Unlocking Value – Exploring The Shanghai Global Exchange Idea

Posted on September 23, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , |

The latest economic data out of China clearly suggests that the overall economic growth rate has most likely peaked, and the economy is now going through a transition period, in other words, a shift in gear. And this transition period needs to be managed well through policy changes and other measures. The policy makers will need to be proactive, and it is probably one of the reasons why the central bank of the country ( PBOC ) decided to extend RMB 100 bn worth of liquidity to the largest banks in China. But any monetary policy tool has its limitations, and the transition will require the leadership to push through essential reforms and adjustment in the economy.

Going forward, the pressure on the leadership and the policymakers to take additional measures to shore up growth will remain somewhat high especially considering the growth target level set by the leadership, but it will be important for the decision makers in China to look at the bigger picture while having a long term perspective in mind. Also considering the overall macro picture, it is quite likely that China based companies may find overseas markets a bit more attractive so it is quite plausible that China’s overall overseas investment might exceed the incoming FDI in the country going forward.

The construction and property sector of the economy has made significant contribution to China’s overall growth rate over a considerable period of time, but there are clear and visible signs that the sector is now entering an oversupply phase. And in the long run, new stimulus measure for the sector may in fact do more harm than good to the overall economy. So the focus should be on consolidation, and managing transition period well while working on unlocking value from other sectors of the economy.

So it is important for Beijing to look at ways to facilitate sustainable growth by exploiting potential value from other sectors of the economy as a way of diversification. And with the creation of BRICS development bank that is to be based in Shanghai, the city and the leadership in China should take the opportunity to lay down the foundation of a future global financial centre, and also start the process of unlocking  value from the financial sector.

The new financial centre should not be modelled or based on any of the existing global financial centres, and the aim should be to look ahead in the future, by creating a financial services infrastructure that can stand the test of time, with open access, and created for the world while creating jobs and growth for the Chinese economy. Also through the financial centre, the policy makers in China could explore ways to better utilise a substantially large shadow banking system with an estimated worth of over US 6 trillion.

And by having the new BRICS development bank based in the proposed financial centre, the government could kick start the process. This is why the bank should not be modelled as a rival to IMF or World Bank, because then it runs the risk of becoming another multilateral agency too slow to change the way the global economy works, but instead, it should aim to take the world and Chinese economy to the next level. The BRICS bank based in the new global financial centre could  plug right into the existing financial infrastructure of the central banks of BRICS nations,and create an integrated platform to facilitate local currency trade settlements among the members, and also develop the ability to finance projects in local currency of the member countries. The other counter parties including of the players from the shadows banking system could also plug into the proposed global financial centre, and make good of various new opportunities by deploying  their capital better.

Most emerging market economies require a buffering or protection against currency exchange risks in the time of extreme volatility, and going forward, the players in the financial centre along with the BRICS development bank could play an important and significant role  in absorbing some of these risks by facilitating trade settlements in local currencies or non physical  trading currency Unit that can be converted into local currency of the vendors. All this could be facilitated by the financial centre with support from BRICS development bank acting as a facilitator, and as an independent counter-party connected to the central banks of the BRICS nations as well as other emerging economies. The conversion and exchange mechanism of the non physical trading currency unit into local currency could be worked out easily between the central banks and the BRICS development bank, and offered to regular clients by intermediaries based in the proposed financial centre. So the volume of overall transactions done through the financial centre could easily reach over trillion dollars mark making the centre an important financial HUB.

And the Government could position Shanghai as the natural financial hub / centre for global emerging economies, where the emerging economies and the companies based in the EM could come to trade and also raise money. And this could help create a first Global Exchange focused on emerging markets. An exchange that will facilitate trading of loans,debts, equities, commodities, funds among other things. The local companies based in China will also benefit immensely from the pool of liquidity provided by the exchange, and by their exposure to the world without having to leave their own backyard. And as suggested before, the existing shadow banking system in China could also play an important role in the whole scheme of things.

The importance of diversification cannot be understated, it is worth noting that although the overall growth rate of the Chinese economy has most likely peaked, still by most projections, the Chinese economy is projected to become larger than the US economy by the year 2020, but its per capita income is estimated to be less than US$ 17,000. Also, the cost of manufacturing is estimated to rise by over 105% making the economy less competitive, so quite clearly the economy is entering a transition period. This is why the policy makers and the leadership of the country will need to work hard on navigating the road ahead by exploring all the under utilised economic potentials of the country. So creating a global financial HUB should fit quite well in the overall plan, and is an idea worth exploring.

There are also significant geopolitical benefits of having the world come to you, and trade with you, also in most likelihood the leadership in China should be able to use this as a soft power approach to promote China. But for this to work, the market participants will have to feel confident and comfortable with the regulations, the governance structure, and the overall jurisdiction related issues among other things. So the government of the day will have to be willing to create a special legislative framework that will allow the financial centre to run at arm’s length from Beijing. This could be a challenging task, but the opportunity is huge. And there is already an existing precedent. After the creation of Shanghai Free trade Zone, some Asian banks including of Singapore based banks have seen their yuan based business grow significantly in size.

The approach will have to be collaborative, and not solely aimed at competing with existing financial centres of the world including of London or New York. Also by design, the new global financial centre should be able to serve and support other major financial centres of the world as an additional and important engine keeping the world economy flying.

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Talking About The All Scary Emerging Market, Market Perception and Investing in General

Posted on January 26, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , , , , , |

The markets are once again busy with chatter about Emerging Market ( EM ) and the sound of CHOAS seems to be re-emerging and many in the market are starting to wonder, what’s next ? A number of analysts have gone on record suggesting in their daily market commentary that emerging markets could now be a danger to global financial stability. No doubt, these are strong statements so it begs the obvious question, are we looking at another financial crisis, this time coming from the emerging markets ? And I do wonder if the fundamentals of EM have changed so dramatically leading some commentators to believe that a crisis is somehow imminent as evident from the way markets have reacted last week? Well, unlike our friends in the financial world, we ( I am referring to our group ) like many others who operate on a daily basis in the real economy can see and feel that the global economy is shaping up nicely and the IMF’s latest revised up global growth projection of 3.7% for 2014 and it’s growth expectation of around 5.1% for emerging markets from an earlier 4.7% GDP growth rate guidance, more or less reflects the ground the reality of the day.  So the obvious question, why this panic and uncertainty ?

Now one could rightly argue that the revised up guidance are just projections and the risks both known and unknown still remains. Also the recent volatility in the markets to a large extent has been driven by downward pressure on the Turkish LIRA as well as Argentine PESOS devaluation and the South African RAND, which is also come under a bit of pressure. And then there are obvious chatters around how good or bad China is doing and how will the leadership manage the US 4.8 trillion dollar worth ( estimated ) shadow banking system along with a relatively high local government debts, and then there are concerns about India as well as Brazil’s fundamentals. These are real and genuine concerns but having said that, I can’t help but wonder, how is all this a SURPRISE to anyone in the market ? For example most of us are aware of the ongoing political uncertainty in Turkey and based on our own common sense, we could safely conclude that if the political turmoil drags on then there will be consequences to the economy.

And also assuming the worst case scenario, one needs to ask and know, did the previous crises in Turkish and Argentine economy kill the overall emerging markets across the board ? the clear answer is NO, so in short it will be unwise to assume that Turkey will some how bring down the emerging markets of Asia, Africa or Latin America, the reality is a potential crisis in Turkey may be more damaging to developed European economies then China or India for that matter. Also it is important to emphasise that there is a crisis of leadership in Turkey today which is weighing down on the economy and a positive resolution could very easily change the overall dynamics of the economy. Now with regards to China, a US 9.4 trillion dollar economy growing at around 7.7% isn’t just going to fall off the cliff under the weight of its shadow banking system and the local government debt. Yes, there are real concerns about how the government may go about handling the whole situation but it will be unwise to assume that somehow the economy will implode bringing down the global economy. There are simply too many opinions on China both bearish and bullish but understanding the structure and behaviour of the overall Chinese economy is an extremely complex task and betting against the government’s ability to deliver on its set forth agenda never really works and this may be one of the reasons why foreign investors tend to struggle in China. And with regards to India, the Indian economy today is in a much better shape fundamentally than last year also the overall investors sentiment around India has improved significantly, the country’s real problem today is a lack of decisive leadership which will hopefully get resolved after the upcoming general election and also most CEOs representing both local and overseas companies are quite upbeat about India’s medium and long term growth prospect. The current government has also made a series of reform announcements aimed at opening up various parts of the economy to overseas investors.

So why then the market is projecting a risk of contagion and giving a sense that somehow an imminent crisis is brewing up in the Emerging market ? I must say, I do wonder if by holding an emerging market stock or bonds or taking up speculative positions in local currency an overseas investor is ever able to get the full picture and flavour of the overall economy ? And the answer is, most likely not because in reality most emerging markets are layered and quite different to each other and also it must be said that there is a reason why they come under the category of being classified as ” emerging markets ” but this is not to say that developed markets are somehow immune to crisis as evident from the financial crisis of 07/08.

In the big picture scenario understanding a market or an asset class isn’t just about reading opinions from various experts of the subject and one must not forget that even in good times people and companies do fail so yes some emerging markets may struggle but today the global economy is in a much better shape than it was few years ago and it is quite unlikely that from here on we are looking at an imminent collapse. However, the inherent risk in the global economic system as well as the financial markets by design still remains so the system isn’t CRISIS proof and never was. Also opinions and projections are part and parcel of how a markets operate but people do need to be rationale and honest because clearly there are those in the market who may prefer a free ride and to keep making  money on the back of easy money printed by the central bankers. This is not to suggest that the global economy has now reached a stage when all the loose monetary policy stimulus should be withdrawn right away, the tapering and tightening of traditional monetary policy tools will most likely be gradual.

But having said that the market will continue to make tapering related bets. Vanguard, PIMCO and BLACKROCK  lost roughly over 35% in value on their investment  in the last 6 months of 2013 by getting their inflation bet wrong on Treasury Inflation Protection Securities (TIPS ). These firms made bets on the assumption that Quantitative easing (QE ) will deliver inflation down the road and although it is quite evident that they got their bet wrong but we mustn’t  forget the fact that QE did in fact create Inflation in ASSET PRICING and also across various Emerging Markets, but obviously not where it was expected so clearly those who held a view that QE will create inflationary mayhem in the economy killing  the dollar down road most likely didn’t incorporate the fact that the economy of today works and behaves a bit differently. There  needs to be a realisation that too much money in the system and ultra lose monetary policy will not necessarily create an immediate spectacular growth trajectory especially when the economy is coming out of a MASSIVE HEART ATTACK. And there are clear evidence that QE has created ASSET pricing inflation through misallocation of capital and this may be what is eating up growth ( growth rate below market expectation ). Also while some managers did get their inflationary bet wrong they should also realise that central bank’s ability to create or control inflation in a 2014 world isn’t always guaranteed or straight forward but having said that inflation will slowly but surely show up in the real economy but most probably not tomorrow.

Investment is about taking risk by relying your own assessment of a specific risk and then taking a decision based on your own judgement. MARKETS OR COMPANIES are all run by Human ideas and thought process so the market or a company is only as good as people behind them. And without being philosophical, we all know that life comes with no guarantee so what do we do? well, we learn to take risks and the same goes for creating a business and how we invest. There are no guarantees and the guarantees you may have or seek could easily become worthless when the circumstances change. And whatever investment decision you make or take will always come with an inherent RISK so there is always a chance that it may or may not work out as planned. You can only make a decision based on what you can see and know today but there are always many unknowns that you may not be able to factor in and going forward  these unknowns may very well influence the outcome.

So investing in general isn’t all about following a trend or analysts reports or getting overwhelmed by the sound bites coming from various corners of the market or committing yourself to a fancy model. In most cases, a good investment is generally about following your own intuition or in other words your own inner radar just like many decisions we make or take in our lives and you can always use the information available in the market to make up your own mind in a similar way as you would seek advice from friends or family when taking an important decision in your life but always remember you will have to live with outcome and blaming others for an undesired outcome never helps although it might be quite tempting to play the game but if you do then you are denying yourself an IMPORTANT OPPORTUNITY TO LEARN and there is nothing scary about learning. So the all scary emerging market as projected by some in the market today in fact may not be that scary after all and remember a perception doesn’t always equal reality.

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Making China’s Shadow Banking System Work Better

Posted on June 30, 2013. Filed under: Uncategorized | Tags: , , , , , , , , , , |

The issue of the shadow banking system in China has put the country on the hot seat and there has been no shortage of opinions coming from various segments of the financial market including of the ratings agencies. The negative perception around the system has grown tremendously and rightly so and some in the market believe the situation now resembles more or less like a wild west and the regulators seem to have very little handle on the sector so there is an urgent need for the policy makers to take proactive steps to reform the existing system.

The authorities including of the officials at the People’s Bank of China ( PBOC ) and the Chinese premier Mr Li Keqiang finally seem to be taking a tough line and have made their intentions quite clear to the market as evident from their recent statements. Also by not reacting to the liquidity squeeze felt by most local banks in the first two weeks of June which pushed the short-term interbank and money market rates to an uncomfortable level hindering banks business the policy makers took a huge risk by refusing to inject cash into the system. Through their action the authorities in China have shown that they are serious about reforming and restructuring the economy and also willing to rein on uncontrolled credit growth by punishing speculators and the shadow banking system.

This is certainly a step in the right direction but not sufficient. The reform agenda will also require the policy makers to look inwards and assess the overall affect of the existing policies. I am starting to wonder if the annual lending quota or limit set by the policy makers at PBOC infact encourages the growth of shadow banking system in the country as most of the local banks lending done under the existing quota system goes to the state owned companies leaving the small and medium size privately held companies to chase very expensive alternative source of capital. Also since the banks aren’t generally able to provide decent return on saving accounts to depositors so a significant percentage of the savers money ends up in the shadow system chasing high returns.

 The shadow banking system in China has been growing at over 34% annually since 09 and is estimated to be worth over US 5 trillion dollars today which is approximately around 58% of the country’s GDP and makes up about 32% of the total banking assets. The size of the system is clearly huge and there is a clear emerging evidence that links the growth of the shadow banking system to the existing regulatory environment. So a reform of the system is badly needed and the reality is that the shadow banking system isn’t going to go away tomorrow even if the policy makers were to carry out a wholesale reform of the system and it isn’t just a Chinese problem.

The shadow banking system isn’t a new phenomenon or trend it has coexisted with the traditional banking system around the world for decades and according to the financial stability board (FSB) latest estimates the global shadow banking assets crossed over the US$ 67 trillion mark in the financial year ending 2011. The existing system has inherent risk and serious vulnerabilities and it is also a significant systemic risk threat to the overall financial system.

Having said that while addressing the regulatory oversight concerns it is important for policy makers to recognise that the existence of a shadow banking system in a country isn’t all negative for the economy. The sector does play an important role in the overall financial system by providing liquidity, risk transfer, access to alternative source of capital, it is also a very adaptive system with tremendous ability to reinvent itself and a good indicator of the overall economic activity among other things. So there are clear visible benefits of the shadow banking system to the economy.

A good and workable solution will require the policy makers at the People’s Bank of China ( PBOC ) along with the government to have a proactive and flexible approach when setting the reform agenda for the shadow banking system in the country. Their aim should be on facilitating the right incentives to make sure the sector works better by adding real value and serves as an important complimentary building block to help create a better and sustainable financial system vital for the overall well-being of the country.

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