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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The Changing GAME, and the Global economy

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

The recent movements in the markets and its overall behaviour is starting to indicate that the game is changing and has already changed somewhat, and the market participants are having to adapt to these changes rather quickly. And here is an example, so when my GrandMa suggested that never mind the good old correlation theory, the markets overall behaviour today has changed so we could very well see the stock going higher while the crude oil could go as low as 70 or even lower,some folks in the market thought, it hasn’t happened before, and probably won’t now because crude and stock pricing have had historical correlation. And that’s a very understandable observation. But in the past month, the stocks have clearly been on an upward trajectory while the crude has continued to be on a downward trend. And by relying on the old economic theory as a reference, some may argue that one of these stories might be not be true, but I would disagree with that old economic assumption that one of these stories must be lying. Not at all, it’s just that people have evolved, and some of the old rules don’t work that well in the markets today. And here is an attempt to explain both the stories.

The stocks have been supported by a number of factors. For example, the European Central Bank ( ECB ) has just started its quantitative easing ( QE ) program, and the Bank of Japan ( BOJ ) as well as the Bank of England (BOE) are still maintaining the level of their QE program, also there are no real indication that the FED or any another central bank for that matter in the developed world  is going to start raising rates around Q1 of 2015, it’s simply too risky. And although at some point, the FED and BOE might have to raise rates in 2015 , the central banks in China and India will most likely be lowering their rates, and PBOC ( the Chinese Central bank ) has already started the process so clearly the game is being played differently around different parts of the world today.

And with regards to the downward trajectory of the current crude pricing, it  isn’t all a reflection of a seriously deteriorating global macro economic condition. In fact the recent policy easing in China as well as the Euro 315 billion investment & growth plan announced by the European Union along with the quantitative easing (QE) plan of the European Central Bank is all aimed at creating  growth so the under normal circumstances, the markets should push the crude prices up but the underlying reasons for a falling crude isn’t all based on global macro issues. There are number of other factors at play, and one of them is that the US marching on to becoming a net exporter of energy, and OPEC mainly lead by Saudis are trying their best to maintain their position in the game by making the shale gas business unsustainable. It’s hard to project, if OPEC and the Saudis will eventually succeed but the game has obviously changed, and the old rules don’t really apply.

The other interesting thing happening today is the positive momentum build up over India. And if India is able to find a way to unleash its potential then quite frankly, the global economy will be better for it. But the Indian economy has to deal with a series structural issues, and inflation being one of them.I believe, the current RBI governor needs to sit down with the government, and help device a plan to carry out wholesale structural reforms in the economy. Monetary policy has its limitations, just look across the world, the central bankers aren’t really able to get a good handle on inflation anymore because as stated before, the game has changed. And we need to look at the  bigger context when talking about inflation today.

For example, the financial assets in the U.S. as well as other developed markets got highly inflated, but without a real increase in disposable income, there is simply no capacity in the real economy to drive up inflation in the developed world. And specifically in context of India, India’s inflation is hard wired into how the country’s economy is structured, and unless the economy is unclogged, taming the inflation isn’t going to work. So practically, it’s almost impossible for India to export its inflation overseas, a process through which the developed world including of the U.S. was able to to export its inflation to an economy like China while continuing to grow and keep a relatively high living standard. The RBI governor has done an extremely good job so far, and I believe , he along with other central bankers know the limitations of monetary policy tools. Also Indian economy isn’t efficient enough structurally to quickly respond to policy changes, and this is thanks to the old ways of doing things. So an incremental reform agenda aimed at unclogging the engine has to be at the forefront. Inflation will tame down going forward with the structural reforms in the economy and also the existing lower fuel prices etc, but without carrying out a thorough structural reform, any slow down in inflation can’t be sustained.  I believe, the current governor of the RBI shouldn’t hesitate to use inflation as a leverage to keep the pressure on the finance minister to keep the reform agenda at forefront. And in Mr Rajan as the governor of India’s central bank, India has found a central banker who has a global reputation, also a central banker who isn’t shy of a debate. And this is why he gets respect in the market.

Overall, it looks like India is heading in the right direction. A country like India needed a strong government, and most importantly a strong leader. And on both these counts, the people of India have delivered, but India is a federal structure so if the states don’t participate in the growth and prosperity agenda of the federal government then it will be a struggle for the central leadership on their own to take the country forward. There is an overall positive sentiment around India today, and the country does have an immense potential. And the way, I would describe India’s potential is, if for example, the economic model followed by China has helped it create a Boeing 777 then India today has the chance to create Boeing a 777 X series plane, an upgraded version that will be largest and most efficient twine engine plane in the world, but for this to happen a lot has to go right for India.

Progress and reform has to be incremental, and also gradual. A steady take off requires the pilot to guide the plane making sure the climb is comfortable, and will not put the passengers as well as the plane at risk. And once the plane is flying at the desired altitude, a seasoned pilot as well as a passenger know that there will always be turbulence on the way. So the approach by the INDIAN  leadership shouldn’t be based around trying to blast off the country into outer space by carrying out one time wholesale Big Bang reforms. No progress or reform is permanent so the leadership and the policymakers should factor in a period of consolidation in the economy, and be always prepared to carry out the next set of reforms.

Also any well thought policy reform will fail to deliver the desired result, if the policy delivery mechanism isn’t fit for purpose. The current economic infrastructure of the economy is old and too  clogged up so the focus of the government should be to take immediate measures to unclog the system, and then the growth will start to trickle through. The road ahead won’t be a smooth ride but the focus should be on unclogging the system and changing the current administrative policy delivering mechanism set up in the country. Also, the rural India will need to be fully plugged into the overall progress agenda. This will create,and is already creating tremendous opportunities for entrepreneurs who are able to spot them. The strategy has to be tailored to make sure all parts of the economy is starting to perform efficiently, and won’t burden the ascend of the overall economy going forward.

Also most importantly a ” progress for all ” idea has to be sold to the entire nation, and by trying to make this into a national movement, the current PM of India is heading in the right direction. However, the people of the country will need to be willing participants by making their own contributions. So the leadership of the country should aim to pitch India as a potential B777 X, the latest and more powerful as well as more efficient version of the existing B777, and India can be that.

The government will need to discover an economic growth model that is sustainable over a long term period and also inclusive. Adopting and following an existing growth model will not work for a country like India, and this is why I always struggle to understand the idea proposed by some in the market that all emerging economies should follow the economic growth model of China as an example for their country without really understanding if that specific economic model is going to be sustainable for their respective economies.

China’s heavy reliance on investments to drive it’s GDP has created a massive over supply, and there are large amount of infrastructure assets that are simply sitting idle without creating any return for the tax payers so if we were to look in terms of return on investment basis then the picture is quite murky. In short they would fall under inefficient investments category, and we are talking about trillions of dollars worth of such investments here. And this is one of the reason why the leadership of China based companies are looking to invest overseas, and it makes good business sense because the companies in China do have tremendous experience in building substantial infrastructure assets.

So going forward, the state owned enterprise in China will look to invest overseas as there isn’t much to do at home, and in a way, this strategy works out well because the emerging economies that have massive infrastructure deficit might find that China based companies are more willing and flexible to help them develop and finance those projects than others. And as Europe and the U.S. gets more competitive, the foreign players currently operating in China will start to move their production facility closer to home, and it’s already happening as the cost of production is starting to get lower than that in China. The economic engine of China is going through a gear change, and the leadership will need to make sure the transition is well managed. And as the game continues to change, companies operating in the real economy will face different type of challenges but at the same time there will be many opportunities, and that’s just a natural process, the powerhouse of yesteryears will become irrelevant as the economy evolves.

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PERCEPTION and the Need For Greater Global Policy Coordination in a 2014 WORLD

Posted on February 4, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , |

Perception is a major factor driving volatility in the market and this is why I am of the firm opinion now that it’s the market psychology and the overall investors sentiment aka the “mood of the markets” that creates and drives the volatility. And when a perception starts getting entrenched then people generally tend to ignore the sense of reasoning and stop looking at the big picture and this is why at times markets tends to behave like headless chickens because the underlying perception creates uncertainty and CHOAS takes over. So it is important to arrest this momentum before it ends up damaging the economy, it’s like this…we create a perception and then use that perception to create a reality.

In an interconnected global economy perception can create volatility and uncertainty and this is one of the reasons why a contagion risk remains a plausible scenario especially when people tend to get overwhelmed by the sound bites coming from various quarters of the financial markets. But it must be said that there is always value in looking at each market and economy individually. For instance, if we look at Turkey and Argentina, the fundamentals of these economies didn’t really deteriorate overnight. The Turkish central bank should have raised rates over a year ago but today the stretched fiscal situation combined with the political uncertainty is hurting the economy real bad but having said that a quick political resolution will likely calm the fears around Turkey and with regards to Argentina, the central bank of the country has been running a wacko monetary policy for sometime now so what the country is facing today is an outcome of such policies.

And assuming the worst case scenario, both Argentine and Turkish economies isn’t big enough to possess a systemic or a damaging contagion risk for all the emerging market economies, at least not based on the ground realities but yes in perception there might be. And to get some perspective, it is worth remembering that both Turkish as well as Argentine economies have gone through crises in the past without causing any significant problems for the world economy and also the rest of the EM didn’t really see any damaging contagion  come through and that’s the reality. Also, it is important to note that economies both in EM as well as developed markets tend to be at a different levels of maturity and they are different in many ways. For example, China and Brazil although a part of the same block of BRICS nations are in fact two different economies in many ways. The leadership in China for instance needs to implement the planned financial reform agenda whereas Brazil clearly needs a wholesale supply side reforms. So in short they aren’t dealing with the same issues.

We live in a very interconnected 24 x 7 world where perception drives the overall investors sentiment creating volatility and the global economy of 2014 reflects that reality. Perception can have a snowball effect and is no doubt contagious. So even though the IMF has revised up its global growth projection for the year 2014, there are a number of factors that could influence the real economic growth going forward. And one of them is a possible decline in positive sentiment and confidence in general around the global economy driven by a change in overall perception. And in most likelihood a potential sluggish growth and deteriorating fundamentals across emerging markets will have an impact on the overall growth dynamics of the developed world so it will be unwise to assume that the developed markets are going to be somehow immune. This is why it will be ill-advised to conclude that the developed markets have entered a self sustaining growth in 2014 so when I hear the sound bites coming from parts of the markets suggesting that the current volatility in the market is more or less an emerging market issue and thus the policy markers in the EM should get their house in order by adjusting to the market expectations, I can’t help but wonder, are they seriously suggesting or assuming that the developed world can grow in isolation especially in a post financial crisis world and also that the turbulent cloud over the emerging markets won’t enter the developed world? The markets clearly believe that a potential turmoil in the developing world could have an effect on the developed world. And there is probably a strong reason behind  that assumption.

When the western economies were on the verge of collapsing during 07/08 crisis, the politicians and the policy makers were busy calling anyone and everyone including their counterparts in emerging markets to help the global economy get out of the mess and most emerging markets did come together and a global policy coordination was worked out to keep the world economy going and from falling under. To help safe the financial sector and the economy, the central banks adopted an ultra loose monetary policy and there is very little doubt that part of the current volatility in the EM is driven by this ultra loose monetary policy adopted by the central banks in the developed world. So clearly, the EMs are dealing with the side effects of QE. The hot and easy money that flowed into various emerging markets chasing yields created asset price distortion. So the fundamentals of the emerging markets were known to the investors while they flocked into EM chasing high returns but now that the supply of hot money flow is being cut, the worry is that the real ground on which they were standing will get revealed.

Generally investors tend to invest in emerging markets attracted by the growth story but GDP numbers shouldn’t be the only indicator when considering an investment opportunity. In theory, we can measure GDP using three different approaches. 1 – overall production approach, 2- overall expenditure approach, 3- and the overall income approach but none of these 3 approaches can fully and comprehensively report or record the overall economic activities or output of a country let alone the world. High growth in a high inflationary environment creates distortion and isn’t really a sustainable growth model. And here is why, entrenched Inflation in the developing world tends to destroy disposable income and living standards and the idea that somehow high growth could fix everything in the long run doesn’t really hold water. In short, strong GDP growth numbers isn’t necessarily a one way ticket to prosperity because high growth creates various types of unforeseen problems and challenges so any growth model has to factor the exponential function rules, for example a 10% growth rate year-on-year means the economy will double in just 7 years and doubling of the economy isn’t just all positive. So any sustainable economic growth model will have to factor in a period of adjustment to allow for consolidation.

An economic journey isn’t about just about speed at which a country can reach from point A to Z quite simply because there is no Z or in other words there is no final destination but targets  to help deliver overall progress. A sustainable economy will have to keep evolving every 5 years or so to remain relevant and this is where the challenge lies for the global economy. By design, the global economic model along with the existing structure of the financial markets are less than efficient and this is why every now and then we find ourselves in a CRISIS. For example, today while the developing world is struggling with inflation, the developed world would love to have some of that inflation in the system.

And the ultra loose monetary policy has so far failed to deliver inflation in the developed world. Also though the tapering of quantitative easing (QE) by FED which I must say is inline with my own expectations ( not that is matters ) is being perceived as a start of an early tightening measure than ideally preferred by some in the market. But this perception does not accurately reflect the reality and here is why. So based on the latest (Jan 2014) data, FED’s balance sheet is now around US$ 4.1 trillion and even with tapering the balance sheet will continue to expand and also by committing to keep the rates near zero the FED continues to be in expansive mode. So by reducing the QE level ,the FED is basically trying to slowly dial down the booster engine put in place during the crisis to support the economy and switch over to traditional and conventional monetary policy tools to manage the economy going forward. And the reality is, it will be unwise to expect the FED to keep operating in crisis emergency mode so a gradual switching over makes good sense. Also it is important to note that if the FED gets its QE exit wrong then it could have substantial losses so it will have to be mindful of the market condition. A continued improvement in the economy along with the housing market will enable the central bank to book a substantial profit on the purchased securities and obviously a big chunk of the overall profit will end up at the US treasury and could very well be used to pay down the debt.

Whatever may be the perception of the market today, there is very little evidence to suggest that Quantitative Easing has in fact financed the global growth however, it has been extremely useful in supporting the financial markets and to a large extent helped create a distortion in the asset pricing across the world so a curb in QE will most likely help the global economy remove all the speculations and fear around the nature of the overall growth going forward because quite clearly the markets today aren’t sure if the world economy has entered a self sustaining growth cycle hence the extreme volatility.

And when looking at the bigger picture, in the medium to long term investment perspective, the Emerging Markets ( with the exception of some ) will most likely grow at a better rate than their counterparts in the developed world. Having said that, today when the markets are dealing with extreme volatility that is clearly creating CHAOS then talking about medium to long term investment horizon may not make much sense to most in the market. Also, a wait and watch approach and hoping that markets will look at the big picture and by applying some common sense figure things out is an extremely risky strategy because the markets are all about perception, momentum and confidence so an announcement on a global policy coordination by major central banks from around the world going forward should go a long way in providing a degree of certainty and should help arrest the current CHOAS from spreading into every corner of the market. And the thing about perception is, if you could keep a perception going for a period time irrespective of it being right or wrong then there is a good chance that perception will most likely be perceived by some as the REALITY.

And this is why the global economy of today requires a greater degree of policy coordination from major economies and is essential to addressing both immediate and long term challenges facing the world economy. Also this has to be by far the biggest lesson learnt from the 07/08 financial crisis.

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A Historic Opportunity For India and the Indian society To Bring About a Change From Within

Posted on January 7, 2014. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , |

 

Good to see the ongoing debate on governance, politics and reforming of the INDIAN TAX SYSTEM stirring up in India in the past few weeks. But by looking at the BIG PICTURE it’s clear that country isn’t just struggling cause of lack of good governance and good governance although essential but on its own won’t go far enough to move the country forward. It is quite evident that the country has been suffering from a severe lack of good reforms and efficient policy decisions but the again a good policy or much needed reforms can only be executed or delivered by an efficient delivery mechanism.And so far this has been India’s major problem because the existing administrative system is simply not fit for purpose. The reality is that a high percentage of the administrators(managers) coming out of the current Indian Administrative Services (IAS) program do not have the right training or the essential background on public policy administration and execution.

A good an innovative policy requires an efficient administrative infrastructure that is not just able to cope with the task at hand but also able to improvise by working closely with the relevant ministerial department on perfecting the policies if and when required. It should also be extremely reactive and responsive to its users / customers i.e. the citizens requirements. The administrative infrastructure created during the British Raj to govern India clearly needs to be revamped and updated. For example we can’t expect to run super fast trains on British Raj Era railway infrastructure without revamping and updating the existing railway infrastructure of the country and this is just common sense. So in short the existing policy delivery mechanism / infrastructure is quite simply outdated. And the problem is not that there is a shortage of talents when it comes to good public administrators but the system simply fails to keep the talent because it isn’t attractive enough. Historically India has produced amazing MINDS and even today the country has no shortage of Talents but the problem has always been the mindset of the Indian society.

Any good system requires a regular overhaul and upgrading and the current IAS program that more or less serves as an operating system to administer and govern INDIA is simply too old and is in need of immediate radical reforms to make it fit for purpose. And here is what the government of the day should look at, a good manager will need to be paid appropriately so what’s the harm in creating a private sector type bonus system linked to verifiable results and overall performance of an official. And the same should apply to ministers. The ministers and the managerial staff will need to work on making various administrative branches of INDIA INC more efficient and responsive and deliver better return on assets for the shareholders i.e. the citizens.

Corruption won’t go away on its own or by street protests or by a creation of new political parties. Also elections and governance etc won’t necessarily solve India’s problem in my own view. If you think the same way you will get to the same place so clearly the country needs to start the process of revamping it’s overall mindset and find a new approach. And this has to come and be driven by the society itself. So a lasting and sustainable change has to come from within. For example lets start with small things if people living in the same community decided to work together and started keeping their streets and town cleans then automatically the entire city will start to look and feel cleaner. Similarly, if people decided and encouraged their friends and families to look at the bigger picture and not to take short cuts for example when getting their kids admitted to a school or getting a normal job done or even when attending prayer events in temples the society will then start to look less messier and more organised as there will be less incentives for folks to ask for favours. It is important to understand that a vibrant bribe culture in India isn’t going to go away just like that and also on the flip side the fear of getting caught might in fact discourage the decision making process making the situation much worst so the people will need to take the initiative and lay the foundation that will bring about the required and essential change in the overall mindset of the Indian society. In other words the society of the day needs to get on 2014 bandwidth.

And obviously the government has a very important role to play by working together with the society and facilitating this change by starting with creating incentives within the existing system. For example, if the government comes with an investment or a social investment program then why not also create a provision where up to 10% of the allocated fund could be paid in bonuses to officials in charge of administering and executing that particular program or policy similarly if a government department is announcing a tender then why not create a BONUS pool of 5 % to 10% that could be paid to the department in charge of the particular project or tender irrespective of who wins the tender. This will mostly likely remove the need for companies to submit unrealistic bids in order to simply secure the project by finding a way to bribe the officials. Also the officials will know that irrespective of who wins the tender their bonus is guaranteed. This by no means should be taken as encouraging corruption but in fact these steps could provide the right incentives by taking away the motivation behind corruption and there are a number of practical, simple and innovative steps to create the right incentives. For example, every government secretariat could have a simple fast track service for citizens and people willing to pay higher fees will be able to access that particular service on fast track basis. Some of these incentives are probably already there. Also why not create a donation incentive so if customers are happy with the services provided by the officials in a particular department then they could donate towards the annual bonus fund. A Corruption that is under the carpet can kill any economy and unless we find a way to start paying people fairly we can’t take the moral high ground and expect people not to take bribe as most of them get involved in corruption because of their obligations towards the family and in a way they do have the right to do what is best in the interest of their family. So this is why it is important that we explore all the practical ways to remove the corruption embedded in the system say.

Now with regards to the TAX Code debate well a country where roughly only 4% of the population pays income tax clearly needs to do better and this will not only require the government of the day to make radical changes in the overall tax structure but also the people who are happy take to the streets to show their anger against corruption will need to have a serious look at themselves in the MIRROR and ask themselves what is their own contribution to the country that they claim to love so much. Talk is generally cheap and easy and most of us are good at it. A big economy like India can’t abolish the personal income tax system altogether, it is simply unrealistic and most probably a wrong debate.

Indian Tax system today heavily relies on indirect tax revenues including of VAT, sales tax, excise duties among others to pay the country’s BILLS. And no doubt the system is struggling cause of corruption but this isn’t just an INDIAN phenomena. Having said that it is surely getting entrenched in the DNA of the Indian society and people will need to realise that if you build yourself a US 100 million dollar mansion in a neighbourhood where the rest of them can’t afford even a US $5,000 house then you are making a serious mistake because you may end up having to spend millions on security etc so why not instead help build your immediate neighbourhood and by this I mean building a good road, a good sanitation system, may be a good school , a good medical centre and then build yourself a billion dollar mansion ( if you can afford it ) because in this case the new neighbourhood will be anchored around you and it always be grateful and most likely you will see significant benefits from your investment in the community. And this is not socialism but just smart and sustainable investment.

If you want to change the country then you will most likely have to start with changing yourself, your own family, neighbourhood and the city. So I will encourage the society, the government and the entrepreneurs to take the important first step and in a society where people like to follow and copy others it is highly likely others will follow suit creating a trend. Collaboration can help us climb mountains and help us get to the moon so the various communities will need to come together and work towards making a better India. A crisis also provides opportunity but it is important not to get overwhelmed by the CHAOS because a grinding process isn’t all smooth and beautiful so I believe it is time for the Indian society to look at the big picture knowing well that it has a truly historic opportunity to take the country forward by playing an extremely important role and in the process it could also set up a good example and precedent for similar societies living in the developing world going forward.

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The BIG Hoo-Ha on FED’s planned Tapering of Quantitative Easing

Posted on September 1, 2013. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , , |

 

The US Federal Reserve Open Market Committee’s announcement on lowering the amount of monthly bond purchases or in other words tapering of the existing level of quantitative easing (QE) has got the financial markets animated in a big hoo-ha causing volatility. And the financial media has been inundated with commentaries on various plausible scenarios. To understand possible outcome and where the economy could be heading, we will need to start with where it is today. And here is something interesting, in over last 10 months US treasury’s overall tax revenues collection was around $ 4.3 trillion, a jump of nearly 15% from the same period last year. According to the Congressional Budget office ( CBO ) projection the US government budget deficit for the Fiscal Year (FY) 13 is estimated to be around $ 642 billion, a decline of over 35% from last year and because of the sequester related spending cuts the deficit is projected to be around 4% level for FY 13 and may fall further to around 2.1% in 2015. Also the recently revised data suggests that US economy grew at an annualise rate of 2.5% for the period April – June 2013. So clearly the US economy is getting healthy and probably entering an expansionary phase but having said that going forward we may still see mixed data and the reason being, the existing high level of external support from the FED to boost  growth.

The Federal Reserve has been acting as the BOOSTER engine supporting the economy and only after the withdrawal of this anchoring support we will get a clearer picture of the health of the economy. Various policy measures or tools have acted as a cocktail of drugs loaded with steroids to help the patient ( the economy ) fight the fatal infection and by all accounts it is quite evident that the world economy ( the patient ) today is not in intensive care and the recovery is gathering pace hence lowering of the HIGH dosage should be considered as a natural course of action. But this proposal of lowering of the high dosage of  drugs by a way of tapering  the current level of quantitative easing ( QE) has caused panic in the market and created volatility hitting the emerging markets the hardest. And since the announcement of QE tapering in June of 2013 a whopping US 1.4 trillion in value has been erased from emerging market equities. The markets have recovered somewhat in the last few days of August but given the uncertainty over the monetary policy exit and geopolitical risk to a certain extent the volatility isn’t going to go away tomorrow. And this is why the global economy needs a smooth transition and not an abrupt or sudden change of gears.

By announcing the planned proposal to start tapering of quantitative easing (QE) from the existing level by a way of lowering the amount of monthly bond purchases, the FED is more or less lowering the current high dosage of antibiotics and cocktail of drugs (steroids) that it thought was essential to fighting the fatal infection during the financial crisis. The temporary policy measures or in other words the current prescribed course of medication has to end sooner rather then later as there is a serious risk of overdose so like a good doctor, the FED has to trust the immune system of the Patient ( the economy ) and allow it to slowly take over the recovery process.

And with regards to the exact timing though Mr Ben Shalom Bernanke as a part of his forward guidance strategy has linked the start of the QE tapering process to Key economic data and the overall US economy reaching certain milestone, the announcement has created a level of uncertainty in the market and there are already a number of projections on the time line, amount or level of tapering as well as possible outcome for the global economy. The debate will most likely continue going forward but it is safe to conclude that Bernanke & Co won’t be rushing into the process without being sure about the health of the economy and the strength of the overall economic data including of employment numbers among others. Also the central bank ( the Federal Reserve System ) does risk losing serious money on its overall assets holding in the existing volatile market environment related to concern over tapering as well as the ongoing geopolitical situation.

The other interesting event which may influence FED’s decision is the treasury secretary Jack Lew’s recent announcement regarding US government borrowings reaching the congressionally imposed limit on federal debt ( debt ceiling) of $ 16.7 trillion around mid October of this year. This will have an impact on treasuries considering the fact that August was a tough month for US treasuries and other fixed income assets. In the month of August bonds funds have lost over $ 30 billion. Also foreign holders of US treasuries are  becoming increasingly concerned, China recently sold around $ 20 billion worth of US treasuries and others may follow suit driven mainly by concern over Fed lowering the amount of monthly bond purchases under its planned QE tapering, pushing the yields higher. A sudden rise in borrowing cost may be damaging for the economy especially when the economy has just started to gather pace.

The uncertainty is obviously not helpful for the market but a forward guiding strategy deployed by the FED primarily aimed at giving some level of certainty to the market especially on policy measures has clearly created more questions than answers in this case as evident from the existing volatility. However, there has to be a clear understanding that the existing policy measures were designed to be temporary and a tapering of the current level of QE isn’t going to kill the global economy or emerging markets for that matter. What quantitative easing (QE) did is provided cheap and easy money and this HOT money flow drove the asset valuation in most emerging markets to a bubble territory level.

During the crisis, the policy makers across emerging markets were happy talking about the shifting of the paradigm and how well placed their respective economies were but the easy money caught them napping as most of them got complacent and are now paying the price for not being proactive and failing to prepare for a post crisis world. This should serve as a wake up call for the politicians and policy makers in the emerging market. Only last year the financial media was full of sound bites on how US is starting a currency war by doing more QE and today when most EM currencies have depreciated heavily and the economies have started to struggle somewhat, the sound bites have changed. The concern over tapering is understandable but it is highly unlikely that emerging market ( EM ) economies will start to fall like dominoes cause of QE tapering. And the reason being, there is no solid evidence to suggest that hot money directly financed the economic growth across emerging markets, quantitative easing has had a significant impact on the overall valuation of the financial assets but not on the real economy. In fact, the outflow of hot money will most likely diffuse the built up asset bubble making the EM assets look more attractive to value investors. Also the investors will need to realise that the global economy is more interconnected then ever before so at some point before getting into a panic mode or jumping ships they should have a sit down and think their strategy through with a clear mind without getting bogged down in non stop sound bites.

Many in the market projected that a break up of the European Union was more or less imminent but it didn’t happen then there were projections about China falling but again it hasn’t fallen and now some are projecting of an imminent crisis brewing in the emerging markets. The projections and the sound bites are part and parcel of the financial market and navigating through them will always remain a challenging task. But investing isn’t a quick 100 metre sprint or about winning one lap, it’s a long marathon and thats what people fail to realise.

The economy and financial markets are human ideas and not an exact science so the human element will always be a key influential factor. The inherent human nature and desire to make a quick BUCK by using any means has lead to downfall of the financial market on many occasions. And the lesson is in history.

Based on the available historical data, the first recorded financial market crash happened over 300 years ago. The modern financial system as we know it today saw its first stock market crash around 1901. Then the panic of 1907 triggered the creation of the Federal Reserve System and after a relative boom period, the markets crashed again in 1929 causing the Great Depression. But the markets recovered from the Great Depression crashing again in 62 then peaking and crashing back again around 1974. After going through a down time the recovery gathered pace from 1975 onwards but then the markets crashed again in 87. So the story of Boom & Bust goes on. The volatility and periods of BOOM followed by a BUST aka ” Boom-Bust Cycle ” is inherent to the financial market and not a new phenomena and almost all the BOOM and BUST cycles were predictable and caused by the human elements influencing the market. So in the case of financial market history does keep repeating itself and in all likelihood the financial crisis of 2007-08 isn’t going to be the last recorded and reported crisis in this history of humanity.

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Infrastructure Financing: Tapping into a diversified Funding Pool

Posted on January 16, 2012. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , |

As a key asset infrastructure is one of the most important driving force of an economy and has a direct impact on the overall growth and development story of the country. Infrastructure assets support a wide range of systems in both public and private sectors without which the industrial society of today simply won’t function or be as efficient. Generally developed world tends to have better infrastructure than emerging economies but having said that the overall spending on infrastructure in GDP terms by developed economies have been declining recently whereas the emerging world has increased its overall spending on infrastructure. In a fast growing economy you would expect the demand for infrastructure assets to increase immensely year-on-year and the opposite is true for a slow growth economic environment.

 So the state of a country’s economy certainly plays an important role in infrastructural needs of that nation. Infrastructure assets should always be forwarding looking because the rapid growth in population and economy especially in emerging countries will put strain on the existing infrastructure creating bottlenecks relatively quickly but at the same time parts of the countries experiencing lower or minimal growth may create a situation of overcapacity.

 Conceiving a smart and forward looking infrastructure asset and supporting it with the right capital is always critical.In the past federal, state, local tax bases other funding sources have been used to pay for vital infrastructure projects across the world. We have seen the business model for developing and funding infrastructure assets evolve in the last decade where a number of high profile infrastructure assets were built and paid for through Public Private Partnership or Initiative ( PPP or PPI). Although a number of high profile PPP projects have failed this model of developing and financing infrastructure projects is still considered one of the best way to pay for it.

 While emerging economies have the need to keep building vital infrastructure to support their growth and improve the living standards of its citizens, the developed nations especially the US are sitting on an aging infrastructure that needs to be updated. All this requires capital and with the ongoing financial CRISIS it is getting harder to source funding for infrastructure assets as banks are still struggling to fix their balance sheet. Also the asset-liability (ALM) mismatch is one of the major defects in the traditional business model followed by banks today which makes it tougher for them to commit more resources towards financing infrastructure projects. Most infrastructure projects require long term capital commitments ranging from 7 to 20 or more whereas banks own source of capital ( i.e. deposits) tend to be of much shorter tenure ranging between 1 to 5 years or less. There are also regulatory issues including of the overall exposure to the sector and the credit risk rating of the asset which limits the ability of traditional banks to commit capital. Alternate source of capital providers including of hedge funds dedicated to investing in infrastructure sector as an asset class tend to prefer investing in liquid assets and in most cases their exposure to the sector is limited to owning stocks or debts of listed utilities, toll road operators, constructions companies, ports operators among others.

 There is a strong need to diversify the source of capital base by making infrastructure an appealing asset class to a wide range of investors especially when governments including of developed as well the developing world are targeting infrastructure spending. Recently the ministry of finance of India announced an initiative called Infrastructure debt fund as to way to attract capital into the sector. This is a step in the right direction but having said that the proposal doesn’t address the core issue facing prospective investors when looking at infrastructure financing opportunities. The government of India is targeting an investment of over US$ 1 trillion ( around 10% of GDP) on infrastructure in its 12th five year growth plan for the country and the expectation is that the private sector’s share will be 50%. It is no doubt a highly ambitious plan and through Infrastructure debt fund the government’s objective is to facilitate the flow of capital from public and private sectors as well as foreign investors into infrastructure projects in India. The government figures suggest that there is a funding gap of over US$ 135 billion and this is based on the assumptions that there will be as much as 50% budgetary support for the planned investment in its recently announced 12th five year plan and the policy & regulatory reforms will mobilize over US $174 billions. Looking at the state of infrastructure in India and the balance sheet strength of the local banks it is safe to say that in reality the funding gap may be much higher than government’s expectation.

 In the developed world, UK chancellor has earmarked over GBP 30 billion in infrastructure spending in his speech delivered to the British parliament in November of 2011. The UK treasury is hoping that two-thirds of its earmarked for infrastructure investments will come from the National Association of Pension Funds and the Pension Protection Fund. It is also seeking investments in infrastructure from insurance companies and from China. The United States will need to spend over $2.2 trillion on updating and developing infrastructure assets across the country over a period of five years to meet the current needs and around $1.1 trillion of the overall spending would be new. This is according to the American Society of Civil Engineers (ASCE), and while private sector is expected to make its contribution most of the heavy spending will have to come from the government as evident from the previous spending on infrastructure in the US. The Congressional Budget Office figures suggests that the federal government, state and local governments spent over US$ 312 billion in 2004 on just water and transport infrastructure in the United states with very little contribution from the private sector.

 The current state of the global economy makes it extremely difficult for infrastructure projects to get funded. In markets like China banks are over exposed to the sector by lending to local government financial vehicles (LGFV) and most local governments are sitting on bad projects that aren’t making money and have also created overcapacity. There is also a lack of an efficient and developed secondary market for infrastructure loans in emerging market economies especially in countries like India, making it difficult for both public and private sector banks to refinance their loan books and in most cases the banks are as the end users of credit by holding the asset on their balance sheet until maturity   therefore becoming super exposed to the sector and minimizing their ability to grant more loans. Also Indian banks have recently been running a daily deficit of over INR 1trillion per day for the past few months causing a systemic liquidity deficit in the banking system further limiting their ability to commit more capital to the sector.

 Considering the above, Infrastructure debt fund (IDF) initiative of the ministry of finance of India does sound like an idea whose time has time come as it proposes to offer banks a platform to help refinance their existing loan book and by means of credit enhancement also be able to tap into low cost long term funding sources including of Insurance and pension funds. Having said that Indian banks will be competing for capital with their peers and there are no guarantees that foreign pension and insurance funds will pick Indian infrastructure assets over others. Money has no nationality and most investors will need to understand the structure better before committing capital. According to the public information released by the ministry of finance of India, the proposed IDFs will either be formatted as a mutual fund or a non bank financial company under modus operandi set out by the regulatory agencies including of SEBI and RBI.

 Although the case for IDFs has merit going forward the structure will have to evolve incorporating the realities of the market. Besides IDFs other plausible long term, simpler and sustainable solution will be for banks to set up their own independent infrastructure investment companies or in a consortium with credit guarantee agencies, construction & development companies, Institutional investors, regional development banks, multilateral agencies, utilities among others. As the promoter of the “ Infra Investment Company(IIC)” banks will inject their existing infrastructure assets and loan books along with the cash flows ( from the projects) into the balance sheet of the company and other founding partners will provide seed capital (in cash equity) of around 10% to 15% of the assets held by the company in order to secure a strong rating and valuation. The Infra Investment company(IIC) will have fixed and guaranteed revenue stream coming from existing infrastructure assets it owns and it will be relatively easier for such a company to secure a credit loss insurance cover on its pool of revenues further protecting its cash flow.

To access a diversified pool of investor base the “IIC” could do dual listing in local and foreign markets, issue bonds in local as well as foreign currency supported by its balance sheet and the strength of its credit rating. It can also act as a platform to deliver infrastructure related credit and assets to end users including of pension and insurance funds. Also through the “IIC” institutional investors such as pension and insurance funds could commit new capital into the sector removing the need for them to hire a fund or portfolio manager to manage their investment in the infrastructure sector across various asset class.

 Infrastructure assets are a vital support pillar of any economy and though some investors may consider the sector boring, good Infrastructure investments does create a positive cycle of growth, providing essential networks and services, stimulating economic growth and improving the standard of living for current and future generations. Also the investment in the sector tends to be less volatile than any other publicly traded securities.

 Although the Infra structure Investment company may not address all the existing issues in the sector but by adopting a flexible strategy the “IIC” should be able to tap into a wide range of funding pool including of retail equity investors, institutional investors, sector focused investors among others. It provides an opportunity to Investors who in principle do like infrastructure but are reluctant to buy into it because of the lack of liquidity that comes with it.

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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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Innovation,Ideas and the Search for Growth in a market disconnected with the Real Economy

Posted on September 14, 2011. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , |

The Best Innovative Idea can come from Anywhere Today.

End users need, market demand, availability of new technology and the search for growth are some of the Key driving forces behind innovation. FOR example Africa out of necessity is becoming the testing ground for new and innovative mobile banking experiments. The ongoing innovation in mobile payment and mobile banking is filling the growing demand generated from a part of the population that was once excluded from the economic activities and considered untouchables by traditional banks. Today mobile phone is allowing people to participate in the demand side of the economy. These mobile banking experiments could potentially change the traditional banking as we know it.  And going forward traditional banking models where if you were poor you are excluded will find it very hard to survive if they don’t adapt to the changing world around them.

Consumer lead innovation generally has a higher degree of success rate as it allows the corporate and entrepreneurs to fill in a growing demand.  Companies as wells as governments across the world have realised that innovation and technological advances are key to their long term sustainable growth.

While corporates are driven by profit, the governments have an important role to play in creating a platform that allows and encourages real value ADD innovation. The governments need to work very closely with companies, entrepreneurs and provide a supporting framework which facilitates Innovation and with it Research & Development (R&D).

Today the policy makers in the developed world find themselves aggressively competing with their counterparts from the developing nations in order to make sure they don’t lose the competitive advantage but who is to say that the NEXT BIG THING won’t come from a developing nation.

Technology has changed the world around us and without it some of us will struggle to carry out routine work. We live in a world of Facebook, Twitters , messengers, youtube and the list goes on. Today our world is so interconnected like never before. And there are legitimate concerns about the impact of ideas like Facebook, Twitter etc on the society. Going forward the society, the policy makers will continue debating the pros and cons but we can all agree that there is no turning back the clock.

The success of ideas like facebook is in its approach to innovation and its application. The scope of applications of a technology or innovations in terms of scale is far greater today than ever before.  Technologies and ideas that had more than 90% chance of failure some 10 years ago are in fact a SUCCESS story today.  Technology is evolving and in some cases too fast with significant affect on the society and the world around us.

Going forward Innovation and technology will be Key to success for developing countries especially economies and societies like China, India who run the risk of chocking on their own growth. For R&D Companies especially in Green Technology demand from countries like China & India will be at the forefront of their business strategy.

We have already seen the fast paced evolution in green technology especially in Wind and Solar.  Today the world wide wind capacity stands at around 251’000 MW and growing while the Photovoltaic production growth has averaged around 40% per year since 2000 and the installed capacity reached over 16 GW in 2011. Going forward the cost of power generation from green technologies like wind & solar will decline steadily as the technology gets better and more efficient.

The demands from developing countries for cleaner, cheaper, smarter, efficient and better technological innovations & ideas are coming out of sheer necessity and NECESSITY IS THE MOTHER OF ALL INVENTION. This growing demand will serve as a breathing ground for innovation. So it is highly plausible that the next BIG IDEA could come from the developing world or could be created for the developed world. And in order to make the most from the available opportunities companies, entrepreneurs, innovators will need to be based in markets that are generating the underlying demand.  The governments in the developing world including of countries like China and India will need to work closely with all the participants and provide the required and essential support to harness innovation and new ideas.

Some of the things the governments in the developing world could do to encourage innovation:

  • Tax breaks over medium to long term to companies, entrepreneurs, innovators
  • Encourage state or privately held companies to acquire R&D companies overseas to fast track innovation. Burning cash on duplicating the efforts already made by others in a competitive R&D environment may not be worth a while exercise.
  • Promote Innovation & technology knowing well that (R&D) is a risky investment but this risk profile can change overnight with a single EUREKA moment.
  • Promote Innovations and R&D that adds real value to the economy and bring simplicity with it
  • Pick and target sectors where it can create a niche and support it by domestic demand.
  • Have a collaborative approach to mitigate the risk profile of the development phase of a certain technology hence enhancing the return on investment
  •  Be willing to share the development risk with the private sector
  • Help with hand holding where necessary including with the implementation of the technological innovation in the market
  •  Open the market to competition  attract overseas R&D Companies and support them with funding, risk sharing and establishment of a market ( if the underlying demand is not sufficient to support the bottom-line) by creating smart legislation and work with regional partners

While innovation and technology are going to be one of the Key drivers of sustainable growth it will be unwise to assume that all the innovations will add real value and provide growth. There are Innovations that add real value to the society and meet the growing needs and demands of the population but there others which may have an impact on the society but their real VALUE ADD is debatable.

Innovation and technology is a risky venture and not all of them will go on to become the NEXT BIG Thing. We live in a world where a company like Facebook with an estimated revenue of around USD 2 billion ( FY ending 2011 ) is valued at over US 100 billion and Twitter carries a valuation tag of around US 10 billon with an estimated revenue projection of approximately US 110 million ( FY 2011 ). Incredible valuation for private companies that may or may not exist after 30 or 50 years but whether or not we agree with the valuation and the methodology used for valuing these companies the fact remains that some in the market are happy to pay the price tag on these companies and ideas.

 In January of this year Goldman Sachs and Digital Sky Technologies (DST) paid US $ 1.5 billion  this investment valued the social network company at US 50 billion, a record valuation for a privately held company. Few months later General Atlantic purchased 2.5 million shares of Facebook valuing the company at US 65 billion.  The valuation jumped by over US 15 billion is less than 3 months without any fundamental improvement in the bottom-line of the company.

Growth projections of a business are mostly an estimated guidance but using it as a KEY ingredient in your valuation methodology is pretty much like assuming that a person is tall by looking at their shadow. The numbers are only as good the people who create and make them so it is unwise to take them as the gospel set in stone.

There is a strong disconnect between the real economy, society and the market. And the problem is if any of these overpriced investments go bad the market and the media will report this as the bursting of technology bubble depriving good and essential innovative idea & technology of capital. And the technology sector will become a no go area again. We saw a bubble burst in the 2000s and its aftermath.

 A sector could go from being attractive and undervalued to be overvalued in no time depending on the speed and the amount of capital flow it gets from investors around the world. There is a strong temptation among some in the market to ride on an in fashion trend and jump in the bandwagon. For example if emerging market is the growth story we are all tempted to ride it but the logic says if a country is growing at 9% percent it doesn’t necessarily mean that all the sectors of the economy are growing and attractive so committing capital based on the overall growth story is not just ill-advised it is how we build bubble and distort the reality.

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Market Psychology and Investors Sentiment ( mood of the market ) – The Driving Force Behind the markets

Posted on April 7, 2010. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , , , , |

A friend of mine once told me Positive Attitude is the MANTRA for success.

 Now some may say being positive is good but one has to be a REALIST too. Isn’t that just COMMON SENSE or maybe not. I believe human psychology plays a very important part in whatever we do as humans. And I do mean everything relationship, business, career etc.

Let us explore this more shall we?

Most of us who operate in the market or just watch the market have witnessed the markets going UP on bad news and vice-versa. And sometimes the strength of these irrational or unexpected moves will make you want to lose all your foresight, judgement, wisdom and commonsense. You will be tempted to abandon your own view and just follow the trend.  There are some who do follow the trend. And there is nothing wrong with that. You don’t need to beat the market consensus but just profit from it.  But sometimes bucking against the market consensus does pay well in the end.  We all know that the markets have a habit of getting either too optimistic or too pessimistic and this has a lot to do with the market psychology.  

Understanding the market psychology and how it affects the markets is never easy. But you can position yourself and also profit from it by simply looking at the bigger picture and not get carried away by the market sentiment.    For example there were folks who went into the CRISIS uncertain about the future and with a very negative frame of mind (who would blame them) but there were others who went into the CRISIS knowing well that eventually things will get better and thus had a POSITIVE frame of mind. In the aftermath of the CRISIS all the evidence shows us that the later did profit from the CRISIS and are better for it.

Things are looking and getting better. Across the globe (with the exception of few countries) in general we are seeing a positive turn in the inventory, the manufacturing sector is beginning to do better, exports are doing well, businesses are beginning to spend some money, we are also seeing signs of improvement in the job markets, consumer and business confidence in the future seems to be getting better and one could say that we may have turned the corner. Having said that we may still see some mixed numbers going forward and although the overall health of the economy is getting better it is difficult to say with certainty that we are heading into a self sustaining recovery especially in the developed world until we start getting hard evidence that the private sector has started driving the growth.  But based on the current state of the global economy where we are getting more positives then negatives I think it is safe to say that there are no tell tale sign or risk of a double dip recession going forward and the global recovery is gathering momentum with Asia leading the way. As I have said before in my post titled “Coming of Age: Emerging Markets – The Next Generation of Growth Engines “. A post that I wrote in July of 2009 the party is in the Emerging markets.

There is no doubt that the policy makers have managed to avoid a Great Depression type event by not adopting an extremely tight fiscal and monetary policy. Keeping a loose fiscal and monetary policy has surely helped. But that said the overall cost of the CRISIS on the Governments has been enormous as evident from their fiscal position. Their balance sheets are too stretched and they are getting calls from all the quarters to take immediate steps to FIX it.  Although one understands that there is an immediate need to fix the balance sheet and also address the inflationary concerns by having a clearly formulated, defined and coordinated exit strategy in place. But that said the Timing will be KEY.  I believe the policy makers would like to see credible and hard evidence that 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 and sustainable. And this is why I believe the chances of a double dip are now becoming extremely remote.  But that said there are still many challenges that lies ahead and any policy mistake here could jeopardise the whole recovery. 

 Although policy makers have done a good job but there is a lot that could go wrong especially if they start playing politics and listening to the popular demand. We also have the general election related uncertainties especially in the UK.  Governments are facing resistance from their citizens and labour unions on the austerity program designed to cut the huge budgetary deficit as evident in countries like Greece and other parts of Europe.  For example in Britain which has seen the worst recession since the World War II people are showing little or no appetite for the shrinking of a system that takes up almost half of the national economic output which is far greater than that of Greece, Portugal or Spain.  And all the political parties are mindful of that. So it is hard to envisage a situation where any government trying to come to power will promise the market a severe cut in the overall public spending and take radical steps to reduce the budget deficit even if they know that the markets may punish them for their inaction.

We are already seeing that European governments are taking decisions that are mostly political by design and targeted towards pleasing their own local electorate as evident from the stance taken by the German Chancellor Angela Merkel on Greece and the EU.  The message from the German Chancellor couldn’t be any clearer. It looks like if the EU nations want a currency Union with Germany then they will have to implement economic and budgetary changes and maintain a good fiscal discipline that brings their performance into alignment with Germany. Which is probably as a fair expectation but although the German proposal especially on Greece was approved by the EU countries however, it does make the future of European Union look somewhat uncertain and also undermines the common currency. No wonder why some the recent statements of the German Chancellor have been received with horror in most parts of Europe. But that said there is a merit in the German proposal especially if you look at how the EU has failed to supervise and monitor Greece effectively. At least with the IMF involvement and it playing an important role the markets should get some comfort knowing well that it will now be extremely hard for the Greek government to misrepresent the figures going forward and there will be independent supervision of the reforms and cuts proposed by the Greek Government. So a combined EU and IMF solution for Greece albeit perceived as political by the market may turn out to be a much better solution than the initial proposal.  

However, there is a genuine fear in the market that since Greece was not guaranteed explicitly by the EU there is a strong chance that Portugal , Spain or Italy won’t be helped either.  And if the EU is unable to fix its own problem or find an EU based solution for an EU problem then it surely reflects badly on the credibility of the whole European Union and undermines the common currency.  Also if the IMF decides to create a deeper austerity program for specific EU nations this may have a negative effect on the overall demand within the Euro Zone.  Which can’t be good for the German export industry but we will have to wait and see.  It is important to point out that to its credit IMF has shown a lot of flexibility when dealing with governments during this CRISIS so one can hope that we may see a sensible plan and in case of Greece they may even agree to the Greek austerity plan created by the Government.  But there is no doubt that speculators would surely try to benefit from this uncertainty by testing the market.

On the other hand we have seen the US dollar benefit on the back of the uncertainty in the EU and also the improving economic conditions in the United States. Central bankers (especially in Asia) and investors who were reluctant to buy US dollar few months ago have all of a sudden found a renewed attraction to the currency.  We have been long on USD and I am glad to say that our bets against EURO and British pound have paid off.  The reality is there is still a dark cloud of uncertainty hanging over Euro Zone and the UK which won’t help the EURO or the pound in short term and It is also very plausible that FED may start raising rates as early as third quarter of 2010 while ECB and Bank of England may have to wait a little longer.  And to add to that the upcoming elections especially in the UK are not going to help the situation. Having said that one could see the merit in the case for British Pound being undervalued especially against EURO, however, it will be hard to find a backer for British pound in the market.  But I believe a cheap pound is a blessing in disguise and it could in fact help the UK economy going forward. Although some in the markets may still hate the UK but we have had a different view based on common sense and reality. I am glad the market in now paying a lot of attention to the UK job story which I have been watching for the past six to eight months.  Here is an extract copy of the e-mail that I wrote to a dear friend ( I have edited the content and removed his name for obvious reason ) on the 20th of January 2010. I thought it will be an interesting read.

 << Hi D,

 Hope you are well.

Picking up from our last conversation on the status of the UK economy I thought I’ll share with you and also get your thoughts on a piece that I am in the process of writing regarding the UK economy. I think bucking against the market consensus does pay well sometimes. We were expecting some positives numbers from the UK and I am glad that is what we got.

 The Market probably still hates the UK and I can  understand the reasons for it but the market does have a  reputation of getting it wrong ( sometimes ) because we  as  people  do tend to get carried away and discounting  UK will be losing out. I won’t say I am turning all bullish but yes there are plenty of opportunities to make money spread across various asset/investment class.

Going forward I believe the market will start paying attention to the Job loss numbers in the UK surprisingly the job LOSS numbers have stayed well below the market expectation unlike any other previous recession? And I believe the main reason for that has been the flexibility offered by both sides the employees and the employers. 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.

Cheers >>

 I think it will be foolish to assume even for a second that the British economy is not in a pretty bad shape but I believe the market has been way too negative on the UK.  And we are already seeing some positive revisions in the official figures from the Government and government agencies. But that said the British pound and the economy will still be under considerable pressure for some time going forward especially because the UK economy is very closely linked to its banking sector.  According to Fitch ratings major UK banks may have to refinance more than US 448 billion of Government -backed guarantees and funding over the period of two to three years which could be a huge challenge depending on the prevailing market sentiment and this could reflect badly on the economy and the pound. What’s more the market is also very wary of UK’s budget deficit but one must add that this is not just a UK problem but today most developed countries including of the US are facing a similar challenge. 

Although one mustn’t underestimate the importance of shrinking the budget deficit to sustainable levels ASAP I think it is also important not to overlook a major problem facing all the developed economies going forward. Which I believe is a slow-motion train wreck and the governments would need to address it without further ado.  And I believe the Greek Crisis may be an early warning of troubles to come. The governments around the world especially in the developed world who are committed to providing very generous pensions over an extended period of time will now be pressed by the markets to re-examine or re-visit their pension program.

To get a perspective let us look at some of pension obligations of the developed world. According to a research recently published by Washington based Cato Institute if the Greek government was to bring its pension obligation on to its balance sheet the government’s total debt in reality will be over 875 percent of its GDP which is over 7 times the official Greek Government debt level.  And France for example will see its total debt rise to over 549 percent of its GDP, Germany will see it total debt soar to over 419 percent of its GDP from the current level of just around 69 percent, and the US total debt will rise to over 500 percent of its GDP.  There are some economists who would argue that having the pension obligations on balance sheet is the correct and appropriate way to assess a country’s total indebtedness.  To service and fully fund these pension obligations countries (especially in Europe ) will have to aside at least 7 to 8 percent of its GDP which seems like an impossible task and not practical to say the least but I think it is important to add that United Kingdom has the most favourable demographic developments among other in the EU.

There is an immediate need to fix this hole. And unfortunately there is no silver bullet the solution will have to be a right combination of higher taxes, benefit reduction, and increase in the retirement age among other measures. Some countries have already started raising retirement age but that alone won’t be enough. There has to be a reality check and going forward we may see generous pensions scheme being shut.  Some pensioners have already found a solution by choosing to retire in emerging countries with a relatively low cost of living. And this could be a part of the overall solution.

Americans, Europeans and others living in the developed world are already buying a record number of second homes in developing markets although some of these second homes could classify as investment but some are genuine second homes so may be the government and the pension funds in the developed world could create and promote “ Retire in your second home initiative”. But for that to happen there will be a need to commit to provide and deliver the entire essential and necessary services and this will require investment in infrastructure and other assets to raise the living standards attractive enough for people to retire with comfort.  These assets could be co-owned and funded by governments and pension fund in the developed world in partnership with their counterparties in the developing world especially in Africa and Latin American countries which are seeing a steady decline in the population and are in serious need for investment in infrastructure and other areas to improve the living standards of the population.  Though this may not solve the problem but it could be part of the combined solution and will surely reduce the burden and stress on the entire system.

The reality is going forward the tax payers may not be able to take any additional burden and lenders no longer willing to fund the excessive borrowings. Going forward the markets would require and expect changes in government programs in order to keep financing the shortfalls.

And with regards to the market itself I am now of the opinion that just like our body the market has its own immune system which is mostly driven by confidence, investor’s sentiment and market psychology (the mood of the market). And a positive mood with a quarter of positive numbers could BOOST that immune system significantly which could translate into surprises on the UPSIDE. In other words it is similar to a doctor getting pleasantly surprised by a quick recovery made by the patient.  Also the placebo effect is well documented and I believe the positive Investors sentiment and market psychology has a similar affect on the markets. As we know Investor sentiments, confidence and market psychology do play a major role in moving the market both ways and why  shouldn’t they  after all the markets are made up of human beings and run by human beings so it will be affected by the human psychology.

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