Saturday, November 27, 2010
The credit crisis of 2008
http://www.nytimes.com/imagepages/2008/09/16/business/16primer.span.ready.html
Tuesday, October 26, 2010
Let the rupee ride
India seems to be the odd man out. At a time when global powers are lined up against each other over exchange rate management and the threat of competitive devaluation looms over everyone, India seems happy to let the rupee rise. This is even as exports are sluggish, a high negative current account balance persists, and foreign direct investment (FDI) is trailing portfolio investment in the current year in reversal of the earlier pattern. What gives?
The worrisome way of looking at all this is to identify a holy cow as the root cause. Nothing must be done to impede capital flows into the stock market which is getting on to a bull run of sorts. Middle class India has been waiting for this for two years now and there is no question of spoiling the party when it is just about to warm up by stemming the inflow of portfolio investment. Not just common folks, the big and the powerful with alternative resources will not have their round-tripping via the stock market stopped. So, no border restrictions, no Tobin tax a la Brazil. The short-term capital inflow continues unchecked, taking the rupee up and turning the tables against buoyant export growth.The positive way of looking at the scenario is to argue that export sluggishness is a result of global trade not picking up as consumption trends in developed economies remain weak. According to the IMF (World Economic Outlook), global trade in volume terms is likely to rebound this year after falling last year, but is projected to grow at an average rate of 6.8 per cent over 2012-15, which will be less than the average 7 per cent achieved during 2000-07. As for the current account deficit, a fast-growing economy powered by high investment expenditure will have a keen appetite for import of plant and machinery which will lead to a sizeable current account deficit. The dissonance between FDI and portfolio investment also need not be considered a wholly negative development as the latter need not necessarily create an asset bubble. Corporate earnings are doing well, helping keep in check price-earnings ratios. Plus, anchor investors in public issues end up financing new capital assets.
Thus, while an appreciating rupee may not be doing the damage that it is popularly supposed to be, it can even be doing some good via the impact on inflation. Global commodity prices, on their way up once again, will sharply impact core (non-food and non-energy) inflation during a period of high industrial growth. Since bringing down inflation while sustaining rapid growth is the key task ahead and agricultural prices remain stubbornly high despite a good monsoon, a strong rupee that keeps raw material import costs down is a great help.
There is yet another reason why clever policy-makers may be secretly happy to live with a robustly valued rupee. Indian tariff rates remain high and should be brought down progressively. Bringing down nominal tariff rates is unpopular with domestic industry. It is so much simpler to let the job be done via creeping currency appreciation. Greater import competition for domestic industry does wonders to a country’s competitiveness over time. The appreciation of the rupee since August, assuming a median import tariff of 10 per cent, has brought down the landed cost of imports by 6 per cent. Being able to stand up to cheaper imports is the obverse of being able to competitively export. So that loops back to export performance where we began.
There are a couple of recent developments that go against this line of reasoning. Recent industrial growth rate figures show a decline largely as a result of poor performance by capital goods. This and a declining order book position do not portend well for investment expenditure which has been a driver of high growth. Faltering growth and appreciating rupee do not go well together. But neither the private nor the public sector currently appears reluctant to invest. Business confidence is at a high and there is no resource crunch for public investment. We may eventually see imports matching a lot of investment expenditure but that will only point to the need to address the competitiveness of the domestic machine-building sector. If Bhel’s power plants cannot compete with Chinese equipment in price, then they must at least be clearly superior in quality.
The foremost agenda for policy-makers is to bring down inflation which is largely the result of high food prices. An appreciating rupee is not a contributing villain. In fact, cheap imported edible oils and pulses help contain food prices. Export competitiveness is indeed a priority but a favourable exchange rate is more of a quick fix. Neither auto components nor software exports seem to be suffering from an adverse exchange rate. Apparel exports are, but that is because western demand for higher-end garments (India’s niche) is yet to pick up and a lot of Indian garment factories are uneconomical in size, a hangover from the days when factories were kept small so as to qualify for being small scale. Export competitiveness is a long, hard-fought battle, won industry by industry, cluster by cluster. Auto components (Deming prize), software (CMM Level Five certification) and pharmaceuticals (FDA certified facilities) all score on quality.
The current growth-induced tax buoyancy and disinvestment inflows offer the government a golden opportunity to improve the fiscal balance which is vital for achieving price stability. Once that is achieved, the rupee can be left to find its own level. The benefits of doing so outweigh those from keeping the rupee cheap.
Source: http://www.business-standard.com/india/news/subir-roy-letrupee-ride/412785/
Thursday, October 14, 2010
U.S. Should Not Force China to Revalue Currency
"China has every rights to manage its currency reforms and appreciation in a gradual way," Stephen Roach, a senior executive with Morgan Stanley, said in a local business forum. "This reflects understandable and correct fixation on financial stability that China needs and the world needs."
His remarks come as the United States is stepping up its pressure on China to allow the rapid appreciation of the yuan, accusing the Asian economic powerhouse of aggravating the U.S. trade deficit and hampering its job market.
U.S. policymakers blame massive imports from China, made possible by its undervalued currency, for its widening losses from trade and sluggish employment by U.S. firms.
Speaking to the World Knowledge Forum, the Morgan Stanley executive refuted the U.S. government claims and instead urged China to adopt local consumption-boosting measures to address the trade imbalances between the two countries.
"(The U.S.-China imbalance) is not necessarily manifest in mis-evaluation of the currency but in a massive saving surplus of China," Roach, also a lecturer at Yale University, said.
"China must put pressure on its policy makers to enact aggressive pro-consumption policy stimulus measures to absorb the surplus savings."
If such measures are adopted, the United States would have enormous economic opportunities by boosting exports to China and subsequent job creation, he noted.
Tuesday, October 12, 2010
Banks find it pays to keep BPLR loans
Three months after the base rate regime to price loans began, only a handful of customers have shifted to it from the erstwhile benchmark prime lending rate (BPLR) system. But don’t blame only lack of customer awareness. Banks are also finding it more profitable to keep customers in the BPLR regime. This is because the ‘exact mapping’ envisaged by banks has not happened. Mapping refers to keeping the effective interest rate intact while shifting from BPLR to the base rate. For example, if a client was charged BPLR plus two per cent for working capital loans, assuming a 12 per cent BPLR, in the base rate it would have been base (eight per cent) plus six per cent with mapping.
But this hasn’t happened as bankers fear a hue and cry among customers in case high spreads are shown. “No new customer will come to banks if spreads are shown as high as 600 basis points (bps), which were 200 bps in the BPLR regime,” said a senior banker from a public sector bank.
What has happened in some cases is mapping of spreads, instead of the mapping of rates, because of which effective interest rates are lower in the base rate system than in the earlier regime. As a result, according to a senior public sector bank executive, “In some cases, it is not viable for the bank to shift the customer to a base rate, if spreads are mapped. For example, in case of a client who pays interest linked to BPLR (of 10 per cent), he is charged 14 per cent on a term loan, which captures risk, including credit risk.”
Now, if this SME client is shifted to the base rate system, if spreads are intact, the effective rate charged will be 12.5 per cent if the base rate is 8.5 per cent. This would mean a dip in interest income for the bank, something not acceptable at a time income growth was subdued, he added.
And since, according to norms, both the parties have to agree to such a shift, banks are not interested in shifting the loan to the base rate mechanism, a s spreads will be lower. As a result, most government-owned banks have seen only 10-20 per cent of the loans shifting to the base rate regime.
“So, as far as working capital loans are concerned, these are mostly for a year. So, it is better for us to wait until the contract comes for renewal,” said the chairman and managing director of a mid-sized public sector bank.
In term loans, especially to retail borrowers, it is mostly the borrowers who are not willing to shift, as they find that the BPLR rates are lower.
Though most banks have implemented one round of increase in BPLR, mainly to encourage existing borrowers from moving to the base rate, bankers feel another round of BPLR rise is required to induce term-loan takers into the base rate regime.
The bankers had requested RBI to invoke a sunset clause for all BPLR-linked loans. RBI is studying the legal implications of the clause. This is because certain customers can move court if the original contract agreement is not honoured.
Source: BS
Sunday, October 10, 2010
Portfolio Management Style - Active & Passive management
As some asset managers have fallen short of investors’ expectations, individual and institutional investors are asking themselves the same question, “are these fees worth the added benefit?” In this article, we will provide insight by comparing and contrasting traditional, long-only active and passive portfolio management.
Active and passive management are two broad-based styles of managing a pool of assets. Both styles see the same investment universe but in different ways. Active managers seek to return a risk-adjusted premium that outperforms their benchmark or tracking index. Generally, active equity and fixed income managers are compensated based upon a percentage of assets. On the flip side, active management requires more research and due diligence for exploiting market inefficiencies and purported above-average returns.
Active management fees for U.S. equity mandates benchmarked against the S&P 500 varied from 25 to 180 bps per annum (median fee was 51 bps <-- basis points, 100 basis points = 1% ). Active management fees for U.S. fixed income mandates benchmarked against the Barclays Capital U.S. Aggregate varied from 16 to 56 bps per annum (median fee was 26 bps). Security selection, sector allocation and the ability to generate alpha or risk-adjusted excess returns are reasons often cited for higher active fees
Passive management on the other hand is a manager’s approach to mimic a set of securities, such as an index. These managers are looking to generate a return and risk profile that resembles that of an index, regardless of how the individual securities perform. Investors are still charged a management fee; however, the fees are much lower (the median fee for both equity and fixed income managers is roughly the same, 8 bps). Fees are less because buying and selling of securities occurs less frequently, suggesting that there is less active involvement in security selection and monitoring.
Generally speaking, an efficient market is one in which prices of traded assets already reflect all known information about the particular instrument. Highly efficient markets or segments within an overall larger market are easier to passively track. Efficient Market Hypothesis postulates that active managers may not make recurring profits through trading because the market price reflects all information already, depending on the form of efficiency.
The large-cap space within the U.S. equity market is highly efficient, whereas the small- and mid-cap space is less efficient. Thus, inefficient or less covered markets and market segments present active managers with added opportunities to generate alpha (<-- excess return over the benchmark index, which the portfolio manager wants to beat)
Active and passive management are two broad-based styles of managing a pool of assets. Both styles see the same investment universe but in different ways. Active managers seek to return a risk-adjusted premium that outperforms their benchmark or tracking index. Generally, active equity and fixed income managers are compensated based upon a percentage of assets. On the flip side, active management requires more research and due diligence for exploiting market inefficiencies and purported above-average returns.
Active management fees for U.S. equity mandates benchmarked against the S&P 500 varied from 25 to 180 bps per annum (median fee was 51 bps <-- basis points, 100 basis points = 1% ). Active management fees for U.S. fixed income mandates benchmarked against the Barclays Capital U.S. Aggregate varied from 16 to 56 bps per annum (median fee was 26 bps). Security selection, sector allocation and the ability to generate alpha or risk-adjusted excess returns are reasons often cited for higher active fees
Passive management on the other hand is a manager’s approach to mimic a set of securities, such as an index. These managers are looking to generate a return and risk profile that resembles that of an index, regardless of how the individual securities perform. Investors are still charged a management fee; however, the fees are much lower (the median fee for both equity and fixed income managers is roughly the same, 8 bps). Fees are less because buying and selling of securities occurs less frequently, suggesting that there is less active involvement in security selection and monitoring.
Generally speaking, an efficient market is one in which prices of traded assets already reflect all known information about the particular instrument. Highly efficient markets or segments within an overall larger market are easier to passively track. Efficient Market Hypothesis postulates that active managers may not make recurring profits through trading because the market price reflects all information already, depending on the form of efficiency.
The large-cap space within the U.S. equity market is highly efficient, whereas the small- and mid-cap space is less efficient. Thus, inefficient or less covered markets and market segments present active managers with added opportunities to generate alpha (<-- excess return over the benchmark index, which the portfolio manager wants to beat)
Monday, October 4, 2010
Your currency, our problem!
It's the silly season for currency interventions. Last week, Guido Mantega , finance minister of Brazil warned an 'international currency war' has broken out. As Brazil's central bank scrambled to buy close to $1 billion a day for almost two weeks - about 10 times its daily average - Mantega was only voicing what many governments have already expressed privately. That for all the calls for collective action and bonhomie displayed at various G20 meetings, when it comes to ground realities, it is each country for itself!
So, what's new about that? What is new is that unlike in the past when 'currency intervention' was always a developing country refuge, a third world stratagem that first world countries eschewed, this time round, first world countries are nothing loath to join the game.
Last month, Japan joined Switzerland in intervening in the foreign-exchange market. As the yen surged to a little short of 90 to the dollar, the strongest in 15 years, the central bank, fearing a strong yen, would jeopardise recovery, sold an estimated $20 billion yen. The last time it intervened to sell yen in the foreign-exchange market was in 2004, when the yen was around 109 per dollar.
It is not the only one. The Swiss central bank has been intervening to prevent the appreciation of the Swiss franc against the euro for close to six months now. The last time it intervened was in 2002. The Japanese and the Swiss are not alone. South Korea, host to the next G20 meet, has shown as much alacrity in intervening to keep the won weak; so have Taiwan and Singapore.
In the developing world, meanwhile, currency intervention has become much more frequent. China, an old hand at the game, has been joined by Brazil, the Philippines, India and Malaysia, to mention just a few. The danger is if intervention becomes the norm, rather than the exception, the resultant 'currency war' will not leave any winners. Worse, it will mean goodbye to any hopes of rebalancing the world economy.
Why is that important? Because as long as the global economy remains perilously unbalanced, the next crisis is not far away. Orderly currency realignment is, therefore, critical to rebalancing. But that calls for coordinated action by the major world economies (read G20) - not haphazard, beggar-myneighbour intervention of the kind that seems to be the fashion now.
The reason is simple. Cheap money policy in the US that causes the dollar to weaken against other currencies will help boost US exports and rein in the US current account deficit. Provided no country intervenes! So, left to itself, this realignment in currency values is a part of the remedy the world is seeking.
But this is where the catch lies! China, the world's largest exporter, continues to suppress the value of the renminbi. In the pre-crisis days, when economic growth was strong, most countries were prepared to look the other way and restrict their response to jaw-jaw. Not any longer! Today, as countries struggle to remain competitive in the global market, many seem to have decided to copy the Chinese. Hence the proliferation of currency interventions aimed at making currencies cheaper in order to boost exports.
So, what's new about that? What is new is that unlike in the past when 'currency intervention' was always a developing country refuge, a third world stratagem that first world countries eschewed, this time round, first world countries are nothing loath to join the game.
Last month, Japan joined Switzerland in intervening in the foreign-exchange market. As the yen surged to a little short of 90 to the dollar, the strongest in 15 years, the central bank, fearing a strong yen, would jeopardise recovery, sold an estimated $20 billion yen. The last time it intervened to sell yen in the foreign-exchange market was in 2004, when the yen was around 109 per dollar.
It is not the only one. The Swiss central bank has been intervening to prevent the appreciation of the Swiss franc against the euro for close to six months now. The last time it intervened was in 2002. The Japanese and the Swiss are not alone. South Korea, host to the next G20 meet, has shown as much alacrity in intervening to keep the won weak; so have Taiwan and Singapore.
In the developing world, meanwhile, currency intervention has become much more frequent. China, an old hand at the game, has been joined by Brazil, the Philippines, India and Malaysia, to mention just a few. The danger is if intervention becomes the norm, rather than the exception, the resultant 'currency war' will not leave any winners. Worse, it will mean goodbye to any hopes of rebalancing the world economy.
Why is that important? Because as long as the global economy remains perilously unbalanced, the next crisis is not far away. Orderly currency realignment is, therefore, critical to rebalancing. But that calls for coordinated action by the major world economies (read G20) - not haphazard, beggar-myneighbour intervention of the kind that seems to be the fashion now.
The reason is simple. Cheap money policy in the US that causes the dollar to weaken against other currencies will help boost US exports and rein in the US current account deficit. Provided no country intervenes! So, left to itself, this realignment in currency values is a part of the remedy the world is seeking.
But this is where the catch lies! China, the world's largest exporter, continues to suppress the value of the renminbi. In the pre-crisis days, when economic growth was strong, most countries were prepared to look the other way and restrict their response to jaw-jaw. Not any longer! Today, as countries struggle to remain competitive in the global market, many seem to have decided to copy the Chinese. Hence the proliferation of currency interventions aimed at making currencies cheaper in order to boost exports.
Inflation.. & everything around it
Consumer price inflation in India has been close to or above double digits for nearly two years, and the more cyclically sensitive wholesale price index, after dipping into deflation territory last year, has been steadily rising to surpass double digits.
The puzzle is simply this: why is inflation in India so stubbornly high and so much higher than other emerging markets, even those that are supposedly overheating, such as China, Korea and Indonesia, where inflation is closer to 3 per cent?
First we consider a few standard explanations.
1. The supply shock factor - relates mainly to agriculture. The weather Gods failed us last year, India’s agricultural output suffered a sharp drop as a result, supply declined and prices rose. The monsoon is looking better this year, so the agricultural shock factor will not have the same bite going forward. And fuel price increases should be of a one-off nature rather than an ongoing source of inflation. Moreover, rising prices are not restricted to agricultural goods and have now spilled over into other commodities: double-digit price increases are no longer confined to agricultural commodities.
Cure : Well, no one can do anything when Gods go crazy..!!
2. Policy shock - Prices of fuel have recently been increased, which is contributing to overall price inflation. Minimum support prices for agriculture have also been increasing. Further, in the face of agricultural supply shocks, price smoothing by the government through greater imports and faster depletion of domestic stocks has been woefully inadequate.
Cure : Better, more thought out policies, or counter policies. <please pour in your thoughts>
3. Overheating: the supply capacity of the economy is simply unable to match the demands on that capacity - Overheating in India can be an agricultural phenomenon or an economy-wide pathology. In either case, there is cause for worry because the implication is that the economy’s current growth rate of 7-8 per cent is above its potential or trend growth rate. In this view, and unless capacity can be significantly increased, attaining China-type double-digit growth rates will remain elusive.
In agriculture, a scissors effect seems to be at work. On the one hand, productivity growth, especially in pulses, is anaemic and possibly weakening further. On the other hand, purchasing power and hence demand are accelerating, courtesy the NREGS (which is increasingly looking like a pure cash-transfer programme).
For the rest of the economy, they could be inadequate investment in infrastructure, inadequate supplies of skilled labour (always a possibility in India because its growth model is so skills-reliant), slow total factor productivity growth or some combination of all the three.
Cure : Given the capacity situation, aggressive monetary policy action will be warranted to bring inflation below 5 per cent..where political pressures come into play while tightening rates, etc.
4. A type of cost-push inflation - Serious micro-economic distortions afflict the land market . In itself, this distortion cannot cause inflation because presumably the distortion leads to a one-off increase in the price of land as an input. In other words, the distortion, unless it is continually worsening, will have increased the price level but cannot cause price inflation.
(meaning of the above para in a more layman language, correct me if I have explained it wrong: that due to whatever reason prices at some places may be sold at higher rate than the market rate, which keeps happening all the time, but that does not mean that the market prices have changed)
But suppose that these micro-distortions interact with macroeconomic factors such as surging capital inflows into real estate and housing. Such surges will lead to sudden increases in the price of land and related inputs, raising the cost of production in the economy as a whole.
A whole range of services, such as retail, construction, entertainment, education and finance — which account for progressively larger shares of the economy — use significant amounts of land as an input, a fact that gets overlooked in inflation discussions, which tend to focus on agriculture and manufacturing (this may also explain why inflation in consumer prices, which reflect services to a greater extent than wholesale prices, has tended to be above wholesale price inflation).
Generalised cost-push inflation could then be a natural consequence with the push resulting from the interaction between a pre-existing microeconomic distortion and a macroeconomic factor that serves to aggravate this distortion, converting a price-level effect into an inflation effect.
Cure : Microeconomic : Clearly, the first best solution is to eliminate the distortions in the land market of which there are many, including urban land ceiling and tenancy laws. The resulting boost to productivity would increase the overall supply capacity of the economy, making inflation less likely. Structural reforms of the land market will thus be good for inflation and good for growth.
Macroeconomic : But if land market reforms are infeasible, and inflation continues to be above acceptable levels, policy-makers may have little choice but to address the macroeconomic factors that aggravate the underlying distortion. In some cases, this may require dampening foreign capital flows, especially those going to real estate and housing; or they may involve other prudential measures such as higher provisioning requirements for real-estate lending.
The puzzle is simply this: why is inflation in India so stubbornly high and so much higher than other emerging markets, even those that are supposedly overheating, such as China, Korea and Indonesia, where inflation is closer to 3 per cent?
First we consider a few standard explanations.
1. The supply shock factor - relates mainly to agriculture. The weather Gods failed us last year, India’s agricultural output suffered a sharp drop as a result, supply declined and prices rose. The monsoon is looking better this year, so the agricultural shock factor will not have the same bite going forward. And fuel price increases should be of a one-off nature rather than an ongoing source of inflation. Moreover, rising prices are not restricted to agricultural goods and have now spilled over into other commodities: double-digit price increases are no longer confined to agricultural commodities.
Cure : Well, no one can do anything when Gods go crazy..!!
2. Policy shock - Prices of fuel have recently been increased, which is contributing to overall price inflation. Minimum support prices for agriculture have also been increasing. Further, in the face of agricultural supply shocks, price smoothing by the government through greater imports and faster depletion of domestic stocks has been woefully inadequate.
Cure : Better, more thought out policies, or counter policies. <please pour in your thoughts>
3. Overheating: the supply capacity of the economy is simply unable to match the demands on that capacity - Overheating in India can be an agricultural phenomenon or an economy-wide pathology. In either case, there is cause for worry because the implication is that the economy’s current growth rate of 7-8 per cent is above its potential or trend growth rate. In this view, and unless capacity can be significantly increased, attaining China-type double-digit growth rates will remain elusive.
In agriculture, a scissors effect seems to be at work. On the one hand, productivity growth, especially in pulses, is anaemic and possibly weakening further. On the other hand, purchasing power and hence demand are accelerating, courtesy the NREGS (which is increasingly looking like a pure cash-transfer programme).
For the rest of the economy, they could be inadequate investment in infrastructure, inadequate supplies of skilled labour (always a possibility in India because its growth model is so skills-reliant), slow total factor productivity growth or some combination of all the three.
Cure : Given the capacity situation, aggressive monetary policy action will be warranted to bring inflation below 5 per cent..where political pressures come into play while tightening rates, etc.
4. A type of cost-push inflation - Serious micro-economic distortions afflict the land market . In itself, this distortion cannot cause inflation because presumably the distortion leads to a one-off increase in the price of land as an input. In other words, the distortion, unless it is continually worsening, will have increased the price level but cannot cause price inflation.
(meaning of the above para in a more layman language, correct me if I have explained it wrong: that due to whatever reason prices at some places may be sold at higher rate than the market rate, which keeps happening all the time, but that does not mean that the market prices have changed)
But suppose that these micro-distortions interact with macroeconomic factors such as surging capital inflows into real estate and housing. Such surges will lead to sudden increases in the price of land and related inputs, raising the cost of production in the economy as a whole.
A whole range of services, such as retail, construction, entertainment, education and finance — which account for progressively larger shares of the economy — use significant amounts of land as an input, a fact that gets overlooked in inflation discussions, which tend to focus on agriculture and manufacturing (this may also explain why inflation in consumer prices, which reflect services to a greater extent than wholesale prices, has tended to be above wholesale price inflation).
Generalised cost-push inflation could then be a natural consequence with the push resulting from the interaction between a pre-existing microeconomic distortion and a macroeconomic factor that serves to aggravate this distortion, converting a price-level effect into an inflation effect.
Cure : Microeconomic : Clearly, the first best solution is to eliminate the distortions in the land market of which there are many, including urban land ceiling and tenancy laws. The resulting boost to productivity would increase the overall supply capacity of the economy, making inflation less likely. Structural reforms of the land market will thus be good for inflation and good for growth.
Macroeconomic : But if land market reforms are infeasible, and inflation continues to be above acceptable levels, policy-makers may have little choice but to address the macroeconomic factors that aggravate the underlying distortion. In some cases, this may require dampening foreign capital flows, especially those going to real estate and housing; or they may involve other prudential measures such as higher provisioning requirements for real-estate lending.
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