Talking about globalisation, productivity and Universal Pay

Posted on January 20, 2017. Filed under: Uncategorized | Tags: , , , , , , , , , |

For starters, what is globalisation ? And is there a metrics that can help us measure the level of globalisation ?

The standard acceptable definition of Globalisation is that, it is a process that has enabled interconnectivity, thereby increasing trade and exchange of ideas as well as cultural experience among other things. Globalisation, as a process spread over 100 plus years has made the world richer, in terms of GDP. The process has also enabled the local champions, to become international bigwigs. And these international bigwigs have then, gone on to influence the change, or in other words, the process that, we have learnt to call ” Globalisation “.

To understand the affect of globalisation, we could look at how our main cities and societies living within those cities, have today become truly global, and therefore globalised in their views. So starting with New York City, which has an estimated GDP of around US$ 1.5 trillion, followed by Tokyo with an overall GDP of approximately US$ 1.4 trillion, and then London with an estimated GDP of approximately US$ 700 billion, followed by Paris with an overall GDP of around US$ 625 billion. And the other emerging global cities including of Delhi, which has an estimated GDP of around US $ 368 billion, are all bigger than some countries, in terms of their economic size. These city economies have reaped the benefits of the relatively freer flow of people as well as ideas supported by flow of capital from around the world. And it is quite safe to assume that, majority of the people living in this global cities, will have a favourable view of globalisation and the interconnected world.

Capital and ideas do not have geographical boundaries. Any attempt to limit or restrict the flow of capital along with ideas will only stifle progress, and it also goes against the natural evolutionary process. Over a 100 year period, human productivity, which is generally measured as a ratio of total output versus total Input, has benefited tremendously from innovation. And we are slowly reaching a point, where in certain sectors of the economy especially manufacturing, humans productivity as well as efficiency is no longer able to compete with the automation process driven by robotisation. Also, there will be increasing pressure on human as a labour force, to continuously reskill themselves. We may work longer, but on a lesser pay ( in terms of overall living standard ) than the previous generation. Technology may have made our lives easier, but it hasn’t increased the overall disposable income of people in general. So, a sizeable percentage of the population within our society will continue to feel under constant pressure. And this pressure and feeling of being slowly eroded isn’t all due to globalisation. The answer and the underlying reasons are more complex than some of us would like to suggest or believe.

The society that, we live in and along with it, our economies changes over time. And that’s part of the natural evolutionary process. Our body changes as we age, that’s how the biological process is designed. We aren’t physically capable of doing things that, we could do as a 16 year old, at the age of 60. So, we learn to adapt accordingly. Humans and humanity’s ability to adapt to change has been at the forefront of our evolutionary advancement. And the next generation of humans will have to be much better equipped than us, to stay relevant. Genetically speaking, humans are 99.99% the same, but we are still different in many ways including in our overall level of individual productivity. Not all the work force doing the same job, will have the exact level of productivity.

A human life is, more of a marathon than a quick sprint, and in the end, how we run the race decides where we end up. And the idea that, governments and political leaders can somehow help us stay in the race by changing the rules of the race in our favour, isn’t a permanent solution. We may get tempted to vote for those who identify with our problems, but the solution to the problems won’t come from pushing back against the natural evolutionary process. To facilitate a change, we must be prepared to change. And to change, one has to be ready to adapt to the changes.

Universal pay guarantee for those living below a specified and tested poverty line, could serve as the spring board, to help support those who may start to fall behind in the race. The fact is, not all of us will win the race, but we could try to finish it, without worrying about our individual ranking. We join the race, the day we are born, so we don’t really get to choose. But we can learn, how to run the race better. This is where, the society and governments could help, and they should.

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Unlocking Value – Exploring The Shanghai Global Exchange Idea

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

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

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

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

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

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

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

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

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

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

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

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

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The statistical data and the design of the modern economy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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The Tax Debate: There is a lot more to an economy than taxes

Posted on July 26, 2013. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , , |

The OECD recently launched a scheme to combat tax avoidance and evasion related issues from both major multinational corporations and individuals. The initiative called base erosion and profit shifting ( BEPS )  plan was presented to G 20 finance ministers on the 20th of July this year on their request.

In short, the BEPS report confirms OECD’s findings that the existing international tax system is failing the rich as well as poor countries. This is more or less stating the obvious. Taking the initiative further during a recent announcement the OECD has also identified 15 policy action points that it hopes will restore trust and fairness in the system. In principle, the scheme does seem to hit the right notes especially with law and policy makers and hence it was fully endorsed by the G 20 finance ministers this month.

The OECD’s action plan on base erosion and profit shifting (BEPS) will most likely be considered by many as a step in the right direction but it does seem to be loaded with complicated ideas to help nations find ways to collect more tax revenues from major international corporations as well as individuals. And while it rightly focuses on tax treaties, tax compliance, overall tax policies among other things to fix the inefficient global tax system, parts of the scheme may not be fair for all and also falls short on addressing the real issues. For example under the planned proposal OECD recommends a multinational treaty aimed at tax avoidance but this treaty could also potentially hurt smaller countries that are using low corporate income rates to attract investments from across the world.

Also after looking at the bigger picture it will be unwise to conclude that the downward trend in tax income revenues is all simply down to deliberate tax avoidance and evasion by major corporations and individuals. But here is something interesting, according to the US government agency data for the financial year ending 2011, the US corporate tax collection was roughly around 2.4% of its GDP. And the historical data suggests that the overall corporate tax contribution  has shrunk dramatically since 1950s but its not just a US problem as most OECD economies collect between 2% to 3% of their GDP in corporate income tax revenues. However, there are no clear evidence to suggest that this downward trend is all cause of corporates tax avoidance and evasion. There are serious existing policy issues related to taxation thats need to resolved and unless the lawmakers take radical measures to reform the existing tax systems even if OECD’s scheme was to be fully implemented it’s hard to project a significant rise in the overall corporate tax income revenues in terms of percentage of the GDP but we will have to wait and see.

Over the past few decades there has been a significant shift in the overall distribution of the tax burden. For example from Oct 1, 2010 to Sep 30, 2011 the US government collected $2.30 trillion in tax revenues of which 47% was individual income taxes, 36% social insurance taxes and just 8% in corporate income taxes along with 3% in excise taxes, 1% custom duties, 0.3% estate and gift taxes, and 4% in other taxes. So clearly from the overall tax distribution stand point it is evident that the US households are bearing the brunt of the tax burden. But again this is not just a US issue for example Europeans overall tax burden is estimated to be over 15% higher than Americans or Asians for that matter. And this shift in tax distribution burden has happened over decades so its not a new phenomenon and while the law and policy makers may find it easier to criticise the corporations, it is not the corporations who make or create tax policies.

The focus of the law and policymakers of G20 countries should be around finding ways to harmonise and simplify taxes across the board as most tax systems are extremely complicated and also work with major corporations to create incentives for them to make sure they pay a fair share in corporate income tax. The world has changed and will continue to change and going forward a good tax system will need to be constantly updated and forwarding looking. Any system that is seen as Tax grab and simply aimed at taking more cash out of the private economy will most likely struggle in the long run. The system needs to be redesigned to look and feel fair and this should clearly be the focus and aim of law and policy makers involved in the ongoing tax debate.

However,the recent steps taken by various governments around the world especially the European as well as the US government has been more or less front loaded with measures to increase the tax burden on the existing tax payers. And the temptation to find ways to collect more tax revenues is understandable as most governments are under severe pressure to find ways to fix their stretched fiscal position but the law and policymakers should also realise that there are already too many hidden and indirect taxes that really affect people’s standard of living. 

And also while higher taxes or finding new ways to increase tax revenues from the existing pool of tax payers in order to pay down the debt may seem as an easier option there needs to be a realisation that the current deficits weren’t caused by corporate and individual tax evasion and avoidance. The law and policymakers do need to realise that there is a lot more to an economy than taxes, and there are no perfect economic or tax systems and probably never will be but without growth most countries will continue to struggle. Also continuing to tap more from the existing pool without enlarging it or cutting down on the overall expenses to a sustainable level is a high risk  plan so the G 20 finance ministers will do well to keep their focus on finding ways to take collective measures to boost the global growth in order to generate more income.

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GREECE – Discovering The Road To Prosperity In a Difficult Debt Terrain

Posted on October 15, 2012. Filed under: Uncategorized | Tags: , , , , , , , , , , , , , |

The gruesome reality of the ongoing European Crisis is that some countries in the EU including of Greece were living way beyond their means and in the last decade benefitted the most from the European Union idea without realizing that all the rise in the living standard and good times hasn’t been paid for. For example after Greece adopted Euro the public sector wages rose by over 50% during the 8 years period ( 1999 to 2007), which is by far the fastest rise in the Euro Zone.

As evident from the unfolding events of the past few years. There is no doubt that Greece was ill-prepared to cope with the global financial CRISIS and has thus seen its real GDP growth decline year-on-year since 2008. According to Eurostat, the real GDP Growth for Greece in 09 was -3.3%, for the financial year (FY) ending 10 was -3.5% and the projection for 2011 is -6.9% and for the year  2012 its around 3.8 – 4.4% . The human cost has been enormous. And the pain and sufferings of millions has gone from bad to worse.

Although people on the streets across Greece have vented their frustrations and anger continuously by rejecting the status quo. A large percentage of the population still wants to be in the European Union. The onus is on the politicians as well as the population to fully understand and appreciate the gravity of the situation. Greece should take this once in a life time opportunity to reconfigure its economy.

The rebalancing and reconfiguration of the economy is a process that will take time and will require all the parties with vested interest to work together without losing sight of the BIG PICTURE. The solution will come from an open and honest collaboration and each party delivering their side of the bargain.

Getting GREEK debt on a sustainable downward trajectory is KEY. And this will require the lenders as well the policy makers in Greece to agree on a clear road map outlining the debt reduction plan.

Based on various media reports the troika consisting of the IMF, the European Central Bank and the European Commission is believed to be working on a Greek debt sustainability analysis and the officials are trying to figuring out ways to bring down the huge debt burden on the country. It is estimated that under the current scenario Greece’s debt to GDP ratio target set by the troika of 120% (of GDP) by 2020 is beyond reach. The median forecast for the economy is to shrink by 3.8 % in the financial year 2013, which will obviously be its sixth consecutive year of declining growth putting the overall debt to GDP ratio to around 180%. This falls way short of the initial goal and is clearly unsustainable going forward.

The need of the hour is to work out a plan incorporating the ground realities that has a real chance of SUCCESS. And creating a sustainable debt reduction strategy will require exploring all the feasible OPTIONS.

Here are some IDEAS worth considering. The suggestions below covers the debt held by troika including of the bonds held by European Central Bank (ECB), the bilateral loans as well as the IMF loans.

  • Consider recapitalising the GREEK banks through European Stability Mechanism (ESM) as planned for Spain.
  • Look at converting a portion (around 25-30%) of the agreed Euro 48 billion loan from European Financial Stability Fund ( EFSF ) marked for the recapitalisation of the banks into equity. This could be managed through the Central Bank of Greece.
  • Consider extending the overall maturity of the loan facility by additional 2 – 3 years  with a grace period on the interest payment.
  • The European Central bank (ECB) should consider taking a hair cut on the bonds it bought from the secondary market as investors or agree on a debt swap extending the overall maturity of the bonds by at least 2 years. Rules defining ECB’s role are vague and unclear but the central bank should take the initiatives here.
  • The policy makers in the EU should consider extending the bilateral state loan to Greece in the amount of euro 53 billion (already provided) by another 2-3 years with a reasonable grace period.
  • Greek government should fast track the planned privatisation process expected to bring in euro 40-45 billion and use part of the proceeds to buy-back the existing debts especially the post restructured PSI bonds that are currently trading at around 22-28% of the par value.

The above measures should reduce the overall debt burden on the Greek economy which is just over euro 330 billion but it won’t be sufficient especially if there are no clear strategy to GROW the economy and fill the fiscal hole from the revenue side. This will require a close cooperation between the Greek Government and Brussels. The politicians in Athens will have to set and drive the AGENDA forward at war footing.

The Government will have to start implementing the structural reforms including of reforming the complicated tax laws, increase competitiveness and productivity by  identifying champion sectors that will drive growth forward providing employment and support them with right legislation and tax incentives, use part of the  privatisation proceeds to support SMEs funding requirement, encourage investment in the real estate and other struggling sectors by inviting the Non- EU nationals to invest in the Economy through various programs that may include providing tax incentives and resident permits, provide flat tax rate to new foreign companies especially the GREEK Diaspora living overseas and explore all the other feasible options.

The next 6 to 9 months will be critical for Greece and the country should use this   CRISIS as an opportunity to come together with a strong resolve and  mindset that it will get over the line. And there is a road that leads to PROSPERITY but discovering it in this difficult DEBT terrain will require patience, perseverance and a right strategy.

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The CHINDIANS – Reshaping the future of the global economy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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Prognosis: Where Are We Heading?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Stimulus: The Exit Strategy and the road ahead

Posted on January 5, 2010. Filed under: Uncategorized | Tags: , , , , , , , , , , , |

Although the economists still can’t agree on the real quantative  impact of various stimulus packages that were adopted by economies from around the world  but one cannot dispute the fact that the size of the stimulus did matter and did  work in most cases.

To investigate this further let us look at the various stimulus packages that were adopted during the CRISIS.

Obviously by the sheer size and percentage of National GDP China’s US $ 586 billion stimulus Package which accounts for above 12.9% its GDP stands out from the REST. It is possibly followed by Saudi Arabia, Malaysia, and the mother of all STIMULUS thrown by United States under its American Recovery and Reinvestment Act of 2009 which is the largest by any measures (US$ 787 billion). 

At the time there were market pundits who were debating the pros and cons and some even doubted if the stimulus packages will deliver and I am glad to admit that some of us including myself had a different view. Based on my judgement and commonsense I concluded in a piece that I wrote in March of 2009 titled “ Getting the Patient Out of Intensive – The Economy “ that it should deliver and put the US and the world economy back to growth. But having said we should have no illusion that the road ahead is still bumpy and uncertain.

In comparison to other economies most European countries with the exception of Germany and France have been reluctant to throw a bigger stimulus package (mostly because of their fiscal position ) with sizes between 0.3% of its GDP  in case of Italy and 1.3% in the case of the United Kingdom. Germany clearly stands out with its two fiscal packages summing up to US $ 110 billion (approximately) which is  2.8 % of its national GDP hence it is no coincidence that Germany and France were the first EU nations among the EUROPEAN UNION countries to get out of RECESSION.

I think it is interesting and also probably important to point out that an unloaded stimulus with mostly tax breaks as the first wave  of stimulus didn’t do much as evident from the one off tax rebate under the American Recovery Act of 08 of Bush Administration. It looks like the additional money was clearly used by majority of the Americans to pay off the existing debt. Also the experience of BUSH administration’s 2001 tax cut bill clearly shows that rebates generally wind up as savings or as debt repayment.

So taking the above into consideration economies like the US, Germany, Australia ,Spain and others who initially clearly favored tax cuts over  spending in their  respective first wave of stimulus packages in 08 decided in favour of an alternative measure that included more expenditure loaded plans in 2009 in combination with other incentives.

According to the IMF the total stimulus amounts to US $ 2 trillion ( approx) which is around 1.4% of the  world’s GDP still below the IMF’s recommendation of 2 % of world GDP, however, only 15 per cent of the overall fiscal stimulus was really allocated for 2008 and the remaining 85% to be allocated over a two year period  2009 and 2010 with 48 per cent and 37 per cent, respectively. Also an important point to note is that while most of the Asian and other economies focused on their fiscal expansions in 2009, China’s and also the US the fiscal stimulus will only reach its PEAK in 2010. It is hard to accurately estimate to which extent the stimulus will be implemented in 2010 especially as the economies are stabilising and getting back to growth. And the recent downgrade of countries like Greece, Ireland, Spain and Portugal also means that going forward the economies will start focusing more on fiscal consolidation or else they run a huge risk of being punished for their inaction.  The bond vigilantes are clearly BACK and they have all the reasons to be WORRIED. 

Let us look at a list of top five debtor nations to get some perspective

1. Ireland – External debt (as % of GDP): 1,267%
External debt per capita: $567,805
Gross external debt: $2.386 trillion (2009 Q2)
2008 GDP (est): $188.4 billion

2. Switzerland – External debt (as % of GDP): 422.7%
External debt per capita: $176,045
Gross external debt: $1.338 trillion (2009 Q2)
2008 GDP (est): $316.7 billion

3. United Kingdom – External debt (as % of GDP): 408.3%
External debt per capita: $148,702
Gross external debt: $9.087 trillion (2009 Q2)
2008 GDP (est): $2.226 trillion

4. Netherlands – External debt (as % of GDP): 365%
External debt per capita: $146,703
Gross external debt: $2.452 trillion (2009 Q2)
2008 GDP (est): $672 billion

5. Belgium – External debt (as % of GDP): 320.2%
External debt per capita: $119,681
Gross external debt: $1.246 trillion (2009 Q1)
2008 GDP (est): $389 billion 

 I should point out that I’ve taken the above numbers from various sources including of IMF, World Bank and others.

It is a pretty Ugly reading isn’t it? The only good news is that it looks like the policy makers and the central bankers are beginning to take note of the worries and as a result have increasingly started to talk about creating a credible exit strategy as a priority. 

Although one understands that there is need to fix balance sheets (fiscal consolidation) and address the inflationary concerns by having a clearly formulated, defined and coordinated exit strategy in place. But that said Timing will be KEY here as exiting too soon or too late has its own risk. And also it is extremely important that the process should only begin when there is enough hard evidence to see that economy will keep growing on its own after the removal of the stimulus or in other words it is evident that the recovery is solid, financial markets are back to normalcy and credit risk spreads are at an acceptable level and there is a significant risk to inflation over the medium term. We have already seen some of the central banks tighten in the later part of 09 and it is becoming increasingly plausible that others especially in Asia including of countries like India will follow suit as the real inflation starts to pick up.

Going forward the Central banks will need to explain clearly how they intend to use all the tools both conventional and unconventional that are available to them. But having said that, there is also a genuine fear that any preannouncement could possibly push the interest rates up prematurely thus derailing any chance of a ROBUST recovery.  The Q4 of 09 and Q1 of 10 numbers should give us a good estimate of the strength of recovery. The economic improvement has to be across the board and not just in one sector to justify any intervention.  We have seen some encouraging numbers reported from parts of the US economy in later part of 09 including of jobless claims falling to 432,000 – the lowest since September of 09 ,ISM Manufacturing Index rise 55.9 in December which is the highest level since 06, and also an improvement in business and consumer confidence etc but on the other hand the construction spending fell by over 0.6% in November of 08, US business loan defaults rose again in November of 09 and so did the US credit card debts write off. So we are still seeing some very mixed numbers come out which is what I have been expecting and this is why I keep saying to my friends and colleagues always look Beyond the Numbers, and dig deep. 

 I think it is extremely important not to overlook the human cost of this recession. According to the New York Times article dated 28th December 09, New York’s state courts are closing the year with over 4.7 million cases- the highest ever.  The courtrooms are clearly seeing the aftermath of economic collapse on average folks on the main street and on businesses. I think from a judge’s perspective and also from the folks who are in the midst of all this it will be extremely hard to see signs of an ECONOMIC RECOVERY. But for some of the Wall Street guys it’s back to PARTY again as expected.  I did write a piece titled “Investing in 2009: Back to Basics “ in Feb/March of 09 and I thought I’ll just quote the last paragraph.  “The markets will come back at some point and there will be parties again on the streets, but the question is, will this happen again? I am sure it will. After all, we are human beings! “

Well, moving on even though we are still seeing mixed numbers I think it is probably safe to assume that we could see the US economy grow between 2.5% to 3.5 % in the year 2010.  And the reason for that is the economy has to grow from a very low bottom so even with a very basic and existing demand the economy will grow. And also it is also very plausible that the US may outperform other developed nations including the EU. But the party is going to continue in the Emerging Market. And among the Emerging markets you would see economies with deeper domestic base like Brazil, India, Indonesia and Turkey do better than export driven emerging economies.

While we are busy talking about growth prospect of the global economy and the road ahead one has to also admit that the policy makers have managed to avoid a Great Depression type event by not adopting an extremely tight fiscal and monetary policy. Also there is no doubt that the stimulus packages have delivered as it is becoming increasingly evident from the performance of the economies like China, India, Germany, France and the US among others.  That said there is no doubt that the road ahead is still turbulent and bumpy and a policy mistake here could jeopardize the whole recovery process. Monetary and fiscal policy changes will have to be coordinated. The main aim of any intervention should be to support growth and maintain price stability.

However, one of the safest open market operations could be raising the interest rate on banks’ reserves at the central bank as it will allow the central banks to mop up the excessive liquidity in the banking system by making sure the money is deposited back at the central bank and in so doing prevent excess credit creation and also inflation eventually. This is exactly what the Fed is intending to do through their term deposit program announced on December 28th 2009.  The clear intention behind the program is to help mop up some of the $1 trillion in excess reserves in the U.S. banking system.  While this should be easily achieved the unwinding of the assets bought by the central banks during the CRISIS will keep them awake.  But that said it will depend on the timing, if they were selling to an extremely confident market they could even make money from the asset sales but let’s see.

And with regards to the performance/returns of various investment classes I think it is probably safe to assume that in 2010 bonds or any other investment class for that matter will not provide or to duplicate the excessive returns as seen in 2009. And going forward we may very well see people chasing the higher yields again and get into more risky asset class. But, however, we may also see people jump back into safer bets like US treasuries if we were to have another Dubai type event so I guess a lot will depend on the market sentiment and confidence. There is still a strong demand for US treasury as evident from the weekly auction in December of 09. If you look at the corporate world you would see that most of them are talking about issuing more public equity to help repay the debt and strengthen their balance sheet. And if the fundamentals keep improving then it will lower the default rate but one shouldn’t underestimate the risk especially if you consider that down the road a rate hike is on the cards so bond holder should position themselves for what is coming. That said I don’t buy the argument that a total meltdown is coming in the bond market and everybody should get out because I believe if the economy grows strongly then it should withstand a hike.  But for now let us hope the policy makers and central bankers get it right ……Fingers Crossed.

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