In my last blog (and in many other posts earlier), I talked about how the big banks and institutions continue with their old business practice, royally oblivious of the fallouts of their devious business practices. Why banks, even the rating agencies have also failed to learn the lessons as much. Or maybe they are simply turning a blind eye on the likely impact of the recession and dollops of bailout packages on government finances. Since Greece is passé, here I will discuss about two countries, Spain and Ireland which still enjoy very high rating despite their economy being in shambles. Spain – A country that grew by leaps and bound aided by the global credit glut and driven by the surging real estate sector to unreal(istic) levels (as has been the case with many countries), Spain experienced its Minsky moment as the world spiraled into a recession. During the 3rd quarter of 2009, when most of the European Union countries climbed out of recession, Spain’s economy shrank, for the sixth straight quarter. While the latest decline of 0.3% is not too bad as compared to some other economies, but the country is in real big trouble. An unemployment rate of 20% (possibly next only to Latvia) is unbearable. More so, if one considers the fact that at one point in time Spain was one of Europe’s top job creator. As per one estimate, Spain has lost about a million jobs in the real estate sector alone. These are mostly for unskilled workers, and it is highly likely that most of these jobs are lost forever. According to their National Statistics Institute (Nacional de Estadistica), Spanish home mortgage lending dropped 31 percent year-on-year in October, as banks continued to restrict credit. Even its finance is in a mess. According to IMF (World Economic Outlook forecast as of October 2009), Spain’s budget deficit for the current year will be around 12.3%, because of dipping tax revenues and the mounting costs of combating the economic crisis. The government has funded public works projects aimed at reducing joblessness, along with unemployment benefits, car buying incentives and other measures that it hoped will help restart the economy. But things are clearly not working. For 2010, the deficit is expected to rise to 12.5%. Clearly, the deterioration in the public finances, which have swung from a budget surplus in 2007 to a deficit of over 10% of GDP, is forcing retrenchment. As a result, the government has planned to raise taxes. This, I think is going to adversely impact the potential recovery, as domestic demand will start to falter. Hence they would necessarily need to depend more on exports to bring the economy back on track. An analysis of Spanish export destinations show that virtually 75% of their exports are accounted for by the EU. A lot, will, therefore depend on how soon and how fast their trading partners recover. I feel that the recovery would not be strong enough to positively impact the economy to the extent desired. Despite such huge economic imbalance, Spain’s sovereign rating is still AA+, with a negative outlook. Ireland – The Celtic tiger is hobbling and how. The high growth rate (at times at 10%) that the economy experienced from 1995 till 2007 has transformed Ireland from being one of Europe’s poorer countries to one of the wealthiest. As the economy grew stronger on the back of fast rising exports, wealth increased manifold. And then, as has been the case with most of the countries, real estate boomed as if there was no tomorrow, and propelled the economy even higher. And then the crisis hit the economy big time and the energy of the tiger was sapped. The economy entered into a recession. Starting from Q1 2008, the economy shrank in 5 out of 6 quarters (QoQ). During the last quarter the trend has been reversed, but only just. In YoY terms, however, the economy shrank the 7th straight quarter. For the year as a whole, the Irish GDP is expected to shrink by 6.4%, while the GNP is likely to go down by as much as 10.4%. Their current unemployment rate is as high as 12.5%. Even if Ireland emerges out of recession, the growth will be so slow that it might not look like any recovery at all. And, to put it mildly, government finances are in tatters. IMF’s forecast of Ireland’s budget deficit for the year is 12.1%, which will grow to 13.3%. However, the country has recently announced certain steps that can bring down the deficit by about a couple of percentage points. This includes a saving Euro 4 billion in this month's budget for 2010 by drastically reducing public spending, even going to the extent of reducing salaries of the employees in the public sector. Despite this, the deficit will be well above the cap of 3% that every EU member must necessarily adhere to. A country that was given up as a no hoper enjoys very high rating for the high growth recorded only during the 12 year period. Despite the current financial vulnerability, Ireland still enjoys a long term rating of ‘AA’, though with a negative outlook. Not even China enjoys this luxury despite their high growth for more than two decades. Add Comment The audacious impunity with which the Wall Street fat cats continue to reward themselves boggle our mind. And one would think the need of the hour is to mend the horrendous ways in which business was done in the past. But that seems to be more of wishful thinking. Leaders of the banks and institutions, bailed out by taxpayers money while their imprudent business practices brought the global financial system on its knees, are rewarding themselves in a way that throws all sense ethics out of the window. Logic given - one needs to pay competitive salaries to attract talent. Talent, huh? Talent for imprudence? Talent for creating monsters a la Frankenstein? But who cares? As the smaller banks continue to fall by the wayside (at last count there were 140 bankruptcies in the US), the TBTFs are on their way to becoming even bigger TBTFs. Who cares for the systeminc risk? Hell, the leaders need to be rewarded. Maybe for leading us to hell. Recently Freddie and Fannie (two institutions whose imprudence are part of the folklore now) have announced that they will reward their CEOs with salaries and bonus of $6 mn each. Their packages are entirely in cash. Wow. Maybe WOW. While their shares are being traded in NYSE for less than $2 each and one is not sure whether these companies will at all turn into profit (and, as a corollary, whether any value would be left of the common shares in the long run), why not give the bonuses in shares atleast? If their performance stinks, why not their compensation? But the niceties are meant only for the taxpayers. For the rich and powerful, its all about making merry. The society is out there to pick up the tab. Clearly the fate of the common taxpayers all over the world remains the same. The fact that the US economy is not in a good shape was made evident yesterday when the final GDP figure for Q3'09 was clocked at 2.2% only. Which is not only lower than the initial estimate of 3.5%, but substantially lower than the second estimate of 2.8%. Historically, there's hardly much difference between the second and the third estimate. But this big revision, much lower than the consensus estimate, is a clear signal of difficult times ahead. Clearly, the only reason that can now be attributed to the Q3 GDP growth is the stimulus package in the from of 'cash for clunker' scheme and the home buyer credits. Beyond that, there's hardly any indication that there's some organic growth attached to it. The problems are further compounded by the new home sales data released today. While yesterday's data showed that there was some increase in existing home sales, the 11% plus drop in new home sales is a cause for big concern. With nearly 4 million foreclosures this year (much higher than 3.2 million recorded in 2008), there's a substantial downward pressure on the price of existing homes. Add to that the extention of home purchase credit deadline till June next year and the decision to extend the credit to even second home purchase seems to have artificially boosted the demand for existing homes. The decline in new home sales will also put enormous strain on economic activity going forward. The Q2 FY'10 GDP surprised me on the upside (see http://kunalsthoughts.weebly.com/1/post/2009/11/q210-indian-gdp-better-than-expected.html). However, I was not quite convinced about the data. Firstly, the government appeared to be too optimistic about the agricultural sector, strangely assuming that the agriculture growth rate in the quarter will be about 0.9%. However, in a year when the monsoon deficit has been 23%, the highest since 1972, and when drought has been declared in 299 districts during the monsoon itself (a record by itself), there seems to be an anomaly. Let’s look at what history has to say with regard to how the foodgrain production in particular and the agriculture sector in general was affected when monsoon played truant with India.  Source: RBI Handbook of Statistics, internet sources The cells highlighted in red refer to the year when there was high rainfall deficit in India. A look at the table reveals that apart from the year 1987-88, the impact of monsoon failure has been quite substantial. And, the only explanation for the marginal drop in performance despite the deficit rainfall is that of low base effect, given that the performance of the previous year was even bad. On the contrary, riding on successive years of the good monsoon and the bumper harvest (save for 2008-09), the growth this year is likely to be substantially lower, given the likely high base effect. Secondly, the performance of the industry and service seems to be quite exemplary. Industry grew by 9.21% (aided by the supposedly high IIP numbers) while the service sector grew by close to 9%. Such good growth should ideally have translated into higher indirect tax revenues. On the contrary, however, the numbers available for the first eight month of the current year (i.e. Apr-Nov’09) tell an altogether different story. Despite a downward revision of the estimation of tax collection due to the ongoing stimulus package, the actual tax collection for the first eight months of the year is only 46% of the lowered target, with excise duty collected being a mere 42.7% of the target. As I have mentioned in my previous blog, something does not seem to be right. My hunch is that the final number of Q2’10 maybe revised downward going forward. But India will be in good company. Japanese GDP estimate for quarter ending September has recently slumped from an initial estimate of 4.8% (annualized) to a mere 1.3% (annualized). Even the estimate of US GDP for the same period has been revised from 3.5% (annualized) to 2.8% (annualized) to a further 2.2% (annualized). While the general consensus is one of bullishness, I would still like to wait watch. Only stability of the Q2’10 number and further improvement in the manufacturing data from Nov’09 onwards, post the closure of festive season, will convince me to change my outlook. Try Austria. Immediately after the Dubai incident, I mentioned in my blog that while the incident in itself is not as important, it does reflect the deeper malaise afflicting the global financial market and is merely a tip of the iceberg. Immediately thereafter, Greece and Portugal were put under rating watch due to severe financial strain and Greece was downgraded, for the second time during the year by S&P, from A- (which incidentally was a downgrade from A in January 2009) to BBB+. Even the new rating can be downgraded further. With forecast for fiscal deficit being doubled from 6% (as given the previous government) to 12.7% of of the GDP, and a debt to GDP ratio expected to hit 126% by 2010, the downgrade is a no brainer. Not surprisingly, it’s Credit Default Swap (CDS) spread increased from a low of 100.27 basis points (BPs) to 267.72 BPs. What is even more disturbing is that their banking sector has huge exposure to Eastern Europe, which is a highly vulnerable region. The Greek banks have close to USD 57bn exposure this region out of total exposure of USD 101 bn (source: BIS). Not surprisingly, the ratings of their major banks have also been downgraded. Recently the Austrian government has nationalized the insolvent bank Hypo Group Alpe Adria (HGAA). The financial institution, which has 40 billion Euros in assets, is the country’s sixth largest bank. The announcement came after a deal was reached for HGAA's owners – Bavaria's BayernLB bank, Austrian mutual insurer Grazer Wechselseitige and the province of Carinthia – to contribute over a billion Euros (1.46 billion dollars) to the troubled bank. Last month, the group announced that massive risk provisions (more than € 1bn) would wipe out the capital injections it received from the Austrian state and shareholders over the past 12 months. “Increased risk provisions and the expected impairment at HGAA will weigh significantly on… earnings in the fourth quarter. It is not yet possible to quantify it exactly, but it can be expected that as a result of these effects, the group will report a loss of well over €1bn,” BayernLB said in a statement. According to the Austrian Finance Minister Josef Pröll said the move was necessary to save the country’s sixth largest bank from bankruptcy. "The risk situation of this bank has created an enormous threat for the Republic of Austria, Austria as a financial centre and the entire economic area in the past days and weeks," said Pröll And why not? The Austrian banking sector has now become quite vulnerable, given its huge exposure to the Eastern European economies, whose purely credit driven scorching pace of growth resulted in disastrous consequence during the current recession.  * - annualized GDP, banking data as of Jun’09 Source: BIS, Statistik Austria, my calculations The total exposure of the banking sector to the Eastern European economies (at about US$ 224bn) is more than 60% of the GDP. And the exposure in all developing economies taken together, it is around 65%. Clearly we have not heard the last about rescue act carried out on the Austrian banks. Austria’s budget deficit is likely to clock 4.3% of GDP this year, and is expected to go upto 5.5% in next (2010) and 5.8% in 2011, as per OECD estimate. With an external debt that is more than 200% of the GDP, the Austrian economy remains susceptible to downgrade. Not surprisingly, the CDS spread of Austria’s sovereign bonds are moving up quite fast. Currently it is as 85.3, more than 30 basis points above its September low of 54 basis points. According to a recently released report by the United Nations Children’s Fund, India has the largest number of stunted children below the age of five in the world. In the developing world, there are approximately 200 million children, under the age of five who suffer from stunted growth. The report 'Tracking Progress on Child and Maternal Nutrition' found that stunting is primarily caused due to childhood under-nutrition, which contributes to more than a third of all deaths in children under five. India also has one of the highest numbers of underweight children, below the age of five, and one third of 'wasted children' (i.e. those facing a greater chance of death) in the world. In fact, out of a total of 19 million newborns per year in the developing world that are born with low birth-weight, India has 7.4 million low birth-weight babies per year, again the highest in the world. Noting that the country is an 'economic powerhouse but a nutritional weakling', a report by the British-based Institute of Development Studies, which incorporated papers by more than 20 analysts from India, says, "at least 46 per cent of children up to the age of three in India still suffer from malnutrition." According to Lawrence Haddad, “it’s the contrast between India's fantastic economic growth and its persistent malnutrition which is so shocking," says Lawrence Haddad, director of the IDS. According to the estimates Dr. Joesph Hulse, who is a distinguished visiting professor with Dr. Swaminathan’s research foundation, there are about 100 million people in India’s rural areas alone who are malnourished. According to the IDS report, the economic boom has enriched a consumer class of about 50 million people, but an estimated 880 million people still live on less than $2 a day, many of them in conditions worse than those found in sub-Saharan Africa. The report also mentions that on an average, 6,000 children die every day in India, of which, between 2,000 to 3,000 die of malnutrition. So, has reforms really delivered to the desired extent? The best way to understand this is by looking at India’s Gini coefficient. It ranges between 0 and 1, where 0 implies perfect equality and 1 connotes total inequality.  Source: IMF working Paper - India: Is the rising tide lifting all boats? As per the IMF staff estimates based on NSSO (National Sample Survey Organization) data of various round, while India’s Gini coefficient was declining steadily, it actually rose during the reform period and the rise was quite substantial. Any why not?  Source: Handbook of Statistics, RBI Considering a period of 18 years during the reform period and eighteen years in the pre-reforms period, the average GDP growth rate was higher by about 169 basis points. While this need not be a bad achievement, fact is, this improvement is mainly attributable to much elevated growth rate in the service sector during the same period, an average growth rate of 8.12% as against 5.49% achieved earlier. An important thing is to note is that growth rate in the agricultural sector has actually declined (from 3.12% to 2.87%) post-reform. This had lead to a drastic reduction in the share of agriculture in GDP. While that need not be a problem in itself, it assumes disastrous proportion if we consider the fact there was hardly an adequate reduction in the dependence of the population on this sector. Currently, about 65% of the population is still dependent on this sector. The reforms also failed to galvanise the industry much, as the average growth rate improved by a mere 34 basis points. This reduces the possibility of people moving out of agriculture and into industry. Not surprisingly, the Gini co-efficient for India has been growing. I highlighted the plight of the agricultural sector here and here in my blog. Fact is, not only has economic reforms failed to galvanise the agricultural sector, it has failed to improve the delivery mechanisms, that could have improved the plight of the poor. Fact is, governance has been a big failure, as far as India is concerned. India is very much through with the so called ‘low hanging fruit’ as far as reform efforts are concerned. Where India is failing is in the next steps, which requires the undertaking of the difficult part of the reform process. One of them is reforming bureaucracy and bringing in more accountability. Else delivery mechanisms (read as governance) will continue to be inefficient and real development will elude us. If after nearly two decades of reform India continues to let these important reform agendas pass by, India would continue to be among the wooden spoon winners in Human Development Index and the commitment to Millennium Development Goals would fall flat on its face. Not that India does not have programs aimed at ameliorating the plight of the poor. But when only about an estimated 15% of the resource allocated for various social programs reach the intended beneficiaries, positive change is hardly visible. Add to that inefficient targeting, and things look quite dismal. It is no surprise, therefore, that poverty and malnutrition continues to be inexorably high in India. Today's report in Bloomberg shows that the revised estimate of Q3 2009 real GDP for Japan indicates a growth of a mere 1.3% annualised as compared to the preliminary estimate of an annualized growth of 4.8%. In effect, the preliminary estimate was bloated by (hold your breath) 300% as compared to the revised estimate. Reason - deflation. As per the revised estimate, nominal GDP shrank by as much as 0.9% as compared to the preliminary estimate of a mere 0.1% decline. Did they employ the Chinese statisticians to cook up the numbers? With deflation and rising Yen being a concern, Japan is really in for a troublesome road ahead. But why Japan? The hubris of the recent deflation are evident in countries across continents. Dubai debt debacle is supposedly a tip of the iceberg. Greek rating has recently been downgraded with Portugal awaiting a similar fate. German IP numbers released recently surprised on the downside. UK economy is in a mess with their CDS spread jumping to 74 basis points from 44 basis points about 2 months ago. Even their investment grade rating hangs in balance. Seemingly China and Chinese statisticians are our only hope for a global rebound. Savour these: 1) In the third quarter of 2009, delinquencies hit 6.25% of mortgages in the US – about three times the historical norm 2) A recent study McKinsey research found that the recession has changed the US consumer behaviour as more and more of them are opting for cheaper products 3) Retail sales for November actually fell from the month before, according to the International Council of Shopping Centers. The drop of 0.3% is a far cry from the minimum 5% growth the experts expected. Four out of five retailers missed their forecasts, including Macy’s (down 6%), Abercrombie & Fitch (17%) and Saks (26%) 4) Last weekend, another six US banks failed. This brings the yearly total to 130. This will cost another USD 2.3 billion to FDIC’s - a coffer that’s been empty for months now 3) Bernanke has put a spanner of all hopes of a strong economic recovery by stating that despite the recently released better unemployment numbers, the recovery would be painfully slow and he does not foresee any change in their interest rate stance 4) Given the experience of earlier recessions, the unemployment rate in US is unlikely to have peaked (refer to refer to my recently published article in Dalal Street Journal). It might take several months before it peaks and then start to decline as jobs start getting created. Not surprisingly, Bernanke said the U.S. economy still faced headwinds and unemployment could stay high for some time, playing down the impact of last Friday's stronger-than-expected jobs report 5) The global economic and financial crises may be close to an end but the fiscal crisis in a number of top-rated countries could last for "several years," ratings agency Moody's Investors Service said today. Moody’s Investors Service said its top debt ratings on the U.S. and the U.K. may “test the Aaa boundaries” because their public finances are worsening in the wake of the global financial crisis 6) Fitch Ratings cut Greece's debt rating to BBB+ from A- with a negative outlook, the first time in 10 years a major ratings agency has put Greece below an A grade, citing fiscal deterioration in the euro zone's weakest member. The cut followed a Standard & Poor's report that Greek banks faced the highest risks in Western Europe 7) Recently, S&P's has decided to put both Greece and Portugal on negative watch. Coming in the backdrop of the Dubai crisis, this lends credence to the belief that the crisis is far from being over and has the potential to implode elsewhere in the globe Reads like some sequel of exorcist, right? My recent posting on food price inflation has triggered an interesting discussion, much to my liking. My sincere thanks to Dhananjay and Dev for their views. Uploaded my article published recently by Dalal Street Investment Journal. http://kunalsthoughts.weebly.com/uploads/1/9/2/3/1923881/dsj_-_dec_709.pdf | AuthorWrite something about yourself. No need to be fancy, just an overview. ArchivesJanuary 2012 Categories |
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