Economy: Ominous Signs.

Shadow Banking System [SBS].
What is SBS? In the world of money and finance, there are activities that are regulated by central banks and laws, such as accepting deposits or making loans; and there are unregulated activities, such as Credit Default Swaps or Cross Currency Swaps or Forex Derivatives. Regulation when it exits tries to reduce excessive risk taking, leveraging, and to ensure prudent behaviour. Unregulated activities are bereft of such oversight. Financial intermediaries that escape regulation include Hedge Funds, Money Market Funds or Structured Investment Vehicles.Often commercial banks, and more importantly investment banks that are otherwise regulated for their core functions extend their activities into unregulated domain. Such extensions are cleverly disguised to escape oversight and obviously *What You See Is Not What You Get*.  For example, the mortgage finance that is a regulated activity was taken off-balance sheet [made into unregulated activity] by the clever subterfuge of securitization or creation of *exotic investment instruments* like Collateralized Debt Obligations [CDO]. What are actually debts carrying differing risks were sliced, diced and mixed into spurious investment bonds or securities; and then sold to unsuspecting investors, who were greedy for high returns. In the years prior to 2008, the unchecked financial leveraging that was built through such subterfuge led to the creation of asset bubbles with a runaway housing market in USA, which when the bubble burst brought down the whole financial system. This process came to be described as financialization of economy, where the world of money gets totally alienated from the real world of people, products, and services; and balloons defying gravity until the collapse.
Financial Stability Board [FSB], a task force of institutions from different countries, warned that SBS has grown to a new high of US$ 67 Trillion globally last year. In the 5 years prior to 2007-08 when the financial crisis struck, the SBS had doubled to US$ 62 trillion. Despite the 2007-2008 crisis, the SBS has grown by US$ 5 trillion, and USA [23 trillion], Euro Zone [22 trillion], and UK [9 trillion] constitute 81% of it. India and Indonesia have reportedly clocked annual growth rates of 20% in SBS since 2007. That means SBS in India has more than doubled during these 4 years and was more than US$ 670 billion in 2011. Compared to USA, where SBS is larger than its GDP, the SBS in India is small compared to India’s GDP thanks to better regulation and controls in place by RBI. But at the same time India is one of the few jurisdictions, where Non Banking Financial Companies [NBFC] are allowed to accept deposits. A route cleverly exploited by two companies of Sahara Group, who have now been ordered by Supreme Court to return deposits worth humongous INR 24,000 crores supervised by SEBI. The growth in SBS even after it brought on the financial crisis and world recession shows the systemic risks plaguing world economy. D Subbarao, RBI governor, is alive to such dangers, when he said that ^^casino banking in certain developed economies underscored the dangers of over-financialization of the real economy^^. However, it was not clear if he was talking of present dangers too, or only of the past. 
World Bank Flags Climate Change.
It is indeed strange to hear about UN Framework Convention on Climate Change [UNFCCC] from an institution created to break barriers to free trade and to spread growth mania. The oddity lies in the fact that concerns of climate change and ecological disaster prompt serious rethinking about growth madness. Financial Express devoted its editorial to Apocalypse Now. ^^…. Jim Yong Kim put climate change on the agenda at a meeting of G20 policymakers earlier this month, by reportedly telling delegates that the issue should not be forgotten while being focused on financial crisis management. And now the Bank has come out with a report that could have a significant impact on the global climate talks process led by the UNFCCC. Turn Down the Heat: Why a 4°C Warmer World Must be Avoided draws attention to the absolute failure of the UNFCCC process to deliver a global treaty to keep the increase in Earth’s temperature within a 2°C….But what the World Bank report underlines is that the dark winds of climate change don’t respect national boundaries. When sea surface temperatures rise in the Indian-Pacific pool, East Africa experiences increased drought frequencies. When the polar ice sheets melt too fast, 10.7% of South Asia’s agricultural land is exposed to inundation. When global warming increases the run-off in the Ganges, flooding increases in the high-flow season and water stress in the low-flow season^^. How the bank proposes to manage this risk  and factor into its workings would be of great interest.
The Rs. 55,80,000 crore question.
In the days of mega scams, this may look like another monstrous figure of a scam. Probably, that is how Nilesh Shah of Axis Direct’s piece in Indian Express derived its title. His point is as direct as it is simple. Indians voracious and unquenchable appetite for gold has meant a drain of precious foreign exchange on imports. In the last fiscal, Indians spent foreign exchange worth whopping US$ 62 billion on gold imports alone. To put the figure in perspective the author says it exceeded the current account deficit of US$ 57 billion. In other words, had Indians turned away from gold, India would have ended up with current account surplus of US$ 5 billion. He adds, ^^This means India is exporting its capital to countries producing gold, silver and precious stones. In return, we get a weak rupee, lower credit rating, higher dependence on foreign inflows, lower investments, lower GDP growth….According to an official estimate, we hold about 18,000 tonnes of gold, importing more than 700-800 tonnes every year. The actual amount we hold is likely to be much more as gold stocked in temple vaults and private lockers is probably not accounted for. At today’s market price, the value of this gold is Rs 55,80,000 crore, which is almost 85 per cent of India’s stock market capitalisation, or just a little less than our banking sector deposits^^.
During the days of gold control, this voracious appetite of Indians for gold had spawned legendary smugglers like Haji mastan, Sukur Narain Bakhia, and later Dawood Ibrahim. Is return to the gold control days an option? Author feels Indian leadership will fail to deliver, reasons not given, where in 1933 Franklin Roosevelt, he says, succeeded in USA. He instead advocates ^^setting up a Gold Corporation of India (GCI) to market the national gold plus scheme (NGPS), a scheme that should offer returns equivalent to those accrued from actually holding gold^^. Point is would Indians trust such schemes the way they trust the gleaming metal?
Indian Economy Unmoved By Reforms.
Both Man Mohan Singh and P Chidambaram must have been flummoxed by this behaviour of economy, though they are talking everything they can talk to get the economy moving. They would do well to listen to what Andy Mukherjee, Reuters Breakingviews columnist, has to say. He has made in nutshell following points.
  1. Fears of untimely fiscal cutbacks in the United States [fiscal cliff] and a deepening of the sclerosis in the euro zone are weighing on sentiment.
  2. Breakingviews analysis of 16 years of monthly bank loan data shows that – after stripping out trend growth and seasonal fluctuations – the cyclical downturn in credit that began in early 2008 is yet to level off, let alone begin a recovery.
  3. By March next year, 10 percent or more of Indian lenders’ loan books will consist of either non-performing or restructured debt, according to Fitch Ratings. It isn’t easy to revive investments when lenders, especially state-run banks, are struggling to cope with past mistakes. One obvious solution is for the government to inject fresh capital into state-run banks. The $3 billion that the government has set aside for this purpose in this year’s federal budget is inadequate. Just one debtor – Kingfisher Airlines – owes lenders more than $1 billion.
  4. He [Chidambaram] has asked the central bank to start giving out new banking licences quickly. Tactically, it is a smart ploy. New private lenders will bring in fresh equity and give the jaded banking system an additional loss-absorbing cushion. But the Reserve Bank of India, which hasn’t issued any new banking licences in 10 years, is holding up the finance ministry’s plan, and for good reasons. Before it allows new deposit-taking institutions to be set up, including by non-financial corporate groups, the RBI, which is also the country’s banking supervisor, wants the legal authority to sack rogue bank boards.
Mukherjee expects the cycle of lean years to last 7 years from the boom period that ended in 2007. That means rough weather for Indian economy for another 2 years. Chidambaram did very little for fiscal consolidation as finance minster during the boom years of 2004 to 2008. Now that the growth is sluggish, tightening the belt on an empty stomach makes little sense.
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One Response to “Economy: Ominous Signs.”

  1. Sadanand Patwardhan Says:

    Neelesh Shah of Axis Direct had said in his article quoted in the post: ^^India’s entire current account deficit of $57 billion (net of software exports and remittances) in the fiscal year 2012 would have turned positive….^^. That means [net of ] even after including software exports and remittances, the deficit would have still stood at US$ 57 billion. But another news item today says: ^^The latest projection of the commerce ministry may further worsen the outlook for India’s current account deficit (CAD), that had touched a 30-year high of 4.2 per cent of the GDP or $78 billion in 2011-12^^. [–300-bn–sops-likely/1034415/. Commerce Ministry's figure of CAD for the same period, fiscal ending 2012, is higher by whopping $ 21 billion than the one quoted by Shah.

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