The World Economy : So Where Are We Today ?

Posted on October 10, 2015. Filed under: Uncategorized | Tags: , , , , , , , , , , , |

The QE along with the ultra low rates, as a loose monetary policy did what it had to do, during the crisis and also in the immediate aftermath, but the temporary measure also made the market somewhat irrational, and then came a time when markets got addicted to it, and kept on going higher regardless of the underlying fundamentals. And what we thought was a large Airbus 380 flying at 40,000 feet turned out to be an Airbus 318, so now, when our perception is changing, we find ourselves stuck, because, we know that an Airbus 318 is, simply not big enough to carry, and then keep the world economy flying at 40,000 feet, and also there is a realisation in some parts of the market that the Airbus 318 was never really flying at 40,000 feet. But the problem is, the central bankers, who kept the plane flying are now running out pages in the instruction manual.

So the central bankers in the developed world will need to find a way to get themselves unstuck. Low rates coupled with low inflation is not what most central banks in the developed world were expecting, and now they find themselves STUCK. In the QE era world, low interest rate environment isn’t necessarily all good and positive for the real economy, because the incentive to chase better returns leads to misallocation of capital. The asset price inflation that came about mainly from the misallocation of capital has more or less peaked, the fundamentals of the real economy were never that strong to drive the record level asset pricing. Easy money supply from QE was the main factor that created asset inflation.

Today, globally , the overall inflationary pressure in the real economy is somewhat subdued, and the central banks in the emerging economies are also lowering the rates. And this creates a very interesting problem for the central banks going forward especially in the UK and the US. The way, I see it is, the world economy is now starting to sail blind ( more or less ), and I must say, I’ve got my fingers crossed.

By waiting for an opportune time to raise rates, the central banks in the developed world have started the work of undoing all the previous good work that was done during the crisis, and in it’s immediate aftermath. Water in the ocean has to travel in a wave, and a still ocean is always a sign of something disruptive that’s probably on the way. So, we are getting stuck, by design, QE and the low rates as a part of the ultra loose monetary policy were supposed to be temporary measures, but for whatever reasons, it became the norm, and now, the markets have simply got addicted to the ” new temporary “.

The FED as well as the BOE will rightly say that there is no change in circumstances that demands a rate hike, in fact, the slowing world demands that the rates remains low for an extended period. And the markets are now starting to position themselves accordingly. But there is no guarantee that a low interest rate environment globally, will do the world any good, even when the developing world is also seeing a subdued inflationary environment. In my own view, the central banks can and should try to influence the flow of capital. It is what is required, and there is almost no real harm to the global economy if the FED was to raise rates by 25 bps, and by not doing that we run the risk of making what was supposed to be a temporary status quo, the ” new permanent “. If we continue with the existing ” status quo ” then there is a serious risk that markets will remain irrational and therefore volatile, and both will have damaging implications on the real economy. Take for example, the recent upswing in commodity prices , the price movement is not based on the assumptions that the fundamentals of the global economy is improving, or going to improve dramatically. In fact, it isn’t, and if we look at the recent growth projection of IMF, and also the overall inflation environment around the world, then it will be quite difficult to find a sound economic argument for the price movement upwards, but in my own view, I believe, the commodity market is moving up because of the realisation that rates will remain low. So the misallocation of capital as well as the distortion of market reality will therefore continue.

The benefits of QE as well as low rates was somewhat limited to the real economy, as a large part of the capital didn’t really flow into the real economy. And most data suggests that financial investors were in fact the main beneficiaries. The financial investors saw no real benefit, in terms of overall return of investing in the real economy , so a large part of the capital went into inflating the pricing of the financial assets for obvious reasons. Real economy isn’t designed to create high double digit returns in a very short period of time. So financial investors chasing quick and substantial return saw no incentive of committing capital to the large part of the real economy. But the hope was, especially from the central banks that at some point, the money will flow into the real economy. Having said that, QE and the low rates more or less served a their good purpose, but the central banks to a large extent failed in their attempt to channel the flow of capital where it could have been utilised to create growth in the real economy.

And if we are to rely on historical evidence, most available data suggests that when the financial markets starts growing bigger and faster, it is generally at the expense of hurting the real economy, and more often than not, it leads to a crisis.

The FED as well as BOE will need to change the ” status quo ” or in other words tweak the current market dynamics, a bit. You need a positive and a negative polarity to create the flow of current. The wind flows, when you have a high and a low pressure environment. And to keep a plane flying, you need to have a strong flow of air across both the wings. An economy like most planes requires two pilots, and so far, the central bankers have taken the lead in flying the plane, and they have done a good job especially in the absence of a strong leadership from various governments, but now, it’s time for the governments to play their role. So far the governments have failed to deliver on the important reforms that was badly needed. We have had sound bites coming out from various pockets of the governments as well as the political class in general, but the real lasting reforms aren’t quite visible yet. Blaming the financial markets and making the banks, a villain, is now an old story. The fact is, without the central banks taking the lead, the governments won’t really have an economy to talk about today. But there is a limit to what can be achieved through monetary policy alone, and I have always suspected that at some point, the central bankers will run out of tricks, and the limits of monetary policy tools will be tested and exposed. And it looks like that’s where we are today.

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Making Sense of The Policy Debate Inside The Financial Market

Posted on June 18, 2013. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , |

There is no shortage of opinion in the market today on the current state of affairs of the global economy and most of the commentary as well as analysis seem to be centred around Central banks policies and its overall current impact assessment and on how things may play out going forward. The discussions are generally focused on what the central banks especially the Federal Reserve System (aka the Federal Reserve ) did do and didn’t do during the financial crisis of 2008 and in the immediate aftermath and also what it should have been done instead among other things.

So during a conference call to discuss a deal, I managed to get myself into a what I would probably classify now as a silly debate on phone with two of my dear analyst friends in wall-street. It was quite evident from our conversation that  both of them had pretty strong opinion on one central banker in particular and I won’t say it’s shocking to learn how some folks create and form an immediate opinion on someone based on mostly what other market practitioners are saying or have said for that matter but what does surprise me is when people fail to realise that markets are run by human ideas and not all Ideas are good. It is good to have different ideas along with different perspective and we can always agree to disagree and but what we shouldn’t do is dismiss everything simply because it doesn’t fit with our own school of thoughts.

The reality is most of us do not have the essential or required foresight to accurately predict or map out the outcome of the implementation of an idea, strategy or decisions we are going to make but we do know that we can’t necessarily FIX today’s problems by applying tools of the past. And the financial crisis of 08 can’t be compared to other crises before it so fixing it will require a new approach and application of new tools. But the problem is we also live in a different era, a 24 x 7 world where any and every decision a policy maker takes will get scrutinised instantly and people pouring in with opinions expecting instant results without realising that a policy needs to go through a policy cycle in order to be fit for impact analysis. The market tends to carry out an instant autopsy right at the birth and sometimes even before an idea or a policy is fully conceived. And yes there are situations where initial debates are quintessential and do help in formulating good policies.

This crisis has been a breeding ground for learning and testing ideas. And unlike many of my friends I haven’t yet made an opinion on the decisions taken by Mr Ben Shalom Bernanke as I believe it is a bit early to carry out a full and comprehensive assessment and analysis of each and every policy decisions taken by the top central banks especially the Federal Reserve Bank of United States. Also it will be unwise to formulate a clear opinion on the type of legacy Mr Ben Shalom Bernanke as the chairman of the FED will leave behind. We will have to wait and see. And to those who are extremely eager to write their version of immediate history I would say this, where is the logic and common sense behind a person writing an auto biography at age 21 when you know you may end up looking like a complete idiot at the age of 65. As human beings we are never a finished item.

Whatever may become of Mr Ben Shalom Bernanke’s legacy, he has clearly been one of the most proactive central banker who made bold and conscious decisions to get ahead of the crisis and to add to that I would say that I have more faith in him than his house mate at Winthrop house in Harvard, Mr Lloyd Blankfein. Also his policy decisions will most likely keep many student of economics around the world busy for some time to come.

In order to make sense of a policy and policy decisions you do need to spend time on understanding the person or people behind the policies. It is important to look at the bigger picture and develop a better understanding of how that person or a group of people think and react in a given or different situations, how they make specific decisions and why, what is their thought process, what are their priorities, what is their understanding of a particular situation and what are they trying to achieve among other things. The ability to fully grasp a situation differs from people to people.

We live in a Facebook world where most of us tend to post and share our thoughts before it had a chance to fully develop or evolve and the same goes for policy making. A fully developed policy idea takes time to evolve but since most policy decisions during the crisis were made against a ticking clock they were generally half-baked ideas so there will obviously be some uncertainty around them which may cause or continue to create volatility in the market. And it is highly likely that most policy makers including of Mr Ben Bernanke are probably keeping their fingers crossed and hoping things will work out well eventually and history will be kind on them but we are not there yet.

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Reinventing The Financial Markets: Back To Basics

Posted on October 3, 2012. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , |

People across Europe and other parts of the world are increasingly feeling disconnected with the financial world and in all likelihood the discontent will only grow if the sector is unable to connect or reach out to the common folks on the main street.

I believe people do understand that an efficient and a well functioning financial system is essential to the development of society and the overall growth of any business and entrepreneurship around the world. Their discontent is not with the importance or the role the financial sector plays but how the system that was supposed to deliver prosperity has let them down.

 It is important for us to understand the growing dissatisfaction and mistrust of many in the society with the world of finance and how it operates. The general sentiment of people on the street is that financial markets operated as casinos and the banks along with other financial institutions laid bets with people’s money and walked away unpunished giving a financial horror show for folks on the street who are still struggling to keep afloat. Also the recent unfolding events of the past few months including of the LIBOR scandal, JP Morgan hedging fiasco among others has dented the reputation of the financial market even further.

 I remember having a number of discussions with my colleagues in the financial world on this subject and before critiquing folks protesting on the streets of Greece or Spain we all need to retrospect and ask ourselves just how many of us operating in the financial sector came in with a passion to change the world and create a system that worked for common folks everyday. The reality is sheer greed of some in the market and profit making at all cost drove the entire industry to its current mess.  The financial system as we know it is BROKEN.

 Since its humble beginning in 14-17th century the sector has gone through many CRISES and has also kept getting complicated or as others would say sophisticated for the understanding of common folks on the street. Over the years the generic description of the financial world for many on the street got limited to indices i.e. DOW, FT 100, S&P 500 among others and tracking their daily performance became a trend with the help of financial media who developed platforms to report the daily performance of these INDICES on a minute by minute basis to the world. So in short the financial world got INDEXED and these indices became a gauge of the overall health of the economy.

As the market grew so did the creation of complicated financial products and the sector got populated with a large pool of service providers to create demand for the such products. So imagine a common man who could pop into a shop and buy a shoe of his or her choice after trying it buying a complicated financial investment product became a totally different experience. This meant most folks bought products without a clear understanding of what it was and had to rely on the expertise of their financial advisors or firms selling those products and some entrusted their savings to professional firms to invest wisely on their behalf.

 Any system that works on trust requires the practitioners to take responsibilities and maintain integrity at all times but unfortunately the system was let down by people and firms who were mainly in it to get RICH quick and were driven by sheer greed. If the only goal and aim of an enterprise is quick profit at any cost it is not hard to understand why mis-selling will thrive in such environment.

 The big picture is, businesses derives profit from folks in the society which is always the end customer. Unfortunately some of us ignore that perspective but without real interaction and developing a strong relationship with customers no business survives. So for the financial system to work efficiently on a sustainable basis the society should feel that the system is fair, accountable and serves as an important pillar supporting its general well being otherwise we will always find ourselves in them and us type situation and this we know is a recipe for disaster. So the onus is on the policy makers and the financial market to deliver a financial system that is safe and fair and connects closely to the folks on the street.

 The markets need to understand that complicated products are not the answer and in all honesty, no one understands them fully. This does not mean the death of INNOVATION. In fact innovation is good for the market and also for the folks on the main Street, but innovation should bring simplicity.

 Fixing the financial system will require re-inventing it. Regulatory oversight and the policies governing the financial markets will need to be focused on removing the existing complicated layerings and simplifying the markets and its operation. Firms creating and selling financial products or assets should be willing to take responsibility and explain in simple terms the pros & cons of the product they are selling. I believe it’s Einstein who said If you can’t explain it simply, you don’t understand it well enough”. The local community banks and financial advisors will need to be more proactive and transparent.

On the macro level the central banks, the government agencies and the market participants have all got a very important role to play. They will all need to develop new skills and tools to better understand the financial market of 2012 and the future.

It will also require going back to basics and creating a system where the market participants will look beyond just profit and their usual what’s IN IT for me approach. It will require leaders  who truly believe that they aren’t just responsible to their shareholders but also to the folks on the main street who make up the society with a clear understanding that their action or inaction will sooner or later have a direct or indirect impact on others.

A society is made up of many actors with different interests and needs so it is worth noting that envisioning a financial system where everyone was happy is probably not a realistic expectation but without a prosperous society a company won’t be able to survive in the long run. The contribution of the financial sector and the role it plays in the overall growth and development of the real economy which directly benefits the society is a very significant one. Banks and other financial institution across the world have served their local communities for centuries.

 The CRISIS serves as a reminder on how closely linked the main street and wall street really is and it is in the interest of wall street to have a vibrant main street and vice versa.

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The SMEs Bank project – An Idea that could energize the SME sector in a gloomy outlook

Posted on September 22, 2011. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , , , , , |

In the past few weeks the markets have come to a realization that the developed world is struggling to generate growth and going forward the global growth projections put out by multilateral institutions including of the International Monetary Fund ( IMF ) and the World Bank paints gloomy picture. The growth outlook has been downgraded to a lower level from previous estimates. To counter the downturn in the economy the policy makers and the central bankers have been trying out various ideas to keep the economy growing. One of the widely used though unconventional monetary policy tool to stimulate growth has been to print more money through quantitative easing (QE) program by the central bankers. Although through their quantitative easing (QE) program the central bankers were able to provide critical support to the market it has had a limited affect on generating growth so far. And one could also argue that monetary policy tools on their own are not going to be enough to create growth.

Going forward the policy makers in the government will have to take the baton from the tiring hands of the monetary policy makers and have the courage to take bold decisions that goes beyond party politics and is right for the economy.  The people on the streets especially those in the U.S. and Europe as well as the markets are increasingly losing faith in their political leaders’ ability to fix the CRISIS.  And it is probably the right time for the politicians to stand up and deliver. In a recent speech delivered by the president of United States to joint session of the congress Mr. Obama proposed tax credit to the SMEs under Obama’s American Jobs act plan as one of his own initiatives to encourage SMEs to hire more and create jobs. He also proposed common sense based regulations to remove the regulatory burden on the SMEs. Although these are steps in the right direction but the tax credits and the removal of unnecessary regulatory burden on the companies won’t do much on their own to create the level of jobs growth that US economy needs. Besides the tax credits and regulatory reforms the SMEs also need to have an easy access to capital at very reasonable and flexible terms. The government will also need to energise the supply and demand side. Consumers’ confidence is going to be one of the key factors in turning the economy around and the government will need to work closely and tirelessly with all the parties to bring the confidence and positivity back in the system.

It is important to point out that a CRISIS born in a globalised world will need a global effort to fully overcome it. Although it is unwise to expect the developing world especially the BRIC nations to bailout European states it is in the best interest of both the developing and the developed world to work together closely on finding a long term sustainable solution.

In the aftermath of the CRISIS high street banks especially those in Europe and the United States have so far failed to support the SMEs and in fact most banks have reduced their lending to the sector significantly while increasing the cost of capital at which they will lend to the SME sector companies. Banks as one of the beneficiary of the quantitative easing program have not passed on the cash to the real economy and they are still struggling with their risk management strategy so to expect them to do more to support the economy and the SMEs sector is probably unrealistic at least for now.

The small and medium size enterprises ( SMEs ) are an important integral part  and the supporting pillar of any economy. Generally the sector tends to lead a country’s new and fast growing industries.  Some of the success stories of developing world today including of Korea, Taiwan among others has been built on the dynamism of the SME sector. Also due to its inherent structure the labour intensity is generally higher in the SME sector companies hence the sector is usually the largest employer in a country. For example over the last two decades the SMEs sector has accounted for around 65% of new jobs created in the U.S. and overall it accounts for about half of non-farm U.S. employment and within Europe the SMEs sector employs around 68 million people which in percentage terms translate to around 72% of the workforce in the non-primary private sector.

Even though the SMEs are seen as an important part of an economy and play a very crucial role in jobs creation in general the sector is not serviced well by banks today. The banks who mostly play the role of an underwriter of loans or suppliers of credit to an enterprise are limited in their abilities to offer a flexible funding solution to the sector and provide the right support  to the SMEs due to a number of reasons, including banks being very cautious in their lending approach, uncertainty about the future and the changing market conditions, a changing mandate from their shareholders and the board, lack of commitment to the sector as well as the lack of the supporting secondary market infrastructure that will encourage and allow the banks to make good PRIMARY loans to the SME sector and be able to refinance in the secondary market if and when required. Financing SMEs do pose real challenges for the banks especially in the current environment where they are continuously feeling the pressure on their balance sheet and struggling to keep their heads above water. Also it is important to point out that while there is an immediate need to address the lack of capital availability to the SMEs it is important that the solution is sustainable and will add value in the long term.

The idea behind the new SME bank or the SME financing vehicle will be to work closely and directly with the sector as well as other banks, credit guarantee agencies, regional development agencies, usiness associations among others to provide direct and right funding solutions to the SMEs and also help in developing the secondary market infrastructure that will allow existing banks and lenders extending loans to SME sector companies to refinance their loan books.

Most Small and Medium Size enterprises require a flexible funding solution that is right for their business and will support them fully and won’t be called back or withdrawn living their business in limbo like an overdraft facility or credit line due to changes in the market conditions or a change in the strategy of the bank. SMEs like any other sector of the economy will prefer certainty and also a ring fencing of their funding commitments from the banks so they can make business decisions.

The inception & operational strategy of the proposed SME Bank

  • The Central banks and the governments could create a SME Bank or SME Financing Vehicle in partnership with financial institutions including of development banks, private investors and other investors with focus on SMEs or similar investment asset class.
  • The investment strategy and the role to be played by the SME Bank should be multifaceted and flexible to allow it to meet a range of capital requirements coming out of the SMEs. A single funding solution or investment strategy may not provide the right support to the sector.
  • The SME bank should also be able to work with traditional and nontraditional lenders to SMEs including of high street banks.
  • The SME bank should also provide a third party service to others and help other banks manage and monitor their existing SME loan books better and get paid a fee for its services.
  • Buy off the existing loans from the balance sheet of the banks enabling them to refinance their loan book and use the new money to extend more loans.
  • Also act as a guarantor to the SME sector companies that are looking to secure funding or provide performance bonds to their counterparties/clients if and when required.
  • Be able to securitise SME loans under special tax free investment provisions for a limited period to attract investors into the asset class.
  •  Provide advisory and consultancy services to SMEs and work intimately with the sector.

 Proposed Shareholders/Participants of the SME Bank (or the SME financing Vehicle) 

The government or the central banks, development agencies, multilateral institutions, local banks, credit guarantee agencies, private investors and financial institutions among others

Proposed Capitalisation and Guarantees

A part of the capital commitment to the SMEs bank could come from the Central banks using the government bonds purchased through their QE program and the remaining from its prospective shareholders. The capitalization of the bank should be based on the real funding requirement of the sector and should be sufficient to service good SMEs.

Benefits of the SMEs Bank

The SMEs bank will play a very important role with huge benefits to the SMEs sector companies, high street banks, lenders focused on SMEs, credit guarantee agencies as well as development banks and other market players. It will also act as an additional pillar supporting the market in the long run and will be a good value ADD going forward.

The local banks, credit guarantee agencies and other lenders or service providers to the SMEs by working closely with the SMEs Bank will be able to take a preemptive action on any loans or services extended to the SMEs that has a possibility of becoming a non performing loan. Also banks could easily offload good and performing loans to the SMEs Bank (or the SME financing Vehicle). While the SME Bank will do direct primary loans and investments to the SMEs sector companies it also will also help develop the secondary market for SMEs loans underwritten by the local banks and other lenders. It could also play the role of the credit guarantee agency to the SMEs sector.

Exit strategy for the shareholders

The shareholders could EXIT if and when required through an IPO in few years time when the markets are going to be much calmer.

The SMEs bank will energize the sector by providing a critical support to the SMEs with a range of financing solutions and will also add significant value to the existing system on a long term basis. It is an idea that needs to be seriously explored by the policy makers.

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