In a bid to deal effectively with what must rank as one of the world's severest global financial crisis, Governments all over the world are promising new lamps for old. The difference being that, unlike in Alladin's story, the old lamp being searched is not a magical one.
Thus a $ 1.1 trillion public private partnership programme seeks to offer new money to private investors (who are asked to pay only 10%, much like a call option) to relieve the banks of old toxic assets. In effect, the shareholders of the bank, and, probably, their depositors, are being rescued by taxpayers.
Bill Gross, of Pimco, has this to say "Slower growth can be a public good if it avoids the cataclysmic effects of double-digit unemployment, escalating foreclosures, and fear of financial insecurity. But the Obama cannon shot will have financial consequences. Do not be deceived by the euphoric sightings of "green shoots" and the claims for new bull markets in a multitude of asset classes." (Source: Pimco)
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Though the April job loss figure in the US at 539,000 is lower than the March one of 699,000, unemployment rate remains high at 8.9%, approaching double digits. To examine financial instability, the US Government conducted a stress test of 19 banks, results for which were declared last week. It has asked 9 of them to raise additional capital of $ 75b by November end. Failure of another large bank in US or Europe is a distinct possibility.
In a bid to promote US jobs, President Obama is changing tax rules which would disqualify for deduction expenditure incurred by US companies creating jobs outside the US (in Bangalore) instead of in it. Such protectionist moves prolonged the depression in the '30s and would do so again, for they negate the benefits of globalisation, which works on the theory of competitive advantage. Bharti Airtel, e.g. has outsourced its IT infrastructure management to Ericsson and Nokia, a $2 b. contract due for renewal shortly. What if the Government of India insists it be outsourced to an Indian company, who may not be as efficient?
On a positive note, the TED spread, which is the difference between the 3 month interbank Eurodollar rate and the short term US Government debt rate, has narrowed to under 1% indicating a return of risk appetite and a willingness to lend by global banks. LIBOR has fallen to under 1%, which would make it easier for corporate borrowers in emerging markets, to borrow.
In its version of new lamps for old, Germany has introduced a cash for clunkers scheme (Economist, April 16) in which Germans are offered a $ 3,330 handout if they trade in, and junk, their old car, and buy a new one. As a result, car sales in April in Germany were up 40%, at a time when US automakers are bleeding and Chrysler has filed for bankruptcy. The question is, will the demand remain once the handouts stop? That is the Government hope, at least. But tell me, which future democratic Government has the political courage to roll back a populist give away?
One understands the need of democratic Governments to try to prop up their auto industry, which provides jobs, directly and indirectly. However, there is a counter pressure, which is the environment. According to latest reports, the world must get its carbon emissions under control within 20 years, else we will see that hell hath no fury as Nature scorned! A chunk of ice the size of New York has already dropped off the North pole! Governments will thus need to discourage private transport and build public transport systems.
At least responsible Governments will. The Heavy Industries Ministry, however, is doing the opposite! It is asking the Ministry of Finance to roll back an additional tax levied on cars above 1500 cc engine capacity! This is reckless folly.
Responsible Governments ought, in fact, to be taking steps to prevent corporate fraud or, at least, to punish wrongdoers. It is now revealed that the family of Ramalinga Raju, founder of Satyam Computers, sold stock in it worth Rs 3,000 crores ($600m) at the higher prices engineered with the help of fake accounts. Yet, one has not heard of their properties being attached to help settle claims of the small investors who suffered because of his fraud!
The small guys seem to be the ultimate suckers. Banks in India are now asking the RBI to link the interest rate for savings account to the reverse repo rate (which is the rate at which RBI borrows money from banks). Look at the fraud implicit in this request. This means that banks are derisking their business! If they get a return by lending money higher than the saving rate they pay on savings account deposit, they lend; else they give it to the RBI to earn the same rate. Besides, interest on savings bank accounts are calculated on the minimum balance between the 10th and the end of the month.
Last week the stock market opened with Sehwag and Jayasurya, who put up 731 runs on the sensex on the opening day! There was a natural correction, subsequently, but the week ended with the BSE-Sensex up 473 points, at 11,876. Of this, 103 points were provided by RIL and 81 by L&T. The NSE-Nifty added 146 points over the week, to end at 3620. What now?
The immediate movement, over the next fortnight, would be based on perceptions of the next coalition mix. Should there be one formed by the third front, a motley group of disparate regional parties with no common ideological glue to bind them for a full term, the market would correct immediately. Should there be one formed by a mainstream party, supported by others, the correction could be deferred. Global events would then dictate the move. As Bill Gross points out in the above referred article, 2 plus 2 equals 4. However much Governments try to change it by offering new lamps for old, the mathematical equation must remain true.