Talking about Economics, Science and Religion. And then adding humans to the equation.

Posted on December 19, 2017. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , |

So what do we know about science, economics and religion ? Well! for starters, science existed since the day Universe came into being, and therefore science has been around long before humans or human civilisation came into existence. Science is as old as the universe itself. There is science on Mars, but no economy. Also there is science all across the cosmos, but till date, the size of the space economy is limited to human activity closer to earth or our solar system, although this may change as humans venture into space on a larger scale. There are vast amount of natural resources spread across various parts of the Universe as well as continents like Antarctic here on Earth, which has resources worth tens of trillions of dollars. But it still has no economy or in other words GDP, and that is down to the fact that, there is no permanent human civilisation based there.

The idea of economics and economy started along side religion, nation state, and culture etc. And therefore, like other human ideas, it was conceived as a subject by humans. So humans will continue to influence it. Human behaviour, human perception and psychology, and their overall sentiment will continue to influence the subject of economics and the idea of economy. The data created by a human society, categorised as economic activity related data, tends to be the metrics widely used, to understand or gauge the overall wellbeing of an economy. And as the human society becomes more complex, so has the economy. It has no doubt continuously evolved and changed reflecting the changes in the human society. But like religion or culture, it has design flaws, and therefore fails to serve the entire human civilisation. The prime example is, the aftermath of the financial crisis. While we can measure the financial cost to an economy, what we cannot accurately measure is, the human costs that is directly and indirectly related to the financial crisis of 07/08. And the same does apply to religion. Although some of may of us continue to argue the case for religion, none of us have tried to accurately assess or measure the human costs of religion on humans, in terms of holding back human’s overall progress etc while the various religious franchise aka religions have gone richer and wealthier over time.

In the US alone, based on various estimates, the society known as the American society tends to give away around $ 82.5 billion a year to religion. And then, there are direct and indirect human costs. Having said that, wars have killed more humans than religion, and they also cost a lot more money than religion. But in historical context, some of the wars were religiously motivated, and humans still tend to fight over their religious and cultural ideology.

The question then is, do we need religion or economy for that matter ? And the answer isn’t that difficult. For many of us religion is still the answer to questions like, why do we exist and what’s our purpose ? And to a very large extent economics and economy has played a very vital role in the evolution of the human society as well as its overall progress. So to take away economics or religion from humans may not work out well. While science has always existed, sometimes, it is the economics that has justified scientific progress. And it is the economics of space that will most likely drive humans exploration of space.

According to space foundation, the space economy is already worth over $ 329 billion, and in the next 50 to 100 years, space industry will become the most dominant among all the sectors of the economy. It will not only create new jobs, but also help take humans as a civilisation to the next frontier. At least that’s what I feel. Imagine an economy that is not only going to measure the economic activities here on Earth, but also from across the Universe. But can it create enough wealth, to help fund the living of the entire human race ? Now this is a rather difficult question to answer, because unless and until, we keep finding ways to make the entire design of the economic system more efficient, it will continue to fall short.

My own assessment is that, economics and economy as an idea and subject is not a complete science, but unlike a religion, it isn’t stagnant, or requires the human society to completely surrender itself, and be at its mercy. It has flaws, but it also does have the capacity to continuously evolve, and so it should. Humans are the key input to the entire equation, and without adding humans, one could say, nothing is relevant. And the human element  will continue to add a level of unpredictability and uncertainty to the field of economics and economy.

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Understanding Emotional Capital

Posted on November 12, 2017. Filed under: Uncategorized | Tags: , , , , , , |

Most Humans are emotional animals, and not just humans, the statement is probably true for most living species on Earth. Unlike money, emotions are hard wired in the overall design of a human being, so separating emotions from a human being is, more or less equivalent to taking out the core of what is being a human.

The driving force behind a goal, ambition, or a dream of achieving something of significance, tends to be emotion. And emotions do play key role in how committed a human is. The idea of a human being, to be in relationship with another human being is also, mostly based on the underlying emotions that humans tend to have for each other. And once they have invested their emotions in a relationship, they tend to work extremely hard to make it work.

My own understanding of a human emotion or emotions in general is still evolving. I have always felt that, humans should not be emotionally attached to their business or profession, and my rational for holding that view has mostly been based on the assumption that, emotions will comprise the ability of a human being to make rational decisions. And the evidence tends to suggest that the view may have a strong merit. But over time, my own view on the subject matter has evolved, and in the process, it has changed somewhat.

And today, I am of the opinion that, emotions are natural enhancing tools, and maybe,I need to relearn the definition and the role that emotions can play in helping humans progress. A business or a profession, whatever it might be, may lose some of the essential intensity, if humans weren’t emotionally invested in it. And the loss of emotional attachment to a business, may not necessarily mean that, the decision making process will become more rationale based.

As humans grow, so does their emotional capital. And through a process of trial & error, also commonly known as living, most human beings tend to get a better handle of their own reservoir of emotional capital. It is by learning to better utilise and understand their emotional capital that, humans can define their own success, whatever that might be. Or in other words, learning to invest your emotional capital wisely by a way of trial & error, will define where you may end up in your human journey.

So therefore, building the right reservoir of emotional capital, by better understanding how emotions can help or enhance a human being positively, individuals as well as the society at large, can learn to make better decisions, whether business or otherwise. The idea that emotions show the weak side of a human being has no scientific merit. And emotional Capital is good for your overall well-being including the financial well-being.

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The statistical data and the design of the modern economy

Posted on July 6, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , , , |

Our modern economic system is overload with all sorts of statistical data, all aimed at helping us better understand and interpret, the overall health and condition of the economy. And one of the top leading economic indicator to measure the health of an economy is the Gross Domestic Product (GDP), used by central bankers around the world to adjust their monetary policies, by the governments to create economic policies and by the markets to make economic assessment in order to make investment decisions.

So how is our world doing ? well, based on the international comparison program ( ICP ) data for the year ending 2011, the PPP- based world GDP is over US$ 90 trillion. And around 32.4% of this GDP comes from the six Middle income countries including of China, India, Brazil, Indonesia and Mexico, while the six high income countries including of US, Japan, Germany, France, UK and Italy make up around 32.9% of this PPP-based world GDP. The average per capita income of Qatar, Macau, Luxembourg, Kuwait and Brunei of around US$ 100,000 is much higher than the six high income countries, and the US being the cheapest in terms of living cost among the high income countries. And EGYPT, Pakistan, Myanmar, Ethiopia and Lao rank among the cheapest economies in the world.

In terms of investment expenditure, China now has the largest share of the world’s expenditure for investment in other words gross fixed capital formation, and roughly 80% of Asia’s ( including the pacific region ) investment expenditure comes from China and India while Brazil makes up 61% of South America ‘s overall investment expenditure.

But for many, all this is might not only be quite boring statistical data but also somewhat irrelevant as they may not be able to relate to it or interpret it. On the other hand, many would find and consider these vital statistical data extremely important as it confirms ( their interpretation ) that our world is getting a bit richer than it was over a decade ago but then some may disagree especially those who are still struggling to keep their head above water after the financial crisis of 07/08, and would rightly argue that rich are getting richer and the income gap is expanding.

Whatever may be the case, these statistical data are nothing but a rough estimate prone to error. So far we have not managed to design an efficient economic reporting system that is able to account for all (100% ) of the economic activities of the world.

So whichever way, we decide to measure or calculate, how rich our nations economy or the world is getting, there will always be an element of misrepresentation of the actual fact. And I believe Simon Kuznets, who developed the idea of using GDP matrix to measure the size of a country’s economy knew about its limitation. This is why Kuznets extensively wrote about its use and abuse. And one of his statement in 1962 more or less sums up the issue. He said,  ” Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what “

Antarctica has trillions of dollars worth of natural resources but zero GDP because it is the people and their economic activities that is what a GDP calculation is tying to measure. So it is the people who make the economy as well as the GDP number, and without people, there is no economy so quite clearly, a economy should be built around people and not the other way round.

The economic literacy of the world population is extremely low, and people on the street today couldn’t be more connected to the financial world than ever before, as evident from the immediate after of the financial crisis. And increasingly more people are starting to talk and pay attention to economic issues that has already affected them directly or indirectly or may affect them going forward as consumers, investors, citizens and what not.

So the design of the modern economy should also incorporate providing basic and essential economic literacy to all the participants and users of the system. A higher rate of basic and essential economic literacy will help people around the world better understand the complex economic system. Economics and overall health of an economy affects people in different ways, and its influence on people’s life is ever increasing so there is strong case for the system to be upgraded, and designed around people, to make it work better.

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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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The Market’s Obsession With Credit Rating and Rating Agencies

Posted on February 27, 2013. Filed under: Uncategorized | Tags: , , , , , , , , , , , |

We live in a complex and ever changing financial environment where the role and behaviour of the financial markets as well as its participants is under constant scrutiny like never before. And while the worst of the CRISIS is now behind us a post-crisis world economy is still struggling with a weak growth prospect. Although most banks in Europe as well as the US are getting back in shape and the corporates seem to be holding abundant cash it isn’t trickling down to benefit the real economy. This by no means is unexpected or a surprise and there are a number of reasons and factors at play and one of them is the financial health of governments around the world especially in the developed world as reflected by the downgrades in credit ratings of countries like the US, France, the UK, Spain among others with few exceptions.

Economic growth requires investment and risk taking and clearly the market isn’t delivering on both these issues yet. The markets obsession with credit rating and rating agencies comes from our love for playing the blame game and also our inherent nature of running away from taking responsibilities for an undesired or bad outcome from the decisions we take or have taken. The reality is everybody fails and we all know how badly the rating agencies failed.

Credit is not STATIC and by it’s design dependent on many variables so projecting it’s behaviour over a period of time requires much more than a financial model that incorporates an anticipated change or changes in the business cycles of a specific sector or an industry as well as trends and events going forward. And since most of us don’t have access to a crystal ball understanding a CREDIT more often than not comes down to developing or possessing a GOOD JUDGEMENT. So I always encourage my friends and colleagues to rely on their own judgment skills rather than paying for a borrowed one from a rating agency.

A good investor or a smart money manager should never try to justify buying into a bad investment by saying that they relied on a credit rating report issued by a rating agency. Risk and rewards generally do go hand in hand but not always and this is why I believe that it is important to look at the bigger picture and to get some perspective we should take a page out of the human history. Humanity has survived many crises and also in the process managed to put a man on the moon, explore mars and has a remarkable list of achievements and accomplishments because of its ability to evolve and take risks. Investment is not all about possessing amazing analytical skills. In my own opinion there is much more to it so I would say this Take Investment as an ART form and learn to enjoy your art as a passionate ARTIST would and with time who knows you may create your own masterpiece.

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EUROPE in Rehab

Posted on May 14, 2012. Filed under: Uncategorized | Tags: , , , , , , |

Committing to and carrying out real structural reforms, managing citizens expectations, finding ways to grow the economy while keeping the spending on track is a BIG ask but it has been done before in Europe and it looks like this is what the policy makers in Germany want from their southern European partners.

The question is are the folks on the streets in Southern Europe willing to sacrifice their living standard and livelihood for the greater good of the European Union in the long run or will Germany offer flexibility in the short term to ease the pain and change course? Well, we will have to wait and see.

There is no doubt that folks in Southern Europe benefitted the most from the European Union idea in the last decade without realizing that all the rise in their living standard and good times hasn’t been paid for and is infact being subsidized by others specially in Germany. Yes, in the current environment it is easy to criticise Germany’s stance on Austerity but I believe it is important to point out that there is a serious trust deficit among European partners so Europe has no choice but to go through the grind. It is no secret that policy makes in Germany are tempted to use this CRISIS as an opportunity to bring about far reaching changes across Europe and although  I have always found myself siding with folks who disagreed with the severe austerity drive without any serious plan for growth there is no denying the fact that while Germany did carry out far reaching structural reforms during  its reunification period and was referred to as “The SICK man of Europe “ by the market its counterparts in southern Europe saw a big jump in their living standards and hence got busy partying. And now while most in Europe are struggling Germany is certainly ripping the rewards of the decisions made during the time of reunification which required west Germany to invest over Euro 1.3 trillion and also significant sacrifices were made by its population in terms of accepting lower wages, cut in pensions and benefits among others so may be folks in southern Europe need to do a REALITY CHECK and remember NOTHING IS FREE and good times don’t last forever.

The protests and civil disobedience across Europe are probably some of the side effects of the REHAB process that Europe needs to go through in order to get back in shape and as we all know rehab is never a quick in and out procedure. It is a process that requires strong will and commitment and this will no doubt test the resolve of the Europeans but it must be said that a good rehab programs gets an ADDICT off the addiction slowly and this is done to manage the side effects better and ease the PAIN. So its probably time for Europe to consider a balanced approached through delivered a GROSTERITY   (i.e. growth with smartly targeted cost cutting measures to bring down the deficit over a period of time) plan instead of its current front loaded severe austerity drive on all fronts.

A strong and sustainable Europe is in everyone’s interest and the solution to the ongoing European CRISIS is a more integrated and competitive Europe on all fronts and not less of Europe. From the onset European Union was a flawed idea which allowed its members to get high on an addiction where everyone assumed their living standards will rise forever without realizing that they may be sleep walking into a disaster waiting to happen because the policy makers got blinded by the BLING BLING of Europe.

Greeks and others in Europe may not like austerity but going back on the European idea is simply not a good option because they are not prepared for the aftermath. Also there is no evidence to suggest that economies like Greece will benefit immensely by having a devalued currency in fact with a devalued currency it will take Greece more than 30 years to recover especially if all the far reaching structural reforms needed to revive the competitiveness of the country is not fully implemented. And also let’s not forget the human cost that will come with exiting Euro. No doubt, a large population of Greece has seen the benefit of EUROPE so saying goodbye is probably not a viable option for them and the same applies for other countries in the Euro Zone area including of Ireland, Spain, Italy and Portugal among others.

Europe needs to come together with a strong resolve and will to get through the CRISIS. The aftermath of this CRISIS should be a strong, resolute, realistic, functional and more integrated Europe but this will depend on the policy decisions made by the European policy makers today.

Europe is capable of finding its own FIX but this will require a strong political will and sacrifice. And its probably worth mentioning as analogy that you can make a football team with different nationalities, cultural background work together and also win trophies but only if all the team member share the same vested interested.

In short Europe has to be good and should work for all its member and not just some but this will require looking beyond national interests for the greater good of the Europe Union. Also the policy makers will need to come up with a balanced approached and folks on the street will have to get realistic about their expectations but I wonder If they are able to look beyond TODAY?

The problem is we live in a world where we expect instant results and changes without realising that this crisis didn’t develop or happen overnight and fixing it will take time and also the FIX will come at a COST. The fate of the European Union is not at the mercy of the markets but its people and the ability of the policy makers to come together.

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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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The CHINDIANS – Reshaping the future of the global economy

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

Indo-China Trade has been growing at over five times the rate of world trade growth. Going forward their increasing economic strength and bilateral trade will create a super growth corridor where the world could plug in.

China and India are now leading economic stories on the world stage and this story may very well last through most of our life time.  And while some in the market regard the two countries as competitors in the years to come collaboration and not competition will take the centre stage. India and China’s trade relationship is historic going back 2,000 years under the thriving Silk Road trade. Relationship between the two countries has been thorny in the past and they did go to war over a border issue in the Himalayan region in 1962 which affected the trade and bilateral relationship negatively.

However from the 2002 onwards when the two countries agreed to work on normalising the relationship and spurring commerce, the bilateral trade between the two has steadily grown from a mere US$ 7.3 billion in 2003 to around US $ 62 billion in 2010 growing by more than 8.4 times in just 7 years at an annual growth rate of over 120% making China the leading trading partner of India, and India jumping 11 places from 20th top trading partners of China in 2003 to be ranked 9th among China’s leading partners in 2010. The two countries have already agreed to push the bilateral trade to USD 100 billion mark by 2015. Although China’s bilateral trade volume with ASEAN, Japan and South Korea is higher the annual growth rate of the INDO-CHINA bilateral trade is far greater and is set to continue as business to business contacts grow. Also the size of the economy, population and the geographic closeness of the two countries provide abundant opportunities for growth in bilateral trade.

Today a significant portion of the world trade growth is coming from China and India. And this trend is set to continue going forward. Intra – Asian trade has clearly been one of the biggest beneficiaries of the growth. According to IMF the interregional trade flows within Asia has grown at the rate of over 13.4% from 2000 to 2009 and is estimated to be valued at just over US 1 trillion. So far China has been the major driving force behind the interregional trade growth. And a noticeable change in pattern has been the increase in imports from Asia to meet the domestic demand coming from Chinese consumers whereas previously a bulk of the imports from parts of Asia were assembled in China and re-exported to the developed markets. The pickup in domestic demand is line with the government’s attempt to rebalance the Chinese economy. In its recent 12th five-year plan Beijing has set out a clear plan and set of measures to rebalance the economy and drive up domestic consumption.

The Government in China has realized that a vibrant domestic market is the only guarantee of a sustainable growth and long term success and relying heavily on foreign demand makes the country vulnerable to external shocks . So expanding domestic consumption is clearly a favoured long-term strategy for Beijing especially when its export based manufacturing seems to be slowing down and gradually may lose competitiveness mostly driven by rapidly rising high wages, higher input cost, shortage of low-skilled workers among others. Various projections suggest that the working age population in China will peak around 2015, so the labor supply is going to gradually decline and push up the wages even higher.

Historically wage growth and household income in China have not matched the overall GDP growth and some research suggests that in fact wages have actually fallen from 53.2% of gross domestic product between 1992 and 1999 to 49.7% between 2000 and 2008. So in its efforts to rebalance the economy the government has taken measures to allow significant rise in wages across the board. In line with government policy the municipalities across China have raised the minimum wage on average by over 20%.

Rising wage pressure, appreciating currency and high input cost driven by inflation may be enough to shut down a significant number of export houses in China especially in the low manufacturing sector where exporters’ average margin is around 3% or less.

Going forward the government in China will have to look at creating policies that will allow private sector to play a bigger role and drive the domestic demand. Having that said it is worth noting that since 1999, the share of State owned Enterprise (SOEs) has declined from 37 percent to less than 5 percent in terms of numbers, and from 68 percent to 44 percent in terms of assets as a result of the SOE reforms carried out in the past under “grasping the big, letting go of the small” strategy. That said still a huge portion of the Chinese economy ( in terms of GDP ) is under government control and it has been the major driving force behind the overall GDP growth whereas the private sector has been driving India’s growth.

 It is estimated that over 80% of the Indian economy is now in private hands and the private sectors is driving the investments story in the country. Private sector in India has benefitted hugely from the Indian growth and has accumulated significant wealth. It is estimated that the combined total assets of India’s wealthy is set to reach around US $ 6.4 trillion( the highest in Asia ) over the next 4-5 years.

India’s demographic profile is very attractive with a strong pool of young population adding to the workforce every year but it must be said that a good percentage of them may not be employable. So the government needs to reform its education sector and also increase the number of good universities and colleges across the country. One way to do it will be to encourage established foreign education institutions to set up campuses in India alongside or in partnership with the local universities and colleges.

As the Indian economy grows it is estimated that around 200-250 million people may be added to the consuming class in the next 7 to 10 years. This presents a huge opportunity to both domestic and foreign companies within Asia and other parts of the world.

 In the short to medium term China will still be at the centre stage like the sun in the solar system driving the interregional growth in Asia and parts of emerging markets. Having said that India’s share is gradually increasing and so is its annual growth rate. It is worth noting that India’s annual GDP growth rate for 2010 was slightly above China according to the recent IMF publications. This does not mean that India will anytime soon match China’s economy in terms of the overall GDP ranking. But both the countries are expected to be major driver of growth for the region and other emerging market economies. Based on this assessment the Intra-Asian trade flow is estimated to grow at an average rate of over 12% year-on-year until 2020 (according to HSBC and Asian Development Bank ) and the series of bilateral free-trade agreements signed recently by both China and India with others Asian countries will significantly boost the regional trade flows. 

However it must be said that said both the countries do face significant challenges going forward. There are some concerns that the Chinese economy is overheating and the increased investments in fixed assets especially infrastructure and real estate which shows no visible signs of slowing down in spite of the tightening measures will hinder the real and required rebalancing of the economy.  The latest Q1 GDP print for 2011 show the economy grew at 9.7% year-on-year which exceeds market expectation and also defy concerns about any slowdown in growth.

Some commentators have also suggested that China’s growth story resembles Japan in the 1980’s and ultimately like Japan the bubble will burst and the country will hit a wall. It is worth pointing out that most of the bold forecasts about China have turned out to be wrong. The funny thing about forecasting and making predictions is if you make enough of them on a regular basis there is a good probability that you may get some right eventually. And with the right marketing skills and a bit of luck you could turn yourself into a market GURU.

Due to its growing economic influence China does attract a lot of attention and there are many economic theories around China. It is worth noting that although China is the world’s second largest economy it still has a very high income disparity and a low per capita income. And unlike Japan in 1980’s the country is still a developing economy and has a decade or more of growth left in the tank. Chinese growth story today resonate more with the U.S. story in the early 1900s when the U.S. went through numerous boom and bust but each time the economy recovered and got bigger.

The market expects the government in Beijing to fast track the implementation of policies that drives up the house hold income in real terms; increase the role played by private sector, and incentivise domestic consumptions among others. Also currency appreciation and a collaborative approach to guard against commodity and oil & gas price volatility may be a useful method to fight against inflation driven by external factors.

The previous strategy under which Beijing encouraged its State owned Enterprise ( SOEs ) to acquire mineral & mining resource assets including Oil & Gas overseas to secure price stability and supply didn’t really deliver the desired result. While state owned enterprise (SOEs) profited from the government’s “equity oil “ strategy  the Chinese consumers and the policy makers didn’t see any real reward. And in the current political turmoil in the middle-east Beijing may have to re-visit the existing strategy and look at ways to increase global co-operation with other resources (including Oil & Gas) dependant countries to create a collective game plan for guarding against supply disruption and greater price stability.

Having said that commodities and oil & gas prices will remain vulnerable to speculation and a significant percentage of the pricing input and price movement of commodities including of OIL & GAS is based on speculation. It is worth noting that the world is not constant but changing where a useless commodity can become relevant overnight driven by innovation and technology. For example Crude Oil was once a useless commodity that became valuable overnight.  Also Bolivia’s Lithium reserves – Lithium is used for the production of batteries and was once considered useless but it is extremely valuable these days and with the explosive growth in hybrid and electric cars the demand is outstripping the supply on a daily basis. So all of a sudden Bolivia is becoming very important in the whole scheme of things. It must be said that evolution, innovation and technological advances are key to sustainability and survival. The saying “Necessity is the MOTHER OF INVENTION “clearly holds TRUE.

India and China together is home to over 2.5 billion people so food and energy security will always be at the forefront of government’s policy. And in line with this policy both India and China have allowed home grown companies to expand capacity by acquiring assets in other emerging markets. Indian Agro companies have acquired and leased various agricultural assets including of farming lands in Argentina, Brazil, Mexico and parts of Africa. India’s agriculture sector is need of serious investments and structural reform including improving farming methods in order to increase its productivity.

China has 10% less arable land than India yet its agricultural production is 25% higher. Also China implemented land reforms in the early fifties which resulted in enhanced agricultural output, establishment of agro industries whereas with the exception of some states land reforms were mostly half measures in India. Bad policies decisions further deepened the crisis and as a result thousands of farmers are committing suicides every year across the country. Having said that private sector in India is making serious investment in the agro based industry and some of them bearing fruits. Going forward the government and the private sector in India will need to work together to boost investments in agro infrastructure as well as upgrading of existing distribution system, irrigation, farming methods and technology.  New Delhi will have to look at liberalizing R&D in agriculture sector, create policies to encourage investments in the agro sector of the economy and this will have to include the much needed land reforms.

China’s ambitious development goals are an official target of reaching a 95 percent grain self-sufficiency rate. This policy is a pillar to establishing the country’s food security, and result in an increase in domestic fertilizer consumption. According to the governments figures China’s national grain consumption will reach 572.5 million tons around 2020, requiring an increase of around 50 million tons in domestic fertilizer production over the next 10 years.  In order to achieve these targets, the government has made clear that it plans to boost investment in agro infrastructure also upgrade existing technologies in irrigation systems as well as seedlings, while improving farming methods and increasing the level mechanisation in the sector.

While both India and China search for a more competent, healthier and sustainable way to develop their economy. They do face similar challenges and one of them is to find a growth model that is inclusive and able to deal with growing income inequality which could potentially create social unrest going forward.

The two great civilizations of the past are finding their way back to the world centre stage as economic powers and in the process reshaping the future of the global economy. Both countries can learn a lot from each other and through collaboration create limitless growth opportunities.

A combined population of 2.5 billion presents a huge market full of abundant opportunities that has a potential of creating a super- highway for growth. And linking to a super growth corridor will allow other countries especially the emerging economies to increase their growth speed limits significantly.  So there is a strong case for companies and economies to have a China- India strategy (aka CHINDIA ) rather than a strategy that focuses only on China or India.


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Prognosis: Where Are We Heading?

Posted on August 17, 2010. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , |

In the last few weeks some of my friends and colleagues have been very busy debating the global economic situation and trying to figure out where we are heading. GO Figure! Eh…. I so wish I could help them and had answers to all their questions.  But then on a second thought no harm in trying…. right?

Let us look at the last few months to get a good handle of where we are, shall we? To begin with I must say if we look at the events unfolding in the last couple of months there was no dull moment and it has been an action-packed rollercoaster ride which has kept us busy and entertained but this depends on how you look at it.

Shall we do a quick RECAP and look at some of the HIGHLIGHTS of the past few months?

Starting with China we saw Agricultural Bank of China raise a record US$ 22 billion in IPO. It was the world largest IPO, the previous record was held by ICBC- China after raising US $ 21.9 billion in IPO. Although some suggested that the reception for Agricultural Bank of China ( Ag Bank ) was lackluster and the IPO was apparently overvalued but most of the analysts surveyed by Reuters expect the stock to go up to RMB 2.81 relatively quickly.  Up to 40% of the Shanghai offering was sold to about 27 strategic investors including of China Life Insurance, China State Construction among others on a 12-18 months lock-in period. And from the Hong Kong listing a total of around US $ 5.5 billion worth of stocks were sold to Qatar and Kuwait’s Investment Authorities.  It is interesting to note that the bank which was considered by many as technically bankrupt with more than 24% in non-performing loans around 3-4 years ago managed to raise a colossal amount of money and also reported a 40% jump in net profit in the first half of 2010. I wonder how Ag bank’s turnaround reflects on the investors’ confidence especially those reluctant to hold bank stocks and may be other banks could take a leaf from Agricultural Bank of China’s book? .Let’s see.

In the short to medium term the market expects China based banks to raise more money as their balance sheet comes under pressure due to excessive lending to the property market.  The China Banking Regulatory Commission (CBRC) has instructed the Chinese banks to test the impact of a 50% fall in the house prices in major cities across China. This is in addition to an early nation-wide stress test that showed the local banks in China could sustain a fall of up to 30% in housing prices without a sharp increase in non-performing loan ratios.

It is highly plausible that the Chinese Government will continue with its controls to restrain the property market fearful of the social pressure that could arise from a BOOM-BUST in property sector as recently seen in the US and in Japan in the 80’s.  And this is already feeding into the overall demand from things like construction raw materials including of steel, cement etc to household products among others.

Most of the recently published figures show a softening in demand. The annual factory output in July slipped to 13.4 from 13.7 in June although above the consensus but still a decline. The Consumer price inflation fell to 2.9% in June from 3.1% in May. These figures along with the weaker retail sales indicate clearly a slowdown in the economic activities across which was reflected in the second quarter (Q2) GDP numbers. According to the National Bureau of Statistic (NBS )  the growth fell to 10.3% in Q2 from 11.9% in Q1 of 2010. The Q2 GDP print was below the market expectation of 10.5%.

Although there are different view as to where the Chinese economy is heading I believe the GDP and other data are in line with expectations and there is no alarm yet. The slowdown as expected looks moderate and I believe there will be no policy relaxation from Beijing in the immediate future especially based on these set of numbers. So going forward we may see the investments come down and the recent numbers out do point in that direction. Let’s look at them. According to the Central Bank the total loans for the month of July stood at RMB 533 billion, below the forecasted RMB 600 billion, the year-on-year credit growth has also slowdown sharply to 18.4% in July, well down from 33.8% of last year, also the annual growth in the broad M2 measure of money supply considered the lubricant of economic growth slowed to 17.6 percent in July from 18.5 percent in June.

What all this means is we may see further softening in demands in China which will reflect badly on imports including of commodities and machineries etc  going forward.  To add to that we are already seeing a significant buildup in inventories and this is not what you want to hear if you were a German machine manufacturer, a miner or a commodity driven company/economy. Some in the financial markets may worry that the policy makers in China are applying the brakes too hard to slowdown the economy which could take out a big chunk of the existing global demand especially because China has been a major driving force. And this may reflect badly on the overall global growth prospect and recovery.

There is no doubt that the slowdown in economic activities is in line with  Beijing’s  expectation and this is clearly a government engineered slowdown as the market feared an overheating of the economy earlier this year and some analysts even suggested that it may be too late for Beijing to a get grip over the runaway economy. This is why I keep telling my friends and colleagues never underestimate the policy makers in Beijing.

The other side of the story is that the economy is still holding up and even with the current slowdown in activities the consensus view is that China could still grow at 9% or there about in the FY 2010. This is by no mean the end of the world as some may fear. I believe it is worth noting that going forward the government may start to ease its credit policy especially if there are signs that the economy is slowing down too rapidly for Beijing’s liking and so by the end of the year they may speed up targeted investments in areas such as low-income housing, rural development and clean energy. Also we shouldn’t forget that one of the advantages of the existing political system in China is that it allows the policy makers to acts faster and swiftly unlike their peers in other parts of the world.

Staying with Asia the fact is many policy makers across Asia are starting to worry more about inflation and hot money flow than a double-dip. Most economies in Asia including of Hong Kong, Singapore, South Korea, India, China, Indonesia and Australia among others have all seen a very significant capital inflows in 2009 and the first half of 2010 mostly from investors attracted by their growth potential. And now there is a genuine concern that the amount of hot money committed to Asia and Emerging market as whole could create an Asset bubble going forward. In fact European and American equities markets are looking cheaper then developing markets and you wonder if some emerging markets may have already produced most of their gains.  That said the growth story of the emerging markets is still intact and investors looking for growth will remain extremely attracted to the EM.

So far this year Southeast Asian Markets has had a very strong run and as of the end of July, Indonesia was the best-performing market in the world in 2010, the Jakarta Composite Index up 26.2 percent; Thailand’s Main Index was up 19.7 percent; Malaysia’s 14.5 percent and The Philippines’ 13.0 percent. However, Singapore Straits Timex Index was only up by 6.3% in the first half of 2010 despite a second quarter (Q2) GDP print of 19.3% year-on-year. The city-state economy is benefiting from government investment in the bioscience, electronics and construction sectors among others and is expected to grow at around 15% or more in the FY 2010.

Moving on let us look at what’s cooking in Europe shall we?

The recent numbers out from the Euro Zone clearly point to a two faced growth in the Euro area. While Germany the largest economy in the Europe expanded at the fastest pace in over two decades reporting a 2.2% growth in second quarter (Q2) and was responsible for almost two thirds of the Euro bloc’s second- quarter growth but unfortunately its southern European counterparts are still struggling to recover from the CRISIS.

Germany’s business confidence data- Ifo index continues to be on the ascending trajectory showing the strongest increase since the reunification in 1990’s. The unemployment rate in June declined to 7.5 % from 7.7 % in May the jobless numbers was down by 88,000. This was mainly due to the government support for maintaining employees on the job with shorter hours instead of laying them off. The economy seems to be getting in shape and the export driven business model of Germany is in full swing. All the signs show that the Germans export benefitted heavily from the demands coming from Asia especially China but going forward it is highly plausible that the growth may lose momentum because of the strengthening Euro and softening in demands from countries like China. Also in the second half of 2010 the austerity measures will kick in hampering the growth further.

The austerity measures are already crippling growth in countries like Latvia, Greece and Ireland.  Take for example LATVIA –one of the first EU nations to implement austerity measures two years ago. The huge budget cuts have made the matter worst. Also Greece has been hit harder than previously forecasted after implementing the severe austerity measures and it is highly likely that the growth will remain negative for this year hurting the economy even further. According to a recent research published by the retail confederation ESEE about a fifth of small shops in Athens have shut down because of the downturn. The unemployment is expected to go higher from its current 12% level hitting the private consumption further. The ongoing recession is deepening consumers’ insecurities about jobs and debt, making them cut their spending and to try to wind down borrowings. It is highly plausible that the impact will become more pronounced in the second half of 2010.  We will have to wait and see. It is going to be a real test for the voters and politicians.

There is a genuine fear in the market that with the austerity measures kicking in around the second half (H2) of the 2010 some of the European nations including of Spain may slip back into recession after reporting a GDP growth of 0.2% in the second quarter (Q2 ) creating a growth gap and making it harder for the European Central Bank (ECB ) to correctly gauge the timing of its policy tightening steps. As things stand I think it is safe to assume that it’s too early for ECB to start thinking about tighter policies and one should not get carried away with Germany’s second quarter ( Q2 ) growth numbers. The reality is Euro Zone countries are still struggling to keep their head above the water and in most countries across the EU the wage pressure are downwards and the core inflation stand at just 1%. Also besides Germany other major European economies like Italy are struggling with the mountain of debt and raising money for them in the market is not getting any easier as reflected by recent jump in the spreads.  Based on Bloomberg data for the first time since June 28 the premium that investors demand to hold 10-year Greek bonds against a German government bond of same maturity rose to 800 basis points (bps) and the Spanish government bond yields climbed six basis points to 4.24 %.  Most investors are also shunning Spanish banks because of their record borrowing of 130.2 billion euros from the European Central Bank in July of 2010.

It is also worth noting that while Germany is forging ahead the others in the EU believe that it is doing so at their expense. By cutting the budget deficit and keeping the wages down Germany is in fact making it harder for other EU states to regain competitiveness. It will be interesting to see how all this plays out for the Euro Zone going forward.

The hope is that the European leaders will learn from their past mistakes and going forward they will look beyond their national interest and work together towards perfecting the Union. The Union was not designed or conceived to handle a CRISIS it clearly exposed the flaws and also the limits of EU integration and coordination.

Staying with the EU let us also look at the performance of the UK economy, a prominent EU member and a major trading partner, in the last few months.

According to the office of National Statistics the UK economy grew at 1.1% in the second quarter ( Q2 ) of 2010. The Q2 GDP print was well above the market forecast of 0.6% but as per my expectations. I wrote a piece in April of 2010 titled Market Psychology and Investors Sentiment (mood of the market) – The Driving Force Behind the markets “. I have copied an extract from the post which explains the reason behind my assumption.

“ And in terms of growth, going forward we could see a market beating quarterly GDP numbers and the reasons for that is simple we simple don’t know how much spare capacity is left in the economy and the inventories are so LOW that even with the existing and basic demand you will see a pickup in growth and this could PUSH the market up”

So does that mean the UK economy is now getting back in SHAPE?

Well let’s look at the bigger picture to get a better IDEA. A recent survey done by the building society Nationwide puts British consumer morale at the lowest since May 2009.  According to Nationwide the rising food and fuel costs may also have played a part in the drop in consumer confidence indicator from 63 in June to 56 in July. The survey also showed a sharp fall in households’ sentiment about the economy, job market and income over the next six months. Consumers are growing increasingly concerned about their disposable income and the planed VAT rise from January of 2011 probably won’t help that concern going forward.

Also according to the Royal Institution of Chartered Surveyors the house prices fell for the first time in a year in July because of the buyers’ reluctance to commit as the sellers rushed to sell their properties. There is a risk that we may see this softer trend continue in the second half (H2) of 2010 as many prospective buyers are still struggling to raise mortgage finance. I believe it is worth noting that the high profits for banks in the first half of 2010 were also facilitated by lower impairment of existing mortgages and expectations that house prices would be stable. Going forward a slowing housing market along with the planned 25% government spending cuts, VAT rise, and a high unemployment  among others will add to the uncertainty facing the Bank of England as it tries to guess the growth prospects for the UK economy.

The new coalition government in Britain has decided to strip down to its bones as it prepares to cut the expenditures by more than 83 billion pounds over the next five years and drastically shrink its responsibilities. You can’t help but wonder if the economy can survive a starvation diet. Imagine an extra extra extra  large ( XXXL ) size human being decides to SLIM down dramatically and goes on a CRASH WEIGHT loss program. The commonsense tells us that he will SLIM down alright but in the process also runs the risk of crashing his/her heart. A gradual weight reduction is always the best advice which also leads to a long term weight control and a healthy system.

There is no doubt that Britain risks losing it growth momentum due to the planned spending cuts, VAT rise etc. And it is evident from the Bank of England recent downgrading of UK’s growth forecast for the FY 2010 the bank also raised its inflation expectation for the next year in its recent published quarterly growth and inflation forecast.

Staying with the spending cuts here is an extract of what I wrote in one of my post titled Stimulus: The Exit Strategy and the road aheadin January of 2010. I think it is still relevant.

Although one understands that there is need to fix balance sheets (fiscal consolidation) and address the inflationary concerns by having a clearly formulated, defined and coordinated exit strategy in place. But that said Timing will be KEY here as exiting too soon or too late has its own risk. And also it is extremely important that the process should only begin when there is enough hard evidence to see that economy will keep growing on its own after the removal of the stimulus or in other words it is evident that the recovery is solid, financial markets are back to normalcy and credit risk spreads are at an acceptable level and there is a significant risk to inflation over the medium term

In the same post there is another interesting point that I thought I’ll share again.

Here is an extract “ ……………….one has to also admit that the policy makers have managed to avoid a Great Depression type event by not adopting an extremely tight fiscal and monetary policy but a single policy mistake here could jeopardize the whole recovery process “.

I think it is important to point out that both the points are still relevant and we can only hope that the policy makers get it right and have a good foresight.

Moving on it is no secret that the global economy is still very reliant on the US and going forward an underperforming US economy will reflect badly on the overall growth prospect.  So let us check out how the US economy has been doing in the past few months.

The market was anxiously awaiting the Financial Regulation (FinReg) Bill  so the biggest news coming out of the U.S. for some was the passing of the FinReg bill in July of 2010 that is supposedly going to prevent future CRISIS. Whether it does or not well for that we will have to wait and see. The FinReg bill deals with a number of issues. Some of the important one’s are Systemic Risk – Under the proposed plan the Financial Stability Oversight Council chaired by the secretary of the treasury will identify firms that threaten stability of the system and subject them to tighter oversight by the Federal Reserve; Ending Bailouts -Firms would have a mandatory “funeral plans” or a living Will that describes how they could be shut down quickly; Supervising Banks – the Comptroller of the Currency will take over from the U.S. Office of Thrift Supervision and the FDIC’s deposit insurance coverage will be  raised to $250,000 per individual from the current $100,000 level ; Hedge Funds – All Private equity and hedge funds with assets of $150 million or more will need to register with the SEC and will be subject to more inspection. However, venture capital funds would be exempted; Insurance – A new federal agency/office will monitor the industry; Volcker Rule And Bank Standards – credit exposure from derivative transactions will have to be added to banks’ lending limits, Non-bank financial firms under the Fed supervision will now face limits on proprietary trading and as well fund investing etc; And Investors protection among others.

Now coming back to the performance of the US economy in the past few months, the recent data from the US has been mixed and also weak. So let us look at some of them.

 We saw the U.S. consumer-price index increase by 0.3%, the most in a year and above the market expectation. The Commerce Department data showed retail sales excluding autos, gasoline and building materials unexpectedly fell by 0.1 % in July. According to Reuters/University of Michigan survey of consumers the preliminary index of consumer sentiment jumped to 69.6 following a reading of 67.8 in July, the lowest since November. Also the U.S. second quarter (Q2) GDP growth slowed to 2.4%.

Based on the recent data coming out the US it is safe to assume that the recovery is softening.  Taking this into account the Federal Reserve has taken fresh steps to lower borrowing costs. In a recent statement the Fed announced that “ to help support the economic recovery in a context of price stability, the committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities”.  This is a significant policy shift as not long ago the central bank was eagerly debating the EXIT strategy from the huge stimulus delivered during the crisis. The Fed is also downbeat about the growth outlook going forward. A recent San Francisco Fed study suggests that there is a strong chance that the US economy will slip back into recession in the next two years. And to add to that according to the latest IMF’s annual review of the U.S. economy the fund observed that the U.S. fiscal gap associated with current federal fiscal policy is huge for probable discount rates.” And it claims that “closing the fiscal gap will require a stable annual fiscal adjustment equal to about 14% of U.S. current GDP. That basically translate into a constant doubling of personal-income, corporate and federal taxes as well as the payroll if the U.S. was to try to close the current fiscal gap from the revenues. So in short the country is living way beyond its means. Some would term this as a technical bankruptcy. Shocking isn’t it? But this depends on how you look at it. Remember the phrase when the U.S. sneezes the world catches cold well this still holds true so fear not. Also you go bankrupt only if others are not willing to lend you the money. It is in the interest of the world to keep the U.S. economy afloat and going forward it is highly unlikely that the foreign buyers of U.S. treasuries including of China, South Korea, Japan, Taiwan and others will abandon the US.  Although the US economy has performed a bit below the market expectations it will be unwise to write it off and underestimate its ability to come back.  But going forward there may be a significant rise in the poverty level across the U.S. and we are also going to see tax rises among other things.  It is worth noting that the Fed’s still have ammunitions at their disposal but we will have to wait and see how effective they are going to be.

There is no doubt that going forward the policy makers in the U.S. will have to find ways to make sure that credit worthy small and medium size businesses have access to capital. Banks, companies and individual consumers are all economically inter-reliant. So if the financial institutions refuse to provide credit to good businesses because of the fear that other lenders will cut down as well. This will create a shortage of credit hence extending the CRISIS and delaying recovery even more.

So how will all this reflect on the growth prospects in a wider context?

There is no doubt that the emerging markets have been leading the way and in general investors have so far been more optimistic about the emerging markets than the US or Europe. Also it is interesting to note that the performance of the Asian indexes has been reflected in the US and other developed markets. And the demand side of the story has been mostly driven by Asia especially China. Although all the recent data suggests that the economic activities in major Asian economies like China is moderately slowing down that said China, India, Indonesia and others have a lot of growing to do. And going forward a big chunk of the global demand is going to come from the developing world especially China and India. According to the Washington based Inter American Development Bank (IADB) the total economic output from China and India combined together is expected to be around 10 times bigger than Europe’s total GDP by 2040. While China is already a leading trading partner of most developing countries as well as developed nations across the world, India is now adding to the demand side. Going forward India – a commodity hungry country, may very well become a key demand side client for commodity driven economies like Latin America.

Also the economic growth outlook for Africa is improving and going forward the region does have the potential to become a significant growth provider. And it is in the interest of the world to foster growth in the region. The policy makers especially in the developed world should look at Africa as a prospective vibrant market that will create demand and work towards creating a long term partnership with the region. Some European companies especially Portuguese are already tapping into Africa and generating more than 50% of their revenues from the region thus compensating for the loss of revenue from their domestic market.

This is why I keep saying to my friends and colleagues that the fear of double-dip might be good for the markets in the long run as it will keep the policy makers awake and alert fearing a policy mistake here could jeopardize the whole recovery process and the global community will blame them for it. That’s the fun of living in a globalised world where your problem may become mine sooner or later. Also I am starting to think that this CRSIS is an opportunity to rebalance the world and comparing this crisis to the past recessions and deploying the old rules of thumb is probably unwise as today we have a number of other factors including of a very vibrant emerging market that could influence the outcome.

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Building the foundation for a healthy and sustainable global economy

Posted on June 4, 2009. Filed under: Uncategorized | Tags: , , , , , , , |

The message from this global financial crisis is loud and clear; the system that we currently have is flawed, susceptible to produce crises and prone to systemic risk.

As a first step, we will have to fully address the SYSTEMIC RISK and the accumulation of excesses in global the economy that tends to build up during the period of strong growth. The hope is that the market participants, the governments and the regulators around the world have learnt their lessons from the ongoing crisis and will take this as an opportunity to reconstruct the financial system and the way it operates. Although one could argue whether it is safe put your faith in the ability of the market, the governments or the regulators to fix the SYSTEMIC RISK issue.  No doubt, they have bungled up in the past and they would probably do it again. But that is not the point. We all make mistakes and learn from it. So we have to give them the benefit of the doubt. I hope we are all done with the blame game. The regulators and politicians were pretty quick to put all the blame on the banks, the investors, the insurance folks, the rating agencies and everybody else but not themselves. How convenient.

Honestly speaking, we are all to blame for this financial crisis including the folks on the main street who happily leveraged themselves not worrying about the shortcomings.  In fact some folks on the main street got very comfortable with the idea of living on borrowed money without having the ability or resources to meet their obligations. And the reason for that was simple they figured that was the norm.

In the immediate aftermath of the crisis some politicians are proposing the need for creating an early warning system and let the IMF be at the forefront of it. You know, one can’t help but wonder if it’s nothing more then a wishful thinking considering the fact that IMF itself didn’t see this CRISIS coming. Besides that it is no secret that IMF has screwed up in the past and one cannot with certainty say that they won’t slip-up again. And to expect that the ratings agencies or others won’t make mistakes going forward is probably nothing more then a wishful thinking. That’s the reality.

The economy goes through boom and bust cycles one where we see a decade or more of strong growth a.k.a BOOM TIME followed by a flat or negative growth a.k.a. DOOM TIME. Generally during the boom time the global economy tends to get obese without worrying too much about the excesses it has managed to accumulate. The excesses tend to clog the vital arteries connecting the global economy to the engine of growth. It also makes the market participants complacent about the risk and shortcomings hence the boom and bust cycles become a regular event. We have had Tech and Real Estate Bubble Burst. And now the Governments in the developed world as well as the developing world are busy creating a massive debt bubble through heavy government borrowings which has reached a breaking POINT and there are no guarantees that this bubble won’t burst.

What the ongoing CRISIS has taught us is that the current system is flawed and the time has probably come for us to start looking at ways to reconstruct and upgrade the whole financial system incorporating the realities of today’s world.

This CRISIS will probably be a game changer. Going forward the developing countries will ask for more influence, oversight and control over how the global economy is managed, supervised and operates. The developed countries will have to give away a lot of their influence and control over how the global economy is run. And the multilateral agencies including of the World Bank, IMF will have more representation from the developing world reflecting the reality of the changing world.

We live in a very interlinked world and this is why we need to create a system with cushions and additional growth engines that will complement each other and are able to absorb the systemic shock. The economy will work better if it has multiple engines of growth.

One of the ways to create multiple engines of growth could be through a Common market community (CMC) model. The common markets as a platform will drive growth by incentivising trade removing barriers and making inter-trade between the regional economies operating within the common market easier. The Common markets connected to the mainstream global economy would cushion and insulate the individual economies operating within the common market from a disruptive global economic downturn. It could also provide them a safety net to fall back on in a global recessionary environment.

The common markets may also work as a Distribution Network Operator (DNO) that will not only distribute growth to individual economies but also filter the harmful excesses making sure the vital arteries connecting the growth engines do not get clogged and the overall economy remains healthy.

We are already seeing a rapid increase in the number of regional and bilateral free trade agreements (FTAs) or preferential trade agreements (PTAs) being signed. According to the UNCTAD data the Intraregional trade in a number of regional blocs of developing countries has been growing faster than their extraregional trade. The common markets could be the obvious next step.

 There is also ample historical evidence of regional trade. These trades were pretty robust worked well byandlarge resistant to the external disruptive forces without a single common currency or monetary union. So the common markets should work and going forward it will add value.

Besides creating multiple engines of growth through a CMC model, we will also need tools that will allow us to shed the excesses accumulated during the boom time without us having to go through the PAIN of Recession or Depression. The economy needs a growth that is sustainable. A growth that can be managed, supervised and where an excess can easily be removed. 

The recent approval by European Commission of an enhanced European financial supervisory framework based on two new pillars: a European Systemic Risk Council (ESRC) which would  monitor and assess the risks to the stability of the financial system as a whole (“macro-prudential supervision”), and a European System of Financial Supervisors (ESFS) consisting of a robust network of national financial supervisors working in tandem with new European Supervisory Authorities (“micro-prudential supervision”) is probably a step in the right direction. A good oversight and smart regulation should be welcomed. The concern is that going forward the policy makers could burden the system with excessive regulation which could have detrimental effect.

The central banks, the government agencies and the market participants will have to get better at spotting the excesses building up in the economy or particular sector in the economy. The Central Banks will also have to widen their target range and may need to get more proactive.  The idea is to create a framework which could be used to quickly identify the excesses building up in a particular or specific sector of the overall economy and to remove them by following a swift course of action before they start clogging the vital arteries connecting the global economy. This can be achieved if the central banks, the regulators, the ratings agencies and others get more proactive in monitoring, supervising and managing the global economy. All the parties with vested interest will have to work together.

The folks on the main street will also have to realize that if you keep eating without maintaining a strict regular healthy diet and exercise regime you would most probably end up accumulating excessive fat and there is no point blaming other for it. We know all what pain some folks have to go through to shed the excesses. The question is why go through that pain especially when people are able to maintain a good health by following a regular healthy diet and exercise regime. There has to be a realization that the era of excess is gone.

The consumers (especially the American and British consumers) will have to learn to save more and live within their means. We are beginning to see that folks on the main street are starting to save a little bit more. Which is a good news but in the short term it also means that consumers will tend to hold their cash pretty close to their chest and against this back drop it’s hard to envisage a rapid pick up in consumer spending on the level  seen in 06 or 07.  But I’ll happily sacrifice a rapid recovery that could easily falter to a sustainable one.

A healthy and sustainable economy will mean more businesses starting-up or expanding, more hiring, increase in trade and the certainty about the future.

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