EUROZONE CRISIS

If you are not living under a rock there is a high probability that you  have heard of eurozone debt crisis and its resurfacing in 2011. It’s being billed as the Greek Debt Crisis by the media, but intelligent analysts, investors, and traders, understand that it is far beyond Greece. It is the European Debt Crisis. Here we will try and understand the causes and implications of the same.

Throughout the 90’s Greece historically faced high rates of inflation and extreamly high debts  and growing fiscal deficits because of its inefficient monetary policies ,so it was no surprise that with the formation of eurozone and floating of the euro as currency in late 90’s  Greece  and other European nations in similar condition like Portugal, Italy, Spain etc . were eager to join the club because:

1.    All member countries would use euro as the currency which would have a common  central bank (ECB in this case) backed by strong european economies such as France and Germany  which meant borrowing money from other nations  would be cheaper  for countries such as Greece (using euro) than using their current currencies (typical interest rate  on Greek drachma was  18% because of reasons stated above)

2.    The grand idea was  that  the  struggling european economies  could borrow  at cheap rates in order to economically develop their countries in a responsible manner. This would help them close the gap with stronger countries like Germany and France, and then all of Europe would grow more powerful.

So by 2000 Greece was allowed to join the EU and use euro as currency (though there were allegations that it cooked up  the figures to meet the stringent euro criteria) .on entering  of course Greece ( so did nations like Portugal, Spain, Italy, and Ireland )  borrowed money at very cheap interest rates (close to 3% as compared to 18%) but it is what they did with that money made things worse. Instead of govt expenditure on infrastructure  building and capacity generation  and paying up of accrued debts (as intended) the country went on a spending spree the wages of public sector employees nearly doubled, and it continued to fund one of  most generous pension systems  coupled with tax evasion endemic among the Greek  populations  resulted in non- payment of loans and debt spiraled to about  €300 billion, more than the entire value of its annual GDP.

That’s just one country take the example of Spain  which had the biggest housing bubble in the world.  Spain now has as many unsold homes as the United States, even though the US is six times bigger. Most of these new homes were financed with capital from abroad.

Thus these countries have spent so much money and developed such irresponsible fiscal agendas that they are now having trouble paying back all those loans. To make it worse, investors are now demanding more yield in order to hold the debt of these countries. That is making it even harder for the PIIGS (Portugal, Italy, Ireland, Greece, Spain) to pay back the money they owe resulting in a sustained crisis situation.

By Suddhasheel Bhattacharya

Weekly Digest

Below Poverty Line: 

With the downgrading of the credit rating of the biggest bank of the country SBI from c- to d+, bringing the broad sensex which is already in a bear grip below 16000 points. The reason cited by  the rating agency Moody is that the bank has collected a huge pile of nonperforming which will continue to grow with the rise in interest rates and a slow economy. Capital infusion by the government can be one of the solution to bring it out but is it possible. For more http://www.thehindubusinessline.com/todays-paper/article2512910.ece

Yuan  Surplus in China – Any Problem?

Strange but true! China’s foreign exchange reserves  have been continuously rising for the past few years and currently it stands at over $3 trillion. This surplus is being viewed next only to Euro Debt and US fiscal in terms of impact that it will have on the economies world over. The Chinese central bank has mopped up the liquidity it created while picking up the excess dollars from the market through the central bank's debt instruments and higher reserve ratios. Technically, this is called a sterilisation operation. To unwind its huge surplus China has started offering loans to all countries. However, for Chinese currency loans to be acceptable widely, China will have to do much more towards making its currency market-based, and not stick to its current practice of a managed peg. Besides, Yuan should be more freely tradable across wider geographies. In words, the current restrictions on the Chinese currency have to go. For more http://www.thehindubusinessline.com/opinion/article2512513.ece and http://www.marketoracle.co.uk/Article8320.html

Downgrade of the SBI stand-alone rating from ‘C-‘ to ‘D+

With the downgrading of the credit rating of the biggest bank of the country SBI from c- to d+, bringing the broad sensex which is already in a bear grip below 16000 points. The reason cited by  the rating agency Moody is that the bank has collected a huge pile of non-performing which will continue to grow with the rise in interest rates and a slow economy. Capital infusion by the government can be one of the solution to bring it out but is it possible.For more http://www.thehindubusinessline.com/todays-paper/article2512910.ece ::: By Ankur Sharman

Fuel for Thought …… THOUGHT for FUEL

With the repetitive up scaling of petrol prices there is huge worry as it goes out of the reach of the common man. India being one of the heaviest gas guzzling nations with the oil & gas commodity directly influencing everything, currently fears the worst if the periodic price rises become a trend. Just a few months ago I remember filling up a tank at 55 Rs/litre. Nowadays I travel by buses, trains and hired taxi-cabs. Petrol being such an important commodity has entered a volatile region where the sudden change of petrol prices is expected and no reaction is expressed by the public.

The most affected complementary good i.e. the automobile sector has already started shifting focus on diesel variants in anticipation of further price rise. Consequentially transport becoming costlier and the chain reaction continues to increasing manufacturing costs and more expense borne by the consumers.  There is no doubt that petrol is similar to blood for the Indian economy, but will this price rise lead to a transfusion of renewable energy sources which would also satisfy our regarding pollution, ecology and other green criteria? Is there a hidden benefit that it brings? or will it suffocate our rigid masses who are over dependent on commodities for daily activities?

De-Jargonize

Base rate:

Base Rate is the minimum rate at which a bank can lend to its customer with added cost.

Bank rate:

The rate at which the banks borrow money from the RBI without selling its securities. It is generally for a long period of time. The bank has to pay an interest on it.

CRR Rate:

Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks(Current 6%).

SLR:

 Every bank is required to maintain at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold and un-encumbered approved securities. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR).  RBI is empowered to increase this ratio up to 40%.  An increase in SLR  also restrict the bank’s leverage position to pump more money into the economy(Current 24%).

Repo rate:

 Is the rate at which a bank borrows money from the RBI for a short period of time by selling its securities (financial assets) with an agreement to repurchase it at a later date at a predetermined price.(Current 8.25%)

Reverse Repo rate:

The rate at which RBI takes a loan from the other banks. Over a short duration of time.(Current 7.25%)

Syndicated loans:

 It is a loan offered by a group of lenders (called as a syndicate) who work together to provide funds to the single borrower. The borrower can be a corporation, a large project or a government. This is done to spread the risk of borrower default across the multiple lenders or institutional investors

Letter Of Credit:

 A binding document that a buyer can request from his bank in order to guarantee that the payment for goods will be transferred to the seller. Basically, a letter of credit gives the seller reassurance that he will receive the payment for the goods. In order for the payment to occur, the seller has to present the bank with the necessary shipping documents confirming the shipment of goods within a given time frame. It is often used in international trade to eliminate risks such as unfamiliarity with the foreign country, customs, or political instability.

Zero coupon bonds:

Is a bond that (1) pays no interest but instead is sold at a deep discount on its par-value, or (2) an interest paying bond that has been stripped of its coupon which is sold separately as a security in its own right. Bondholder’s income is determined by the difference between the bond’s redemption on maturity and its purchase price. Also called non-interest bearing Bond, zero interest bonds, or zero rated bond. See also deep discount bond.

Non coupon bond:

There is no interest on these bonds. You only get the money when you sell the bond and their price keeps on fluctuating. They are available at a highly discounted rate. They are for a specific period. Also called as deep discount bond, non interest bearing bond, zero interest bond.

Capital reserve:

It is the reserve that is created to deal general and unspecified contingencies such as inflation and is not distributed as dividend to share holder

General reserve:

It is created by transferring certain amount of undistributed profit for funding expansion, acquisitions, paying of dividends, discharging of liabilities, redemption of securities .

Money at call and short notice:

Money at call is a loan that is repayable on demand.  Money at short notice is repayable within 14 days of serving a notice.

Concepts in the India Case

Disinvestment

A process where the government reduces its holding in business and moves out of doing so. It encourages private participation and divests its stake in business.

Deregulation

Price decontrols – moving from controlled and administered prices to a market driven, competitive price scenario.

Liberalization

A process of opening up the economy, freeing its market and allowing the competitive processes to function.

Economic Reforms

The process of transforming from a close, controlled economy to a market driven, competitive state. Reforms are in all sectors – goods and financial markets.

By, Dr. Archana Pillai, Shivam Bashin, Lakhan Thakkar