Friday, September 12, 2008

Lehmann Splits in 2 Brothers

It is now almost imminent that Lehman Borthers will join the growing list of victims from the sub-prime crisis. ""The NYT Reports say that ailing firm is considering a proposal to split the bank into a "good" bank and a "bad" one. The proposal would essentially involve placing about $30 billion of troublesome commercial mortgages and real estate that it owns into a new publicly traded company — the "bad" bank. The rest of Lehman — the "good" one — would then be able to carry on with the help of a cash infusion from one or more investors"".(Sources:Economic Times) The logic behind the proposal - NYT writes, "Creating the separate company, the thinking goes, would strengthen the confidence of people who do business with Lehman every day — other banks, hedge funds and institutions like pension funds — thereby encouraging them to continue doing business with the firm. Shareholders, who would own shares of both the real estate portfolio and the new unencumbered Lehman, could bet on whether the commercial real estate market recovers or gets worse and sell its "bad bank" shares".The logic is self-evident.

The only problem is that in the real world, it rarely ever gets translated into results. Something else happens. Stripped off all the jargon, is this not precisely the definition of "asset stripping"? Privatizing the gains, while socializing the losses? The "smart" investors and promoters get away with their profits intact, leaving the "dumb" others to shoulder the debt burdens? Or set the stage for the private equity directory to swoop down and takeover the weak assets at knock away prices, and then experiment with even more impenetrable and complex financial engineering?

Tuesday, September 9, 2008

Problem Is not the Bond but its Segmented Market

Why did the RBI choose to create a special oil bond, forcing a segmentation of the bond market?

The answer, most likely, is that this was done to contain the fiscal deficit.
The huge oil subsidies are putting tremendous pressure on the government budget, imperiling the fiscal targets. Paying the subsidies by issuing bonds has the signal advantage that such spending is kept off budget. But it has the disadvantage of increasing the government's interest expenses. Expenses increase because the amount of government debt increases. Then, they could go up some more because the increase in government debt might lead to a rise in interest rates. It's a simple matter of supply and demand: the higher the supply of bonds, the lower the bond price -- which means the higher the interest rate.
"By making oil bonds a separate category, not eligible for the SLR, the RBI could preserve demand and supply in the regular bond market. Banks would ignore the oil bonds and bid aggressively for regular government bonds to meet their SLR requirements, thereby keeping interest rates low and keeping the government interest burden down.
But this "solution" created two new problems. First, it segmented the government bond market. There are now two completely different prices for government bonds, depending on whether they are SLR-eligible or not(sources: Economic Times)". This is a major impediment to market efficiency and development. For how can private firms price their bonds accurately, when even government bonds for similar maturities have two different prices?
The second problem is that the special oil bonds failed to solve the original problem. The oil companies still need cash.

Monday, September 8, 2008

Indian Perspective!!!

This time I heard a new word like AIDS taken by World Bank and IMF in my Economics lecture..
As I was going through google I learned some facts about how India views the two institutes.....and on interest views where do we see India wrt these institutes!!

An Indian perspective on the IMF

Many in India view the Fund as a potential source of assistance in the event of a future currency crisis, as was the case in 1981 and 1991. This thought process leads to concerns about a better relationship with the Fund or Monetary credit(as they say) in a future crisis scenario.

I think that India's globalisation has gone so far that it will not be easy to mount a 'rescue' in the event of a currency crisis. The IMF lacks the resources to cope with a currency crisis for a country of this size.
More importantly, the tools are at hand for largely eliminating the risk of a currency crisis. If we embrace a policy framework comprising a floating exchange rate, convertibility, and a narrow inflation-targeting central bank, then the contest between currency speculators and central banks (for which the IMF was designed) does not arise. It is better for India to walk down this path, where there will be no need for an IMF program in the future. "Once we start thinking like a mature market economy, we lose interest in issues of who controls the IMF" as said by William Woodridge.

An Indian perspective on the World Bank

As far as the World Bank is concerned, there is a consensus on two issues. Gross capital formation in India is nearly $200 billion a year. In this, $1 to $3 billion from the World Bank is just not a big deal, even after the problem of India's current account surplus is firmly out of the way. More generally, the market-oriented economics that has transformed India's growth opportunities and thus poverty reduction is now sustained by a domestic process of policy reform, where the World Bank is not an actor. The core business of Indian GDP growth, leading to poverty alleviation, seems to be driven entirely by private capital and the domestic political economy that sustains liberal economic policies.

Can the World Bank help by improving monitoring and evaluation? I didn't see that happening with SSA. It was Pratham - and not the World Bank - which discovered (at a tiny cost) that the kids getting enrolled through SSA aren't learning much. The bureacratic incentives of the World Bank are probably as unfriendly to discovering bad news as are those within the GOI.
Another perspective is that of incentives. Compare private sector financing versus World Bank financing in an infrastructure setting. Suppose a expressway project is packaged by Goldman Sachs(my fav company) and has private sources of equity and debt. Compare this against a traditional World Bank financed expressway project. I think the private sector version is superior for two reasons. First, there is generally less leverage with greater private sector involvement, which leads to more healthy project structure. Second, the private owners have an incentive to fight on all aspects of project success, from effective execution to O&M to revenues. In contrast, a World Bank bureaucrat is more likely to lose interest in a project once it is signed. It is better for India to have private financing rather than World Bank financing.
Finally, I instinctively dislike bundling. It is hard to think rationally about either knowledge services or cost of capital when the two are bundled together. The Indian project would be better off separately procuring the best knowledge services, and then procuring the lowest cost equity and debt capital. Mixing them up hinders clear thinking.
Hence, I'm unable to see an important role for the World Bank in a country like India or China, where high growth rates have already been ignited. High GDP growth, and thus poverty reduction, now rides on the domestic political problems of economic policy in these countries.
On the other hand, there are much more daunting problems with "failed states" which could merit a focused effort on institution building through an agency like the World Bank. I know, the World Bank's mandate prohibits involvement in political issues. But there is plenty of low-intensity work to be done in building a State, that is not present in what we say World bank's charter.

All around us, India has countries in dire need of nation building: Pakistan, Afghanistan, Central Asia, Nepal, Bangladesh, Burma, Sri Lanka. It is in India's best interest if these countries are able to achieve sound institutions and ignite high GDP growth. From a selfish Indian perspective, that's a great role for the World Bank - to give us a safer neighbourhood and enormous trade growth in our immediate neighbourhood.

That leaves the problem of a funding model. At present, the World Bank needs customers like India and China to make ends meet. If the Bank reorients itself to focus on nation building, it needs new sources of financing. In resolving this problem, I think it helps to see that nation-building in Afghanistan or Sudan is about producing global public goods. Everyone benefits when these countries are set on track. Placing the brunt of financing of these global public goods upon India and China does not sound like a fair arrangement. A reasonable solution could be to pass the hat around to the 25 biggest countries of the world, and ask for contributions in proportion to GDP.

Saturday, September 6, 2008

India Which Direction!!

Since mid-2007, the global economy has been unravelling in disconcerting fashion. That has taken governments and `aam aadmi' by surprise in most countries. The nature and speed of this `unravelling' has been discomfiting. It affects everyone: i.e. individuals, poor, middle-income, or rich, multinational and domestic firms, academics, governments or regulators.
Global turbulence is certainly affecting India. We can see that in sudden changes in our inflation rate, growth rate, exchange rate, and in our capital markets. "We can see it in the stresses and strains it is putting on fiscal, monetary and social policy"-as said by Prayag Ved. But, by and large, the impact of global ructions has so far been less on India than on other energy importing countries. The continental dimensions of the Indian domestic market are now generating a powerful internal growth dynamic with rising domestic incomes. That provides India with some shelter from this global storm.
Energy exporters are, of course, booming. They cannot absorb the huge surge of funds that are flooding into their small economies. "Energy exporters in the Middle East have built up incremental reserves of over $3 trillion in just the last five years"-as said in Business Standard. This huge imbalance in global financial flows and in rapidly accumulating financial stocks represents both a cost and an opportunity for India. But we risk exacerbating the cost and blowing the opportunity.
India is not as dependent as China is on the US and EU for manufactured exports. But that gives us little comfort. Our service exports are facing headwinds. Remittances may fall if the US and EU go into recession. But that may be offset by remittances from Gulf countries. Yet, paradoxically, India will weather this storm with less damage than the US, EU or Japan; and most developing or transition countries.
Regardless of what is happening in the world, we are building up many problems of our own by default. We do not seem to have either the political consensus or the administrative capacity to address simultaneously that large number of urgent issues that confront us.
Our deficit on merchandise trade is approaching 10% of GDP. Despite export income from services and remittances we now have a current account deficit of 2.5 to 3% of GDP. We have a `real' fiscal deficit approaching if not exceeding 10% of GDP taking all off-budget items into account. These are not good signs; especially in an external environment that is not benign.
We now have significantly lower growth than we thought we would -- from 9% to 7%. It is a reflection of how far we have come in the last five years that not just government and industry, but even common man the bhala manush, is now concerned about GDP growth falling to 7%. We face much greater economic and financial uncertainty. Our stock markets have lost 40% of their value in just six months. No one knows when we will get back to January 2008 levels.
Our inflation rate seems to have gone from 5% to 12.5% almost overnight! That seems to have come upon us suddenly and caught us all by surprise. We seem to be in denial about the extent to which our growth rate might be hit in the next 18 months.
Such discontinuities will be presented as we cant create a perfect market where the FII is more than the Economic strength.