“Our economy is based on spending billions to persuade people that happiness is buying things, and then insisting that the only way to have a viable economy is to make things for people to buy so they’ll have jobs and get enough money to buy things.”


“If poverty were communicable, its incidence would be far lower by now”

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I today read an excellent article — The State of Global Poverty by Senior Vice President and Chief Economist of the World Bank Kaushik Basu in Project Syndicate. Here is an excerpt from his article.

The economic geography of the world is changing. The eurozone faces the specter of another round of stagnation; Japan has slipped into recession; and the United States, despite relatively strong performance in the latter part of 2014, has raised concerns worldwide with its exit from quantitative easing. Meanwhile, emerging economies have continued to perform well. India and Indonesia are growing at more than 5% per year; Malaysia at 6%; and China by more than 7%.

The scale of the global change can be seen when purchasing power parity (PPP) – a measure of the total amount of goods and services that a dollar can buy in each country – is taken into account. According to the figures for 2011, released last year, India is now the world’s third largest economy in terms of PPP-adjusted GDP, ahead of Germany and Japan. The data also revealed that China would overtake the US as the world’s largest economy in PPP terms sometime in 2014 – a shift that, according to World Bank estimates, occurred on October 10th.

Despite this progress, a large proportion of people in developing countries remain desperately poor. Globally, the poverty line is defined as a daily income of $1.25, adjusted for PPP – a line that many criticize as shockingly low. But what is truly shocking is that nearly one billion people – including more than 80% of the populations of the Democratic Republic of Congo, Madagascar, Liberia, and Burundi – live below it.

One reason global poverty has been so intractable is that it remains largely out of sight for those who are not living it, safely somebody else’s problem. If poverty were communicable, its incidence would be far lower by now.

Another reason poverty endures is persistent – and, in many places, widening – inequality. The current level of global inequality is unconscionable. According to some back-of-the-envelope calculations, the wealth of the world’s 50 richest people totals $1.5 trillion, equivalent to 175% of Indonesia’s GDP, or a little more than Japan’s foreign-exchange reserves. If one assumes that this wealth yields 8% per year, the annual income of the world’s 50 wealthiest people is close to the total income of the poorest one billion – in other words, those living below the poverty line.


Global economy faces strong and complex cross currents


The world economy is facing strong and complex cross currents.  On the one hand, major economies are benefiting from the decline in the price of oil.  On the other, in many parts of the world, lower long run prospects adversely affect demand, resulting in a strong undertow.

International Monetary Fund (IMF) released World Economic Outlook Update yesterday in Beijing, China. IMF expect stronger growth in 2015 than in 2014, however their forecast is down from last October. The forecast for global growth in 2015 is 3.5%, three-tenth of a percent higher than global growth in 2014, but three-tenth of a percent less than their forecast in October. For 2016,  IMF forecast 3.7% growth, again a downward revision from the last World Economic Outlook.

The cross currents make for a complicated picture for the countries. Good news for oil importers, bad news for exporters. Good news for commodity importers, bad news for exporters. The oil price decline increases real income, decreases costs of production for firms, and both lead to more spending. The effect can potentially be large. To the extent that the price decrease is persistent, oil exporters will have to reduce their level of government spending. Some energy firms may also face financial risks.

Since August 2014, the dollar has appreciated in real terms by 7%, the euro has depreciated by 3%, and the yen by 10%. Good news for countries more linked to the euro and the yen, bad news for those more linked to the dollar. In short, many different combinations, many different boxes, and countries in each box.

IMF forecasts reflect the increasing divergence between the United States on the one hand, and the Euro area and Japan on the other.  For 2015, they have revised US growth up to 3.6%, Euro area growth down to 1.2%, Japan growth down to six-tenth of a percent. Some of the largest downward revisions are in emerging markets, notably in Sub-Saharan Africa, the economies of the Commonwealth of Independent States (CIS), and Latin America. They were smaller in Emerging Asia, where growth is still very high, particularly in its leading economies like India (6.3% for 2015 and 6.5% for 2016) and China (6.8% for 2015 and 6.3% for 2016).

Unfortunately, the positive developments are offset by bad news on a number of fronts. Economic Counsellor and Director of the Research Department of the IMF Olivier Blanchard said that assessing the favorable effects of the decline in the price of oil in the current environment is difficult. This decline may turn out to be a stronger “shot in the arm” than is implicit in the forecasts.


Blanchard, Oliver. 2015. Global economy faces strong and complex cross currents. iMFdirect, January 19.

International Monetary Fund. 2015. World Economic Outlook Update. IMF, January.


The road to normal is proving to be bumpy

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Simon Kennedy said that stunning monetary-policy shifts in Switzerland and India sent markets on wild rides, highlighting Federal Reserve Chair Janet Yellen’s November warning that “normalization could lead to some heightened financial volatility.”

Today, Reserve Bank of India (RBI) cut their key interest rate for the first time in 20 months and Swiss National Bank (SNB) abandoned a three-year-old cap on the franc’s gains. Both decisions were unscheduled and, in Switzerland’s case, unexpected. Swiss franc surged 27 percent against US dollar while the surprise rate cut by RBI boosted benchmark stock indices 2.6 percent, the biggest percentage gain since May 9, 2014. These decisions indicate the prevailing divergence in the global economy. Central banks are no longer aligned and they are often a source of volatility.

SNB dismantled the franc’s 1.20 per euro ceiling a week before the ECB’s expected announcement of quantitative easing. That move would intensify upward pressure on Swiss franc, rendering the cap untenably expensive. RBI reduced the repo rate by 25 basis points to 7.75 percent after weakening of inflation giving them room to support the Indian economy growing half the pace of four years ago.

In the end, central banks showed that they still have the power to stun. Forward guidance has its limits as policy can shift abruptly when economic conditions change and officials still like the odd surprise. Axel Weber, former Bundesbank president and now chairman of UBS Group AG commented “Better an end with a shock, than shocks with no end.”


Banks are adjusting their activities to absorb bank levy


On April 16, 2010, the International Monetary Fund (IMF) proposed the idea of a “financial stability contribution.” It was proposed as one of three possible options to deal with the crisis similar to the recent financial crisis of 2007-10. These options were presented in response to an earlier request of the G-20 leaders, at the September 2009 Pittsburgh summit, for an investigative report on all possible options to deal with the crisis. Financial stability contribution or bank levy is a tax on banks’ balance sheets (most probably on their liabilities or possibly on their assets) whose proceeds would most likely be used to create an insurance fund to bail them out in any future crisis rather than making taxpayers pay for bailouts. This is in addition to existing deposit insurance schemes, which is primarily to cover discrete failures in normal times.

Bank distress can have severe negative consequences for the stability of the financial system, the real economy, and for public finances. Regimes for the restructuring and resolution of banks, financed by bank levies and fiscal backstops, seek to reduce these costs. Bank levies attempt to internalize systemic risk and to increase the costs of leverage.

In case of a crisis, the management, shareholders, and creditors do not bear the full systemic costs of a failure, while the real economy feels the burden and society pays the price, whether in the form of bailouts, lost productivity or unemployment. While profits remain privatized in good times, downside risks are socialized.

Systemic banking crises have imposed fiscal costs of up to 7 percent of gross domestic product (GDP) in some countries, and output has fallen by 23 percent compared with long-run trends. Crises increase public debt significantly, aggravating the risk of public sector default.

To lower the probability of banking crises and internalize the costs of bank distress, policy makers have chosen two main instruments. First, the new Basel III regulations impose higher capital requirements for banks (and thus lower leverage), demand better quality of regulatory bank capital, and implement capital buffers to account for systemic risk. Second, regimes for restructuring and restoring banks have been established. They rely on fiscal backstops and bank levies, which seek to both internalize systemic risk and increase the costs of leverage.

Following the financial crisis and the subsequent imbalances for financial institutions and even national economies, legislators all over the world have introduced various measures concerning the regulation and supervision of financial institutions and financial markets. In this context, some countries have introduced bank levies some of which have been given the form of a tax while some others are regulatory levies. Since 2009, 14 countries have introduced compulsory bank levies (Belgium, Finland, France, Germany, Hungary, Iceland, Korea, the Netherlands, Portugal, the Slovak Republic, Slovenia and the United Kingdom) or stability fees (Austria, Belgium and Sweden). In addition, Greece has operated a bank levy since 1975 and Australia has had a supervisory levy dating back to 1998. With the exception of Finland and Slovenia, these are permanent measures.

Bank levies are generally calculated by taking banks’ total liabilities and deducting equity and retail deposits/insured deposits, etc. Every country has different rate and formula to determine the composition of the tax base. In a few countries like France, it is levied on the amount of risk-weighted banks’ assets, which are used for the determination of banks’ capital requirement. Also, the notional amount of off-balance sheet financial derivatives less used for hedging etc are included in some cases.

A research conducted in Germany to study the effect of the bank levy indicated that in the short run, banks could adjust by reducing their lending activities, increasing their loan rates, and/or lowering deposit rates to compensate for the increase in their funding costs due to the levy. The extent of this adjustment depends on the pricing power in loan markets. In the long run, a bank levy might also affect banks’ risk-taking behaviour.

As a consequence of negative deposit rate policy of the European Central Bank (ECB), the profit margin of the European banks are getting squeezed. Many German banks have partially passed on the cost of levy to their customers in December 2014 on selective basis.


Buch, C. M., B. Hilberg and L. Tonzer. 2014. Taxing banks: an evaluation of the German bank levy. Deutsche Bundesbank Discussion Paper No. 38/2014.

OECD Special Feature. 2013. Revenue Statistics 1965-2012. OECD.

OECD. 2012. Funding Systemic Crisis Resolution. Presentation given at the Meeting of the Investment Committee, Paris, 20 March 2012.


Deposit Interest rates going negative


The Swiss National Bank (SNB) today imposed the negative deposit rate as the Russian financial crisis and the threat of further euro-zone stimulus heaped pressure on the franc. Switzerland normally sees money flowing into its coffers in difficult economic times. A charge of 25 basis points or one-fourth of a percentage point on sight deposits of commercial banks at the central bank, will apply as of January 22. That’s the same day as the European Central Bank’s first decision of 2015.

The European Central Bank (ECB) cut a key interest rate below zero, the first major central bank to venture into negative territory. The ECB cut its deposit rate to minus 0.1% from zero on June 5, then again to minus 0.2% on September 4, when President Mario Draghi said interest rates had reached the “lower bound.”

Interest rates have fallen below zero before. Negative deposit rates have been used by a handful of smaller central banks in recent years, including Sweden’s, which cut its deposit rate below zero again in July after a 14-month experiment in 2009-2010 at the height of Europe’s debt crisis. Denmark returned to a negative deposit rate in September, though the cut was aimed at protecting its currency rather than stimulating growth. U.S. Treasury securities traded at negative yields during parts of the 1930s and 1940s, and Switzerland imposed negative interest rates in the 1970s as part of capital controls.

The ECB officials say more stimulus is needed to prevent a slide into deflation, or a spiral of falling prices that could derail the recovery.  The cut is part of a combination of measures designed to ensure price stability over the medium term, which is a necessary condition for sustainable growth in the euro area. It’s one way to try to reinvigorate an economy with other options exhausted. It’s an unorthodox choice that the U.S. Federal Reserve Bank and other peers have so far rejected.

The economy of the eurozone is grappling with a shortage of credit and unemployment near its highest level since the currency bloc was formed in 1999. The ECB has particular reason to use negative interest rates. The US Federal Reserve Bank (Fed) and the Bank of Japan have turned to large-scale asset purchases, known as quantitative easing, that create new money to fuel the recovery.

By reducing interest rates and thus making it less attractive for people to save and more attractive to borrow, the central bank encourages people to spend money or invest. If, on the other hand, a central bank increases interest rates, the incentive shifts towards more saving and less spending in the aggregate, which can help cool an economy suffering from high inflation.

In truth, the impact of negative interest rates is uncertain. Proceeding with this move underlines the ECB’s concern and the need for drastic measures to turn around the European economy. It sounds attractive in theory, but it could have unpredictable and unintended consequences. While negative interest rates are normally aimed at institutional investors, in the long-term they can have a detrimental effect on savers, if investors decide to recoup the costs of the rate by levying charges on consumers.

In theory, an interest rate below zero should lower all market rates, thus also reducing borrowing costs for companies and households. In practice, though, there’s a risk that the policy might do more harm than good. Janet Yellen, the Fed chair, said at her confirmation hearing in November 2013 that the closer the deposit rate is to zero, the bigger the risk of disruption to the money markets that help fund banks. A deposit rate cut could hurt banks’ profitability by lowering money-market rates, potentially hampering credit supply to companies and households and reducing banks’ incentive to lend to other financial institutions.

In Denmark, commercial banks aren’t passing on negative rates to depositors for fear of losing customers. When banks absorb the costs themselves, it squeezes the profit margin between their lending and deposit rates, and might make them even less willing to lend.

Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. A deposit rate below zero effectively punishes banks that have extra cash but are reluctant to extend loans to weaker lenders.

Banks are starting to charge their customers for depositing large amounts of euros, passing on fees imposed by the ECB, rather than paying interest. They said that the changing regulatory landscape has made it harder to eat the cost, as they might have in the past. The reversal from paying interest to charging it comes after the ECB started charging 20 basis points or two-tenths of a percentage point, in fees for funds parked at the bank.

Deutsche Skatbank, a division of VR-Bank Altenburger Land, which was founded in 1859, is not the biggest bank in Germany, but it’s the first bank to confirm that retail and business customers with over €500,000 on deposit as of November 1 will earn a “negative interest rate” of 0.25%.

Commerzbank AG is the first major lender in the eurozone to pass this negative interest rate policy on to its institutional clients when they announced it on November 19. Other major banks viz. Deutsche Bank, Bank of New York Mellon, Goldman Sachs, JP Morgan Chase have also decided to selectively pass on the negative interest rate policy.

The latest move by the banks is notable because so many of them are taking the step, giving customers fewer options for moving their money. With the global economy still fragile, negative rates remain a tool that banks could use. Only time will tell whether the outcome of negative rates will in fact be positive.


Detusche Welle, 2014, Commerzbank imposes penalty on big depositors. Deutsche Welle, 20 November.

Eurpean Central Bank, 2014, Why has the ECB introduced a negative interest rate? European Central Bank, 12 June.

Randow, J., 2014, Less Than Zero — When Interest Rates Go Negative. Bloomberg QuickTake, 18 December.

Richter, W., 2014, The Wrath of Draghi: First German Bank Hits Savers with ‘Negative Interest Rates’. Wolf Street, 30 October.

Schneeweiss, Z. and J. Schwalbe, 2014, Swiss National Bank Starts Negative Interest Rate of 0.25% to Stave Off Inflows. Bloomberg News, 18 December.


IFC issues first Masala Bonds in London


International Finance Corporation (IFC), a member of the World Bank, issued a 10-year, 10 billion Indian rupee bond (equivalent to $163 million) to increase foreign investment in India, mobilizing international capital markets to support infrastructure development in the country. J.P. Morgan was the sole arranger for the bond.

IFC issued the bonds in London to leverage the city’s standing as a premier financial center. Issuances in overseas financial centres such as London give countries like India a chance to tap global investors for funding investment needs. The vast majority of investors are European insurance companies.

The IFC Masala bonds are a boost for Indian rupee-denominated issuances as listing on LSE will provide visibility, and set a benchmark for yields in future issuances. It could also increase demand for similar products later as liquidity of these bonds goes up. This also shows the confidence of international investors in the Indian economy and its currency.

The bonds were issued under IFC’s $2 billion offshore rupee program with a AAA benchmark rating. The bonds yield 6.3%. Given the IFC’s triple A rating, the yield is almost two percentage points lower than the rate at which the government of India itself can raise money.

The “Masala bonds” mark the first rupee bonds listed on the London Stock Exchange. This is the longest dated offshore issue in the rupee markets so far at 10 years. Proceeds from the offering will support a forthcoming infrastructure bond issuance by Axis Bank, which plans to raise Rs 6,000 crore by March 2015.

Rupee-denominated assets have become more attractive after the Indian currency rallied 2.3% in the past year to 61.69 per dollar, the best performance among emerging-market peers. International investors have plowed a record $23 billion into onshore rupee debt so far in 2014, exchange data show. Bond risk for Indian firms fell this year. The average cost of credit-default swaps protecting the debt of eight Indian issuers dropped 128 basis points, or 1.28 percentage point, to 209, according to data provider CMA.

Earlier this year, IFC sold four separate “Maharaja” bonds worth about $100 million on September 23, 2014. The AAA-rated IFC Maharaja Bonds are listed on the National Stock Exchange (NSE). This was the first time in a decade that an international financial institution had raised onshore debt in Indian rupee.

Foreign bonds have a variety of nicknames: A bond sold by a foreign company in the United States is known as a Yankee bond; a bond sold by a foreign firm in Japan is a Samurai and pound sterling-denominated bonds which are issued by non-British borrowers in the British market are called Bulldog bonds.

The “masala” bond is the Indian counterpart of the “dim sum” label applied to Chinese offshore issues, which the IFC has also pioneered. Bonds issued inside India are known as Maharaja bonds. IFC has named these “Masala” bonds as “masala” is a globally recognized term that evokes the culture and cuisine of India.


Crabtree, J., 2014, IFC launches India’s first Maharaja bond. Financial Times, 23 September.

IFC Press Release, 2014, First Masala Bonds in London, Attracting International Investment for Infrastructure in India. IFC Issues, 10 November. Washington, DC: International Finance Corporation.

Joshi, A and Karunungan, L., 2014, Masala Bonds in London Boosting Modi Project Push: India Credit. Bloomberg News, 17 November.

Economy, Strategy

Bank risk in emerging markets

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The past decade saw an unprecedented rise in the fortunes of emerging-market banks. Less affected by the global financial crisis than their developed-world peers, their collective revenue surged to $1,400 trillion in 2012 from $268 trillion in 2002. The future, however, may be a different story. Historically strong capital and liquidity positions have eroded, and operating pressures are mounting from a combination of factors including tighter US monetary policy, stronger growth in developed markets, a changing regulatory landscape, and increasing competition.

Profitability in emerging markets is still much higher than in developed markets: countries such as South Africa, for example, enjoy very high return-on-equity ratios and strong value creation. Yet revenue margins that have been double those in developed markets have already been hit in some regions, and further deterioration seems likely. The net result is that risk management has moved to the top of the agenda for emerging-market bank CEOs and their boards. Risk teams that once focused only on measurement, compliance, and control must now shift toward mitigating challenges on credit, capital allocation, and liquidity or funding.

Traditionally, banks in emerging markets have paid little attention to cultivating a risk culture, where employees feel encouraged to speak up when they observe new risks. In the current economic and banking environment — where banks must respond decisively to existing and emerging risks — it’s critical to develop a strong risk culture. Many banks have begun to take the initiative by setting up dedicated sessions with business, risk, and control functions to evaluate risk-response scenarios; explicitly defining what’s expected of all stakeholders; and engaging in tests to reinforce a strong risk culture. In addition, many emerging-market banks plan to introduce or upgrade institutional frameworks on risk to promote prudent decision making—an action strongly encouraged by regulators concerned about strengthening banks’ risk management and governance.

There is significant room for improving credit collections. For example, loan-loss impairments for emerging-market banks nearly tripled to €34 billion between 2007 and 2012. Addressing this issue requires two steps: identifying actions on nonperforming loans that can have an immediate positive impact on bank performance, and supporting improvements to credit management related to a defined recovery strategy, organizational structures and processes, and systems.

Emerging-market banks need to make better-informed credit decisions. There is simply not enough information on creditworthiness, whether in the form of reliable financial data about customers (especially for small and midsize enterprises), credit-bureau information, or historical performance data. Given these gaps, banks have strong incentives to develop their own innovative risk models that incorporate both qualitative and quantitative factors. Where credit bureaus are active, they are having an impact.

Bank capital will be increasingly scarce in most markets. Yet banks can support business growth and unlock profit potential by understanding where current capital is consumed and optimizing its absorption. We have seen some banks establish a capital-based threshold at which they retain a client’s business. Others seek more collateral or push for more favorable collateral from a risk-weighted-asset standpoint and add covenants to mitigate “rating drift.” Emerging-market banks can also optimize their product portfolio for capital consumption, steering customers toward receivables-based financing rather than working-capital financing.


Costa, O., Khan, J., & Natale, A. (2014) Rethinking bank risk in emerging markets. McKinsey&Company, September.


Cyber-terror attack on banks — a devastating possibility

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Bankers and U.S. officials have warned that cyber-terrorists will try to wreck the financial system’s computer networks. What they aren’t saying publicly is that taxpayers will probably have to cover much of the damage.

Even if customers don’t lose money from a hacking assault on JPMorgan Chase & Co., the episode is a reminder that banks with the most sophisticated defenses are vulnerable. Not simply an effort to steal money, the attack looted the bank of gigabytes of data from deep within JPMorgan’s network.

US Treasury Department officials have quietly told bank insurers that in the event of a cataclysmic attack, they would activate a government backstop that doesn’t explicitly cover electronic intrusions. A worst-case event that destroyed records, drained accounts and froze networks could hurt the economy on the scale of the terrorist attacks of September 11, 2001.

The government might have little choice but to step in after an attack large enough to threaten the financial system. Federal deposit insurance would apply only if a bank failed, not if hackers drained accounts. The banks would have to tap their reserves and then their private insurance, which wouldn’t be enough to cover all claims from a catastrophic event.

AIG in May began offering a new line of insurance in addition to previous policies for the costs of data breaches, hack investigations and business interruption. The new policies cover physical damages to people and property, such as inoperative computers or broken electrical grids. Still, even expanding product lines can’t solve the problem of a systemic crisis.

“Nobody has really been able to define what cyber-terrorism risk is,” said Mirel, now a partner at Nelson Levine de Luca & Hamilton LLC. “So even the companies that are offering these policies don’t entirely know what they are covering.”


Dougherty, C. (2014) The Cyber-Terror Bank Bailout: They’re Already Talking About It, and You May Be on the Hook. Bloomberg, 30 August.


Iraqi bonds gain on Maliki resignation optimism

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Iraqi government bonds advanced, sending yields down the most in 11 months, on speculation Iraqi Prime Minister Nouri al-Maliki’s resignation will improve the country’s security situation.

Maliki’s move ends a political impasse and may enable Prime Minister-designate Haidar al-Abadi to pull together a more inclusive government better able to counter Islamist militants advancing in the north.

The financial markets had largely priced in this change as we witnessed a 2.5 point rally in Iraq 2028 bonds during the week. The bonds continued their impressive rally on Friday and the yield on the dollar-denominated debt maturing in January 2028 fell 27 basis points to 6.88% at 6:10 p.m. in London, the biggest decline since September 2013.

The Iraqi bonds joined the continued strengthening we’ve seen elsewhere in Emerging Markets and Russia in particular. The rate decreased 61 basis points in the past five days, the first weekly retreat this month. Yields on the government’s 2028 securities have risen 59 basis points since the Islamic State militants captured the northern city of Mosul on June 10.


Who buys bonds with a negative yield?

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Bloomberg today reports that German bond gains sent the two-year rate below zero for the first time since May 2013 before the European Central Bank announces its latest decision on monetary policy today. The two-year note rate was at minus 0.002 percent, and touched minus 0.004 percent, the least since May 24, 2013. A negative yield means investors who hold a security until it matures will receive less than they paid to buy it.

Another way to look at it is that Germany is not only able to borrow money from the market but they are earning a small amount of interest on top of it. This rare but realistic phenomenon is being driven by only one thing – fear. Investors in other parts of Europe are so worried about getting their money back that they are willing to pay a little for the peace of mind of knowing that they will get back their full capital later.

Now one may wonder why investors in Europe are willing to pay interest on German notes/bonds when they can buy the US, UK or Australian bonds and still earn some interest and the reason is foreign exchange risk. Investors don’t want to have to worry about changes in the value of the EUR/USD or about the cost of converting their currency back into euros in the future if it means paying a small amount of interest.