Shakespeare had said: “All the world’s a stage...” Yes, we are mere players but irony often enters the characters when we say our lines, especially in the theatre of finance and economics. The year 2009 will be remembered for several such ironies that are in the realm of the theatre of the absurd, and the focus here is on the top 10 stories that add spice and intrigue.
The financial crisis that started in 2007 was still the subject of continued debate. Institutions were blamed and finally it was decided that the culprit was Alan Greenspan who loosened the strings too much and too soon, which engendered the bubble. But once the crisis came in, memories were taken back to the Depression when nothing was done and the crisis was exacerbated. Not surprisingly, Ben has lowered the rates again to virtually zero. Is this the beginning of another bubble?
The RBI basked in its own glory by behaving as if it knew all the time that securitisation and collateralised debt obligations (CDOs) would lead to a financial crisis. They claimed that India came out unscathed because we were prudent. Was this really the case or was it that we have now gone in for sophisticated products because we could not understand them? Few knew beyond the textbook what CDOs were all about, and hence not being affected by the crisis could be simply because we never tried them out. With RBI controlling every aspect of banking right from interest rates to where money should go, we can actually never go wrong. Right?
A fallout of the crisis was that CEO salaries came under the scanner. CEOs of some of the companies that were bailed out through public money had the temerity to give themselves hefty bonuses, which is the ultimate arrogance of capitalism. Indian government officials hence had a field day getting back at the private sector, which had objected to the Pay Commission’s proposals a couple of years back by lambasting the CEO pay structure.
Next, Dubai was a case in itself. Once touted as being a potential global financial centre, we had a case of the government refusing to honour the debt of one of its own undertakings. Clearly a financial centre in the 21st century cannot be created by building Taj Mahals.
The monsoon became a major issue, and right up to September all our leaders kept saying that it would revive which was based on optimism rather than belief, until the IMD declared 2009 a drought year. Not to be deterred, we have been told to carry on with our chins held high as the rabi crop will be good. Do we have any reason for such an assumption?
Notwithstanding the fact that agriculture has failed, we have taken solace in the double-digit industrial growth rate and the fiscal stimulus package to now believe that GDP growth will be closer to 8% than the more humble 6% just one month back. A rare display of the conjurer’s magic wand in North Block?
The capital market matched our irrational mood swings. It was down to 8,000-levels in March when we claimed we did better than the world through the crisis. Then it soared to cross 17,000 when we had more bad news pouring in such as inflation and drought. But, good news like good industrial and GDP growth failed to excite it further. We still have to understand the way the Sensex and Nifty move.
Inflation was a crazy phenomenon and debates ranged over whether this was deflation or dis-inflation, and as economists had a roll on this subject, we have suddenly seen prices shooting upwards and no one knows what can be done as one has realised that banning futures trading, imposing strict stock limits, lowering duties and taxes can just not increase production. There are evidently no short-term solutions here.
The derivatives markets had a mixed package. While the commodity market rejoiced when wheat futures was restored, it had to sulk when sugar was banned. Interest rate futures have once again run into rough weather unlike currency futures, which have been a major hit clocking volumes of close to Rs 25,000 crore a day. Can there be a derivative product on risk of failure?
Lastly, while the mood seems to be upbeat (for the right or wrong reasons) a major shadow has been cast by Suresh Tendulkar, who has estimated that 37.2% of our population is below the poverty line. Is he right? We’ll have to wait a while to find out.
Thursday, December 24, 2009
Sunday, December 13, 2009
t’s optimistic to expect change in supplies soon: Mint 12th December 2009
Except by getting physical supplies, you can’t control inflation in any other way. says Madan Sabnavis, chief economist at the National Commodity and Derivatives Exchange Ltd: ravi Krishnan
Mumbai: Wholesale food prices rose at the fastest in 11 years to scale 19% for the week ended November 2008, fuelling inflationary expectations. Mint spoke to Madan Sabnavis, chief economist at the National Commodity and Derivatives Exchange Ltd about the reasons for the steep rise and the likely policy impact. Edited excerpts:
What are the reasons for this high increase in food prices?
It’s caused by a combination of three factors—the first is that kharif output has been officially stated to be lower than what it was last year, major gaps being seen in food grains, oil seeds and sugar cane. Second, the carryover stocks in case of pulses, oil seeds and sugar cane are not high enough. So we have stocks of only rice and wheat which are officially maintained by the Food Corporation of India. So, therefore, we don’t (have) any kind of stock, which can help us tide over this crisis. Third, are we in a position where we can import products where the harvest has not been satisfactory?
The answer is yes and no. Yes, we can import something like sugar, but the international prices are also ruling at a very high level. (But) for something like pulses, there are limited countries which grow pulses and could supply us like Canada and Burma. They also have their own seasons and until those seasons coincide (with ours) and we can get those imports in, we will continue to be afflicted with these kind of problems.
Besides, another reason (for the high inflation) has been the high rise in the prices of vegetables, in particular. Here we have been quite severely affected by the floods in Andhra Pradesh and Karnataka. So what we are really looking at is the next crop of vegetables, which should be probably coming in a month’s time or so. It’s only then we could hope to have some relief.
Do you think it’s going to fan inflationary expectations?
Normally what happens in October, November, December, prices of agricultural products would tend to come down, for the simple reason that we have the arrivals (harvest) coming into the market. But unfortunately what we have seen this year is that week-on-week inflation is also going up. Which evidently means that we are having severe problems in terms of supply. So, to expect a change to happen very soon is a bit optimistic.
So, this is supply side inflation and monetary policy wouldn’t have any impact.
Today, when I am talking about inflation being a supply side phenomenon, when it’s because of shortages—by increasing the rates, RBI (Reserve Bank of India) is not going to bring down the prices, because I don’t have the supplies of the commodities. Except by getting physical supplies, you can’t control inflation in any other way. But the fact that high inflation leads to high inflationary expectations, which is the case today, will prompt RBI to take the monetary policy option. Sucking out liquidity will not make too much sense. So, if RBI wants to send a strong message that it wants to control inflation, it will have to be through interest rate movements.
Mumbai: Wholesale food prices rose at the fastest in 11 years to scale 19% for the week ended November 2008, fuelling inflationary expectations. Mint spoke to Madan Sabnavis, chief economist at the National Commodity and Derivatives Exchange Ltd about the reasons for the steep rise and the likely policy impact. Edited excerpts:
What are the reasons for this high increase in food prices?
It’s caused by a combination of three factors—the first is that kharif output has been officially stated to be lower than what it was last year, major gaps being seen in food grains, oil seeds and sugar cane. Second, the carryover stocks in case of pulses, oil seeds and sugar cane are not high enough. So we have stocks of only rice and wheat which are officially maintained by the Food Corporation of India. So, therefore, we don’t (have) any kind of stock, which can help us tide over this crisis. Third, are we in a position where we can import products where the harvest has not been satisfactory?
The answer is yes and no. Yes, we can import something like sugar, but the international prices are also ruling at a very high level. (But) for something like pulses, there are limited countries which grow pulses and could supply us like Canada and Burma. They also have their own seasons and until those seasons coincide (with ours) and we can get those imports in, we will continue to be afflicted with these kind of problems.
Besides, another reason (for the high inflation) has been the high rise in the prices of vegetables, in particular. Here we have been quite severely affected by the floods in Andhra Pradesh and Karnataka. So what we are really looking at is the next crop of vegetables, which should be probably coming in a month’s time or so. It’s only then we could hope to have some relief.
Do you think it’s going to fan inflationary expectations?
Normally what happens in October, November, December, prices of agricultural products would tend to come down, for the simple reason that we have the arrivals (harvest) coming into the market. But unfortunately what we have seen this year is that week-on-week inflation is also going up. Which evidently means that we are having severe problems in terms of supply. So, to expect a change to happen very soon is a bit optimistic.
So, this is supply side inflation and monetary policy wouldn’t have any impact.
Today, when I am talking about inflation being a supply side phenomenon, when it’s because of shortages—by increasing the rates, RBI (Reserve Bank of India) is not going to bring down the prices, because I don’t have the supplies of the commodities. Except by getting physical supplies, you can’t control inflation in any other way. But the fact that high inflation leads to high inflationary expectations, which is the case today, will prompt RBI to take the monetary policy option. Sucking out liquidity will not make too much sense. So, if RBI wants to send a strong message that it wants to control inflation, it will have to be through interest rate movements.
Agriculture slows, but decouples: Dec 11, 2009 : Financial Express
The 0.9% growth number in agriculture for Q2 of this year has spoilt the otherwise joyous party that spoke of growth in GDP of 7.9%. But, does this number matters? The answer is that the second quarter of the financial year is not agri-intensive, and while less than a fifth of the agricultural output emanates from this period, most of it is in the nature of residual farm output as well as forestry and fishing. Agriculture is basically a two-season phenomenon and would typically cover the third quarter (kharif) and fourth quarter (rabi). Therefore, the number of 0.9% is not startling even though it is lower than that last year (2.4%) which may be partly attributed to the base year effect.
It must be pointed out that the first two quarters contribute to just over 40% of agricultural GDP. Around one-third of our agricultural GDP comes from the third quarter while over a quarter comes from the fourth quarter. Hence, the performance in the next two quarters will really be more decisive.
The ministry of agriculture has already indicated that there are problems on the kharif front caused by the triad of late monsoon, drought and floods (in some regions). Rice output is to decline by 18%, coarse grains by 20%, pulses by over 7%, oilseeds by 15% and sugarcane by 9%. This virtually means a sharp decline in farm output in the third quarter. Considering that the kharif season accounts for around half of total foodgrains and 65% of oilseeds production, we are really talking of a double digit fall in farm output. We are also aware of the major fall in production of vegetables, which has led to the exorbitant increase in prices in the last four months or so. If the ‘market guess’ of 15% decline works out, then overall growth in this sector could slip to between -4% and -4.5% for the first three quarters. The disturbing aspect of this decline is that it spans all major products such as rice, jowar, bajra, maize, moong, ‘other pulses’, soybeans, groundnuts, sesame, sunflower, castor and sugarcane.
What does this mean for the full year? There is an increasing dependence on rabi and we have heard bold statements that the rabi crop will compensate for the loss in kharif even before the latter fructified. The rationale was that the late arrival of the rains would substantially add to the water table level .that would aid rabi production. Further, it was felt that the farmers who lost their income would possibly sow early or grow more rabi crops to make up for the deficit. Also, it was argued that the floods in Karnataka and Andhra Pradesh would assist the growth of rabi crops. All this may partly be true, but the more important question is whether or not this will help to alleviate the damage.
Given the relatively lower importance of rabi in oilseeds and an equal share in foodgrains, we need to have substantial growth in Q4. Can this happen? Wheat had reached a record of 81 million tonnes last year and to make up for this loss, would have to touch 93 million tonnes, which does not look realistic. The same holds for oilseeds that have to grow by 26% to maintain overall oilseeds production at last year’s level. Even the more optimistic minds would not really take a chance with these numbers.
Therefore, it would be reasonable for one to expect a decline in overall production by the end of the year, notwithstanding the major rabi crops succeeding in the last quarter. Putting numbers on farm output is fraught with risk as no one really knows how the harvest will turn out to be. Very often such conjectures are based more on hope than conviction.
A positive development over the years is however a certain kind of decoupling between agriculture and the rest of the economy. The high growth in social and public services, which is the mirror image for fiscal stimulus, can make up for this loss of output. Industry, too, appears to be more urban-centric and is gradually getting divorced from the farm sector. Therefore, while at the margin the rural folk dependent on agriculture for an income may cut down on demand for industrial products, the urban class has made up for this loss, as it is supported by higher wages (already seen) and booming stock markets, (which provides liquidity to spend).
It will not, therefore, be surprising to have steady growth in real GDP coexist with a negative growth in farm output, high industrial growth, booming service sector and low WPI but high food inflation and higher poverty levels. ..
It must be pointed out that the first two quarters contribute to just over 40% of agricultural GDP. Around one-third of our agricultural GDP comes from the third quarter while over a quarter comes from the fourth quarter. Hence, the performance in the next two quarters will really be more decisive.
The ministry of agriculture has already indicated that there are problems on the kharif front caused by the triad of late monsoon, drought and floods (in some regions). Rice output is to decline by 18%, coarse grains by 20%, pulses by over 7%, oilseeds by 15% and sugarcane by 9%. This virtually means a sharp decline in farm output in the third quarter. Considering that the kharif season accounts for around half of total foodgrains and 65% of oilseeds production, we are really talking of a double digit fall in farm output. We are also aware of the major fall in production of vegetables, which has led to the exorbitant increase in prices in the last four months or so. If the ‘market guess’ of 15% decline works out, then overall growth in this sector could slip to between -4% and -4.5% for the first three quarters. The disturbing aspect of this decline is that it spans all major products such as rice, jowar, bajra, maize, moong, ‘other pulses’, soybeans, groundnuts, sesame, sunflower, castor and sugarcane.
What does this mean for the full year? There is an increasing dependence on rabi and we have heard bold statements that the rabi crop will compensate for the loss in kharif even before the latter fructified. The rationale was that the late arrival of the rains would substantially add to the water table level .that would aid rabi production. Further, it was felt that the farmers who lost their income would possibly sow early or grow more rabi crops to make up for the deficit. Also, it was argued that the floods in Karnataka and Andhra Pradesh would assist the growth of rabi crops. All this may partly be true, but the more important question is whether or not this will help to alleviate the damage.
Given the relatively lower importance of rabi in oilseeds and an equal share in foodgrains, we need to have substantial growth in Q4. Can this happen? Wheat had reached a record of 81 million tonnes last year and to make up for this loss, would have to touch 93 million tonnes, which does not look realistic. The same holds for oilseeds that have to grow by 26% to maintain overall oilseeds production at last year’s level. Even the more optimistic minds would not really take a chance with these numbers.
Therefore, it would be reasonable for one to expect a decline in overall production by the end of the year, notwithstanding the major rabi crops succeeding in the last quarter. Putting numbers on farm output is fraught with risk as no one really knows how the harvest will turn out to be. Very often such conjectures are based more on hope than conviction.
A positive development over the years is however a certain kind of decoupling between agriculture and the rest of the economy. The high growth in social and public services, which is the mirror image for fiscal stimulus, can make up for this loss of output. Industry, too, appears to be more urban-centric and is gradually getting divorced from the farm sector. Therefore, while at the margin the rural folk dependent on agriculture for an income may cut down on demand for industrial products, the urban class has made up for this loss, as it is supported by higher wages (already seen) and booming stock markets, (which provides liquidity to spend).
It will not, therefore, be surprising to have steady growth in real GDP coexist with a negative growth in farm output, high industrial growth, booming service sector and low WPI but high food inflation and higher poverty levels. ..
The thesis on Dubai we must not buy: Financial Express:Dec 03, 2009
The emirate meltdown can pose a big problem for India, and others:
There is a feeling of déjà vu in our official reaction to the Dubai crisis when we say that India will not be affected. If one recollects, we had said the same thing in 2007 when Bear Stearns went down as we scrambled to find out how securitisation and CDOs worked. We retained our high position when Lehman came down and it was only when the meltdown took place that we realised that even though our financial sector had stayed indoors all the time, our feet still got wet; and the rest, as the cliché says, is history.
The Dubai crisis, once again linked with real estate, means that the state does not have money to repay $59 billion that Dubai World owes. One is not really sure of the guarantee provided by the state, as the stance now is that the government was not a party to the bonds issued by the government-owned company. There are two aspects here. The first is that the government has the money but is not willing to help its own company, in which case the future of government-run companies will be questioned, as it is normally assumed that when we put our money in a public sector bank or undertaking, the government provides a guarantee somewhere. The other is that the government is distancing itself merely because it does not have the dollars, which is more serious. The issue is either of credibility or solvency, or a little of both.
The question is what would happen in case the government defaults. Dubai will seek help from the other Emirates, especially Abu Dhabi, and if it succeeds, the problem will become less acute. However, the broader issue is one of confidence, considering that Dubai was touted as being a global financial and gold hub given its natural advantages. Singapore will surely score in this respect and there is a major reputation hit for Dubai.
Did we see this coming? Not really, because while everyone knew that there were repayments due and that the economy was not insulated from the global meltdown, its inability to service debt was never seriously discussed, even though there were some feeble signs thrown by the rating agencies earlier in the year when the credit rating of several banks and government-backed issuers were put on the negative list.
Is India isolated? Absolutely not, because we are going to be affected quite clearly, though the.magnitude could be a matter of conjecture. First, we have over $50 billion of remittances coming in every year, with this region supplying over a quarter of it. Second, we have over 4.5 million Indians staying in the Gulf and several jobs will be in jeopardy in case of a default and its backlash. Third, our trade with the UAE may not be very significant at around $30 billion per annum, but given that exports are primarily food products being consumed by the Indian population, there will be some impact. Fourth, while construction and project companies claim to be secure, it must be remembered that several of our engineering and construction companies have contracts in the GCC region, which will be affected either directly by defaults or indirectly through lower business in the future. Fifth, banks lending to companies in Dubai, either directly or to companies which have projects lined up in this country, would have to revisit their accounting books.
There are two other areas that have to be explored. The first is that if repayment is sought by off-loading US federal bonds, there would be reverberations in the US, which will mean excess selling that can drive up rates, something which the Fed has been trying to eschew for a long time. The other is whether there are similar bubbles elsewhere in the world where the Dubai model of rapid growth through the creations of world’s ‘first’, ‘tallest’, ‘largest’, ‘only’ landmarks through high leverage exist. The creation of such empires, admittedly in retrospect, is a reflection of financial opulence with little character.
The lessons are the following. The first is that one needs to examine closely any fast growth story that is based on high growth sponsored by leverage. The second is that overseas investors will be wary of putting their money even in state-owned outfits as government guarantees appear to be porous. The third relates to rating agencies, which will again have to constantly send out signals to the world and warn of a crisis. The fourth is more of a question, and it is a puzzle with no answer—the latest issue of Economist talks of the high levels of debts in some developed countries. How is one to view them now against the backdrop of this seeming crisis? ..
There is a feeling of déjà vu in our official reaction to the Dubai crisis when we say that India will not be affected. If one recollects, we had said the same thing in 2007 when Bear Stearns went down as we scrambled to find out how securitisation and CDOs worked. We retained our high position when Lehman came down and it was only when the meltdown took place that we realised that even though our financial sector had stayed indoors all the time, our feet still got wet; and the rest, as the cliché says, is history.
The Dubai crisis, once again linked with real estate, means that the state does not have money to repay $59 billion that Dubai World owes. One is not really sure of the guarantee provided by the state, as the stance now is that the government was not a party to the bonds issued by the government-owned company. There are two aspects here. The first is that the government has the money but is not willing to help its own company, in which case the future of government-run companies will be questioned, as it is normally assumed that when we put our money in a public sector bank or undertaking, the government provides a guarantee somewhere. The other is that the government is distancing itself merely because it does not have the dollars, which is more serious. The issue is either of credibility or solvency, or a little of both.
The question is what would happen in case the government defaults. Dubai will seek help from the other Emirates, especially Abu Dhabi, and if it succeeds, the problem will become less acute. However, the broader issue is one of confidence, considering that Dubai was touted as being a global financial and gold hub given its natural advantages. Singapore will surely score in this respect and there is a major reputation hit for Dubai.
Did we see this coming? Not really, because while everyone knew that there were repayments due and that the economy was not insulated from the global meltdown, its inability to service debt was never seriously discussed, even though there were some feeble signs thrown by the rating agencies earlier in the year when the credit rating of several banks and government-backed issuers were put on the negative list.
Is India isolated? Absolutely not, because we are going to be affected quite clearly, though the.magnitude could be a matter of conjecture. First, we have over $50 billion of remittances coming in every year, with this region supplying over a quarter of it. Second, we have over 4.5 million Indians staying in the Gulf and several jobs will be in jeopardy in case of a default and its backlash. Third, our trade with the UAE may not be very significant at around $30 billion per annum, but given that exports are primarily food products being consumed by the Indian population, there will be some impact. Fourth, while construction and project companies claim to be secure, it must be remembered that several of our engineering and construction companies have contracts in the GCC region, which will be affected either directly by defaults or indirectly through lower business in the future. Fifth, banks lending to companies in Dubai, either directly or to companies which have projects lined up in this country, would have to revisit their accounting books.
There are two other areas that have to be explored. The first is that if repayment is sought by off-loading US federal bonds, there would be reverberations in the US, which will mean excess selling that can drive up rates, something which the Fed has been trying to eschew for a long time. The other is whether there are similar bubbles elsewhere in the world where the Dubai model of rapid growth through the creations of world’s ‘first’, ‘tallest’, ‘largest’, ‘only’ landmarks through high leverage exist. The creation of such empires, admittedly in retrospect, is a reflection of financial opulence with little character.
The lessons are the following. The first is that one needs to examine closely any fast growth story that is based on high growth sponsored by leverage. The second is that overseas investors will be wary of putting their money even in state-owned outfits as government guarantees appear to be porous. The third relates to rating agencies, which will again have to constantly send out signals to the world and warn of a crisis. The fourth is more of a question, and it is a puzzle with no answer—the latest issue of Economist talks of the high levels of debts in some developed countries. How is one to view them now against the backdrop of this seeming crisis? ..
Friday, November 27, 2009
Loan futures could bring transparency to lending business: Economic Times: 25th November 2009
The interest rate movements in the past seven months throw up some interesting details. The cost of raising funds for the government as represented by the yield on 10-year paper increased from 6.13% in April to 7.40% in October.
In the corporate debt market, public sector banks paid a premium of between 1.8% in June and 2% in May over the government borrowing rate for a similar maturity. In contrast, private firms, including private sector banks, paid a premium of between 1.9% in October and 4.38% in May for loans of similar tenure. What do these mean?
Firstly, there is a high risk premium attached to corporate debt over government securities which increases with the type of entity. These spreads were much lower within a range of around 2% in 2006-07 before the financial crisis set in.
Secondly, anyone entering the market needs to take a view on interest rates well before the issuance as the corporate debt market is not liquid and there may just not be a secondary market for the same. There is hence a balance to be struck between requirement of funds and the interest rate expectations.
Thirdly, while the cost to a corporate is higher than that for the government, it is still lower than the bank PLR, though banks do not give loans for such tenures. But, still, it is preferable to the PLR-based lending of term financial institutions. Fourthly, both borrowers and lenders carry this risk of rates moving in either direction as when one party gains, the other loses.
A practical solution is the cover available through interest rate future, though ideally options would be desirable. A company which borrows money today at, say, 10% and expects rates to come down after six months can simultaneously lock into an interest rate future, IRF, contract by buying the underlying GSec that can be sold when the price rises and interest rates come down. This would be a useful hedge.
The lender could also take a counter position and hence both the markets would receive an impetus. The existence of the IRF market would make the corporate debt market more buoyant as it would to an extent cover the lacunae of a liquid secondary market. There is a theoretical solution too, even though it may sound unconventional. Today interest rates are fixed based on market perception and not market forces. Usually, it is linked to the existing PLR with an adjustment for the risk involved as well as the expectations of interest rates as these are typically long-term bonds.
A thought worth pursuing is having a derivative market for bond or loan futures wherein there are fixed denomination bonds that are traded on NSE for fixed tenures for a certain grade of rated company. Hence, we could have a bond for Rs 100 crore with a coupon rate of 8% and rated triple A which would be transacted six months down the line. The nomenclature for the same would be AAA 8% May 2010 contract where every contract has a size of Rs 100 crore.
Banks would be the sellers and corporates the buyers though anyone can actually participate on the exchange. The price of the bond would move during these six months and may settle for say Rs 98 implying an implicit yield of 8.16% which can then be taken to be the market determined rate. This innovative product would go beyond the IRF where one is indirectly seeking cover and add a great deal of the market mechanism in interest rate determination.
A successful market for such loan/bond futures would go a step further in providing a view of what the PLR should be from the point of view of the market. This will bring in some degree of transparency into the lending business. Today rates are fixed by banks based on their internal pricing policies which may not be inclined towards the market and loan futures will in a way create a market. Loan futures will address the concerns of the market mechanism and players simultaneously.
In the corporate debt market, public sector banks paid a premium of between 1.8% in June and 2% in May over the government borrowing rate for a similar maturity. In contrast, private firms, including private sector banks, paid a premium of between 1.9% in October and 4.38% in May for loans of similar tenure. What do these mean?
Firstly, there is a high risk premium attached to corporate debt over government securities which increases with the type of entity. These spreads were much lower within a range of around 2% in 2006-07 before the financial crisis set in.
Secondly, anyone entering the market needs to take a view on interest rates well before the issuance as the corporate debt market is not liquid and there may just not be a secondary market for the same. There is hence a balance to be struck between requirement of funds and the interest rate expectations.
Thirdly, while the cost to a corporate is higher than that for the government, it is still lower than the bank PLR, though banks do not give loans for such tenures. But, still, it is preferable to the PLR-based lending of term financial institutions. Fourthly, both borrowers and lenders carry this risk of rates moving in either direction as when one party gains, the other loses.
A practical solution is the cover available through interest rate future, though ideally options would be desirable. A company which borrows money today at, say, 10% and expects rates to come down after six months can simultaneously lock into an interest rate future, IRF, contract by buying the underlying GSec that can be sold when the price rises and interest rates come down. This would be a useful hedge.
The lender could also take a counter position and hence both the markets would receive an impetus. The existence of the IRF market would make the corporate debt market more buoyant as it would to an extent cover the lacunae of a liquid secondary market. There is a theoretical solution too, even though it may sound unconventional. Today interest rates are fixed based on market perception and not market forces. Usually, it is linked to the existing PLR with an adjustment for the risk involved as well as the expectations of interest rates as these are typically long-term bonds.
A thought worth pursuing is having a derivative market for bond or loan futures wherein there are fixed denomination bonds that are traded on NSE for fixed tenures for a certain grade of rated company. Hence, we could have a bond for Rs 100 crore with a coupon rate of 8% and rated triple A which would be transacted six months down the line. The nomenclature for the same would be AAA 8% May 2010 contract where every contract has a size of Rs 100 crore.
Banks would be the sellers and corporates the buyers though anyone can actually participate on the exchange. The price of the bond would move during these six months and may settle for say Rs 98 implying an implicit yield of 8.16% which can then be taken to be the market determined rate. This innovative product would go beyond the IRF where one is indirectly seeking cover and add a great deal of the market mechanism in interest rate determination.
A successful market for such loan/bond futures would go a step further in providing a view of what the PLR should be from the point of view of the market. This will bring in some degree of transparency into the lending business. Today rates are fixed by banks based on their internal pricing policies which may not be inclined towards the market and loan futures will in a way create a market. Loan futures will address the concerns of the market mechanism and players simultaneously.
It’s not just sugar that tastes bitter: Financial Express: 21st November 2009
The current imbroglio on sugarcane pricing needs deeper thought. The issue basically is that the minimum price to be paid to the farmer was increased by the Central government through the fair & remunerative price (FRP). However, the state governments would like to have a higher statutory price, which they would not like to pay for. They would have the mills pay this difference as was the case earlier. The farmers evidently want a price higher than the FRP that has been offered (Rs 130/ quintal). All this has led to harsh words over these actions being anti-farmer and pro-sugar mills. The view here is that we need to take a closer look at the broader issue of price determination by the government in agriculture. Prices are fixed to provide a basic minimum income to the farmer, which reduces volatility in his earnings, ensures that enough of the crop is cultivated and that the consumer pays a reasonable price. This ideology is fair enough as all governments support agriculture with subsidies and may be justified as being necessary. However, price intervention by the government in India comes in two forms. The first is the minimum support price (MSP) where the government assures the farmers of a minimum price that will be paid for a fair quality of produce. The scheme is open-ended and the cost is borne by the government in the form of the food subsidy Bill. There can be no quarrel here as it is a government prerogative. The second intervention is like that in sugarcane, where the Central government sets a minimum price that mills have to pay and could pay more depending on demand & supply conditions. Here there is no government purchase and the mills have to pay the cost. Similar prices are set for cotton and jute. There is an issue here because the government is fixing a floor for the mills. The SMP or FRP makes sense in terms of guaranteeing protection to the farmer, but anything beyond should be left to market forces. This is so because once the minimum threshold price is increased; it can never be lowered in future even if there is surplus production. Hence, while hiking rates at a time when sugarcane production is down, which sounds pragmatic to encourage sowing, this would lead to a disastrous situation in case there is surplus production when prices become unrealistic. A solution would simply.be to pay cash subsidies to farmers directly by the state or Central governments for producing a certain quantity of sugarcane. The price should be left open to the market. The other problem with these prices is that while they are meant to improve the cropping pattern, once they reach unrealistic levels, would tend to distort the same. Therefore, higher MSP, FRP, SMP or SAP would make farmers grow more of the crop, thus creating distortions in production of other crops. We have seen this happen for rice and wheat where farmers prefer to grow them because of the higher relative income to be earned. This has created two problems. The first is that pulses and oilseeds, where India is in the deficit territory, have tended to lag as the first choice is rice and wheat. The second is that these crops, including sugarcane, are more water-intensive, which has resulted in the water table levels dropping, which has serious implications in the future as rainfall has been inconsistent progressively. The final problem is inflation. The government has, in a way, indirectly sponsored inflation to a great extent by inflating these numbers. When the threshold price level is raised, there would be a tendency for it to become a benchmark, which increases the prices of other grades, too. Last year, the MSPs were increased by over 30% for rice, 35-40% for coarse grains, 30-50% for pulses etc. Now, if sugarcane prices are going to be doubled, then quite evidently we must be prepared for high sugar prices. A cash subsidy would take care of the inflation aspect and also keep the prices market oriented. The debate hence is quite myopic today, and we need to take a longer term view of such pricing given. We also need to gradually move towards a market pricing system, which is more efficient. The government should also move away from purchasing, storing and transporting products except for what is essential (PDS and buffers). In this context, futures trading in sugarcane should be seriously considered and can be supplemented by direct cash subsidies, in case prices move downwards. This market would be exciting as there would be large number of hedgers on both ends, which would make the price discovery process more transparent and efficient. There is hence an urgent need to downplay the current pressures on pricing, which are transient, and could change.
Tuesday, November 17, 2009
The folly of GDP predictions: MInt 16th November 2009
GDP forecasts can mislead, while their multitude can confuse. Governments should rather focus on targeting
Think of any variable and you will realize that its number is amenable to forecasting. Earlier, macroeconomic forecasts used to be accompanied by shoulder shrugs but today, there is a sense of finality as strong econometric models back them. Hence, we have a wide array of such forecasts provided by different agencies and, not surprisingly, the final number is quite different. All of which prompts confusion, and perhaps even imprudent decision-making.
Let us look at the forecast for gross domestic product (GDP) growth for India today. The Reserve Bank of India (RBI) put out a forecast of 6% for 2009-10 on 27 October, which was lower by 0.5 percentage point from what the Prime Minister’s economic advisory council had predicted a week before. Subsequently, the Planning Commission upped its own forecast from 6% to 6.5%. The International Monetary Fund (IMF) says 5.4%, the Asian Development Bank says 6.0%, the World Bank says 5.1%, the Organisation for Economic Co-operation and Development says 5.9%, the Indian Council for Research on International Economic Relations says 5.8-6.1%, while the National Council of Applied Economic Research says 7.2%.
So the range of forecasts is between 5.1% and 7.2%; quite clearly, the actual number will lie somewhere in between. All will claim, when the actual GDP figures are out, that they missed it by a certain margin. However, in monetary terms, this margin is substantial. India’s real GDP in 2008-09 was around Rs36.1 trillion. A variation of 1% in the forecast would actually mean around Rs36,000 crore (in constant terms). That amount is too large to be simply waved as a statistical error. Can we then choose the best forecast?
The answer is that it is inherently very difficult to gauge how the economy will behave by the end of the year.
First, we need to distinguish between statistical forecasts and targets. If it is the former, then we have a problem because when we have to forecast GDP, we have to take a call on agriculture, industry and services, which is a tough one. How do we know the behaviour of the monsoon in April or the performance of the rabi crop? Also, industrial growth is whimsical and dependent on agriculture. Further, around 40% of the service sector output comes from the unorganized sector—transport, hotels, retail trade, real estate—subject to varied imputations, thanks to lack of recorded data, and hence difficult to conjecture.
Econometric models use past data; but this is very unreliable because the performance of any sector is based on current conditions such as the monsoon, crop damage, government spending and so on. The variables that determine the forecast are themselves subject to forecasts, which make the entire process prone to error. Rough GDP scenarios are better hedges, but are not precise.
One can instead sit back and say: Agriculture accounts for around 20% of GDP and will show a growth of 2%; industry, with 20% of GDP, will grow by 8%; services, with 60%, by 8%—and then simply arrive at a GDP growth rate of 6.8%, which will not be far off from the final number!
Hence, pragmatically, it makes more sense to talk of GDP targeting instead, which governments should do. Ideally, they should target growth of, say, 7% and align policies for the same. They can then scale this target based on changing circumstances.
Second, we should remember that there are just too many imponderables during a year. Besides the varied domestic factors mentioned above, globalization has increased the shock effect of unknown variables—or the epsilons in econometrics jargon. Oil prices rising or falling, a war, the US Federal Reserve’s rate changes, housing boom and carry trade are some events which affect our economy indirectly through the trade and capital flow routes.
Third, this plethora of estimates is confusing, even though they are theoretically sound. Rarely does an estimator always get the number right, which means that the reader will never know which is the best estimate. So what is the reader to believe?
Curiously, IMF—which uses some of the most sophisticated models—also goes off the mark most of the time (see table). Based on the World Bank’s estimates of GDP in 2008, the world economy was sized at $60 trillion. A deviation of 0.1% of GDP here means going off the mark by $60 billion. The euro economy going off the mark by 0.7 percentage point means a $95 billion change! As can be seen in the table, the 2008 estimates were quite out of line, while 2007 was only marginally better.
So what are we to make of such statistical exercises in India? In general, RBI has been closer to the mark. Global agencies tend to be pessimistic, while agencies that try to “sell” India are usually optimistic. Politicians are overly sanguine when they take a call for future years, especially if the present looks cloudy.
But here’s the rub: Taking business decisions based on forecasts could upset the apple cart. Over-sanguine or over-gloomy forecasts could prompt over- or under-investment. So, even after businesses overcome the confusion of deciding whose estimate to rely on, they could be hurt when they realize that the estimate was far from reliable.
So while governments should consider targets, the average businessperson is best off glancing at one of these myriad forecasts, and then probably doing nothing about it.
Think of any variable and you will realize that its number is amenable to forecasting. Earlier, macroeconomic forecasts used to be accompanied by shoulder shrugs but today, there is a sense of finality as strong econometric models back them. Hence, we have a wide array of such forecasts provided by different agencies and, not surprisingly, the final number is quite different. All of which prompts confusion, and perhaps even imprudent decision-making.
Let us look at the forecast for gross domestic product (GDP) growth for India today. The Reserve Bank of India (RBI) put out a forecast of 6% for 2009-10 on 27 October, which was lower by 0.5 percentage point from what the Prime Minister’s economic advisory council had predicted a week before. Subsequently, the Planning Commission upped its own forecast from 6% to 6.5%. The International Monetary Fund (IMF) says 5.4%, the Asian Development Bank says 6.0%, the World Bank says 5.1%, the Organisation for Economic Co-operation and Development says 5.9%, the Indian Council for Research on International Economic Relations says 5.8-6.1%, while the National Council of Applied Economic Research says 7.2%.
So the range of forecasts is between 5.1% and 7.2%; quite clearly, the actual number will lie somewhere in between. All will claim, when the actual GDP figures are out, that they missed it by a certain margin. However, in monetary terms, this margin is substantial. India’s real GDP in 2008-09 was around Rs36.1 trillion. A variation of 1% in the forecast would actually mean around Rs36,000 crore (in constant terms). That amount is too large to be simply waved as a statistical error. Can we then choose the best forecast?
The answer is that it is inherently very difficult to gauge how the economy will behave by the end of the year.
First, we need to distinguish between statistical forecasts and targets. If it is the former, then we have a problem because when we have to forecast GDP, we have to take a call on agriculture, industry and services, which is a tough one. How do we know the behaviour of the monsoon in April or the performance of the rabi crop? Also, industrial growth is whimsical and dependent on agriculture. Further, around 40% of the service sector output comes from the unorganized sector—transport, hotels, retail trade, real estate—subject to varied imputations, thanks to lack of recorded data, and hence difficult to conjecture.
Econometric models use past data; but this is very unreliable because the performance of any sector is based on current conditions such as the monsoon, crop damage, government spending and so on. The variables that determine the forecast are themselves subject to forecasts, which make the entire process prone to error. Rough GDP scenarios are better hedges, but are not precise.
One can instead sit back and say: Agriculture accounts for around 20% of GDP and will show a growth of 2%; industry, with 20% of GDP, will grow by 8%; services, with 60%, by 8%—and then simply arrive at a GDP growth rate of 6.8%, which will not be far off from the final number!
Hence, pragmatically, it makes more sense to talk of GDP targeting instead, which governments should do. Ideally, they should target growth of, say, 7% and align policies for the same. They can then scale this target based on changing circumstances.
Second, we should remember that there are just too many imponderables during a year. Besides the varied domestic factors mentioned above, globalization has increased the shock effect of unknown variables—or the epsilons in econometrics jargon. Oil prices rising or falling, a war, the US Federal Reserve’s rate changes, housing boom and carry trade are some events which affect our economy indirectly through the trade and capital flow routes.
Third, this plethora of estimates is confusing, even though they are theoretically sound. Rarely does an estimator always get the number right, which means that the reader will never know which is the best estimate. So what is the reader to believe?
Curiously, IMF—which uses some of the most sophisticated models—also goes off the mark most of the time (see table). Based on the World Bank’s estimates of GDP in 2008, the world economy was sized at $60 trillion. A deviation of 0.1% of GDP here means going off the mark by $60 billion. The euro economy going off the mark by 0.7 percentage point means a $95 billion change! As can be seen in the table, the 2008 estimates were quite out of line, while 2007 was only marginally better.
So what are we to make of such statistical exercises in India? In general, RBI has been closer to the mark. Global agencies tend to be pessimistic, while agencies that try to “sell” India are usually optimistic. Politicians are overly sanguine when they take a call for future years, especially if the present looks cloudy.
But here’s the rub: Taking business decisions based on forecasts could upset the apple cart. Over-sanguine or over-gloomy forecasts could prompt over- or under-investment. So, even after businesses overcome the confusion of deciding whose estimate to rely on, they could be hurt when they realize that the estimate was far from reliable.
So while governments should consider targets, the average businessperson is best off glancing at one of these myriad forecasts, and then probably doing nothing about it.
Tuesday, November 10, 2009
Why bank on RBI’s rate change? Mint: 22nd October 2009
If commercial lenders reduce intermediation costs, they can cut lending rates. RBI should consider that Since there is general agreement in India’s macroeconomic circles that inflation will increase, the logical corollary is to conjecture the Reserve Bank of India’s (RBI) view on interest rates. Apologists for industry are warning that any increase in interest rates could hamper industrial recovery, as had happened in the past. But before we jump to that conclusion, the positions of the four constituents in this matter—RBI, banks, borrowers and deposit holders—need to be considered.Last year, RBI intervened as many as 11 times with the cash reserve ratio (the portion of deposits each bank keeps as reserves), nine times with the repo rate (to inject liquidity into the system) and five times with the reverse repo rate (to absorb liquidity from the system). To begin with, it increased these rates initially to counter what was agreed to be cost-push inflation—one caused by a decrease in aggregate supply, and hence an increase in prices of goods and services—and then lowered the rates to spur growth as part of the government’s stimulus package in the wake of the slowdown. Inflation today is still a supply-driven phenomenon, but RBI has to brace up to ensure that such a situation does not snowball into a demand-pull inflation scenario—one caused by an increase in aggregate demand relative to supply that the central bank can influence more easily. Hence, it may embark on increasing interest rates.Prima facie, the view that higher rates will affect industrial investment and production may be an overstatement since interest costs as a percentage of total expenses is quite low; in fact, it has declined from 5.1% in fiscal 2000 to 2.7% in fiscal 2009, according to data from the Centre for Monitoring Indian Economy. The overall business environment rather than borrowing costs is more likely to be the clinching factor for investment decisions.This view is supported in Table 1, where prime lending rates (PLRs) have been juxtaposed with growth in credit. Growth in credit in fiscal 2007 was buoyant despite higher rates, while the expected pattern was not witnessed in fiscal 2001, 2002, 2006 and 2009. Interest rates may be the clinching factor at the margin in case of mortgages or auto loans in the retail segment—but the capital cost of the dwelling or vehicle may still matter more.Households could feel some relief if interest rates on deposits are increased as they earn a negative real return on deposits at present —with inflation, as measured by consumer price indices, exceeding 10% (the real rate equals the nominal rate minus inflation)—and as they are at present not organized to lobby for higher rates. Yet, banks have always argued that they cannot alter deposit rates in the face of state-administered interest rates on small savings, which are high. And, they say, if they can’t change the deposit rate, they can’t change their lending rates. However, this does not always hold, as seen in fiscal 2002 (Table 1).The solution really lies in the operations of banks. Banks perform the function of intermediation and take deposits from the public and bear the risk of lending the money. Can there be any benchmark for the cost of intermediation where the interests of deposit holders and borrowers are matched?The behaviour of banks in the last decade sheds some light. To begin with, they have been free to determine their interest rates ever since India went in for deregulation in 1994-95. However, the repo rate has still served as the benchmark, without good reason. The average quantum of borrowings from RBI through the repo or reverse repo windows has not exceeded Rs30,000 crore a day. Given that incremental credit in a year is in the region around Rs5 trillion, the relatively low levels of repo borrowings should not be significant.Table 1 shows that banks have tended to adjust their rates in a differential manner. In eight of the 10 years, deposit rates have moved in accordance with changes in the repo rate, while lending rates have followed suit in only five. In fact, in fiscal 2010, the deposit rate has come down by 1.5 percentage points while PLR has decreased by 0.5 percentage point. Can lending rates not respond faster?The table also shows that banks have been working on a relatively high spread (difference between PLR and deposit rate), which has increased from as low as 2.5% in fiscal 2001 to 7% in fiscal 2004. There is potential for banks to actually operate on lower spreads— considering that they are in the region of 1-2.5% globally.While the intermediation spread captures the macro picture, Table 2 provides the actual spread of banks, defined as excess of returns over cost of funds. The variation is quite stark out here: Foreign banks have exceptionally high spreads, followed by private banks and then public sector banks. The difference can be attributed to the composition of loans, with some banks focusing more on cards, automobiles and personal segments, where rates are higher. Public sector banks have more moderate spreads, as there is a commitment to the priority sector, where PLR easily becomes the benchmark.The message clearly is that we need to reduce intermediation costs to strike a balance. Banks complain that they have limited manoeuvrability to lower lending rates, which is perhaps an excuse.
Finally, a pragmatic sell off: Financial Express: November 10, 2009
Disinvestment has been a glowing controversy ever since we first spoke about it several years ago. It came in the form of privatisation to begin with, which raised the hackles of the left parties as anything ‘private’ was looked upon with suspicion. Coincidently, anything ‘private’ was looked at by the policymakers as being progressive.
Privatisation through disinvestment did not quite make the capitalist ideal, as the question raised was that the same outcomes could have been effected by changing the work ethics rather than the ownership. Further, the fact that only profit-making enterprises were targeted made the concept opportunistic, as it suited both the parties. The government was happy because it would get money, which the loss-making firms—which probably required private ownership more—would not achieve. Private sector would not have touched a loss-making unit anyway and profit-making firms were attractive propositions for them. It was a win-win situation, but the critics slammed it, saying that we were selling the family silver. Some big companies were partly divested, then the pace slowed down and, amidst controversy, went into a recess.
The issue of disinvestment to take care of the budgetary requirements came up as a compelling economic argument for the same. Protagonists said that such proceeds should not be used for financing the revenue deficit, but for lowering public debt. It was argued that public debt could be repaid through these proceeds, which, in turn, would lower interest payments and hence the fiscal deficit would come down in course of time. While this argument looked okay, there was a counter-argument here. If these funds were not used for financing the fiscal deficit but used to lower public debt, then fiscal deficit would increase proportionately, as borrowings were needed to finance the budget and the size of the debt would not really change. Therefore, this argument, too, was not strong enough, as it would simply be an exercise in financial accounting. The budget then stopped putting these numbers in the final accounts.
Now, there is a new look being taken by the government. It wants to have the unlisted ones listed and get the listed ones to have at least 10% of their shares held by the public. The funds so mobilised—something of the order of Rs 50,000 crore or above—would go into the National Investment Fund (NIF). The initial thoughts on the NIF were that the interest on the fund would be .used for social purposes, but now it appears that the capital amount will directly be deployed for social capital, and hence, will be of much larger amount. Is this thought process okay?
In a way it is, because we are at least clear that we want to use this money for investment projects in the social sector, which if deployed judiciously, cannot be argued against. We are not bringing in the private ethic, which has failed in the West, or the fiscal deficit or public debt argument, which is somewhat contradictory as argued earlier. Therefore, the result can be only positive. The policy appears to be pragmatic in this context by choosing only profit-making firms, as the loss-making ones would not command similar valuation in the market.
But, can this be a policy? This is the broader issue because if the government keeps on doing this, there will be a point when a critical decision will have to be taken as to whether or not the unit will remain in the private sector. And a logical corollary is that this will not be a bottomless moneybag from where funds can be drawn. But, nevertheless this money can be used for investment in social infrastructure.
A curious issue will be that in case these funds are earmarked for capital projects, then will there be less pressure on the government to incur such expenditures within the confines of the traditional budget? Therefore,
if we exclude these disinvestments, it should not be the case that the government concentrates only on the revenue side and not the capital side. The other possibility is that the disinvestment finances incremental capital formation, in which case the fiscal deficit is not affected and remains at the usual level, which will then be beneficial.
What about the capital market? This move is good news as there will be more equity issues in the pipeline and the market is looking for such issues. Investors can cheer, as they will have more options and there will be a lot of money to be made with the overall market capitalisation of Indian firms increasing substantially.
Therefore, we can on the whole feel good about this move at disinvestment if we keep in mind the fact that we are not particular about selling our silver. As we reach the 49% mark, a hard decision will have to be taken. Till then it may just be rightto say, hallelujah. ... ..
Privatisation through disinvestment did not quite make the capitalist ideal, as the question raised was that the same outcomes could have been effected by changing the work ethics rather than the ownership. Further, the fact that only profit-making enterprises were targeted made the concept opportunistic, as it suited both the parties. The government was happy because it would get money, which the loss-making firms—which probably required private ownership more—would not achieve. Private sector would not have touched a loss-making unit anyway and profit-making firms were attractive propositions for them. It was a win-win situation, but the critics slammed it, saying that we were selling the family silver. Some big companies were partly divested, then the pace slowed down and, amidst controversy, went into a recess.
The issue of disinvestment to take care of the budgetary requirements came up as a compelling economic argument for the same. Protagonists said that such proceeds should not be used for financing the revenue deficit, but for lowering public debt. It was argued that public debt could be repaid through these proceeds, which, in turn, would lower interest payments and hence the fiscal deficit would come down in course of time. While this argument looked okay, there was a counter-argument here. If these funds were not used for financing the fiscal deficit but used to lower public debt, then fiscal deficit would increase proportionately, as borrowings were needed to finance the budget and the size of the debt would not really change. Therefore, this argument, too, was not strong enough, as it would simply be an exercise in financial accounting. The budget then stopped putting these numbers in the final accounts.
Now, there is a new look being taken by the government. It wants to have the unlisted ones listed and get the listed ones to have at least 10% of their shares held by the public. The funds so mobilised—something of the order of Rs 50,000 crore or above—would go into the National Investment Fund (NIF). The initial thoughts on the NIF were that the interest on the fund would be .used for social purposes, but now it appears that the capital amount will directly be deployed for social capital, and hence, will be of much larger amount. Is this thought process okay?
In a way it is, because we are at least clear that we want to use this money for investment projects in the social sector, which if deployed judiciously, cannot be argued against. We are not bringing in the private ethic, which has failed in the West, or the fiscal deficit or public debt argument, which is somewhat contradictory as argued earlier. Therefore, the result can be only positive. The policy appears to be pragmatic in this context by choosing only profit-making firms, as the loss-making ones would not command similar valuation in the market.
But, can this be a policy? This is the broader issue because if the government keeps on doing this, there will be a point when a critical decision will have to be taken as to whether or not the unit will remain in the private sector. And a logical corollary is that this will not be a bottomless moneybag from where funds can be drawn. But, nevertheless this money can be used for investment in social infrastructure.
A curious issue will be that in case these funds are earmarked for capital projects, then will there be less pressure on the government to incur such expenditures within the confines of the traditional budget? Therefore,
if we exclude these disinvestments, it should not be the case that the government concentrates only on the revenue side and not the capital side. The other possibility is that the disinvestment finances incremental capital formation, in which case the fiscal deficit is not affected and remains at the usual level, which will then be beneficial.
What about the capital market? This move is good news as there will be more equity issues in the pipeline and the market is looking for such issues. Investors can cheer, as they will have more options and there will be a lot of money to be made with the overall market capitalisation of Indian firms increasing substantially.
Therefore, we can on the whole feel good about this move at disinvestment if we keep in mind the fact that we are not particular about selling our silver. As we reach the 49% mark, a hard decision will have to be taken. Till then it may just be rightto say, hallelujah. ... ..
More about IMF than about RBI: Financial Express: November 5, 2009
How important is a transaction of 200 tonnes of gold from an economic standpoint? At the moment, we have a case of the IMF selling gold and RBI purchasing the same at a value of around $6.7 billion.
There is another lot of gold (of similar amount) which will also be up for sale soon. Such transactions are not very common, but at the same time do not have any shock value. To begin with, there was some movement in the gold market, which stabilised subsequently. The last time the IMF had indulged in such a sale was in 1999-2000 when Mexico and Brazil were the purchasers. Still, this transaction is quite interesting for several reasons.
First, the sale of gold by IMF is significant because it evidently means that the Fund needs money to carry out its operations. They have tried to get members to supply funds but the sale of gold, which would otherwise have been residing in their lockers, is probably a prudent step. We are told that China may be the potential buyer for the second lot. Hopefully the money generated would be used for its core purpose—correcting imbalances in the balance of payments of countries. The IMF has come under scrutiny of late for losing its relevance at a time when global capital flows have taken care of forex issues of several countries.
Did the IMF get a good deal? The answer is yes, because when they had thought up this plan, the price was around $850/ounce. This means that the sale at $1,045 is a bonus of just over 20%.
Second, from our point of view, this purchase can be taken with a sense of pride, since we are increasing our gold reserves. In terms of share in forex reserves, as per latest
RBI data, such a shift would mean an increase from 3.6% to 6%. But, does this mean anything significant? Not really.
We have actually purchased gold at a time when the price has crossed the psychological $1,000/ounce barrier.
Therefore, the timing may not have been very appropriate. In case the RBI was keen to augment its gold reserves, there could have been savings by buying in the market as a Treasury activity. It appears that it has entered the fray merely because the gold was up for sale by the IMF. It would be useful if the RBI periodically evaluates the mark-to-market holding on to these additional gold reserves.
Third, will the bullion market be impacted? It was affected to a certain extent when the news came out that the IMF was selling gold. But, it should not really matter because this entire transaction doesn’t affect the markets—gold was merely moving out of the IMF’s vault to RBI’s locker. Nobody should have been affected by such a transaction and thus, besides the initial reaction, there have not been significant reverberations.
To the extent that there have been, it is based more on what will happen, or rather who is to buy the remaining 200 tonnes. Further, with average daily volumes of around 500 tonnes a day on COMEX, this quantity is not really significant as such. The good news here is that such bilateral sales are price neutral, which would not have been the case, in case the IMF sold actively in the market.
Fourth, there are implications for the dollar, which is serious. The fact is that nations are looking at alternatives to the dollar given the way in which the US economy has been functioning and the dollar weakening. There has been talk of countries moving over to the euro, which is considered to be stronger. The preference for gold is a corollary. However, with the IMF not expected to go beyond the 400-tonne level, there may not be too much to this transaction in terms of broader implications for the dollar.
Fifth, the decision for the IMF and countries like India to deal with gold is also slightly anomalous because the world economy had actually moved out of the Gold Standard after the Depression of the 1930s. The hope when IMF was created in 1944 was to move away from metals to currencies and the SDR came into being for this purpose. Going back to gold, which hopefully will not be a habit, does sound a bit anachronistic.
One may recollect that India had to pledge gold way back in 1991 when our forex reserves had declined and then had gone to the IMF for a loan. The IMF is not in a crisis situation but certainly requires liquidity. It is ironical that India is actually providing IMF with cash now, thus reciprocating an exchange from 18 years ago.
There is another lot of gold (of similar amount) which will also be up for sale soon. Such transactions are not very common, but at the same time do not have any shock value. To begin with, there was some movement in the gold market, which stabilised subsequently. The last time the IMF had indulged in such a sale was in 1999-2000 when Mexico and Brazil were the purchasers. Still, this transaction is quite interesting for several reasons.
First, the sale of gold by IMF is significant because it evidently means that the Fund needs money to carry out its operations. They have tried to get members to supply funds but the sale of gold, which would otherwise have been residing in their lockers, is probably a prudent step. We are told that China may be the potential buyer for the second lot. Hopefully the money generated would be used for its core purpose—correcting imbalances in the balance of payments of countries. The IMF has come under scrutiny of late for losing its relevance at a time when global capital flows have taken care of forex issues of several countries.
Did the IMF get a good deal? The answer is yes, because when they had thought up this plan, the price was around $850/ounce. This means that the sale at $1,045 is a bonus of just over 20%.
Second, from our point of view, this purchase can be taken with a sense of pride, since we are increasing our gold reserves. In terms of share in forex reserves, as per latest
RBI data, such a shift would mean an increase from 3.6% to 6%. But, does this mean anything significant? Not really.
We have actually purchased gold at a time when the price has crossed the psychological $1,000/ounce barrier.
Therefore, the timing may not have been very appropriate. In case the RBI was keen to augment its gold reserves, there could have been savings by buying in the market as a Treasury activity. It appears that it has entered the fray merely because the gold was up for sale by the IMF. It would be useful if the RBI periodically evaluates the mark-to-market holding on to these additional gold reserves.
Third, will the bullion market be impacted? It was affected to a certain extent when the news came out that the IMF was selling gold. But, it should not really matter because this entire transaction doesn’t affect the markets—gold was merely moving out of the IMF’s vault to RBI’s locker. Nobody should have been affected by such a transaction and thus, besides the initial reaction, there have not been significant reverberations.
To the extent that there have been, it is based more on what will happen, or rather who is to buy the remaining 200 tonnes. Further, with average daily volumes of around 500 tonnes a day on COMEX, this quantity is not really significant as such. The good news here is that such bilateral sales are price neutral, which would not have been the case, in case the IMF sold actively in the market.
Fourth, there are implications for the dollar, which is serious. The fact is that nations are looking at alternatives to the dollar given the way in which the US economy has been functioning and the dollar weakening. There has been talk of countries moving over to the euro, which is considered to be stronger. The preference for gold is a corollary. However, with the IMF not expected to go beyond the 400-tonne level, there may not be too much to this transaction in terms of broader implications for the dollar.
Fifth, the decision for the IMF and countries like India to deal with gold is also slightly anomalous because the world economy had actually moved out of the Gold Standard after the Depression of the 1930s. The hope when IMF was created in 1944 was to move away from metals to currencies and the SDR came into being for this purpose. Going back to gold, which hopefully will not be a habit, does sound a bit anachronistic.
One may recollect that India had to pledge gold way back in 1991 when our forex reserves had declined and then had gone to the IMF for a loan. The IMF is not in a crisis situation but certainly requires liquidity. It is ironical that India is actually providing IMF with cash now, thus reciprocating an exchange from 18 years ago.
Tuesday, October 20, 2009
Reconciling Williamson and Ostrom in our world: 20th October 2009: Financial Express
It is quite appropriate that the Nobel Prize in Economics this year has been awarded to persons who have worked broadly in the field of governance, which is the talking point today. The winners have spoken on how to enforce rules where detailed contracts or legal frameworks do not exist. The recent financial crisis was a failure of governance where unbridled greed exposed the fallacies of Smith’s invisible hand. The two awardees do compel us to reflect over how their theories should be viewed in the context of what has transpired.
Elinor Ostrom’s work is significant because it talks of how community resources are best managed by users of the resource. At the most rudimentary level, when a housing society owns the premises, it best uses the resources that go along with it. There is no wastage of water or electricity as the society ensures that there is optimisation Forests, water, pastures etc, would ideally be best managed by users, provided property rights are transferred to them. This is the problem in India, where there is a difference between owners, managers and users, with all of them having their own motivations. The owners are typically the government or the private sector. Governments are inefficient as they have no interest in maximising benefits and often conduct business where there is no expertise. They manage an irrigation system because they have to, and are not concerned with leakages or wastage. Private sector is profit- motivated and would squeeze the maximum from the resource that does not optimise the welfare of society. Users do not value a service when the government provides it at a low cost. Farmers tend to waste water or over-graze cattle or over-exploit land for sowing when it is cheap. If the resource is provided by the private sector, then it is not affordable for them. This is the conundrum.
Therefore, ideally, resources should be owned by users. The formation of cooperatives was a step in this direction, where the cooperative works for enhancing value for the members. However, rarely has the natural resource been owned by the cooperative. This means that unless we have a combination of joint ownership by users, which means transfer of property rights to them at a cost, such resources will continue to be sub-optimally used as they are owned by the government or private enterprise.
Now, this ideal situation would confront the Oliver Williamson theory,which states that administrative decisions within a legal entity are more efficient than a market transaction. Williamson showed that complex transactions, involving investment decisions that are much more valuable within a relationship than to a third party, are best made within a firm. But he also showed that organising matters within companies had costs as it relied on internal authority—which could be abused—to get things done.
In light of the recent financial crisis, is it possible to put these two theories together? Firms should be classified as those that are owner-driven or professionally managed, where owners are several and dispersed. Owner-driven firms tend to be more efficient in taking decisions and tend to be more efficient than the markets, but they will not have public interest. Here, there is less likelihood of abuse of internal authority. But the financial crisis showed that it was organisations where the appointed chiefs were not the owners that delivered sub-optimal results, by over-leveraging and stretching their luck in the securitisation markets.
If we go back to the Ostrom case of user ownership, the possibility of abuse of internal authority is possible. Absence of professionals to run the organisation will have an inherent bias toward less efficient governance. While farmers may run their resource say an irrigation project well, the moment the scale changes, there would be need to bring in professionals who can improve functioning. As we move from micro-level resource to a larger setup, the downside risk of decision-taking internally could be a stumbling block.
Both theories are good at the micro-level in the ideal state, which rarely occurs. Ownership necessarily leads to the creation of structures, and managing the same cannot be divorced from the market. The price mechanism-based capitalist setup should ideally provide the best solutions, with government restricting itself to fiscal duties like taxation. Ostrom is an extreme case while Williamson’s will never always get it right. The Schumpeterian story of creative destruction would be a necessary corollary, just as natural calamites and wars are necessary to prove Malthus right.
Elinor Ostrom’s work is significant because it talks of how community resources are best managed by users of the resource. At the most rudimentary level, when a housing society owns the premises, it best uses the resources that go along with it. There is no wastage of water or electricity as the society ensures that there is optimisation Forests, water, pastures etc, would ideally be best managed by users, provided property rights are transferred to them. This is the problem in India, where there is a difference between owners, managers and users, with all of them having their own motivations. The owners are typically the government or the private sector. Governments are inefficient as they have no interest in maximising benefits and often conduct business where there is no expertise. They manage an irrigation system because they have to, and are not concerned with leakages or wastage. Private sector is profit- motivated and would squeeze the maximum from the resource that does not optimise the welfare of society. Users do not value a service when the government provides it at a low cost. Farmers tend to waste water or over-graze cattle or over-exploit land for sowing when it is cheap. If the resource is provided by the private sector, then it is not affordable for them. This is the conundrum.
Therefore, ideally, resources should be owned by users. The formation of cooperatives was a step in this direction, where the cooperative works for enhancing value for the members. However, rarely has the natural resource been owned by the cooperative. This means that unless we have a combination of joint ownership by users, which means transfer of property rights to them at a cost, such resources will continue to be sub-optimally used as they are owned by the government or private enterprise.
Now, this ideal situation would confront the Oliver Williamson theory,which states that administrative decisions within a legal entity are more efficient than a market transaction. Williamson showed that complex transactions, involving investment decisions that are much more valuable within a relationship than to a third party, are best made within a firm. But he also showed that organising matters within companies had costs as it relied on internal authority—which could be abused—to get things done.
In light of the recent financial crisis, is it possible to put these two theories together? Firms should be classified as those that are owner-driven or professionally managed, where owners are several and dispersed. Owner-driven firms tend to be more efficient in taking decisions and tend to be more efficient than the markets, but they will not have public interest. Here, there is less likelihood of abuse of internal authority. But the financial crisis showed that it was organisations where the appointed chiefs were not the owners that delivered sub-optimal results, by over-leveraging and stretching their luck in the securitisation markets.
If we go back to the Ostrom case of user ownership, the possibility of abuse of internal authority is possible. Absence of professionals to run the organisation will have an inherent bias toward less efficient governance. While farmers may run their resource say an irrigation project well, the moment the scale changes, there would be need to bring in professionals who can improve functioning. As we move from micro-level resource to a larger setup, the downside risk of decision-taking internally could be a stumbling block.
Both theories are good at the micro-level in the ideal state, which rarely occurs. Ownership necessarily leads to the creation of structures, and managing the same cannot be divorced from the market. The price mechanism-based capitalist setup should ideally provide the best solutions, with government restricting itself to fiscal duties like taxation. Ostrom is an extreme case while Williamson’s will never always get it right. The Schumpeterian story of creative destruction would be a necessary corollary, just as natural calamites and wars are necessary to prove Malthus right.
Why don’t we get it about development: Financial Express:10th October
In the early 1980s it was quite common to see Rajiv Gandhi on TV, talking convincingly to a large gathering of presumably illiterate villagers about the great strides which the Congress party had taken in building the information technology highway and the different allocations for mega power projects in the Plan and so on. While the speech was in Hindi, these achievements would be uttered in English as the peasants nodded away in appreciation. He went on to win the elections and become PM. Things are not very different today where successive governments speak eloquently on how the Indian economy is one of the fastest growing nations, which has withstood the financial crisis and will be growing by 6%, or 7% or even 8% this year. The stock markets react buoyantly and there are several interviews with the PM, FM, Planning Commission etc, where these numbers are explained. The two situations are similar because in both the cases we are looking very narrowly at the economy and the performance of the government and probably feeling good about it without pausing to see if life around us has really improved. UNDP’s recently released Human Development Report is an eye-opener as it comes at a time when we are in this mode of self-praise, and brings us back to reality. Looking at growth numbers is passé today and the French President Mr Sarkozy has spoken of a happiness index to gauge the real success of an economy and Joseph Stiglitz is a part of the committee that will be looking at conceptualising these alternatives. Now, the HDI (Human Development Index) has been doing this for some time. The HDI basically looks at four parameters such as life expectancy, adult literacy, enrolment rate and per capita income and scores the nation out of 1. India has got a score of 0.612 and comes in the lower half of the medium range of human development countries and is ranked 134 out of a set of 184 countries. This is disappointing because it clearly shows that our performance is pathetic in the area of social development, which is missed when we talk of our growth story. The curious part is that while we are better than countries like Pakistan and Bangladesh, we are lower than Botswana and Bhutan. Clubbing India as part of the Bric group looks odd considering that Russia and Brazil are ranked 59 and.75 and come under the high human development group, while China is ranked in the upper half of the medium development group with a rank of 92 and a score of 0.772. It is not hard to guess that the countries which are ranked lower than India are generally located in Africa (over 35 of the remaining 48 nations). Quite clearly, there is a lot of housekeeping that needs to be focused on before we take our growth numbers seriously. In fact, the report also does a check on the rank of a country with respect to human development and the same in per capita income and the difference is presented. India has a negative number here. It is time that we did focus on the quality of development and not get carried away by purely growth indicators which camouflage the true picture. This report is significant as it comes a month or so after the World Bank and IFC brought out the Doing Business Report for 2010. This report talks of the basic environment provided by the government for industry to operate. It talks in some detail on the ranking of countries in terms of the ease of doing business and has ranked India 133 in a list of 183 countries. Once again we seem to be falling short of expectations and it indicates to an extent the difficulties that industry faces when doing business in India. Quite expectedly the African countries and certain Central and Latin American countries fare lower than India. Some of the sub-ranks that we have are 182 in enforcing contracts, 169 in taxation, 175 for construction permits and 138 for closing business. This means two things. The first is that even in terms of facilitating industrial growth, we have not done much and we make things difficult for industry to operate. The impediments are high, which means that despite the sounds made on economic reforms and liberalisation, life is still tough for those who operate within our boundaries. The second is that enterprise in India has to be lauded for doing this well despite tough operational conditions. We evidently can produce better numbers if we are able to bring about improvements in our mindsets. The two reports, hence, do expose considerable frailties in bringing about quality growth in the country and clearly show the distance between the developed and developing nations. More significantly,even within the developing nations our approach can be improved substantially to deliver superior results.
Friday, October 9, 2009
The message from gold & real estate: 30th September 2009 Financial Express
Two apparently unrelated attractive investment avenues are real estate and gold both of which have shown similar proclivities of late. Conventional wisdom suggests that their prices must go up in the long run for the simple reason that they can never come down over such a period. This is why even rural India considers both of them to be safe investments and this is ingrained in our psyche. They also help to buffer against inflation and bring in capital appreciation to levels comparable with those on the stock market. However, while the long-run direction is clear, inter-temporal variations affecting them are quite different even though demand is typically from the same segment of users. Gold has been quite volatile in the last few years and has offered commensurate returns. Further, gold is not correlated with stocks meaning that it is a good product diversifier. The price of gold is inversely related to the dollar and typically, the weakening of the dollar strengthens gold. The recent race past the $1000/ounce mark was a direct result of the weakening dollar which has inched towards the 1.50 level (vis-a-vis euro). However, while India is the largest consumer of gold (20% share) we still remain price takers and not price setters which should have been the case. Hence, while at the margin, prices domestically are affected by demand factors, there is not much deviation from the international price with the correlation remaining above 95%.
The physical balances do matter at times, especially on the supply side when there are larger quantities in the market. However, the main source for the same, i.e. releases by central banks, is more or less controlled to ensure that there are no serious distortions in the market. The rising price of gold, however, does not deter consumption as it is purchased essentially for its quality of store of value and for purposes such as marriage, social mores and egotistic wealth. Demand tends to be fairly inelastic most of the time and demand is almost a straight line. Conjecturing the price of gold really means knowing how the dollar will move. This is tricky today as the dollar is declining despite the US current account deficit improving. This is so because global sentiment is adverse on account of the high risk perception of US assets. Countries are holding fewer dollars and have switched to the euro. The revival measures have.further caused consternation over the future of the dollar. Hence, the interest in gold will always be there with global cues being the guiding factor, while physical demand will simply be reacting to the prices that are being set in global market, COMEX in particular. The other phenomenon is real estate where prices have steadied after declining for most of last year. Typically the cycles follow a set pattern. Prices are demand-led where higher demand creates the supply as builders get into the act of making available housing spaces. But, prices do not come down to the same extent when there is a downturn in business due to the holding power of builders. The semi-oligopolistic set up ensures that prices never come down sharply even during these times and a correction of not more than 20% takes place at the best of times. Demand is driven by two segments, households and investors. The former have started investing in houses on account of lower interest rates being offered (one is not sure if they read the fine print of the limited validity on these rates), and the expectations that property rates will move up in future. The emergence from the slowdown has added to the demand for housing in recent times. Besides, the continuous migration of population to the urban centres has added to the demand for housing at the lower end. Also the expansion of companies into the suburbs of cities would keep up the demand for commercial property except during recession times. There is hence a positive correlation between economic recovery and demand for property. The other group of demand comes from investors who typically operate in the stock market and would move funds across to property when the time is right. Here the link with the equity segment is distinct where a longer term view is taken when the markets are down. Funds move to property and provide support for prices as they buy low and wait to sell at a higher price when conditions improve. This segment is typically less active when the stock market is up. Hence, while real estate sector is in a way indirectly dependent on the stock markets for seeking direction, gold continues to be an independent investment avenue for individuals. It is not surprising that all the markets are up today.
The physical balances do matter at times, especially on the supply side when there are larger quantities in the market. However, the main source for the same, i.e. releases by central banks, is more or less controlled to ensure that there are no serious distortions in the market. The rising price of gold, however, does not deter consumption as it is purchased essentially for its quality of store of value and for purposes such as marriage, social mores and egotistic wealth. Demand tends to be fairly inelastic most of the time and demand is almost a straight line. Conjecturing the price of gold really means knowing how the dollar will move. This is tricky today as the dollar is declining despite the US current account deficit improving. This is so because global sentiment is adverse on account of the high risk perception of US assets. Countries are holding fewer dollars and have switched to the euro. The revival measures have.further caused consternation over the future of the dollar. Hence, the interest in gold will always be there with global cues being the guiding factor, while physical demand will simply be reacting to the prices that are being set in global market, COMEX in particular. The other phenomenon is real estate where prices have steadied after declining for most of last year. Typically the cycles follow a set pattern. Prices are demand-led where higher demand creates the supply as builders get into the act of making available housing spaces. But, prices do not come down to the same extent when there is a downturn in business due to the holding power of builders. The semi-oligopolistic set up ensures that prices never come down sharply even during these times and a correction of not more than 20% takes place at the best of times. Demand is driven by two segments, households and investors. The former have started investing in houses on account of lower interest rates being offered (one is not sure if they read the fine print of the limited validity on these rates), and the expectations that property rates will move up in future. The emergence from the slowdown has added to the demand for housing in recent times. Besides, the continuous migration of population to the urban centres has added to the demand for housing at the lower end. Also the expansion of companies into the suburbs of cities would keep up the demand for commercial property except during recession times. There is hence a positive correlation between economic recovery and demand for property. The other group of demand comes from investors who typically operate in the stock market and would move funds across to property when the time is right. Here the link with the equity segment is distinct where a longer term view is taken when the markets are down. Funds move to property and provide support for prices as they buy low and wait to sell at a higher price when conditions improve. This segment is typically less active when the stock market is up. Hence, while real estate sector is in a way indirectly dependent on the stock markets for seeking direction, gold continues to be an independent investment avenue for individuals. It is not surprising that all the markets are up today.
After the dollar, what? DNA 9th October 2009
There has always been the requirement for an anchor or reserve currency in the world, which started off with gold and then the pound, moved over to the SDR (special drawing rights) and then settled with the dollar.
The reserve currency is one which is accepted as being strong, safe and stable. While individuals can default, the country that owns the currency cannot and has to be seen as one which is well governed and has to be responsible because it does not have any limit on the quantity of currency that can be printed. In a way it has to be seen as one which writes cheques that will not be cashed.
It is not surprising that the dollar is the reserve currency and between 60 to 100 per cent of foreign exchange reserves of countries are indollars with an average of 64 per cent reserves being in dollars, while euros, yen, pound and SDR take up the rest. Further, 88 per cent of world trade is in dollars and USA has anchored the global economy -- its deficits and monetary policy pronouncements are tracked assiduously.
The question raised today is whether or not we can continue to depend on the dollar for support. Let us look at the reasons for dissatisfaction with the dollar. The US deficits, both current account and fiscal, are very high at 2.9 per cent and 13.5 per cent of GDP respectively.
The Americans are clearly spending more than they should be doing and the dollar has been depreciating sharply and is close to $1.48 per Euro. This gives the USA an unfair advantage in world trade, as its exports become more competitive.
Last year, this has been exacerbated by the bailout of the financial system which has already been valued at close to $5 trillion which is one-third of the GDP of the USA. The fiscal stimulus programme has been another factor driving down the dollar and the earnest talk by president Obama on Medicare means that the deficits will persist.
Under these circumstances, the issue raised is whether such a state is sustainable in the medium run. Would any other country have survived under such economic conditions?
Anecdotal evidence shows that around 80 per cent of currency failures follow a pattern: a large country borrows cheap (other countries invest in the US bonds) and loads up debt by importing much more than it produces.
The other (emerging) markets benefit to begin with until the borrowing country gets overburdened and trade retreats causing deflation which erases the wealth of creditors as less dollars are available externally. The amount of dollars available is dependent on the trade deficit and creates a problem for those countries trying to trade in dollar denominated assets. In fact, 2008 would have been catastrophic had the US Federal
Reserve not agreed bail out the system by inducting dollars in currency. Is the world satisfied with these developments? The answer is no, as can be seen by relentless noises being made by the oil producers, Russia and China. China is the largest subscriber to Fed treasuries (with forex reserves of over $ 2 trillion).
China has already flexed its muscle by setting up currency swaps with several countries like Argentina, Belarus and Indonesia and by letting institutions in Hong Kong issue bonds denominated in the Chinese currency, renminbi. Brazil and China are now working towards using their own currencies rather than the US dollar.
The oil-producing countries had even earlier justified the increase in oil prices in 2007 and 2008 to the shaky dollar as they are denominated in dollars. Further, there has been a tendency for foreign trade between nations to also be reckoned in alternative currencies like the Euro as it is seen as being more stable.
What then should be an alternative anchor currency? In the 1960s, an economist by the name of Triffin came up with the paradox that as the marginal supplier of the world's reserve currency, the US had no choice but to run persistent current account deficits.
Today, China could be a choice but its economy is opaque.The euro will be a good idea, but again it is based on the coordination between several members' nations -- some weak and others strong and cannot sustain the world economy.
As the emerging markets do have a fair say in the world economy, they would necessarily have a bigger role to play and we need to think of reinventing the SDR (a basket of four key currencies created by the International Monetary Fund in 1969) with the renminbi, euro, peso and so on, and maybe also the rupee, playing a role. The Stiglitz Committee under the auspices of the UN has suggested this route.
Will the dollar collapse? Not really as doomsayers predict but it will gradually lose its sheen as a currency that will be globally acceptable. The fact that nations are moving away to alternatives means that one is not overly dependent on the dollar. This by itself should induce more discipline in the way in which the US operates.
The reserve currency is one which is accepted as being strong, safe and stable. While individuals can default, the country that owns the currency cannot and has to be seen as one which is well governed and has to be responsible because it does not have any limit on the quantity of currency that can be printed. In a way it has to be seen as one which writes cheques that will not be cashed.
It is not surprising that the dollar is the reserve currency and between 60 to 100 per cent of foreign exchange reserves of countries are indollars with an average of 64 per cent reserves being in dollars, while euros, yen, pound and SDR take up the rest. Further, 88 per cent of world trade is in dollars and USA has anchored the global economy -- its deficits and monetary policy pronouncements are tracked assiduously.
The question raised today is whether or not we can continue to depend on the dollar for support. Let us look at the reasons for dissatisfaction with the dollar. The US deficits, both current account and fiscal, are very high at 2.9 per cent and 13.5 per cent of GDP respectively.
The Americans are clearly spending more than they should be doing and the dollar has been depreciating sharply and is close to $1.48 per Euro. This gives the USA an unfair advantage in world trade, as its exports become more competitive.
Last year, this has been exacerbated by the bailout of the financial system which has already been valued at close to $5 trillion which is one-third of the GDP of the USA. The fiscal stimulus programme has been another factor driving down the dollar and the earnest talk by president Obama on Medicare means that the deficits will persist.
Under these circumstances, the issue raised is whether such a state is sustainable in the medium run. Would any other country have survived under such economic conditions?
Anecdotal evidence shows that around 80 per cent of currency failures follow a pattern: a large country borrows cheap (other countries invest in the US bonds) and loads up debt by importing much more than it produces.
The other (emerging) markets benefit to begin with until the borrowing country gets overburdened and trade retreats causing deflation which erases the wealth of creditors as less dollars are available externally. The amount of dollars available is dependent on the trade deficit and creates a problem for those countries trying to trade in dollar denominated assets. In fact, 2008 would have been catastrophic had the US Federal
Reserve not agreed bail out the system by inducting dollars in currency. Is the world satisfied with these developments? The answer is no, as can be seen by relentless noises being made by the oil producers, Russia and China. China is the largest subscriber to Fed treasuries (with forex reserves of over $ 2 trillion).
China has already flexed its muscle by setting up currency swaps with several countries like Argentina, Belarus and Indonesia and by letting institutions in Hong Kong issue bonds denominated in the Chinese currency, renminbi. Brazil and China are now working towards using their own currencies rather than the US dollar.
The oil-producing countries had even earlier justified the increase in oil prices in 2007 and 2008 to the shaky dollar as they are denominated in dollars. Further, there has been a tendency for foreign trade between nations to also be reckoned in alternative currencies like the Euro as it is seen as being more stable.
What then should be an alternative anchor currency? In the 1960s, an economist by the name of Triffin came up with the paradox that as the marginal supplier of the world's reserve currency, the US had no choice but to run persistent current account deficits.
Today, China could be a choice but its economy is opaque.The euro will be a good idea, but again it is based on the coordination between several members' nations -- some weak and others strong and cannot sustain the world economy.
As the emerging markets do have a fair say in the world economy, they would necessarily have a bigger role to play and we need to think of reinventing the SDR (a basket of four key currencies created by the International Monetary Fund in 1969) with the renminbi, euro, peso and so on, and maybe also the rupee, playing a role. The Stiglitz Committee under the auspices of the UN has suggested this route.
Will the dollar collapse? Not really as doomsayers predict but it will gradually lose its sheen as a currency that will be globally acceptable. The fact that nations are moving away to alternatives means that one is not overly dependent on the dollar. This by itself should induce more discipline in the way in which the US operates.
Monday, September 21, 2009
Saved by chance, not design: Financial Express: 17th September 2009
Just as September 11 was a wake-up call for the battle against terrorism, September 15 has become symbolic of vaulting greed, something which may be likened to Macbeth’s vaulting ambition, which “overleaps itself, and falls on the other”. The newspapers are flooded with a retrospective on Lehman and its aftermath, all of which have been traced to the inherent ills in capitalism. Tellingly, even months after the rescue packages were announced, some bankers still have had the temerity to hike their bonuses and stock options, which is the ultimate arrogance of capitalist behaviour. Over here in India, RBI has marked the one year anniversary of Lehman with self-eulogies. The question to be posed is whether at all RBI actually expected the eventuality of the crisis. The answer is that no, no one did anywhere in the world. Otherwise 2008 would have been anticipated after 2007 when Bear Stearns and Northern Rock stumbled. The truth is that while we all knew that something was amiss, no one knew where the cracks lay. Now, when finance from banks is routed to any activity which is price-sensitive, and there is an upsurge in prices, commonsense would say that when prices fall there would be a problem. Therefore, overvalued markets always run this danger. But when is a market overvalued and when will the downturn happen? The answer is that no one can be certain. As Schumpeter had stated a long time ago, capitalism involves a continuous process of creative destruction and we get cleansed and learn as we got through these crises. Should RBI be applauded? To begin with we need to differentiate between the financial crisis and the liquidity crisis which resulted from the former. There was no financial crisis in India, as no institution had failed. Banks did not fail because none took the risks that were taken by their US counterparts. Besides, our system never dealt with sophisticated financial instruments and financial engineering remained confined to text books. In fact, it was quite ironical in the mid-1990s when the first capital market scam emerged, we didn’t know what the banker’s receipt was! Banking has, by and large, been conservative in its operations. Of course, this is a viable model which has been executed very well by RBI. The result has been the emergence of a strong system where risk is low but growth is normal. Innovation has been minimal. In fact, none of us really knew about securitisation and CDOs; and any such knowledge was restricted to textbooks or seminars conducted by professors from US universities. Therefore, to say that we did not encourage such operations is not convincing because we were not sure how they worked and preferred to keep away from the unknown.
Curiously, even today, the working of, say, the commodity futures market is an enigma and the differentiation between volumes traded and open interest created is not understood. Foreign exchange futures and IRFs have come in only in late 2008 and 2009! A banking system where over 30% of assets are locked in government securities and lending to another 40% is directed by the central banks cannot really face a crisis. The biggest potential default lies in the area of agriculture when monsoon fails but we always have governments coming up with bail-out programmes and hence failure is not possible. Further, banks have limited exposure to capital markets or other ‘sensitive’ sectors such as commodities and real estate. In India, we have never had bank failures, and when systems were challenged in mid and late 1990s with stock market related issues, it was more in the nature of fraud. The financial crisis in the West was not about fraud but clearly a case of financial engineering multiplying the possibilities of lending which was to be backed by spiralling prices. And when the prices crashed and defaults resulted, all those who were part of this onward lending spiral suffered losses. It did not have traces of crony capitalism of the East Asian variety. Indian banking has never really been on this line and has been confined to plain vanilla lending. In fact, the only aggressive and dynamic forays have been made by ICICI Bank and it is hence not surprising that our banks do not really feature in the global top league. RBI has done a great job in managing liquidity. However, there is little cheer in a parent feeling one-up on another because his/her children did not get hurt as they never went and played the game. The worry now is that financial reforms could take a back seat under these circumstances with caution being superseded by over caution.
Curiously, even today, the working of, say, the commodity futures market is an enigma and the differentiation between volumes traded and open interest created is not understood. Foreign exchange futures and IRFs have come in only in late 2008 and 2009! A banking system where over 30% of assets are locked in government securities and lending to another 40% is directed by the central banks cannot really face a crisis. The biggest potential default lies in the area of agriculture when monsoon fails but we always have governments coming up with bail-out programmes and hence failure is not possible. Further, banks have limited exposure to capital markets or other ‘sensitive’ sectors such as commodities and real estate. In India, we have never had bank failures, and when systems were challenged in mid and late 1990s with stock market related issues, it was more in the nature of fraud. The financial crisis in the West was not about fraud but clearly a case of financial engineering multiplying the possibilities of lending which was to be backed by spiralling prices. And when the prices crashed and defaults resulted, all those who were part of this onward lending spiral suffered losses. It did not have traces of crony capitalism of the East Asian variety. Indian banking has never really been on this line and has been confined to plain vanilla lending. In fact, the only aggressive and dynamic forays have been made by ICICI Bank and it is hence not surprising that our banks do not really feature in the global top league. RBI has done a great job in managing liquidity. However, there is little cheer in a parent feeling one-up on another because his/her children did not get hurt as they never went and played the game. The worry now is that financial reforms could take a back seat under these circumstances with caution being superseded by over caution.
Hedging against inflation across markets: Economic Times 9th September 2009
TODAY, a major concern for everyone is inflation and while the WPI remains in the negative, the CPI is a positive double-digit number. Inflation hedging becomes important considering that one cannot trade any inflation index in the futures market. The alternative is to look for proxies, which are positively correlated with inflation that can be used for hedging purposes.To begin with WPI and CPI are correlated at 0.96, which means that high levels of CPI are associated with high values of WPI. Hence, only the WPI has been considered for preservation of clarity. Some interesting results emerge when these coefficients are calculated on an average monthly basis for the period 2004 to 2009 (up to July) i.e. 67 months.Gold is the best inflation hedge which can be used to guard against inflation followed by the euro. This really means that taking a long position in gold or euro when we expect inflation to increase would make sense as we can sell the same and take cover for inflation. Silver is the third best option. The fact that the euro serves the purpose better indicates that RBI should get set to introduce forex futures in euro as well, especially as the dollar contracts have been quite successful on the NSE. This way the lacunae in the commodity market can be bridged by the forex derivative market.As for the Gsec market, it is not highly correlated with the WPI numbers . It has been held that the WPI number matters for the bond market which is sensitive to the information. The low correlation between the benchmark 10-year bond yield and WPI indicates that on an average long-term basis this relation is not really strong.Surprisingly, the stock market is also not linked strongly with inflation with a correlation of just over 50%. The stock market is guided by other factors and inflation is just one of them. The same holds for crude which, with a weight of 14% in the WPI, could provide a partial hedge with a 51% correlation. The surprise package is guarseed which has a significant though low correlation with inflation, even though it is not a part of the WPI.The rupee-dollar move differently with other markets. Depreciation in the rupee has an inverse relation with both the stock market and crude oil price. While the stock market can be expected to decline with the rupee weakening, typically one would have expected falling crude prices to strengthen the dollar, which has not happened, meaning thereby that the crude oil bill is not significant in affecting the dollar rate and is influenced by a combination of capital receipts as well as RBI action.Commodities like gold, silver and guar have a median positive correlation with Nifty, which means that there are limited opportunities for arbitrage across these segments. The Gsec market, however, becomes negatively related with bullion, indicating substitution and hence offering scope for independent decisions that can be taken by banks and insurance companies in the commodity space.Therefore, there are several windows open for trading and hedging across markets which will improve overall efficiency. And more importantly , inflation cover can be achieved through various options.
An inadequate capital measure: MInt: 9th September 2009
Looking at bank capital adequacy and non-performing assets independently camouflages the true picture With the proliferation of financial reforms under the umbrella of the Basel II Accord on banking supervision, the focus of banking has shifted quite dramatically from size and growth to prudential practices.With accounting prudence being followed, banks are more cognizant of both their quality of assets and possession of capital. The number of non-performing assets (NPAs) is important as they speak a lot about the credibility of the system. The build-up of such assets has invariably resulted in financial crashes and, therefore, there has been considerable discussion on reining in NPAs. Capital adequacy is the other measure of soundness of banks as they need this base to build their balance sheets. Hence, for future expansion banks do require to build their capital base, proportionate to their assets.Usually, both these concepts—NPAs and capital adequacy—are looked at independently, as they indicate separate issues. However, the two can actually be linked which, in turn, provides a different dimension to the health of banks. We normally talk of NPAs as a percentage of total advances while capital adequacy is in terms of the base, or denominator, available to support the risk-weighted assets. This can be misleading because a bank can explode its denominator and still show a low NPA ratio in the conventional sense. Further, a bank showing a high capital adequacy ratio (CAR) may have built up toxic assets, which CAR does not reflect.The two can actually be put together. NPAs per se reflect the contaminated part of the portfolio, which can be juxtaposed against the available capital that belongs to the bank. The idea here is that capital is what the banks actually own—gross NPAs should be adjusted to arrive at the available free capital. Therefore, to begin with, the ratio of gross NPAs to capital (where capital is defined loosely as the sum of equity and reserves) is critical. This gives the extent to which the bank’s own capital is being blocked by its impaired assets. A similar measure was developed by Gerard Cassidy at Canada-based RBC Capital Markets and termed the Texas ratio: Here, NPAs were pitted against the capital as also loan loss reserves, or reserves meant to cover losses on theportfolio. A Texas ratio touching 1 indicates that the bank is in deep crisis.The ratio of gross NPAs to capital has been used here in the broader sense to show how much of capital would be erased by NPAs—this can be termed the “knock-out ratio”. This narrow definition of capital takes into account largely what the Basel Accords define as tier I capital—the core capital of a bank, which is equity and disclosed reserves. This would exclude tier II capital, which takes into account subordinated debt, loan loss reserves and perpetual preference shares. With this ratio so defined, the accompanying table examines the vulnerability of some of the leading Indian for fiscal 2009. The table also extrapolates, in crude terms, what CAR would look like in case NPAs were deducted from the capital of the bank—this is the adjusted CAR. Gross NPAs have been subtracted from capital and the corresponding CAR ratio has been calculated in the absence of information on actual capital and risk-weighted assets of banks.The table shows some hard-hitting facts. First, for the Indian banking sector as a whole as represented by 39 banks (27 public sector and 12 private, including six new private banks), the average “knock-out ratio” (NPAs to capital) was quite high at 20.4%. Second, 14 banks had ratios above this average; another eight were within a range of 2 percentage points below this average. Five of the six new private banks were below the average—indicating that their wherewithal to grow prudently washigher. Third, under the concept of adjusted CAR, six banks now slide below the 9% mark that Basel II stipulates—these banks were in the clear with the conventional CAR—and 11 have adjusted CAR in the single-digit range between 9% and 10%. This means that while only one bank had a single-digit CAR, there are now 17 with adjusted CAR less than 10%. Fourth, the median decline from conventional to adjusted CAR was 2.42—the average decline was 2.6—with the highest being 6.86 for Development Credit Bank and the lowest being 0.87 and 0.9 for Yes Bank and Indian Bank, respectively.Quite clearly, the capital situation of our banks looks less glamorous with these adjustments. In the future, it may be useful for the Reserve Bank of India to work on the concept, and have banks calculate their unimpaired capital adequacy ratio. A variation of this could be presented: adjusting for net NPAs after provisions for the bad debt have been made.
Against the background of the financial crisis, it does make sense to pay more attention to these ratios, especially CAR, as this measure has been used to show the solvency of banks. By not netting out the existence of toxic assets, banks may be overstating their positions, which may camouflage the true picture. Lehman Brothers, one must remember, had a very high CAR when it went down.
Against the background of the financial crisis, it does make sense to pay more attention to these ratios, especially CAR, as this measure has been used to show the solvency of banks. By not netting out the existence of toxic assets, banks may be overstating their positions, which may camouflage the true picture. Lehman Brothers, one must remember, had a very high CAR when it went down.
Bulls on top, but bears lurk below : Financial Express 9th September 2009
The bath tub inspired not just Archimedes but also Alan Greenspan who coined the phrase ‘irrational exuberance’ centuries later in 1996, before he had to deliver his black-tie dinner speech titled ‘The Challenge of Central Banking in a Democratic Society’ at the American Enterprise Institute in Washington. It is now well known that these words brought down the markets in Tokyo and Hong Kong by 3%, London and Frankfurt by 4% and the US by 2%. We are, therefore, careful with words today. But, these words would really best describe what we are seeing in BKC (Bandra Kurla Complex where NSE is located) and Dalal Street (which houses BSE) these days. The Sensex has soared to cross 16,000—this mark has been reached after 361 trading days; it was last seen at this level on 2nd June 2008. Since April 1, the Sensex had soared by 62% to reach 16016 on the 7th of August (16123 on 8th) while the Nifty has gained 56%. Those who back stock markets as being reflective of true sentiments would say that conditions are looking bright with a monsoon revival, commitment of the world to move out of the recession, foreign funds gushing in and IPOs meeting with stupendous success. Stock market movements are always justified to reflect developments that may be coincidental. That is how the spirit is kept up and that’s how money keeps moving the market in a certain direction. We already have broking firms pointing at the sky because by doing so the sentiment is built up and people invest more, thus keeping the spiral moving. It should be remembered that markets boom when more money pours in. This is not so much fresh money being generated but merely transfer of funds from buyers to sellers in such a cycle. There is no new wealth being generated as such and hence the basic question is whether or not this is sustainable? To answer this question we need to check the factors that may be causing the indices to increase—the fundamentals. The economic fundamentals have not changed, and while growth has been encouraging in Q1, the government has admitted that growth in Q2 and Q3 would not be that good. The monsoon has failed and it is now accepted that farm output will be down and inflation higher. In fact, even as the possible drought scenario had spread from the beginning of... July, the Sensex had bounced by 9.4% till date. Further, the Sensex has climbed by 5% since 21st August when the FM uttered the dreaded D (drought) word. This really means that monsoon news does not matter for the stock market. If this is so, then the news that there has been a revival of the monsoon cannot be a factor driving sentiments. Against this backdrop one could expect fiscal intervention—the fiscal response will entail outlays that can impact the deficit as well as interest rates ultimately. Hence the near-term environment is not too conduciveto enthusiasm. While industry has shown signs of growing, corporate profits in Q1 are more due to cost cutting and weak commodity prices rather than topline growth. And given the present upward trend in commodity prices, such a scenario may not be sustainable. Also growth in credit so far has been tardy and does not warrant euphoria. The other factor which has been quoted as being responsible for these price movements is that foreign investors are taking greater interest. However, this is not really borne by Sebi data which shows that in September so far, there had been an inflow of just $ 19 million in equity up to 8th September. The impact of the G20 resolution to continue with the economic stimulus measures also needs to be viewed with caution. The fact that all countries are keen to move out of the recession was known to all as governments and central banks have provided several relief measures to their financial sectors as well as invoked tax cuts and enhanced expenditures to keep their economies moving. Hence, the present resolution is only a continuation of a resolve and not any specific measure(s) to actually provide a further boost to the world economy. Lastly, the success of IPO is a bit contrived. A bull market run by irrational exuberance instills faith in investors who go out shopping for deals, and IPOs provide an option. The absence of alternatives with interest rates being low has made investors turn to the bourses. All this means that while the present impetus may be attributed to positive sentiments emanating from various announcement effects, the underlying conditions do not appear to be too sanguine in terms of growth or inflation. The fundamentals as of now do not inspire confidence and there is a limit to which sentiment, either rational or irrational,can keep the spirits up. A correction may be expected soon.
Thursday, September 3, 2009
Why sugar leaves a bitter taste: Financial Express: September 3, 2009
Just think of a product valued at Rs 50,000 crore that is consumed by individuals who contributearound Rs 20,000-22,000 crore to its consumption. The product has a combined weight of 5.2% in the WPI and accounts for around 6% of private consumption in both direct and indirect terms. Its price is on the verge of doubling by October as output for the ‘product year’ 2008-09 is expected to decline by more than 50%. The product is sugar, and the story is not new.
Sugar cycles in India are well known, and there is a sugar crisis. every 4-5 years. Production falters, and when not supported by imports, results in higher prices, and panic policy responses. We have already seen the government ban futures trading in sugar (the price continues to increase) and introduce strict stock limits to prevent hoarding (but prices still increase). The logical response is to import sugar, which should have been done earlier when the futures prices indicated that there would be problems on the supply front. But, by delaying the decision, the severity of the issue has been exacerbated.
India is one of the largest consumers of sugar, and the USDA estimates that global sugar output is to fall by 17 million tonnes in 2008-09. Sugar production has been affected by various factors including past decisions to divert land to the production of bio fuels which lowered cane production. This has had an impact even on the current production of sugar in major producing countries. India’s entry into the import market, as a very large consumer, automatically pushes up prices.
The problem in India, of course, starts in the sugarcane fields. Price is controlled through the statutory minimum price programme which assures a fixed price to the farmers. However, farmers are not paid on time as the mills can pay them only after they sell processed sugar. But sugar sales are regulated, even in the free market, through a release system where the government announces monthly releases. While the releases system aims to balance the supplies and ensure that it is available throughout the year, it creates problems for the mills in terms of their ability to pay the farmers on time.
The result is that the farmers often move away from sugarcane cultivation. They also prefer to sell to the molasses and gur manufacturers where payment is less of an issue. Therefore, cane production per se has been whimsical. Further, the monsoon playing truant has affected the production of cane, and given that there has not been substantial improvement in productivity, yields remain stagnant. The yield had touched a high of 71 kg/hectare in FY00 and has remained at a lower level since then. The area under cultivation has fluctuated between 37 lakh hectares and 52 lakh hectares, which lends to uncertainty in the output. The fact that cane is a water-intensive crop implies that any shortfall in rainfall in terms of late arrival or progress causes farmers to switch crops, as has happened this year, which finally impacts the production of sugarcane and sugar.
The solution is evidently to improve productivity, and policies on sugar. Enhanced productivity is possible only in the medium run. While sugar is partly decontrolled, it is the only industry which faces regulation at both the raw material and final product ends. In the case of wheat and rice, the MSP helps the farmer and the government through the FCI which is the main buyer, but in case of cane, the price is fixed and the private mills have to pay this price and have no alternative. While the free market price is theoretically free, as mentioned earlier, its distribution is subject to the releases announced by the government thus making it a controlled product. This does not happen for any other product—there is just too much intervention in the production and distribution cycle.
Looking ahead, the government should take a stance on whether sugar is as critical as rice or wheat for food security. While one view is that the market should take care of the dynamics, the other believes that sugar is too critical to be left to the market as it is a mass consumption item. If this is to be the stance then the government should consider the creation of a buffer stock, just as in rice and wheat. More importantly, at a broader ideological level, we do need to seriously look at the extent to which the government should be intervening in price stabilisation of all products that are consumed by people. We began with rice and wheat and now have made sugar and edible oils targets of government price intervention. Should the same stretch to vegetables and milk which are also essentials, and affect the common man? Surely not. That will createmore problems than solutions ...
Sugar cycles in India are well known, and there is a sugar crisis. every 4-5 years. Production falters, and when not supported by imports, results in higher prices, and panic policy responses. We have already seen the government ban futures trading in sugar (the price continues to increase) and introduce strict stock limits to prevent hoarding (but prices still increase). The logical response is to import sugar, which should have been done earlier when the futures prices indicated that there would be problems on the supply front. But, by delaying the decision, the severity of the issue has been exacerbated.
India is one of the largest consumers of sugar, and the USDA estimates that global sugar output is to fall by 17 million tonnes in 2008-09. Sugar production has been affected by various factors including past decisions to divert land to the production of bio fuels which lowered cane production. This has had an impact even on the current production of sugar in major producing countries. India’s entry into the import market, as a very large consumer, automatically pushes up prices.
The problem in India, of course, starts in the sugarcane fields. Price is controlled through the statutory minimum price programme which assures a fixed price to the farmers. However, farmers are not paid on time as the mills can pay them only after they sell processed sugar. But sugar sales are regulated, even in the free market, through a release system where the government announces monthly releases. While the releases system aims to balance the supplies and ensure that it is available throughout the year, it creates problems for the mills in terms of their ability to pay the farmers on time.
The result is that the farmers often move away from sugarcane cultivation. They also prefer to sell to the molasses and gur manufacturers where payment is less of an issue. Therefore, cane production per se has been whimsical. Further, the monsoon playing truant has affected the production of cane, and given that there has not been substantial improvement in productivity, yields remain stagnant. The yield had touched a high of 71 kg/hectare in FY00 and has remained at a lower level since then. The area under cultivation has fluctuated between 37 lakh hectares and 52 lakh hectares, which lends to uncertainty in the output. The fact that cane is a water-intensive crop implies that any shortfall in rainfall in terms of late arrival or progress causes farmers to switch crops, as has happened this year, which finally impacts the production of sugarcane and sugar.
The solution is evidently to improve productivity, and policies on sugar. Enhanced productivity is possible only in the medium run. While sugar is partly decontrolled, it is the only industry which faces regulation at both the raw material and final product ends. In the case of wheat and rice, the MSP helps the farmer and the government through the FCI which is the main buyer, but in case of cane, the price is fixed and the private mills have to pay this price and have no alternative. While the free market price is theoretically free, as mentioned earlier, its distribution is subject to the releases announced by the government thus making it a controlled product. This does not happen for any other product—there is just too much intervention in the production and distribution cycle.
Looking ahead, the government should take a stance on whether sugar is as critical as rice or wheat for food security. While one view is that the market should take care of the dynamics, the other believes that sugar is too critical to be left to the market as it is a mass consumption item. If this is to be the stance then the government should consider the creation of a buffer stock, just as in rice and wheat. More importantly, at a broader ideological level, we do need to seriously look at the extent to which the government should be intervening in price stabilisation of all products that are consumed by people. We began with rice and wheat and now have made sugar and edible oils targets of government price intervention. Should the same stretch to vegetables and milk which are also essentials, and affect the common man? Surely not. That will createmore problems than solutions ...
Thursday, August 27, 2009
Green shoots, but what about the roots? Financial Express 27th August 2009
The ‘green shoots’ theory is cloaked ironically in black humour as the shoots in the fields will probably not blossom with the nation being in the midst of a drought. Industrialists are talking of how industry is immune to this phenomenon, even though a drought means more poverty and cattle death. The issue is whether these green shoots are for real or whether they are hyped, imaginary visions.The excitement over a recovery is palpable across the globe where analogies are drawn from the English alphabet, with the recoveries being debated as being U, V or W shaped. The true picture really is dynamic because every time we think we have spotted the rainbow lining to the U (we have not reached the V as yet), there is a downside making the so-called W more plausible in small rather than capital letters. To take an impassioned view, the two sides to the argument may be laid down.First, the green shoots can be spotted from increasing industrial growth rates in the last four months and come against the background of negative growth rates, which really means that things have changed. Growth appears to be sanguine in case of basic, intermediate and consumer durable goods, which is encouraging as it gives hope that if sustained, it can actually forge the strong backward linkages. Cement, coal and electricity segments of infrastructure are looking up, which means that something must be happening.The above is partly reinforced by the numbers on traffic carried in terms of coal by the railways, which has been increasing. The capital markets are up, not in terms of the secondary market indices but plain capital issues as companies are raising more capital through both the debt and equity routes, which must be for investment. There is hence reason to believe that industry is going to invest more, which would not have been the case if they were not very optimistic of production.To a certain extent this story is supported by growth in production of passenger cars and two-wheelers, which implies that contrary to the gloom in the white collar job market, people are spending more, which has probably—and not with certainty—been supported by the banks (the overall picture tells a different story).The other side of the arguments has a longer list. The first is that growth in credit, which is the foremost leading indicator of industrial activity, is slack. Growth in credit for the period April-July has been lower at 1.1% (2.6%) and even the YoY number is lower at 15.8% (25.6%). Second, while industrial growth has been showing a recovery, cumulative growth for the first quarter is still lower than that last year—3.7% as against 5.3%. Third, production and sales of commercial vehicles including tractors are down, indicating that the drought will cast a shadow on this segment. Fourth, corporate performance continues to provide an ambivalent picture. While net profits have been growing, top line growth is missing. Sales have declined and are in the negative territory. Profit growth is more due to sharper decline in costs, which means the sector is becoming efficient, though not really growing.Fifth, while trade deficit has improved due to softer crude oil prices, both exports and imports growth are less than that last year. This is also seen from the port traffic statistics where less cargo is being handled for exports. Sixth, investment in mutual funds, which is a quick indicator of retail participation in the capital market, is lower in the first four months of the year relative to last year. This means that the shine being seen at times in the stock market is more due to foreign institutional activity and not really from within. Finally, WPI inflation numbers are in the negative zone for non-food manufactured products, which have to turn positive to support the turnaround hypothesis.The arguments are tilted against the motion that the green shoots are flowering. The drought is serious and while negative growth in agricultural production in the past does not mean lower overall growth (correlation with industry and services is 26% and 31%), it will call for various policy actions on both monetary (increase in loans, higher NPAs) and fiscal (loan waivers, subsidies) fronts. The so-called green shoots that we are conjuring may last for a longer while as the statistical low base of 2.3% growth in the IIP last year cannot get worse.Also, the predominance of the services sector of which around 40% is in the unorganised sector (such as transport, restaurants, retail trade, etc) may help to deliver good numbers by March 2010.
Monday, August 17, 2009
Banks: too much capital, little lending: Financial Express: 17th August 2009
The performance of the banking sector in the first quarter of this year has been quite impressive in terms of growth in the top and bottom lines. However, there are two interesting facets which emerge from the numbers presented by them. The first is that there is a difference in the performance of the public sector and private banks and the second is that there is some concern in the areas of impaired assets and, ironically, excess capital. Overall performance was impressive with profits surging by 64.4% for a set of 40 leading banks—25 public sector, 6 new private and 9 old private banks. There are some interesting features. The first is that total income has been aided mainly by the surge in other income, which is primarily treasury income as fee based activity has been on the downswing ever since the financial crisis of 2007. The ratio of other income to interest income increased from 14.3% to 18.8% showing hence a higher reliance on other income. Secondly, net interest income had come under pressure with interest expenses rising faster than interest income. This has been a major concern for banks as they have had to lower their PLR with successive reductions in the reverse repo and repo rates and CRR cuts. This has not been compensated by lower deposit rates, which have been benchmarked to the small savings rate which still delivers 8% nominal return, which could be tax exempt. The third is that the most impressive performance has been put up by the public sector banks in all the top line indicators relative to the private banks. The new private banks, excluding ICICI Bank, have done better than the old private banks. The fourth is that ICICI Bank has adopted a different approach to banking. It has shrunk its balance sheet. This is a conscious policy pursued by the bank, which is also visible when one visits the bank branch. The staff encourages customers to withdraw deposits and invest in insurance products. This has been done on both the deposits and credit sides. The expense bill too has come down with both salary and non-salary based expenses coming down in this quarter.
The fifth is that non-performing assets have increased quite steeply in all banks both at the gross and net levels. It is significant as the rate of growth of the impaired assets is higher than that of the lending portfolio. The gross non-performing assets ratio has remained unchanged for public sector banks at 2.09 while it has increased for new banks to 3.06 from 2.65% and from 2.6% to 2.64% for old private banks. This is a worry because it reverses a trend observed earlier of a decline in this ratio over the years. In fact, Development Credit Bank (2.84% to 10.86%), ICICI Bank (3.72 to 4.63%) and Kotak Bank (3.17% to 4.95%) were the ones with high ratios. The public sector banks had controlled this ratio to less than 3%. For all banks put together, this ratio increased in 9 of the 25 public sector banks, 5 out of 6 new private banks and 4 of the 9 old private sector banks. Growth in non-performing assets is linked with overall performance of the borrowers, industry in particular. With low growth in industry there is an inherent tendency for delinquencies to increase, which is also possible this year with the drought and a possible slowdown in industry lingering. Another feature of the performance is the capital adequacy ratio. Banks have tended to increase this ratio, which is both a blessing and a concern. It is a blessing to know that the banks are well-capitalised and hence future expansion is possible without there being any impediments. However, it is also a concern because high ratios indicate that capital is not being efficiently utilised. Against the Basel norm of 9%, there were several banks which had a ratio of over 15%— 5 out of 6 new private banks and 1 old private bank. The public sector banks had ratios in the double digit range. This is also reflected in the growth in loan portfolio (where the NPA ratios and amount have been used to extrapolate the asset size). Public sector banks have been more active in increasing the loan portfolio relative to the private banks. Therefore, the overall picture when looked at from beyond profits is a bit disconcerting with net interest income being under pressure, too much dependence on other income, non-performing assets growing across banks and banks being over-capitalised —not the way the ideal results profile should look like.
The fifth is that non-performing assets have increased quite steeply in all banks both at the gross and net levels. It is significant as the rate of growth of the impaired assets is higher than that of the lending portfolio. The gross non-performing assets ratio has remained unchanged for public sector banks at 2.09 while it has increased for new banks to 3.06 from 2.65% and from 2.6% to 2.64% for old private banks. This is a worry because it reverses a trend observed earlier of a decline in this ratio over the years. In fact, Development Credit Bank (2.84% to 10.86%), ICICI Bank (3.72 to 4.63%) and Kotak Bank (3.17% to 4.95%) were the ones with high ratios. The public sector banks had controlled this ratio to less than 3%. For all banks put together, this ratio increased in 9 of the 25 public sector banks, 5 out of 6 new private banks and 4 of the 9 old private sector banks. Growth in non-performing assets is linked with overall performance of the borrowers, industry in particular. With low growth in industry there is an inherent tendency for delinquencies to increase, which is also possible this year with the drought and a possible slowdown in industry lingering. Another feature of the performance is the capital adequacy ratio. Banks have tended to increase this ratio, which is both a blessing and a concern. It is a blessing to know that the banks are well-capitalised and hence future expansion is possible without there being any impediments. However, it is also a concern because high ratios indicate that capital is not being efficiently utilised. Against the Basel norm of 9%, there were several banks which had a ratio of over 15%— 5 out of 6 new private banks and 1 old private bank. The public sector banks had ratios in the double digit range. This is also reflected in the growth in loan portfolio (where the NPA ratios and amount have been used to extrapolate the asset size). Public sector banks have been more active in increasing the loan portfolio relative to the private banks. Therefore, the overall picture when looked at from beyond profits is a bit disconcerting with net interest income being under pressure, too much dependence on other income, non-performing assets growing across banks and banks being over-capitalised —not the way the ideal results profile should look like.
Parched Economy: DNA 17th August 2009
The prospect of a monsoon failure and a drought is scary not just because it means the obvious pain caused to people who derive a living from it. A monsoon failure actually affects every segment of the economy. The stress it causes calls for policy actions that would once again upset the apple cart. It goes beyond those numbers shown on the calculators or the back of envelopes.Agriculture per se accounts for around 18 per cent of GDP which means that all those who derive their income from this sector would face declining incomes. Around 60 per cent of our workforce is employed here which means that these families will have to face hardships for the entire year until the next season if they were solely dependent on farming for a livelihood which would be so in over half the families. The meltdown caused by a drought can be traced from the time the harvest is impacted.First, the incomes of the farmers get affected as the kharif crop provides at least 60 per cent of the income to farmers, even those who follow dual cropping covering the two seasons. A loss of income affects their consumption power which gets reflected in lower demand for goods. The limited income earned is used for sustenance. White goods and rural housing (and by implication cement, steel and machinery) will see a fall in demand. A related fallout is unemployment, which can only partly be compensated for by the National Rural Employment Guarantee Schemewhich again provides income for sustenance but cannot start a spending spiral. A more serious fallout is urban migration which has already been prompted by the relative unattractiveness of farming to manufacturing and service jobs (such as unskilled labour, coolies, running small retail outlets, road labour) in cities. This has medium-term implications for agriculture as there will gradually be less labour available to cultivate land.Industry will also be affected in a dual manner. The first is low demand from farmers starting from October onwards when the harvest begins. On the supply side, the food industries will be affected in terms of supply of inputs such as oilseeds, cereals, sugarcane which will increase costs while putting pressure on availability. While industrial growth is still possible at an elevated path notwithstanding this slowdown if the non-rural middle and upper classes continue to spend, that growth would have been smoother with support from the farm sector.Intuitively one can smell higher inflation this year as food prices will continue to be under pressure. The fuel price hike has already increased cost of transportation of farm products and limited supplies will accentuate it. It may just be a goodbye to the 5 per cent inflation number. Typically government's reaction to a drought is to increase the Minimum Support Price (MSP) of all farm products at harvest time which has high latent inflation potential.In the past the government has acted proactively, albeit with a characteristic delay, to supplement domestic production with imports when production falters. It happened with wheat in 2007 and sugar this year. Interestingly, whenever the Indian government plans to import food products, there is a ratcheting of global prices. The trade balance will be affected as imports will increase thus putting pressure on the rupee even if other conditions remain constant.Droughts always invariably lead to higher government subsidies and outlays which mean further pressure on the fiscal deficit. Programmes have to be introduced to provide more employment to the unemployed, increased quotas for those covered by the Public Distribution System, outlays on fertilisers and other inputs. The fiscal deficit level of Rs4.5 lakh crore will be surpassed depending on the extent of government intervention. Therefore, fiscal policy will come for further review in these circumstances which will once again raise questions on government borrowing and movement in interest rates.Lastly, the Reserve Bank of India will have to get active. Anecdotal evidence shows that farm failures invariably lead to interest rate subvention, loan waivers (we are just trying to put to an end the earlier scheme which cost more than Rs70,000 cr) and public sector banks being forced to lend more to farmers through various resuscitation packages.Therefore, the impact of a drought is all-pervasive and all sectors intertwined in some way or the other would have to brace up to face the challenge. Even with its small share in GDP, the farming sector could influence the way in which the entire economy conducts its operations. Unfortunately, there is no solution for avoiding drought -- the only common-sense hint being that we need to spruce up our attempts at providing irrigation to more farm land -- against the low 20 per cent that is covered today. There is really no alternative if we do not want to hear the replay of this story again in the future.
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