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

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

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

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

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

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

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

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

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Understanding Emotional Capital

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

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

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

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

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

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

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

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When talking about the Indian economy, are we missing the big picture ?

Posted on September 24, 2017. Filed under: Uncategorized | Tags: , , , , , , , , , , , |

So the new government got into the office on the back of a pitch that was based on a lot of hope and promises, and while I have been personally quite supportive of the need for change. I have never been in any doubt that, the changes will require time and government will have to let down people. In a country like or anywhere else for that matter, a government gets elected mostly on perception built around the hype. Average people are simply unable to breakthrough each policies and make sense of it. A country like India needs a complete overhaul of its existing economic and financial infrastructure , and that requires a lot of re-wiring and also redesigning of the entire system. Any good reforms takes time, and a prudent policy is always, to not overload the system with Big Bang reforms, one after the other, the changes have to be incremental, but constant. A system overhaul takes time, and you can’t expect the system to start firing on all cylinders right away especially when you are creating more capacity in the old system.

But economic policies alone can’t re-wire the system, it also requires better execution. And if we are talking about creating growth then, there should be a realisation that, without the ability of funding, government policies on their own aren’t the magic fix. So I don’t care what economic policies the government can come up with, driving growth in a country like India , where almost 80- 90% financing is sourced from banks simply isn’t going to work, unless and until the banks are back in shape. The fact is, the bad loans problem hasn’t been fixed, and the lenders have been too slow to offload the garbage sitting in their living room, yes there are legislative policy changes and reforms to help the banks, but banks haven’t been proactive enough. And a lot has to do with the existing training as well as mindset of the executives within the current banking system. For example, based on my own experience, I have realised that a sizeable percentage of the senior bank executives in India aren’t willing to make tough decisions, because for them, as I understood it, it’s all about a peaceful retirement and self preservation. And the investigative agencies haven’t helped decision making process either. Also some of the rule changes don’t really help the banks clean up their balance sheet. The asset reconstruction companies or ARC as they are known in India are, like a time bomb waiting to explode . On practicality basis, there is almost zero value in the ARC structure.

Without recycling the rubbish, you can’t get rid of the stinky garbage, and monetise it. Many quality ideas are simply not getting funded in India, and young entrepreneurs who could drive growth are more or less shut out from funding. And the other real issue is that, like European banks, the Indian banks are also now scared to lend. The ex RBI governor did good talking and provided public opinion on almost everything, but failed to provide real solutions, and now he is busy promoting a book.

I would prefer a wholesale reform of the financial infrastructure of the Indian economy, where capital market becomes the largest source of capital and not the banks. The regulators also need to support the government by unburdening the system from socialistic era policies. Also the government needs to do more work and talk less, there is too much distraction. A lot of announcement, but not much is getting done. Media channels have an endless lineup of experts, who probably wake up everyday, ready to provide new round of expert opinion. And the quality of journalism is rubbish, where is a decent discussion on, what reforms need to be brought in, to help the nation grow? The issue is everyone is drinking from the same source, whether you are the federal or state government, central or state government owned companies, or the private sector. And unless there is new liquidity going into the banks, it’s going to be tough to fund growth.

Various state governments across India are struggling with a very bloated fiscal situation, and they also own companies that have not made money for a long period of time, so it doesn’t make any good business sense for these states, to continue to own unprofitable companies. And in most cases, these companies are competing with other unprofitable or distressed state owned companies across India. These companies were set up in various states across the country, to provide services to the citizens, and by design they were probably never pushed to make a profit. But the time has come for states across the country to find an exit, by either privatising the companies or merging them together with similar companies in other states, and then exiting it. This will also reduce the debt burden on the states.

Also to fund growth, I will encourage the government of India to put in $ 3 billion in equity and then raise additional $ 7 billion from local banks as well as international investors/ banks, to create a growth and investment fund. This fund could also be made tax exempt from withholding taxes for foreign investors, and let this fund buy new loans from the banks, the fund could then repackage the loans in an asset backed security ( ABS) as a way to refinance itself. The fund could also provide working capital loan indirectly to the SMEs through the banks, and let the originator banks hold just 10% of the new loan on their books. RBI could also buy some of these securities from the secondary market to improve the liquidity and pricing. Also Emerging market focused fixed income investors could buy into these securities, and will be exempt from any withholding taxes. I am not a great fan of using pure debt to finance infrastructure, I would rather first raise equity to fund the infrastructure, and then give equity investors an exit by issuing the debt. If you look at it from pure risk perspective, the equity investors are in fact protected from the completion of the underlying asset, and that’s why you need a strong construction company to provide completion and construction risk coverage. So once the asset is built, equity investors will have their value protected, and the return will come from issuing the debt at a premium. There is a natural cycle, and any insurance cover to protect your investment in infrastructure asset will not work, if you simply buy a credit protection. I prefer a equity – debt- equity – exit cycle , which is based on water cycle of cloud – liquid water- ice – water – cloud. That’s the best value preservation model.

The idea that you can protect your asset for its entire life cycle carrying just debt is completely absurd, and it simply doesn’t work, any debt, if not managed well tends to have the natural tendency to end up spiralling into an unsustainable burden. And, if there was no refinancing then, most debt will not be repaid. You can repay debt from cash flow, but refinancing still remains the most frequently used tool. So we need to link the cycle especially for infrastructure assets. The issue with an infrastructure asset also is the permanent loss of value, and this is when the asset becomes redundant for a number of reasons, but if as an investor, you haven’t recovered money during the cash flow generation lifespan or lifecycle of the asset then, you are looking at a permanent loss of capital.







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Making Sense of The Policy Debate Inside The Financial Market

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

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

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

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

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

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

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

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

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The Market’s Obsession With Credit Rating and Rating Agencies

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

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

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

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

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

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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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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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Coming of Age: Emerging Markets- Next Generation of Growth Engines

Posted on July 9, 2009. Filed under: Uncategorized | Tags: , , , , , , , , , |

Developing countries’ share of global equity market capitalization jumped to a record 24 % in the first half of 09 from the past levels of 15% at the start of 07 as more investors flock attracted by the growth story.

 Investors are now beginning to realize that developed nations are possibly faced with decades of very low growth and may need decades to work off the mountain of debt which is the biggest since World War II.  According to IMF recent forecast the total debt of developed nations used to fund various bank bailouts and stimulus packages could reach above 113% of GDP by 2014. This is more then three times the estimated forecast of 34% for developing nations. Though one could argue that developed countries have had bigger debt burden in the past ( post World War II ) reaching close to 250% of GDP in case of U.K., and over 100% in case of USA but these debts were repaid pretty quickly. On the other hand, we have to take into account that developed nations recorded decades of high growth just after the World War II ended which allowed them to get their fiscal house in order. In the current circumstances it is highly unlikely that the developed economies will see growth levels of post World War II era going forward.

 Developed countries are in a catch-22 situation if they spend more to keep stimulating the economy they risk running into a huge unsustainable fiscal deficit. The combination of low growth and ballooning budget deficit could be very damaging to developed economies. The talk of the town is now increasingly focused on getting the fiscal deficit under control.  It looks like the Governments in the developed world have resigned to the fact that they are entering into a low growth era. World Bank is now forecasting the GDP of high-income countries to shrink by over 4.2% in 09 and the overall global economy to contract by 2.9% in 2009. In terms of regional growth the World Bank is forecasting the growth in the Middle East and North Africa to fall to 3.1 percent, while that of sub-Saharan Africa to drop to 1 percent from an annual average of 5.7% and the LATAM to fall to 2% however, East Asia should post a growth of above 5%. Although the report suggests that economic growth in emerging countries could slow to 1.2% in 09 China and India should achieve a growth of above 6% in 09. We must also add that one of most interesting growth area of the global economy could potentially be rural India with its 700 million plus population. Some companies have already started to focus on rural area of the Indian economy as they see a very bright growth prospect going forward.  The recent Indian budget has rural India at the centre and it looks like the government of India is aiming to UNLOCK the growth potential of rural India which is most certainly a step in the right direction. 

It is becoming more apparent that going forward the growth is going to come mainly from the developing world. The ongoing CRISIS will mostly probably be recorded by historians as the event that triggered a POWER shift. The developing countries are already asking for more influence, oversight and control over how the global economy is managed, supervised and operates. The industrialized world’s clout to impose its policies will only weaken from here on. G-7 countries are beginning to realize that their grip on global affairs is slowly waning and they will have to give away a lot of their influence and control over how the global economy is run but that said it will be unwise to assume that developing economies are ready to lead the world. 

 We are already seeing signs of what could possibly be a shifting world order. We saw Russia host the first BRIC summit albeit a symbolic one. China, the world’s 3rd largest economy seems to be promoting Yuan as a serious alternative to dollar and it looks like they have a Grand plan for Yuan’s role as a global reserve currency going forward. This is evident from People’s bank of China recent unveiling of rules on Yuan-settlement facility. The rules will apply to companies involved in trade with Hong Kong, Indonesia and Macau. As a trial the central bank is going to allow companies in Shanghai and four cities in the Guangdong province to settle their trades in Yuan with companies in Hong Kong, Macau and Southeast Asia. In a separate announcement on July 6 Bank of China signed clearing agreements for Yuan settlement in Shanghai with over 11 overseas banks, including Standard Chartered, Bank of East Asia and Bank Mandiri of Indonesia. As one of the major trading countries it makes complete sense for China to start reducing its reliance on dollar. Despite of the fact that the stage is being set to promote a real alternative to dollar by major developing economies including China, Russia, Brazil and now India one has to admit that in the short to medium term it is hard to envision dollar loosing its status as a global reserve currency. 

However, more and more investors are getting attracted to the emerging market story and who would blame them. We saw the MSCI Emerging Markets Index rise by over 35 % in June 09, beating a mere 2.9 % rise in the MSCI Index  of developed economies and increasing the value of stocks to $8.6 trillion from $5.1 trillion in 2008. We also saw the market capitalization of Brazilian equities reach close to US 950 billion while that of Indian equities reaching close to US one trillion and Chinese equities surpass the US 3 trillion dollar mark in June. It is becoming more and more evident that developing economies are now moving closer to the centre stage and it looks like the investors have formed an opinion that emerging market is where the PARTY is going to be and this probably explains why the Investors have poured in close to US 26 billion into emerging market equities in the 2nd quarter of 09.

Although one understands the euphoria but we should not forget the fact that we live in a very interlinked world and any country on a stand alone basis is not capable of growing in isolation forever. It has to be said that not all emerging countries will fair well, Latvia is a prime example, but emerging markets have mostly certainly come of age and going forward without much hesitation one can safely conclude that they are going to be the next generation of growth providers.

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Building the foundation for a healthy and sustainable global economy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Oh, Recovery, What is thy shape?

Posted on May 16, 2009. Filed under: Uncategorized | Tags: , , , , , , |

Some of my friends and colleagues are busy trying to figure out what could be the shape of the most eagerly awaited recovery. The debate is whether we are going to see a V, W, and U or prolonged I__I shaped recovery. 

 There are some who are suggesting we are probably going to see a V shaped recovery then there are those who are predicting a U or prolonged U shaped recovery and yes there others who believe we might see a W shaped recovery. Boy! Go Figure. Someone has to be right but then I wonder isn’t this all a bit premature? Aren’t we getting ahead of ourselves on making such prognoses or am I simply being Silly?

Let’s find out, shall we?

The shape of the current economy could probably give us some clues as to what the shape of the recovery might be or at the least we could rule out some.  To get a good estimate of the health of the economy let us look at some of headline news during the week ending Friday, the 15th May 09.

We will start with the numbers out from the European Union. 

According to European Union’s statistic office the GDP in the 16 member Europe region fell by over 2.5% from the fourth quarter, the steepest decline in over 12 years. This was above the market expectation of 2%. German economy shrank by over 3.8% from the fourth quarter of 08; the Italian economy by close to 2.4%; the Spanish economy contracted by around 1.8% in the first quarter of 09; the French economy by around 1.2%. Some pretty grim numbers, no doubt. The Euro zone inflation is at record low of 0.6%. Going forward the rising unemployment will dampen the consumer confidence and there is a strong possibility of inflation remaining lower the ECB’s target of 2%.

 And how are things at the corporate front? 

ING announced higher then expected net loss of Euro 793 million in the first quarter of 09. Allianz reported a fall in profit by over 98%

So how is the UK doing?

According to the Council of Mortgage Lender’s, Home repossession surged by over 51% in the first quarter of 09.  Rents for commercial properties in London fell by over 25% over a period of 12 months. The prognosis is pretty grim especially if we take into account a 56% increase in the number of companies going out of business in England and Wales in the first quarter of 09. With unemployment expected to reach 3 million by 2010 one can safely conclude that we are looking at a slow paced recovery.

Let us look at the US and others.

US retail sales dropped more then expected by 0.4% in April after a 1.3% drop in March. The new mortgage applications dropped to the lowest level since March. Consumers are mostly cash -strapped and to hope that they going to keep spending lavishly is probably a wishful thinking. On the unemployment front the news isn’t good either. The recent announcement by GM to slash its dealership network by around 1,100 and Chrysler by around 789 paints a pretty grim picture.

What about others? 

According to FSS Russia GDP shrank by almost 23% on quarter – on – quarter terms.

China seems to be doing better then the rest. The domestic investment has increased significantly but it will be unwise to assume that China be able to recover in Isolation. The exports and import number out from China are not that encouraging. With the current momentum it is safe to assume that China could grow at 7% or there about in 09 but it won’t be a position to save the world. The data out from China on the 11tth of May suggests very strongly that China has slipped into a deeper disinflation. Consumer prices fell by over 1.5 percent, factory gate prices fell by over 6.5% so it’s highly unlikely that we are going to see a significant increase in demand for raw materials from China. 

There seems to be a slow paced growth momentum building in Asia but it will be unsafe to assume that the recovery will be rapid and the growth will be on a scale seen before.

Something to think about 

When talking about any recovery I think we should keep in mind that going forward the central banks of the world and the governments will have to raise rates and taxes to fix their balance sheet and to deal with hyper inflation. And on top of that we are going to be overloaded with Heavy Regulation. That’s the aftermath. And these are not the factors that will support speedy recovery on a big scale in fact just the opposite; it will choke off the recovery. It’s pretty much like throwing a spanner into a wheel. There is so much uncertainty ahead. I think we can safely rule out a V shaped recovery. We saw most markets get back in the Red again (at least for now) the week ending Friday, the 15th May 09 on growth and earning concerns probably the markets were pricing in a pretty rapid V Shaped recovery which they now believe is extremely unlikely hence the retreat. One can’t help but wonder as to whatever happened to all the talk about the negatives being priced-in? Probably the investors are beginning to realize that the prices rose too fast without any solid fundamental support or justification for it and the massive rallies were overdone. I’m not for a moment assuming or suggesting that we are not going to see speculation driven rallies. 

Going forward 

We are not done with volatility yet. We are going to see more mixed data come out in the next quarter which will probably swing the markets both ways. The hope is that the investors will not loose foresight and look at the story behind the numbers and not get carried away by sheer sentiments like seen in the past. 

All the talk about the shape of the recovery is probably premature and a clear sign of the market getting ahead of itself. We should be able to get a good estimate of the health of the economy after the H1 numbers for 2009 are out. It should serve as a good us a pointer for 2009. It should also tell us if the worst is over or there is more to come. Looking at the first quarter numbers we could safely assume with that recovery most likely months away. 

The bottom line is what the markets need is a sustainable recovery that won’t slip out of our hands. And a slow paced recovery will probably be a blessing in disguise for the global economy. It will take time to reconstruct the financial system which we all know now was pretty flawed to begin with and  prone to boom and bust type events.

The shape is secondary honestly speaking I’ll take it in whatever shape it comes.

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