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.
Friday, November 27, 2009
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.
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