared by the European Commission. It shows the average of confidence in industry, services, the construction sector, retail and consumer confidence. It is an excellent indicator of the mood of all these economic actors at a moment in time. It exists for the European Union, the eurozone and all EU member states. So, this is what I have prepared. I have taken the index for Germany and compared it with the performance of Germany’s sovereign debt, the 10-year Bund. Now, since the creation of the euro, the confidence index for Germany has been extremely tightly correlated with the same index for the eurozone as a whole. The conclusions we can draw from the German chart also apply to the eurozone.

WILLIAM DE VIJLDER

The conclusion is that there is very close correlation between the behaviour of these two series, which makes sense. As economic confidence improves, with economic actors, households and businesses growing more confident, this is not lost on the bond markets. Investors thus anticipate economic improvement and yields rise.

FRANÇOIS DOUX

What happens to bond yields once confidence levels hit a peak? You have come up with a second chart, which is something of a new development for our show. We can see it on the screen now. It plots bond yields, with, at the centre, the point where, in general, confidence peaks. Have I got that right, William? Explain what we are looking at.

WILLIAM DE VIJLDER

I was struck when preparing the first chart by the degree to which the peak in economic confidence and in long-term yields coincide. This is why I prepared this second chart. I first identified the peaks in economic sentiment, which are set to the zero point of the graph. I then looked at the level of long-term rates at the time this peak was reached, and how rates had moved in the previous four months. On the left of the chart, we have the four months leading up to the peak in economic confidence. So, where there is a rising series, where the line rises, rates have tended to rise as we approach the peak in economic confidence.

WILLIAM DE VIJLDER

We can also see what happens after the peak, on the right-hand side of the chart. What this shows us, that is really very interesting, is that in the majority of cases, once we are past the peak in economic confidence, bond yields tend to fall. This is an important observation for the present moment. Why? Because economic confidence has increased very rapidly in recent months, for understandable reasons.

WILLIAM DE VIJLDER

We can say that in all likelihood, we will hit the peak in this series within a few months. The peak in economic confidence. So, history tells us, that at that moment we will also hit a certain peak in bond yields. This is not to say that rates will not continue to climb after this point. But if they do, it will be for reasons beyond a simple improvement in the economic outlook. One factor, for example, could be trends in inflation. Another would be the influence of expectations of continued rate rises coming from the USA.

FRANÇOIS DOUX

So, we will need to keep a close eye on bond yields, particularly in the eurozone. Thank you William De Vijlder for this update on growth, confidence and the bond markets. Coming up, we will be talking about the Indian economy with Johanna Melka.

 

3 QUESTIONS

FRANÇOIS DOUX

In India, the second wave of the Covid-19 pandemic has been deadlier than the first. The total death toll is now more than 300,000. To look at economic prospects after the pandemic, we are joined by Johanna Melka.

FRANÇOIS DOUX

Hello Johanna.

JOHANNA MELKA

Hello François.

FRANÇOIS DOUX

First question: what impact has the second wave of the pandemic had on India’s economic growth?

JOHANNA MELKA

Last year, in 2020, India was particularly hard hit by the Covid-19 crisis. Its economy contracted sharply. Then, just as it had returned to strong positive growth in the early months of 2021 the economy was hit, head on, by the second wave. In mobility indicators we can already see that activity has slowed noticeably in services, due to lower mobility. But one positive in this latest phase of the crisis has been that factories have not been closed.

JOHANNA MELKA

We estimate that across the whole 2021-22 fiscal year, that will end on 31 March 2022, the second wave could cut two percentage points off economic growth.

FRANÇOIS DOUX

Second question: what are the longer-term prospects?

JOHANNA MELKA

Over the longer term, the outlook remains positive, but we are unlikely to return to growth rates of around 7%. Unfortunately, a return to something around 6% looks more likely. As we can see on the chart, the reality is that economic growth in India had begun to decelerate well before the Covid-19 crisis, for mainly structural reasons. What’s more, the quality of growth had deteriorated. The labour participation rate had started to slow some time before the onset of the Covid-19 crisis.

JOHANNA MELKA

The government will have very little scope to support economic activity given the considerable constraints on the already weak public finances, which have deteriorated further with the COVID 19 crisis. Meanwhile, banks and companies will have to consolidate their financial position. In this context, the Modi’s government has therefore decided to adopt major structural reforms in order to support and attempt to restart economic activity over the medium term. These were adopted in the autumn of 2020. Today the challenge lies in implementing them.

JOHANNA MELKA

It is always difficult to implement reforms in India. Moreover, the recent elections in April and May have shown that Narendra Modi’s ruling BJP party seems to have lost a bit of its aura, with results that were somewhat more mixed than we are used to.

FRANÇOIS DOUX

Third and final question. What are the major risks for the Indian economy?

JOHANNA MELKA

Unfortunately, as a result of slower growth and a worsening of the public finances, the ratings agencies have put a negative outlook on India’s sovereign rating. For the time being, refinancing risks are seen as being under control. Why? The structure of debt is extremely sound. Debt is denominated in rupees, is held by residents and has long maturity. The problem is that if growth slows too abruptly, or if the government is unable to consolidate its finances, we could see the agencies downgrade India’s sovereign rating. And with the second wave of Covid-19, all the ingredients are in place for a marked slowing of growth, or a deterioration of the public finances, and thus the risk of a downgrading of the country’s credit rating.

FRANÇOIS DOUX

Thank you Johanna Melka for this update on the Indian economy, something we will have to watch over the next few months. I’ll be back in a month’s time for our next edition of ECOTV.

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