It took US$ 1 trillion to correct this mistake

Jun 26, 2010

In this issue:
» A step back in India's road target
» Is China playing games with the Yuan?
» Fuel prices may raise inflation by 1%
» An industry that has tripled revenues in 4 years
» ...and more!!

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'We need more Lehmans' said legendary investor and commodities guru, Jim Rogers. This was his remedy to get the US government to get stricter with regulating its financial sector. The US lawmakers seem to have finally taken a step in this direction. But sadly it took a trillion dollar of bailouts before they realized the necessity to correct their mistake.

The US government has now rewritten rules that may shrink the trading profits of the big banks. Restriction of derivatives trading is a welcome move. Also subjecting the banks' investments to strict guidelines will shield depositors' money from more risky activities.

While the new rules do not bar the banks completely from the US$ 615 trillion derivative market, it only restricts them. However, this will mean loss of revenues to banks that rely heavily on such instruments to boost profits. It will also mean loss of revenue to rating agencies as they will have less complex instruments to rate.

All said, this much debated legislation was long overdue. No doubt it has plugged some very big holes in the global financial system. But that's not to say that it will avoid yet another crisis. As long as the entities know that they will be bailed out one way or the other, undue risk will continue to remain on their minds.

Do you think this legislation will prevent financial crises in future? Share your views with us.

 Chart of the day
The Planning Commission may be doing its job of planning the economy's long term targets. But the government hardly seems to be having any long term planning in mind. No, we are not even referring to the poor execution of long term infrastructure projects. Even when it comes to managing the government's day to day finances, it seems to be at a loss of any well thought-out approach. Today's chart shows that over the last 6 fiscals, the government has been increasing the share of revenue expenses. While the capital expenses necessary to build a developing economy are languishing where they were! At this rate, Indian can only hope to come close to China's growth rates.

Data source: RBI
The capital expenditure
is an amount spent by government to acquire or improve
a long-term asset such as equipment or buildings, Eg: purchase of defense equipments.
The revenue expenditure is an amount that the government expenses immediately during the fiscal.
This includes payment for subsidies, interest cost etc.

The '20 km per day' target of building India's road network was set with much fanfare and enthusiasm. But like most other targets set by the government, what has followed is a series of misses and revised targets. Transport Minister Kamal Nath is reported to have said recently that India is likely to build only 12 to 13 km of roads a day during FY11, as against the 20 km announced earlier. Some reasons for this are problems in acquiring land and delays in awarding contracts. Not to forget the consequent skepticism of foreign investors in funding such projects.

Whatever the reasons may be, the impact of such a slack performance can indeed be expensive. Estimates peg the cost of poor infrastructure in India to be 1% to 2% of India's GDP! Growth that would otherwise benefit the country had the state of core infrastructure in India been better. We await the day when a 'target' finally means 'something that has to be achieved'. And not 'something that is fun to announce'.

Ok, the Chinese have finally done what they were supposed to do. They have announced a change in their currency policy. And the markets did react with good degree of enthusiasm immediately after the move. But surprisingly, all that enthusiasm seems to have fizzled out. The news does not generate any excitement anymore. So, what went wrong? Some experts blame it on the intent of the whole episode.

If Nobel Laureate Paul Krugman is to be believed, the Chinese announcement was an exercise in bad faith. Infact, in an article in New York Times, he has come down quite heavily on the Chinese leadership on this whole currency revaluation issue. He believes that China has no real intention of making the Yuan appreciate significantly. And all the drama of the big bang announcement was staged so as to keep the backlash down in the upcoming G20 summit.

Krugman doesn't stop here. He goes on to say that the Chinese currency is seriously undervalued and is aggravating the problem of poor economic growth in the US. "If the renminbi isn't deeply undervalued, why has China had to buy around $1 billion a day of foreign currency to keep it from rising?", Krugman is believed to have said. As if the stinging criticism was not enough, he goes on to conclude that if China refused to toe the line then it is time to talk about trade sanctions. Strong words indeed. Is this the end of globalization as we know it?

Inflation in India has been high for quite a while now. Therefore, once it was evident that India was recovering from the impact of the global crisis, the RBI immediately got down to tightening its monetary policy. But now the problem could only get deeper. The government has decided to free petrol prices and raise kerosene, diesel and cooking gas rates. This means there will be that much added pressure on the central bank to keep a lid on inflation. The category of fuel, power, light and lubricants carries a weight of 14.23% in the WPI. Chief Economic advisor Kaushik Basu is of the view that fuel price hike will raise core inflation by 0.9%. That is the immediate impact. But by the end of the fiscal, inflation is expected to cool down. Especially when the impact of the fuel reforms also begins to make its way felt in the form of a lower fiscal deficit.

Which industry requires specialized services, skilled professionals, good English speaking abilities that can be easily outsourced to India? The old answer was financial services. The new answer is legal process outsourcing (LPO).

Overseas law firms and company legal departments are facing cost cutting pressures. Thus outsourcing is a great option for them. LPO industry revenues in India tripled since 2006 to US$ 440 m in 2010. According to ValueNotes, it is expected to reach US$ 1.1 bn by 2014. Almost tripling again in four years! Jobs like court appearances or witness questioning can never be outsourced. But, for everything else there is always India. Fast growth in new skill based services will surely increase India's comparative advantage as an outsourcing hub.

The Indian markets ended on a flat note this week. A substantial portion of the gains that the markets witnessed during the week, were cut on Friday as the BSE-Sensex ended lower by about 155 points (almost 1%). A key reason was the apprehension over fuel prices stoking inflation and interest rates. Also, the Indian Prime Minister expressed his concern over the strength of global recovery.

While most of the Asian markets fell on a weekly basis, some key markets reported gains. Sentiments were mixed on concerns over the decline in US housing sales. However, China and Hong Kong bucked the trend with gains of about 2% each. Gains in these markets were on the back of the People's Bank of China signaling an end to the Yuan's two-year-old peg to the dollar.

Data source: Kitco, CNN Money

 Weekend's investing mantra
"Although its easy to forget sometimes, a share is not a lottery ticket. It's a part ownership of a business." - Peter Lynch

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10 Responses to "It took US$ 1 trillion to correct this mistake"


Jun 28, 2010

the writeup is very enlightening and relevant.



Jun 26, 2010

Before 'manufacturing' the economic crises, american economy was run by a 'drunken driver' with following three 'possible trinity' as opposed to the 'impossible trinity of the monetary economic theory'.

The immediate consequences of an economy running with a drunken driver are obvious to understand:

First,a drunken driver (the american economy) risks and endangers his own life

Second, a drunken driver also risk and endanger the lives of the passengers travelling in the car (the american tax payers)

Besides, risking and endangering the lives of the pedestrians travelling on the road he is travelling (the economies of the world)



Jun 26, 2010

LPO/KPO: Request for research reports from you on Investment Opportunities.



Jun 26, 2010

Controlling the banks transactions to make them less risky will definitely improve the economic function, although the incomes generated will be lower for the banks and all punters. I feel forward trading, hedging, derivatives etc., are being manupulated for getting max benifit. It is a case of making money from money. There is no wealth generation in the process- I mean real wealth like infrastructure,goods for a better living and health. Easy money obviously heats up the economic system. Consumerism beyond the needed and ideal levels increases. It automatically creates wastages of all goods, food, shelter and fuel. Production to meet these exaggerated demands will have to be kept up increasing the consumptions of all utilities and thereby increasing emissions, endangering global warming.
The whole world has to practice CONSUMING JUST ENOUGH TO LIVE.Contentment iis what is needed. It will lead to a better QUALITY OF LIFE.
Some economists will not agree to this curtailment of needs, fearing lower GDP,which is the present parameter for judging the health of the economy. The real GDP due to real wealth generation and that too to the most unwasteful level will be the actual barometer. In fact the consumption pattern has to become more equitable with the west cutting down on waste and the developing nations increasing the consumption to the optimum levels, bringing in equality in social structure.
Luckily the west bitten by the recession has boldly taken the the first step towards a balanced equitable distribution of wealth, by initiating the controls on the wayward banks.



Jun 26, 2010

yes ,to continue with the analogy, apart from the lock (improved laws) it is also the policemen the law enforcing machinery) .so the biggest problem is not dearth of laws but the dearth or even collusion of law enforcers.after every crime ,you will have seen how the govt is saying that they will enact tougher laws etc but there is no mention of the people who were supposed to check the laws my opinion what we need is lesser laws more enforcing of it. though how that can be accomplished is a mystery to me. joke will be ,it will be done with more laws!!!



Jun 26, 2010

It is difficult to avoid financial crises in such a environment where most of the things are happening in isolation just to hide the previous mistakes. But the bailout scenario has been unhappily faced by the government just to save their pillars of financial sector and to keep the confidence of an investor in the market. These are the situations where government of any country is forced to take actions like that. But that does not mean that we make it a habit. The regulations are required to control these situations in the future course of time to avoid this kind of economic crisis



Jun 26, 2010

It all started with Japan who reduced the interest rate to zero to support the exports which itself hurt the exports because of strenthening Yen. Americans followed suit.So also others and in consequence, there is no cost of money. This coupled with huge deficit ensured that lot of money was available but no where to deploy. This brought into picture the so called fund mangagers, investment managers, etc and the public had no other option other than to hand over their money to these entities directly or indirectly as yield on bank deposist or other instruments was reduced to a pittaance. Imagine companies raising equity of face value of Rs.2/-at Rs.2000 Even if these companines pay hefty ,dividend, the yield is a pittance.This helps in not having any cost of money in P&L, which improves EPS which in turn improves PE which again helps in raising money still cheapr. It is like the so called directors of the companies who get apart from the salaries and perks, commission on profits, which again is used to buy ESOPs at rock bottom price. How else can one explain the huge wealth in the hands of these executives? All these are sheer manipulations and governments too are interested in these. None of the Govt ever has to publish a balance sheet but only has to talk about deficit in per centage terms. This coupled with tax free status for dividend and cpital gains ensured that fianncial jaglleries are the only magic wand to become super rich.
The higher the return, hgiher is the risk. If sovereign bonds which are supposed to be the safest has a yield of say 5-7% can the highest risk bearing instruments yield anything more than 3 to 4 times the govt yield. In other words, the wealth accumualtion of corporates and investment managers woud continue to be borne by the public whether directly or indirectly. This problem would not be solved unless and until there exists a clear cut risk range and corresponding return range and there is no free money or atleast there are other available instruments safe and secure return on alternative instruments which is comparable with the highest risk instruments. It would be interesting to analyse the total money in circualtion(M3) gloabally vis a vis the requirment globally. With liberalisation and gloabalisation money would move from one door to the other and even the Govt's have no control whatsowever.It would be interesting to even note that in any company on the total funds emplyed(that of the shareholders and the secured and unsecured loans) the so calledpromoters have less than 3%-5% but mind boggling valuations are given for transfer of their rights.
In other words funadametals are yet to be addressed and pheripheral regualtaions framed from time to time to address scams would be of no avail.


suresh jain

Jun 26, 2010

Laws should be enacted to prevent re-occurance of such crises and to safeguard taxpayers/public money.Also policy of bailout should be eplicitely discouraged.Trading in derivaties by banks should be completely banned and proper regulatry controls should be in place to prevent such crises in future.



Jun 26, 2010

A small good step indeed! But not sufficient looking the impending gravity globally.Its like a bandage where surgery is required.Good cost wil hv to b paid to rectify the mistake yet.Very higher dose of remedy required to heal the wound.All will hv to pay heavy penulty-including India b4 v can think of 'recovery'.



Jun 26, 2010

No law can totally prevent a future financial crises. However, that does not mean we do not enact laws based on our past experience and the limited foresight that we have to try and prevent such crises from repeating. At least then we will not have made the same mistakes. The analogy of the lock and thief has to be applied in these scenario (not to hint that all bankers are thieves). It is always a race between the lock maker and the thief and the idea is not to totally prevent a theft but to make it more difficult.

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