$1 Trillion Platinum Coin OR Hit the Ceiling

If you thought that delaying the solutions by few weeks regarding spending cuts issue of the American Government was essential to ponder upon the right strategy to be used to get over the Fiscal Cliff trouble completely then think again because the spending cut issue would collide now with a gargantuan pain called as raising the Debt Ceiling for the American economy to survive.

The American government could run out of cash to pay all its bills in full as early as Feb. 15, according to one authoritative estimate, and congressional Republicans want significant spending cuts in exchange for raising the borrowing limit. (KUHNHENN, 2013)[1] This dilemma has forced the entire think tanks to come out with a solution that would not drag the issue for a long time and would make it easy for the Federal Reserve and the Treasury to absorb the implications of the economic steps.

The most talked about solution is to mint $1 Trillion Platinum Coins by the Treasury which can then be deposited with the Federal so that it can be used to pay the debt obligations of the government to its lenders. Though it sounds a bit ridiculous to mint a coin of such a great monetary value but there are certain loopholes that actually let the Treasury create coins in whatever value it wants, even $1 trillion. Astonishing but True!!

 The Treasury can't print money on its own, because the money supply is in the strict purview of the Federal Reserve but the restriction lies only with minting monetary notes and not the coins. So that gives the Secretary of the Treasury the authority to mint platinum coins, and only platinum coins, in whatever denomination and quantity he or she wants. (O'BRIEN, 2013)[2] Even a $1 trillion coin is a possibility.  Treasury can after minting the coin can deposit the denomination with the Federal in its account and when the time arises they can meet the obligations and prevent the country from defaulting and get its economy intact.

People have mixed views on the implication of minting such coins in terms of its effect on the economy through inflationary problems. Nobel Laureate and world renowned Economist Paul Krugman backed the idea of minting the coin as well as emphasized that though in the short term inflation won’t impact the implications of the coin minted to prevent defaulting of the country but in long term this can create an issue. Paul Krugman also points out that there's a limit to how much seigniorage (Seigniorage is the difference between the face value of a coin and its cost of production) a government can extract before hyperinflation sets in, and that's certainly far less than $1 trillion. (Weisenthal, 2013)[3]

Though there was a solution in the offing but with the latest update it seems that The Obama Administration has rejected the views of minting the platinum coin to avert the debt crises which means that once again the political phenomenon would settle in and parleys & discussions would go on before a political stand comes out to the fore with consent of both the Democrats and Republicans which seems unlikely in few weeks time. 

Let’s wait and watch the political act to unfold and witness the volatility in the world stock indices as we move closer towards the days of settlement.

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[1] KUHNHENN, J. (2013, January 14). Yahoo News. Retrieved January 14, 2013, from Yahoo News: http://news.yahoo.com/hitting-debt-limit-bills-paid-160938609--finance.html
[2] O'BRIEN, M. (2013, January 8). Retrieved January 14, 2013, from The Atlantic: http://www.theatlantic.com/business/archive/2013/01/everything-you-need-to-know-about-the-crazy-plan-to-save-the-economy-with-a-trillion-dollar-coin/266839/
[3] Weisenthal, J. (2013, January 8). Retrieved January 14, 2013, from Business Insider: http://www.businessinsider.com/why-the-mint-the-coin-debate-could-be-the-most-important-fiscal-policy-debate-youll-ever-see-in-your-life-2013-1?nr_email_referer=1&utm_source=Triggermail&utm_medium=email&utm_term=Business%20Insider%20Select&utm_campaign=Bu

Too Many for Too-Big-To-Fail Institutions

The Vickers Commission in the United Kingdom has advocated ring fencing of core banking activities and on the other hand The Volcker Rule in the United States prohibits banks from engaging in certain kind of investment activities.

These rules and regulations have come to fore after the loopholes in the banking sector were magnified during the sub-prime crises and the consensus on the implementation of these rules is still debatable. In the Vickers Commission, core activities of the bank like taking deposits from and making loans to individuals and small and medium sized organization would be “ring-fenced”. Some activities like trading, purchase of loans and securities, transactions outside the European Economic Area and with non ring-fenced banks would be prohibited. It is also stated that the ring-fenced entity would require more capital than advocated by the Basel 3 committee.

The Volker Rule attempts to limit banks’ exposure in certain investment activities like in hedge funds and private equity. Proprietary trading, which is banks trading on their own account is completely banned. Demise of Lehman Brothers and Bear Stearns is because of these trading acts. The Glass- Steagall Act that was repealed in 1999 had the rationale of keeping the investment banking separate from the commercial banking activity and now the new founded acts and rules are trying to advocate the same thought which was envisaged by Glass and Steagall long ago.

Sandy Weill, the former chairman of the Citigroup advocates the return of Glass-Steagall Act altogether and there are many academicians who are carrying Sandy’s point of view forward too. But the question here arises that by demarcating the commercial and investment activity of the bank can the big institutions survive? In today’s time where the customers don’t have much time to spare on different investment instruments to choose from and want everything on a single platter in a quick and organized manner, a simple commercial bank became a universal bank by providing one shop investment solutions coupled with core banking  to retain their customers.

But has this opportunity been over utilized by the bankers and has put on stake the security of investors’ money? But what can be the solution to this dilemma? Limiting the scope of the banks and raising the capital requirement won’t answer these questions appropriately. Multiple approaches are required to unearth the solution to these issues. Mr. Raghuram Rajan, CEA to GOI, advocates that setting limits on all trading assets or income can help the big institutions to be in the limits and so they can also manage the risk properly. Mr. TT Ram Mohan of IIM-A states that the problem is not the scope of activities carried out by the banks but the sheer bigness of these institutions that pose a challenge. If the size of bank’s asset to GDP is controlled and looked carefully upon then the risk can be mitigated in a better way.

Though many solutions by the eminent leaders of the world are advocated and discussed upon but the lag in adoption and implementation of certain rules and regulations can again pose a challenge for the financial sector because of the paucity of time and the anemic growth which the world is witnessing.

Acting fast and shielding the global economy from another financial headwind is the only solution.

References:

• Investopedia: Glass-Steagall Act
• “How do we resolve the Too big to fail problem?” by Mr. TT Ram Mohan from IIM-A, EPW, September issue.

Combat ‘FDI’- Head On!!

There has been a great amount of hue and cry across the country regarding the approval of FDI (Fixed Direct Investment) in retail (in particular) as compared to the FDI in aviation and broadcasting. The small kirana stores are really scared that the entrance of Biggies like Walmart  Carrefour etc would snatch their daily earnings and hamper their survival. But that is not the case empirically, look at China where FDI in retail has been in existence for almost two decades now but still the penetration of the so called Biggies in the Business is hardly 20% of the entire organized retail sector. One of the CRISIL report suggests that even if  these big international players enter the domestic market they would not be able to capture more than 15% of the organized retail market. In short, the spectre of these big names taking away the business from the kirana stores is highly hypothetical.

Let’s be practical and analyze the situation, domestic organized retail sector witnessed some of the large brands getting established like Big Bazaar, Reliance retail or Pantaloons but none of them were able to sweep away the market off these kirana stores. Domestically their existence was not lethally harmful for these kirana stores. Their business was definitely dented but the reality is that still majority of people across the country has an ease to visit these kirana stores more as compared to the big domestic players.

Now as the government has approved and paved the way for the international players to enter the domestic market lets be a little pragmatic and consider the situation. As proved earlier that these retail chains can't suck the business out of these emotionally bonded kirana stores then why this hue and cry? Rather its an opportunity to streamline the business now, make it more operationally efficient, try and woo the customers with attractive prices and make the most of the market knowledge which these stores have and the big retailers don’t.

Competing with big players is not possible in terms of prices they offer but there are many advantages which these small domestic suppliers have and these biggies don't, like:

·        1. Kirana stores are in existence from many decades now and no one knows the pulse of the domestic market as better as they know.

·        2.  Accessibility of these stores is the biggest positive while the biggies have to have a big place outside the main city to avoid the high realty prices and rents.

·       3.   At the end of the day an emotional connect with the supplier acts as an adhesive for the kirana stores.

Though these big retail chains can dent the business of these domestic mom and pop stores a bit but definitely they can’t grab the market share which these kirana stores have.

Its an opportunity for these domestically loved kirana stores to revamp their business strategically, become more operationally perfect, stronger emotional connect with the customers is the need of the hour and better supply chain management would make these small outlets the biggest competitor of these international biggies.

So a message to all the kirana stores, national and international retail chains: Face D Intense competition (FDI) and Finally Deliver the Inevitable (FDI) and that inevitable is to deliver the right product at the right price for the right customer. Because at the end of the day – “Customer is King”.  

ESM – The Savior?

Finally a gargantuan obstacle has been overshadowed for the survival of the Eurozone by the German Constitutional Court as it delivered a momentous decision with far reaching implications for the euro’s future by ratifying the bailout fund and budget pact. Germany was the only country in the 17-nation euro zone that had to ratify the European Stability Mechanism (ESM), which was meant to erect a 700 billion-euro firewall against the spread of the three-year-old sovereign debt crisis.¹

Rejecting injunction requests from 37,000 plaintiffs seeking to block the ESM and a separate pact on new budget rules, the court set two main conditions for the treaties to go ahead.²

It said German liability in the rescue fund must be limited to 190 billion euros, the share set out in the current ESM treaty, and that any increase in that amount would require prior approval by the Bundestag lower house of parliament.³

Now as the firewall has been erected and ratified, will ESM be the facility which would bailout and bring back the financial stability of the beleaguered zone? Many analysts believe that the 700 billion-euro firewall won’t be enough for the European sustainability. It might delay the essential fiscal consolidation restructuring but it cannot eradicate the viability of it. Though the corpus of the mechanism might help the debt stricken countries like Spain and Italy to make a comeback in terms of financial stability but the sustainability of the present contagion i.e. Percentage of Debt to GDP ratio (which is alarmingly high) is still a major concern.

Creation of sustainable banking structure across the union, capping extravagant expenditure and rather utilizing the easily availability of monetary resources in asset creation, generating more employable options and benchmarking the wage rates to the Asian peers can raise hope to curb this financial malady. Strong conviction across the union leaders and trade opportunity creation by the developed partners for the developing ones can substantiate the 700 billion-euro injection.

Though ESM would surely resurrect the mood of revival in the Eurozone but the political collaboration among the countries is also of an utmost importance for the economic survival of the monetary union. Only if the political willingness moves in tandem with the economic affirmation this European Stability Mechanism ratification would be justified.

And as it is quoted by Andy Warhol, an American artist  “The idea of waiting for something makes it more exciting” and so it would be really interesting to see how this ‘stimulus package’ is used? And will this mechanism mark the political and economic resurrection of European Union once again?

Sources:

 1- EconomicTimes.Indiatimes.com                                                  

 2 & 3 - in.reuters.com/article

Captive Competitiveness

It has been uttered, noted, depicted and even analyzed that the domestic economy is really dented by the recession and its negative effects are now palpable across the industries. The results are: Flat corporate earnings, weak top and bottom line, plummet in exports and expanding twin deficits. In short a hard recession hit financials are really worrisome. But still in this tough financial environment where nothing seems to be soaring up except the Inflation, there is one financial value which is growing at an abnormal speed. 

From some few thousands of crore of rupees to lakhs of crore of rupees (and its recession proof too) that is the financial value of scams in our country. From 2G to Coalgate - Indian National Rupee amounting to – 1860000000000 (don’t get astonished by the zeros added to the figure because that is the reality) is what our exchequer lost because of the Coal allocation scam which was unearthed by the CAG report a fortnight back. We as the citizens are now so much used to these gargantuan monetary figures that indifference has seeped deep within us.

But one peculiar thing which was highlighted by the CAG is that the Coal mining scam is even bigger and shoddier than the infamous 2G scam, where at least some of the benefits were passed on to the final consumers in the form of increased competition and lower call charges. But that was not the case with unused coal blocks, which did not increase availability of coal, or lower the price of power or steel.

The CAG report narrates how the government favored and benefitted private players through its policies. The report says that coal fields in the period 2004-2009 were allocated to private entities instead of being auctioned. The Prime Minister’s Office has also been bought under scrutiny as it delayed introducing the process of competitive bidding, though cleared by the Law and Justice Ministry. The report also states that mining was undertaken only in 28 out of the 86 captive coal blocks that were scheduled to take up production, and they failed to produce even half of what was targeted from those blocks.

There are many questions which comes to my mind after reading about the issue – Why was the competitive bidding policy was wrapped in obscurity? Why did the end users’ benefits were not considered while allocating captive blocks? And even if nepotism was at peak during allocation, still there was no fundamental change in the authentic usage of blocks, why? When the democratic process is brutally murdered it endangers the sovereignty of the state and this is what is happening today and not only the sovereignty is at risk but the Mother Nature’s appalling misuse is also a major concern.

Lastly, in order to restore the democratic fundamentals of the states these blocks and captive mines should be re-allocated only through the process of transparent competitive bidding. Or simply it should be handed over to Coal India. The government has been pushed to the limits, having even considered a vote of confidence, as the Opposition stalls the proceedings of Parliament. The mood of the nation inclines towards a mid-term poll, and the ruling coalition is well aware of this fact. Many key UPA allies can be seen actively preparing for mid-term polls and may even be ready to ditch the Congress and form a Third Front should the NDA fail to produce substantial numbers in the polls.

Excerpts from www.ibtl.in news-opinion and Indian Express.com

The Currency Enigma

The epicenter of the recent recession is undoubtedly the United States of America but this financial contagion affected the entire world in different magnitudes.  In Europe, the crisis led to the other crisis which impacted them in a real hard way and it is now becoming extremely tough for them to come out of this situation, on the other hand the developing countries combated the American crises comfortably but the impact on their financial health is quite palpable and deplorable. BRICS definitely need a life supporting system for survival at this point of time in terms of rapid public investment, more employability and steep reduction in deficits but for all of it to happen the emerging economies has to reign in the depreciation of their currencies.

And in the mean time after the American sovereign’s downgrade it was somewhat nice to predict that the capital flow in emerging economies was inevitable and which would boost the financial health of the countries, a perplexing situation emerged which led the global investors to flock into the (USA- where it all started) US dollar, which was considered as a safe haven and the other currencies depreciated rapidly.

This was a stark reminder of the grim reality confronting the world – the lack of a credible alternative to the US dollar even as the fundamentals of the US economy are no longer as strong as earlier. Though because of immense liquidity of markets in dollar assets, the depth of the markets in dollar assets that results in tight bid ask ratio and wide-spread availability of derivatives to hedge dollar exchange-rate risk, proves that US dollar is the currency superpower but there are many economists who believe that the dollar’s hegemony wont sustain for long from now on. “The Economist” has recently estimated that USA has lost ten years of economic progress because of the Great Recession meaning that its economy is back to where it was in 2002. And secondly “Triffin Dilemma” has become acute for USA with an urgent need to curb its twin deficits.

It is likely that the US Dollar will no longer enjoy a pre-eminent status but will share it with other currencies. The Australian Dollar, the Canadian Dollar, the Swiss Franc and the Scandinavian currencies have all attracted safe haven flows in recent years with central banks increasingly diversifying their foreign exchange reserves into these currencies\assets. But by far the most serious challenge to the dollar today is posed by the Chinese Renminbi.

China has taken several strategic steps to promote international use of its currency. Entering into currency swap arrangements with several developing countries in Asia and Africa. In April 2011 China led BRICS initiative to establish mutual lines of credit in local currencies to protect intra-BRICS trade from foreign exchange risk. Trade settlement is only one of the steps in internationalizing the Renminbi. In January 2011, Bank of China started offering Renminbi deposit accounts in New York and also took steps that included in approving the use of Renminbi for FDI in China.

Though China is trying its best to make its currency the next internationally accepted currency but it fails to meet several criteria normally required of a reserve currency such as full convertibility, deep and liquid bond markets and secure legal structure in the country.

This shows that the stage is now set for the emergence of multi-currency based global financial system with several currencies competing for dominance and no single currency having the overwhelming status enjoyed by the US Dollar since World War II. 

Source: 

• ·         Article - Currency Conundrum in “The Indian Banker”,  June 2012 by Mr.Radha Syam Ratho.
• ·         Article on Shadow Currency by Mohi-uddin, http://www.ft.com/intl/cms/s/0/c70e236a-bcfd-11e0-bdb1-00144feabdc0.html.

MSME - A Behemoth in Making

India did recover from the crises of 2008 in a very impressive manner but this stint of speedy recovery didn't last for long. The invariably long stint of India’s growth story (GDP growth of 8-9%) as perceived by many was not the reality. But the fact was that the period of 2003-08 was considered now as an aberration and the real GDP growth forecast is around 5-6% from now on.

Now macroeconomic and financial stability is being pursued following the global crisis in India. But recovery from recession following financial crises takes much longer due to the overhang of debt because high leverage is almost invariably the cause of all the financial crises. Hence, the pace of recovery from the current crisis is very slow and uncertain. In this scenario, a strengthened and more resilient Micro, Small and Medium Enterprises (MSME) sector would aid in economic recovery and add greater stability to the system.

Inclusive growth is being accorded very high priority and is being assiduously pursued by the policy makers through financial inclusion, financial literacy and consumer protection initiatives. MSMEs are not only envisaged to be major beneficiaries of these efforts but are also expected to facilitate financial inclusion. MSMEs have a critical role to play in enhancing our export competitiveness given their very significant share in exports.

Several institutions have been structured like Industrial Development Bank of India (IDBI), Small Industrial Development Bank of India (SIDBI), national Bank for Agriculture and Rural Development (NABARD), Export Import Bank of India (EXIM Bank), State Finance Corporation (SFC)s, State Industrial Development Corporation (SIDC)s, National Small Industries Corporation (NSIC), etc. has enabled necessary institutional support to MSMEs for meeting their credit needs. Inclusion of credit to MSMEs as a part of priority sector lending has increased the scope of this industry to contribute a bigger chunk in the country’s GDP pie.

The Government of India has taken a number of measures to revitalize the MSME sector such as:

·         Approval of the public procurement policy (PPP) that envisages procurement of a minimum of 20% of annual purchases of goods and services from Micro and Small enterprises by the Central Ministries/Departments/PSUs

·          Permission to set up stock exchange/ trading platform for SMEs by recognized stock exchanges

·         Conducting skill development programmes for development of self employment opportunities as well as wage employment opportunities in the country and

·          Adoption of cluster approach as a key strategy for enhancing the productivity and competitiveness as well as capacity building of MSEs in the country.

In spite of the Government’s efforts the extent of financial exclusion in the MSME sector is very high. As only 5 to 10% of MSMEs are covered by institutional funding, there is a need to bridge the huge gap through enabling policies. Banks and financial institutions need to support the MSMEs in their need for finance. Some of them could grow into large corporates and potential MNCs in future.

If this sector is provided the right financial support and is entrusted with more responsibility of providing economic stability then it would play a very critical role in the economic development given its contribution in employment generation, export competitiveness and, more importantly, entrepreneurial development. As MSMEs are spread across the length and breadth of the country and have a strong presence in rural areas, their growth also leads to more balanced and sustainable development and eases pressure on urban infrastructure.

So I feel that right support at the right time to the right sector would definitely reap benefits for the nation and this time is absolutely perfect to provide impetus to this sector which would contribute magnanimously to the country’s GDP in the near future.

Excerpts from:

• Small is still beautiful and competitive - Reflection on growth of MSMEs in India - Address by Shri Anand Sinha, DD, RBI.
•    http://www.sidbi.com
•     http://www.nabard.org