Soverign Defaults

It was dubai earlier, now Greece, when its due for US and the great(?) Britain?
the govt spending to stop the system from collapsing in alst year alone amounts to 85% of their GDP and their total debt, risk of inflation, weakening of their own currencies, reduced production…its not just another market crash, but a disaster…

Fiscal deficit

Fiscal deficit is going to be a big issue for both the governments which we are concerned of, the US and India. The official data release from US government quotes the fiscal deficit to be at 12 % of GDP and India’s Deficit will be around 11% ( 6% central govt+ 3.5% state govt+2% on Oil & fertilizer subsidy). Even though the real monetary values are different, the percentage share of both the deficits is more or less same. It means , even with so much of Stimulus and rescue plans, US is at the same level and we here in India boasting of affected less by the economic turmoil and lesser govt stimulus, are in the same boat. And the deficit is going to be more deepening in India with central govt announcing cut in Service tax and Central Excise and revenue forecast going down.

What causes Fiscal deficit? – The difference between the revenues and expenses is called Fiscal deficit.

What will Govt do to manage the gap? Obviously like us, government will also borrow.

From who? Surely not from money lenders but from public (banks, RBI, world bank) through issuance of long term bonds (Dated Securities), Market Stabilization schemes or the most dangerous route of printing more money (Monetizing deficit). But if there is less than expected demand/growth, this last measure of printing money will spur inflation. Remember Argentina…?

What will the government do with the borrowed money? Will use it for expenditures it had planned (people welfare measures)

What will be the short term impact on higher fiscal deficit?- If government needs more money, the banks will buy bonds issued by govt and the corporate will be left with lesser cash to borrow from banks. Also, the yield will push upwards and make the interest rates costlier and in turn borrowing costlier for the corporate. So, lesser private participation in driving growth and chance of higher inflation rate.

What would be the long-term impact on common man? If we see the past few years, the fiscal deficit was brought down from around 6% to 2.5 % last year, so the government was relaxing the tax for common man. But now, as government needs more money and obviously there will not be any tax cuts. Also, if money is taken from market, higher interest rates would have a sprawling effect in jobs, inflation and individual borrowing.

Anything else can affect the situation more- Yes, the stimulus package announced by govt for infrastructure is pegged around 70K crores and again this need to be borrowed from the market and this is election time and govt will look forward to announce any kind of sops to win votes at the expense of voters themselves.

What can a common man do- A lot… if you are a theist, pray relentlessly and if you are an Atheist, Laugh…

Financial Calendar 2008

		Financial Events – 2008
Date	Government Activities	Value	Bank / Company losses	Details	Job Loss	Stock Market
January, 2008						Sensex ~ 21000 points Dow Jones Industrial Avg ~ 13200
	Bush proposes stimulus package	$145 Billion
	Fed Reserve slashes Interest Rates	0.75 % (From 4.25% – 3.5%)
February, 2008
			GM suffers loss in Fourth Quarter, 2007	$722 Million loss	17000 jobs eliminated
March, 2008
	Fed Reserve oultines loan pgm to borrow Treasury securities	$ 200 Billion	Bear Stearns taken over by JP Morgan	$236 Million-Bear Stearns buyout value
	Fed Reserve slashes Interest Rates	0.75% (From 3.5% – 2.25)
April, 2008
May, 2008
June, 2008
					Increase from 5% to 5.5%
July, 2008
August, 2008
					84,000 Job losses
September, 2008
			Fannie Mae, Freddie Mac under govt conservationship
			Merrill Lynch taken over by Bank of America	$50 Billion – ML Buyout value
			Lehman Brothers declares bankruptcy			Dow Jones Industrial Avg drops 500 points (4.4%)
	Congressional negotiators and Treasury secretary agree to pass on the Bailout plan	$700 Billion bailout	AIG backed by the Fed Reserve	$85 Billion provided to AIG
			Wachovia Bank taken over by Citigroup	$ 2.2 billion Wachovia Bank – Buyout value
			Morgan Stanley and Goldman Sachs become bank holding companies
	The house of representatives reject the bailout plan		Washington Mutual taken over by Fed regulators and majority of WaMu taken over by JP Morgan		Increased to 6.1%	Dow Jones Industrial Avg drops 778 points
October, 2008
	Senate passes a new comprehensive bailout plan	$700 Billion bailout	3 Icelandic banks nationalized by govt			Russia stock markets plummets by 20%
	The house approves the bailout plan					Dow closes below 9000
	Bush announces plan to invest in 9 largest US banks as part of bailout plan	$250 Billion to be invested			159,000 jobs lost	Iceland stock exchange suspend trading
November, 2008
	Treasury shift course on bailout package, says it will use part cash to help banks lend to consumers		Citigroup backed up by US treasury and Fed deposit Insurance Corp, also injecting $20 Billion in cash into the company	$306 Billion potential losses incurred from high risk loans and securities	240,000 jobs lost, unemployment rate – 6.5%	Dow falls 427.47 points (5.1%) to 7997.28
	Fed reserve and tresury dept finance lending programs	$800 Billion				Consumer Price Index fall by 1%
December, 2008						Sensex ~ 9500 points DJIA ~ 8400 points
	Congress considers bailout package for Automakers, GM and Chrysler	$ 14 Billion rescue package			533,000 jobs cut, unemployment rate at 6.7%	Dow drops 680 points on the official announcement that the US is in recession
	Senate rejects the bailout package					Bernard Madoff, an investment Mgr is charged with defrauding clients with as much as $50 Billion
	Govt lends GM and Chrysler to survive next three months	$ 17.4 Billion
	Fed reserve slashes interest rates	From 1% to 0.25% to Zero %
	Hedge Funds will be allowed to borrow from Fed Reserve	Access gain of $200 Billion for Hedge Funds

Slowdown Vs Recession

If you are a guy who gets hooked to the business channels and those pink papers, there is a maximum possibility of you listening to the word Recession, spelt out by those once blue eyed boys of Wall Street and the so called economists (but their predictions go seldom rightJ). But there will be another group of ever optimistic guys, who says that’s just a slowdown and not a recession. Just tried to dissert what do these terms means to simple souls like us and where does the current crisis/situation leading to? 

First, let’s get to our basics,

A Recession is a period of negative economic growth for more than two quarters in a row. A country’s GDP is a good measure of Economic growth. A recession might last for a period of six month to 2 years. A vicious cycle of fall in sales, fall in profits and decline in economic growth, ultimately results in unemployment and lower consumer spending, the key reflector of recession.

A slowdown is just a slower growth of economy, and might be industry specific. But a recession will have its impact on all the industries and all walks of life. To be more precise, if the same situation persists for another month, what US will undergo will be a recession and what India would undergo will be a slowdown. (Already there are signs of FM and PM hinting that we might not be able to achieve the projected growth – the GDP growth is getting revised every time FM meets the press…).

But is recession a sudden explosion due to the financial crisis? NO, says the basics of economics. This is not a new phenomenon, but a recurring cycle, which will take place and which had, in the past.

Economy and industries will always run in cycle. The Industrial cycle will more or less follow economic cycle, since the major industries rely on the major economic factors and the allied /service industries solely depend on major industries. So, let us see the economic cycle first. An economy which grows over a period of time tends to slow down the growth as a part of the normal economic cycle. An economy typically expands for 6-10 years and tends to go into a recession for about six months to 2 years.

Take the period of 2005 to 2007, we all witnessed a massive bull run in the economy and life seemed so sophisticated with easy loans, appreciating assets, huge profit margins, wonderful job market and what not!! Banks gave easy loans to corporate with lesser margins, home loans were disbursed over a coffee (in 2006, one of the Indian banks, which are into trouble now, even advertised this in Media as their USP…). Everyone believed or was made to believe that share prices of companies and the plot/house values will only move upwards…even the then Federal bank’s chairman Mr.Greenspan forgot his basics of economics ,that everything is a cycle. What goes up should come down and now admitting, he might be partially wrong…

 Cut, Late 2007

Share prices fell, people started ‘googling’ a new term, Sub Prime crisis. Governments all through the world were increasing the bank rates, trying to pull out money from the market, desperately wanted to contain the inflation which might gallop at any time. Real estate prices fell and loans became dearer. People began investing in gold and other fixed assets. The world and in particular, the US economy was in a slowdown phase.

Circa 2008, the Industrial growth saw a surge, jobless claims were at its peak, and banks were pressurized to sell not only their products but themselves for a throwaway price. Governments revised their GDPs downwards, share markets crashing worldwide, losing more than 50% of their peak values.

It’s just that everyone is waiting for the NBER (National Bureau of Economic Research) and the Fed Government to officially announce that US is in a recession period.

Why should people other than those in the US, should worry on US getting into recession? It is because the global economy is getting more interconnected and complicated now, and the tremors in the financial heavyweights can cause a catastrophe in other countries (Sounds like Butterfly theory/Chaos theory??) Oil that we use and most of the natural resources are controlled by the Big daddy, and remember most of the countries use dollar as their trading currency. So when prices of oil and gas increase, there is a global impact. Many Asian countries such as Taiwan, China and South Korea are major exporters of consumer goods to the US. Similarly, a good proportion of global consumption for goods and services is accounted for by US. Even though India is not a major export oriented nation, most of its service industries (IT/ITeS/Tourism/Textile etc) are in direct proportion to US consumerism.

A recession can be characterized by

·         Consumers losing confidence in the growth of the economy and spend less.

·         This leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment and,

·         Investors spend less as they fear stocks values will fall and thus stock markets fall on negative sentiment.

What do the central banks and governments do while an economy is heading towards recession?

·         Central banks cut Interest rates, such that corporate can get access to cheaper money to carry on the business

·         Governments will spend more on development measures like infrastructure spending, manufacturing sector etc, so as to create job opportunities, and indirectly helping lot other allied industries to revive.

·         Government may cut the tax rates to ease the burden of the citizens in a view that they can spend more, which indirectly would create demand and suppliers a.k.a business houses to revive production.

But all these measures also has their ill effects which might attract long term consequences,

Whenever a government cuts tax rates, it takes a big hit in their revenues and by default there will be a deficit in their accounts. This will have an impact on government spending. (Where will they go if they have no/less revenue?). Adding to this the government will also plan to spend more on development and infrastructure. It will be left with no option other than to raise debt thru bonds and spend. This will create a huge fiscal deficit. Also the government needs to oblige the bonds after few years. The problem, which is too much debt, cannot be fixed by creating more debt. That just makes the problem worse. Because of the nature of the banking system, a dollar cannot be created without a dollar’s worth of debt being created. There is another problem of fuelling inflation with more money supply into the system.

To summarize, as the text book says, the effects/indicators of recession would be,

·         Currency crisis

·         Inflation

·         Bankruptcies

·         Foreclosures

·         Reduced sales

·         Stock market crash &

·         Unemployment.

All these terms seem familiar and you feel like you are there already??? Yeah… kindly wait for few more days for the NBER to issue a press release… J