Wednesday, March 28, 2012

Canada and the U.S. Agree to Protect 400,000 Transboundary Acres


Missoulian: British Columbia OKs Law Protecting Flathead Basin

Montana Fish, Wildlife & Parks, Montana Outdoors: How a Great Place was Saved

The Nature Conservancy: North Fork Now: Protecting the Transboundary Flathead

North Fork Preservation Association: Obama Proposes $29 Million in Montana Land Conservation Projects

Economic indicators suggest the depressed U.S. real estate market may be showing signs of recovery, however, 400,000 acres of unspoiled wilderness on the border between the United States and Canada were recently valued at the bargain price of just $10 million. The Canadian and U.S. governments finalized an agreement to preserve the North Fork of the Flathead River Valley, which runs south from the Canadian province of British Columbia into Montana and forms the western boundary of Glacier National Park. The area is home to the highest concentration of grizzly bear populations on the continent and remains one of the last great wild frontiers. Elk, moose, wolves, lynx, mountain goats, and other large mammals maintain their highest population levels in North America in the Flathead Valley. Now, as a result of collaborative efforts between the countries, the valley is permanently protected from exploration, drilling, mining, and ultimately, environmental destruction.

The Flathead Valley, with its rich potential for oil, gas, coal, and gold, has long been the center of developmental disputes. Most recently, in 2005, Canadian mining companies proposed massive coal mining operations near the headwaters of the Flathead River in British Columbia. Binational efforts to preserve the land commenced immediately. The governor of Montana and the premier of British Columbia collaborated to encourage oil, gas, and mining companies to abandon their rights and leases on the land. In 2009, a UNESCO review team concluded that mining operations in the Flathead Valley would irreparably damage the ecology of Waterton Lakes National Park in Canada as well as Glacier National Park on the U.S. side of the valley. But the Flathead Valley holds vast reserves of natural resources and preservation of the valley meant the exploration companies and the Canadian government had to walk away from billions in potential revenue.

After years of negotiations and wrangling, Canadian mining companies agreed to abandon their claims to the land in exchange for compensation for exploration expenses – a mere $10 million. U.S. geophysical companies also surrendered their leasing rights paving the way for the Flathead Watershed Area Conservation Act to receive approval from the Canadian Parliament on November 14, 2011.

Ironically, this highly successful collaboration ultimately hinged on one issue – how to raise the $10 million – which nearly broke the agreement. Although President Obama announced $29 million in funding for Montana land conservation projects in March 2012, the U.S. federal government declined to contribute funds to the Flathead River Valley conservation project. U.S. officials were concerned about setting a precedent by compensating foreign companies for their expenses incurred in a foreign country. The rationale being that the federal government should not use U.S. tax dollars to directly subsidize foreign private industry. Moreover, the U.S. companies holding land rights to the Flathead Valley did not request compensation for giving up their claims. In the end, the U.S.-based Nature Conservancy and the Nature Conservancy of Canada agreed to raise the $10 million and the Flathead Valley will remain untouched.

Sunday, March 25, 2012

Peruvian Government Seeks to Regulate Illegal Mining

BBCNews: Peru Mining Protest Turns Deadly in Puerto Maldonado
Bloomberg Businessweek: Peruvian Jungle Gold Miners Protest Leaves Three Dead
FOXBusiness: Peru Hopes Tax Legislation Will Lift Government Revenue to 18% of GDP
MarketWatch: Large Gold Mines Dominate Peru Economy: Report
Reuters: Wildcat Miners in Peru Suspend Protest After Deaths
WSJ: Peru’s Informal Mining Protests Turn Deadly

Minerals have largely contributed to the economic development of Peru. In addition to being the world’s sixth-largest producer of gold, Peru is a leading global producer of copper, zinc, and silver. The mining industry accounts for 60% of exports and 30% of government tax revenue. A recent gold-mining industry report noted that in 2009 alone, the government collected $800 million in tax revenue from mining.

Much of Peru’s gold, however, is mined illegally. Illegal miners are responsible for extracting up to thirty metric tons of gold per year, yielding over $2 billion in profit. Illegal mining has increased in Peru in recent years because of soaring gold prices globally. The Peruvian government has sought to curb illegal mining activities, claiming that they pollute rivers with mercury that is used to separate and collect gold from rocks and soil, causing a public health concern and devastating the Peruvian environment. The government also believes that illegal mining fails to economically benefit the poor gold-mining region. Illegal miners do not pay taxes and take gold out of the country as contraband. The government has, therefore, confiscated and destroyed dozens of dredges (devices used to extract gold and other metals) and imposed ten-year prison sentences for illegal miners. The government insists that it is not targeting subsistence mining but rather large-scale organizations that finance illegal mining, causing irreparable harm to the environment and exploiting workers.

Illegal gold miners in the Madre de Dios region of Peru’s Amazon River basin (along the border with Bolivia and Brazil) protested last week over the government’s measures. They fear that the government’s actions will put them out of work. They also accuse government officials of favoritism towards large multinational companies for whom officials are willing to give mining concessions. Peru’s President Ollanta Humala, for example, encouraged the U.S.-based company Newmont Mining to build a $4.8 billion gold mine.

Throughout the protests, the government has insisted that sanctions are necessary to encourage illegal miners to obtain the necessary permits and obey environmental rules. Approximately 50,000 miners do not have licenses to operate. The government, however, has changed its official stance following the death of three people and wounding of thirty-two more during the protests. The government announced that it will work to incorporate illegal miners into the formal economy by easing some of the barriers to incorporation. As a result, the miners suspended the protests, pending the outcome of talks with government officials in Lima.

Fitch Upgrades Greek Debt Amidst Debt Writedown

Bloomberg: Greece has Rating Upgraded by Fitch
Boston Globe: Greek Debt Upgraded, but Outlook Still Grim
Business Day: Fitch Lifts Greece out of Default Territory
Eurostat News Release: Euro Area Government Debt Down to 87.4% of GDP

On Tuesday March 14, credit rating agency Fitch upgraded future Greek bonds from a “restricted default” to a B- rating. Fitch is the first of the major ratings agencies to upgrade Greek debt. The main reason for the improved outlook is the recent debt write-down, or “haircut,” accepted by 83.5% of private investors holding Greek bonds. The haircut will result in private debt holders taking investment losses of more than 70%, which includes both lost interest and principal, and will cut Greece’s debt burden by $159 billion—about one third of Greece’s total debt. Fitch also assigned a “stable outlook” for Greece, meaning it is not expected to change Greece’s rating again in the near future.

The B- rating applies to all future bonds Greece issues. Unfortunately, a B- rating qualifies as junk status, meaning Greek debt is not viewed as a stable investment in the international markets and regulations prevent some institutional investors from purchasing junk bonds. Foreign-law bonds, which are not governed by Greek law and therefore were not forced to agree with the Greek 70% haircut, maintained their C rating based on the uncertainty surrounding their debt write-down settlement scheduled for April 11.

The debt write-down is a positive sign for Greece. First, the haircut was a central aspect in the Eurozone and IMF deal agreeing to provide $226 billion in bailout funds over the next few years. That total includes amounts not yet disbursed from the initial Greek bailout, along with $170 billion in new bailout funds. Second, the write-down significantly decreases Greece’s debt-to-GDP ratio. Currently, the Greek debt-to-GDP ratio stands at approximately 160%, but an IMF report claims that the write-down paves the way for the ratio to fall to 116.5% by 2020 and 88% by 2030. However, that same report notes that the country’s debt-to-GDP ratio could remain as high as 145% in 2020 if Greece is not financially disciplined.

Even amidst the debt upgrade, international debt experts warn that Greece’s recovery is still a long way off, meaning employment and economic growth will be slower than expected. While the debt writedown paves the way for the immediate disbursement of bailout funds, Greece must continue to meet fiscal targets every three months set by international creditors to receive future bailout funds. While the debt haircut greatly decreases Greece’s current obligations and led to a ratings upgrade, the financial future of Greece remains very unclear.

Saturday, March 24, 2012

Spain Set to Breach Deficit Limits for 2012

FT: Spain Defies EU Over Deficit Rules
NYT: Spain
Telegraph: Spain Planning to Breach EU Budget Targets
WSJ: Euro-Zone Ministers Press Spain for a Deal on Deficits

Earlier this month, Spanish Prime Minister Mariano Rajoy announced that the country would not be able to meet its intended budget deficit target for this year. The country had previously set a fiscal deficit target of 4.4% of gross domestic product (GDP) in an effort to reassure Eurozone leaders and investors of Spain’s commitment to tougher fiscal measures. However, due to Spain’s current economic situation, Mr. Rajoy expects this year’s fiscal deficit to surpass the set target and reach 5.8% of GDP.

According to Mr. Rajoy, Spain’s current economic situation makes it difficult for the country to implement further austerity measures (spending cuts and tax increases) needed to meet the 4.4% of GDP deficit target. The Spanish government already passed a €15 billion austerity plan in December 2011 to reduce the deficit. Further tax increases and spending cuts could seriously hurt growth and make it even more difficult for the country to bring its fiscal deficit down. When taxes increase, demand falls as consumers have less income to use to purchase goods. The decrease in consumption causes companies, faced with less revenue, to lay off workers, thus increasing unemployment. Spending cuts such as lowering wages and reducing unemployment benefits can also dampen demand.

It is not feasible for Spain to meet its deficit target since the nation’s 2011 budget deficit was higher than the previous government forecasted. The actual 2011 deficit was 8.5% of GDP compared with a target of 6%. Since the deficit for the previous year was higher than what the government forecasted, the measures taken to bring down the deficit would not be enough to bring down the deficit to the set target. In addition, the current government has predicted that GDP will shrink by 1.7% this year, compared with the growth predicted by the previous government when the original deficit target was agreed. Growth helps to combat deficit as the government will have higher revenues from tax collection. Thus, this slowdown in growth will make it even more difficult for the country to bring the deficit down.

The news of Spain’s higher-than-expected fiscal deficit caused Eurozone leaders to increase pressure on the country to lower its deficit. On March 12, Eurozone finance ministers reached an agreement with Spain for the country to make additional efforts to cut its budget deficit by an additional 0.5% of GDP this year. Mr. Rajoy has stated that despite that higher deficit, Spain will continue to work on achieving the goal of a 3% deficit in 2013, which would bring the country into compliance with European Union law.

Friday, March 23, 2012

Strong Currency Limits Australian Economic Growth

On March 21, the Australian dollar (commonly referred to as the “Aussie”) traded at US$1.0537, the highest value with respect to the U.S. dollar in three decades. The Aussie exchange rate has risen over the last three years primarily because Australia has higher interest rates than other advanced economies. A higher interest rate attracts foreign investors who are able to get higher rates of return on their investments than they can elsewhere. The influx of investment to Australia creates a demand for Aussies, which raises the currency’s value relative to other currencies. Another reason why the value of the Aussie has risen is that in the wake of the European sovereign debt crisis, investors have viewed Aussies as a safe investment, which leads investors to buy Aussies, thereby increasing demand and raising the currency’s value. Furthermore, developing countries such as China are looking to diversify their holdings of foreign currency away from the U.S. dollar to minimize their exposure to a potential downturn in the U.S. economy, and the Aussie is viewed as a good alternative given the relatively higher growth rate in the Australian economy compared to the United States.

The higher value of the Aussie has limited the country’s exports (which are a primary driver of economic growth) as Australian products are more expensive for foreigners. Australia’s economy grew by 2.3% in 2011, but only by an annualized growth rate of 0.4% in the fourth quarter—both of these figures are much lower than the average growth rate of 3.25% over the last several years. Furthermore, Australia’s economic growth has been limited because Australian households have increased their savings over the last two years to pay down household debt. With less money being spent in the local economy, businesses are discouraged from expanding their operations which limits economic growth.

Perhaps more concerning to the Australian economy is that demand from China for Australian commodities has decreased and is likely to continue falling. Mining is the main economic sector in Australia and will account for over 40% of total business investment over the next few years. Much of Australia’s mining exports go to China. However, Chinese food and oil prices have been rising over the last several months, which has created inflationary pressure as producers pass on higher costs to consumers in the form of higher prices. With higher inflation, China may tighten its monetary policy by raising its interest rates, thereby encouraging Chinese to save instead of spend, which could decrease demand for Australian goods.

Tuesday, March 13, 2012

Extreme Poverty Falls, Even Amid Economic Recession

Boston Globe: Economic Downturn did not Harm Efforts at Reducing Extreme Poverty in Developing World
Business Standard: Extreme Poverty Drops Worldwide
World Bank: World Bank Sees Progress Against Extreme Poverty, But Flags Vulnerabilities

A new World Bank report finds that the number of people living in extreme poverty—defined as living on less than $1.25 a day—in the developing world has fallen every year between 2005 and 2008, the most recent year where complete data is available. Additionally, according to preliminary data from 2010, the recent global economic recession, which many experts thought would lead to an increase in extreme poverty, instead has only slowed the rate of reduction.

Global attempts at reducing extreme poverty have been notable. In 1981, 1.94 billion people in the developing world lived below $1.25 per day. However, by 2008 that number dropped to 1.29 billion, a reduction of over 600 million people. Poverty reduction has been so rapid that the United Nations Millennium Development Goal of cutting extreme poverty in half from its 1990 level has already been achieved, well before the 2015 deadline.

Progress has been especially dramatic in East Asia. In 1981, the region was the poorest in the world, with approximately 77% of the population living in extreme poverty. By 2008, the percentage had dropped to only 14%. In South Asia, the percentage of people living in extreme poverty dropped from 61% to 36% between 1981 and 2008. In Latin American and the Caribbean, the population living in extreme poverty remained relatively constant at 12% between 1981 and 2002. However, since 2002, extreme poverty has been declining rapidly. In 2005 extreme poverty fell to 9% and by 2008 the number had fallen further to 6%.

Sub-Saharan Africa is the region of the world that has made the least progress since data collection began in 1981. In 1981, 51% of Sub-Saharan Africa lived in extreme poverty, but that percentage rose to 59% in 1993. Some progress has since been made, as the percentage of people in extreme poverty fell from 56% to 52% between 2002 and 2005. In 2008, the population living in extreme poverty was 48%—the first time in the region’s history that less than half of the population was not living in extreme poverty.

Despite the significant reduction in poverty, the World Bank believes additional progress needs to be made. At the current rate of progress, over one billion people will still live in extreme poverty by 2015. Additionally, while many people have escaped extreme poverty, these people remain extremely poor by middle- and high-income country standards. For example, many of those who have escaped extreme poverty now live on less than $2 a day, as evidenced by another recent study showing there has been only a 5% reduction in the number of people living on less than $2 a day between 1981 and 2008 (from 2.59 to 2.47 billion in 1981 and 2008 respectively). This data suggests that while 600 million people have escaped extreme poverty between 1981 and 2008, many of those people remain in dire financial positions. In total, 22% of the developing world still lives in extreme poverty and 43% lives on less than $2 a day. The World Bank hopes that the current trends will continue and world poverty will continue to decline.

Tuesday, March 06, 2012

Portugal Meets Economic Targets

FT: Portugal Announces More Austerity Measures
International Workers Association: About the Austerity Measures and the Last General Strike
Washington Post: International Lenders Say Portugal is Making Good Progress on Implementing Bailout Program
WSJ: Portugal Bailout Seen on Track

The European sovereign debt crisis has affected almost every corner of the globe and resulted in economic problems for many European countries. In 2010, Portugal adopted a set of austerity measures (spending cuts and tax increases) to combat its own debt problems and hopefully avoid the need for a future bailout. Unfortunately, these austerity measures were insufficient, due to the country’s large debt and slowing economy, and a bailout was necessary. The three major credit rating agencies also downgraded Portuguese debt to junk status, signaling that the ratings agencies lost confidence in Portugal’s ability to pay its debt. The rating agencies’ negative views on Portugal spread to investors, resulting in Portugal being required to pay a much higher interest rates to borrow money (higher risk makes an investor demand a higher interest rate because the increased interest income will offset the higher possibility of loss). Because Portugal was forced to pay higher interest rates on its debt, the country had difficulty making its debt payments and moved very close to default.

To fight off default, eight months ago Portugal agreed to a €78 billion ($104.5 billion) bailout with the IMF. To receive bailout funds Portugal must meet economic benchmarks and implement additional austerity measures. Thus far, Portugal has received €34.2 billion ($45 billion) of the bailout. Before the IMF disburses the next portion of the bailout, it must first complete an analysis of the country’s economic position to determine if additional austerity measures are required. The IMF recently completed its analysis and decided that the country is on track to meet the bailout’s economic benchmarks, meaning Portugal does not need to take further action now to receive the next €14.6 billion ($20 billion) of bailout funds.

Portugal’s austerity measures have included labor market reforms aimed at making it easier to hire and fire workers, along with numerous cuts to the public sector including requiring state employees to work additional hours without additional pay, eliminating some paid holidays, and forfeiting bonuses worth more than one month’s pay. The combination of these measures reduced public sector wages by an estimated 20% in 2011 as compared to 2010. Outside the labor markets, the austerity measures have also included a 25% increase in the cost of using public transportation and an increase in the value-added (sales) tax.

Based, in part, on the above austerity measures, Portugal has successfully reduced its deficit-to-GDP (gross domestic product) ratio. In 2010, the ratio was 9.8%—well above the Eurozone maximum of 3%. While exact numbers are not yet available, Portuguese officials believe the ratio will be approximately 5% in 2011—below the 5.9% target set by the IMF. The reduction in the deficit is one of the main positive factors in the IMF’s report.

Even though Portugal will likely meet IMF benchmarks, its economy is not strong. Financial experts project the country will end 2012 with an economic contraction of 3.3%—down from a previous forecast of 2.8%—and currently has an unemployment rate of 14%, which experts project will peak at 14.5% later this year. However, the IMF believes the country’s economic problems will subside in 2013 thanks to increased private investment (leading to the creation of new jobs) and increased exports (increased demand creates a need for more workers to meet that demand).

The IMF’s report is a good sign for the European Union (EU), as it shows that Portugal’s economy is moving forward. However, Portugal is still in the midst of an economic recession and may face future debt problems. If Portugal continues to meet its economic targets, it may avoid the need for a second bailout and additional austerity measures, which will hopefully lead to a faster recovery for the country.

Saturday, March 03, 2012

G-20 Officials Meet in Mexico and Postpone Decision to Increase Aid to Europe

CBC News: G20 Fails to Reach Europe Debt Deal
Council of the Americas: Feb. 25-26: G20 Finance Ministers Meet in Mexico’s Capital, Discuss EU Crisis
FT: China and Japan Unite on IMF Resources
NYT: G-20 Meeting Focuses on Euro Firewall Fund
Reuters: Mexico Hopeful of G20 Promise on IMF Resources
WSJ: G-20 Defers Move on Aid for Europe

On February 25 and 26, the Group of Twenty (G-20) finance ministers and central bankers, representing twenty major world economies, met in Mexico. They mainly discussed whether to increase the lending capacity of Europe’s rescue funds by combining the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). Uniting the EFSF and ESM would create a $1 trillion firewall to help support struggling European economies like Spain and Italy. The EFSF is a temporary bailout fund Eurozone countries created to address the sovereign debt crisis, and the ESM will replace the EFSF when it takes effect in July 2012 as a permanent bailout fund to provide relief for EU countries in financial crises. G-20 officials also debated whether to increase the IMF’s lending capacity by $500 billion to approximately $1 trillion to provide additional protection for countries facing the effects of global financial instability.

Commentators have remarked on the irony of Mexico serving as Chair of the G-20 for 2012. Three decades after the Latin American debt crisis during which Mexico defaulted on its debt obligations, Mexico’s economy is characterized by “low debt, well-managed fiscal accounts and an inflation rate that is under control.” As Mexican President Felipe Calderón opened the summit, he emphasized Mexico’s unique position to contribute to the European crisis’ resolution considering its own recovery from crisis to emerge as a stable and growing economy. Mexico proposed that the G-20 agree to a simultaneous increase of the European bailout funds and IMF resources. Mexico argued that an increase of both funds is necessary to achieve a large enough firewall to help countries in crisis and stop the debt crisis from continuing to spread.

Contrary to Mexico’s wishes, however, G-20 officials postponed their discussion of an expanded European bailout fund to the next G-20 meeting of finance ministers and central bankers in April because of a lack of consensus on the issue. Germany does not agree that the European bailout fund should be increased, and since it would serve as the major financial contributor, an increase in the bailout fund will not occur without its agreement. Germany’s resistance stems from a belief that increasing the size of the bailout fund would mean that countries like Spain and Italy will not follow through on implementing structural changes. If additional money becomes available to help these countries during the crisis, they will be less likely to institute reforms and impose austerity measures that burden their citizens.

G-20 officials also postponed a discussion of whether to increase IMF resources. To many of these officials, expansion of IMF resources should be contingent on whether Europe’s bailout fund is increased. The United States and Canada have refused to increase their contribution to the IMF without Germany first agreeing to increase Europe’s bailout fund. They hope that if Europe’s bailout fund is substantially increased, an increase of IMF resources will prove unnecessary. China and Japan have also expressed their unwillingness to contribute additional money to the IMF unless European countries first expand their bailout fund. They argue that if the European bailout fund is not increased, an increase in IMF resources cannot cover the gap in funding necessary to stop the Eurozone crisis from spreading to other economies around the world.

Friday, March 02, 2012

Ireland to Hold Vote on European Fiscal Pact

FT: Ireland Calls Vote on European Fiscal Pact
Guardian: Ireland Set for Referendum on Eurozone Fiscal Treaty
Spiegel: A Decisive Moment for Ireland
WSJ: Ireland to Hold Referendum on EU Treaty

On Tuesday February 28, Ireland’s Prime Minister Enda Kenny announced that the country would hold a referendum on the recently-agreed-to European Fiscal Pact. The Pact sets tough deficit limits as well as strict enforcement mechanisms to prevent Eurozone countries from accumulating large amounts of debt. Under the Pact, member countries’ deficits must not exceed 0.5% of the country’s gross domestic product (GDP), debt must be below 60% of GDP, and countries must add balanced-budget rules to their constitutions. Within the next three months, at least twelve Eurozone countries must ratify the Pact for it to come into effect, but not all countries must follow Ireland’s lead and hold a referendum.

Under the Irish constitution, a public vote is necessary to ratify any significant transfer of decision-making power to the European Union (EU). However, Ireland’s past experiences have shown a suspicion towards further European integration. The Irish people have twice rejected EU treaties (in 2001 and 2008), only to approve them in second referendums after certain concessions in the treaties were made to appease Ireland’s voters. Thus, European leaders are concerned that the referendum will not pass. If Irish voters reject the Pact, the most immediate result would be that the Irish government would lose access to financial assistance from the European Stability Mechanism (ESM)—the Eurozone’s bailout fund, according to a provision of the Pact. Further, if Irish citizens vote “no” it could lead to uncertainty in financial markets as investors lose confidence in Ireland and the Eurozone’s ability to create more binding and enforceable fiscal rules.

Nonetheless, Prime Minister Kenny is optimistic that the Irish people will reaffirm their commitment to the Eurozone. There is a general consensus among economists and observers that Ireland still needs external assistance from the “Troika” (a group comprised of the European Commission, the European Central Bank and the International Monetary Fund in charge of monitoring the economic situation in distressed countries) and the ESM for its economic recovery. Thus, the referendum will show whether the Irish people are willing to cede additional decision-making powers to the EU or, as in the past, certain concessions in the Pact will need to be made to win their support.

India Shows Signs of a Slowing Economy

India’s economic growth rate slipped to an annualized 6.1% in the fourth quarter of 2011, the lowest growth rate in nearly three years. This growth rate marks the seventh consecutive quarterly slowdown in India and a steep drop from the 6.9% growth rate in the third quarter of 2011. In 2007, India’s economy grew 9.5%, but growth slowed to 8.4% in the last two years and is expected to fall to somewhere between 6.5% and 7% in the fiscal year ending in March.

One reason for the slower economic growth is very high interests rates in India (the official interest rate is at 8.5%), which gives businesses and consumers an incentive to save their money rather than spend it, lowering demand for goods in the economy and limiting economic growth. High interest rates have lowered corporate investment from an average of 18% of GDP in the previous five years to 14% of GDP in 2011. Furthermore, high borrowing costs have stifled the growth of the manufacturing industry, which only grew at an annualized rate of 0.4% in the fourth quarter of 2011—a three-year low.

While other Asian countries have cut their interest rates to promote economic growth in the wake of the global economic slowdown, India has not because it is struggling to rein in inflationary pressure. This inflationary pressure is due, in part, to an increasing government fiscal deficit that has pumped extra cash into the economy. Lower tax revenues due to the slowing economy, along with expensive oil subsidies and a rural worker employment-guarantee program have contributed most to the increased deficit. The money for oil subsidies and the employment-guarantee program increases demand in the economy by ensuring consumers have more money available to spend, but with the supply of goods staying stable, prices rise due to simple supply and demand principles. India’s 2011-2012 fiscal deficit has swelled to an estimated 6% of GDP, which is higher than its 4.6% target, and up from an average of 3% of GDP in the previous four years. Since the inflation rate is so high, the Reserve Bank of India has been unwilling to cut official interest rates. Lower interest rates would encourage businesses and individuals to spend rather than save (borrowing would be cheaper and saving would not provide as high a rate of return), which would further increase demand and push inflation even higher, destabilizing prices and creating a risky atmosphere for foreign investors who worry that prolonged inflation will decrease the value of their assets.

The Reserve Bank meets on March 15th and there are indications that it will cut interest rates to promote economic growth. However, this decision is far from certain. India faces a unique mix of high inflation and slowing growth, and these pressures could increase because of rising oil prices. Higher oil prices cause inflation because producers face higher costs to provide the same amount of goods (e.g., heating, gasoline, and manufacturing products) and pass the cost on to consumers in the form of higher prices.

India is in a difficult position. The Indian government has so far been unwilling to control its spending which has contributed to inflationary pressures, but with high inflation the Reserve Bank has been unwilling to cut interest rates which would increase inflation, but promote economic growth as well. Unless India can manage this problem, it may have to grow accustomed to disappointing economic growth rates in the future.