Interview of the Week: Surjit Mohapatra, Sr. Economist

 

It gives us immense pleasure in announcing another new feature on Businessviewsreviews.

In an exclusive interview with Businessviewsreviews, Surjit Mohapatra, Sr. Economist, discusses about the causes that led to the downgrading of the US credit rating by rating agency S&P, and its possible consequences. 

What triggered the US debt rating downgrade by S&P?

USA is the largest economy in the world with $14.56 trillion in 2010. The US Gross National Debt reached $14.58 trillion by August 2011. This is 100% of its GDP of 2010. The gross national debt has increased from 57% of GDP in 2000 to 100% of GDP in 2011 and does not seem to be decreasing in near future.

 

USA economy is still under recovery stage from the last economic slowdown. To improve the situation USA economy needs more government expenditure which will raise its total debt. USA is having a system of debt ceiling which was set after World War I to limit the government expenditure. Though the ceiling has increased several times, USA parliament increased the debt ceiling by $ 2.1 trillion on August 1, 2011 to raise it to $ 16.4 trillion approximately to avoid sovereign debt default. The parliament has cut the federal deficit by as much as $2.5 trillion over a decade. 

How will it impact the US Economy?

S&P, which has given the USA a top AAA ranking since 1941 has cut its grade to AA+ in 2011 after USA government striking the deal. The USA government may have to pay higher interest rate for its treasury bonds or public debt which will aggravate the debt situation. Mortgage rate will rise following higher Treasury bond rate which will impact real estate market. 

Do you think that the US will resort to third quantitative easing measures to combat the ongoing fiscal deficit crisis which has let it to lose its pristine triple-A rating?

 

With immediate effect, reduction in USA expenditure may further slowdown the USA economy. However, for fiscal 2012, there will be only $21 billion cut from expected spending of up to $3.7 trillion which is very small amount in a $15 trillion economy. Even the $2.5 trillion deficit cut in one decade is negligible for the US economy. In the next 10 years, if USA government does not raise revenue and reduce expenditure, the total debt may increase to 150 % of GDP which will be a big problem for the economy. The debt is accelerating in the present situation while the economy is moving slow. 

What impact do you foresee the unfolding US crisis on the rest of the global economy?

 

Looking at the exposure to USA Treasury bond, China holds largest USA bond worth $ 1.2 trillion followed by Japan with $ 0.9 trillion. In case of debt default by USA, these countries will have higher impact. Cutting of bond rating from AAA to AA+ will increase interest rate which will reduce the price of old bond. That will impact negatively on interest income of the above countries. On the other hand, government expenditure cut will directly impact on exporting countries. China is the largest exporter for USA, any cut in public expenditure will directly impact its GDP growth. This does affect Indian economy as well. However, the impact may not be so deep.  If the crisis persists, there may be problem in world currency market. However, with the debt crisis in European countries, USA Treasury bond is still an attractive option for investment.  

What are the options before the US Government to tide over the present crisis?

Being the largest economy and dollar being the major world reserve currency, USA is left with very few options in dealing with this situation. It will difficult to reduce its import significantly at the same time it has to maintain its dollar supremacy. The main option with USA right now is to reduce its expenditure and increase tax revenue. USA government can increase revenue in the future if it opts to allow tax cuts (enacted under George W. Bush) to expire as scheduled in 2013. 

What lessons it offers for India? 

India’s $229 billion external debt (22% of GDP), recorded at the end of March 2009, increased to US $297.5 billion by the end of December 2010, and went further up to US $305.9 billion (17.3 % of GDP) at end of March 2011, which is a sharp increase of 2.8% in three months. Total debt by March 2011 is approximately US $905.9, which is a sharp increase of 20.6% over the same period of 2010 (US $751.1). The gross public debt to GDP ratio is about 66.2% in 2011 which is highest in Asia region.

 

Looking at the debt structure, internal debt is higher in India than external debt and most part of the internal debt is held by banks. Hence India government does not have much problem in this area. However, taking higher risk in public debt may attract downgrading of its bonds by rating agencies. Being a developing country, where economy is growing at 8%+ per annum, India should not take the risk which will have significant impact on its economic growth.

Beware Couples: Demographic Time-bomb is ticking

Amidst the falling fertility rates, mitigating the negative effects of demographic changes is one of the major concerns that nations are facing. In fact, there is little that they can do to reverse or even slow the ageing population over the coming decades.

The structural changes that took place over the last 50 years combined with remarkable advances in health care and family-planning technology have led to lower fertility in most populated countries. In fact, as economies grow richer, falling birth rates are common phenomena. Accordingly, many European nations are experiencing below the level needed to keep population a stable. Amidst 30-year-old one-child policy, the world’s most populated country (a fifth of the world’s population lives in China) which is near its peak is also ticking demographic time bomb with armies of young rural workers congregating to its factories.

Japan, Asia’s forerunner of ageing and sinking population where almost a quarter of people is over 65 while children make up just 13%. Against these troublesome figures, National Institute of Population and Social Security Research warns that Japan’s population of 127 million will by 2055 shrivel to 90 million, its level when it kicked off its post-war boom in 1955. Even Russia is facing broader demographic challenges as Russian statistics paint a horrifying picture on this subject against the present population of 140 million. Similarly, most Asian countries are experiencing falling birth rates. China now has 1.6 births per woman, Singapore has 1.2 and South Korea has slightly less than 1.1. Taiwan has just 1.03 births per woman. On the other hand, the adverse affects of demographic imbalance in the Middle East are also worrisome.

Unintended Consequences

The ever changing demographic trends causing growing social welfare burden, especially the economies which are facing a debt-to-GDP ratio nearing 200% the rich world’s highest. Experts warn that exclusive of structural changes in old-age related government spending, a rapidly greying society will lift expenditures. This, in turn, frightens to weaken the sovereign ratings on Japan in the long term.

To counter the upcoming societal doom, experts suggest that nations need to allow more immigration. However, governments from Singapore to Tokyo have been reluctant to do so. Singapore’s government moved a step ahead and put on match-making events for university graduates on the basis that best and brightest could be cajoled into producing a generation of brainy offspring, but hardly ever with great success. With the model in social engineering has failed to bring a baby boom in many nations, bureaucrats across the Asia have sought to squeeze policies and tax codes to get more couples in the mood. However, experts say the crux of the problem have been gender attitudes steeped in Confucian traditions -with men still expecting their wives to handle the childcare and household chores that may not top a modern woman’s wish list.

Outlook

Prima facie, there is no solution for the demographic bomb at least in near future as women make difficult choices between careers and motherhood. Although most people are aware of the threat that silent playgrounds and empty classrooms bother for their greying societies, but they remain improbable to rush to their bedrooms to help avoid societal doom. Are policy makers are watching ticking demographic bomb?

Jany, Chief Economist.

Tags: Demographic Time-bomb: Societal Doom, Aging Population

Robots to mimic iRobot in Real life!

What seems to be a major initiative to standardize all future generation robotics, scientists are vying for a common platform where all the robots can exchange, store and discover the world in their language.

No, it isn’t a Sci-Fi movie script, According to BBC, European Scientists are currently developing a project codenamed – RoboEarth, the bible for robots. Wherein robots can upload information from a common source and share how they executed a particular task, enabling new robots to master these sequences via RoboEarth.

“The idea behind RoboEarth is to develop methods that help robots encode, exchange and re-use knowledge”, quoted Markus Waibel from the Swiss Federal Institute of Technology in Zurich in BBC. He further added, “Most current robots see the world their own way and there's very little standardisation going on.”

Further, maintaining a common bible via RoboEarth for all the robots, will mean quicker upgradation and implementation of tasks along with availability of information in the form of maps, descriptions of objects and instructions as to how to execute certain tasks.

“Wikipedia is something that humans use to share knowledge, that everyone can edit, contribute knowledge to and access. Something like that does not exist for robots, stated Waibel and added, “It would be great if a robot could enter a location that it had never visited before, consult RoboEarth to learn about that place and the objects and tasks in it and then quickly get to work.”

This project is currently handled by around 35 researchers and is funded by The European Union, which believes that more and more service and domestic robots are going to be placed in homes, a la iRobot style.

Let’s see how it works!

For more refreshing news and insights, keep watching this space.

Until then, its Venky …..Shutting down…Robot style..|

Apple finally launches iPhone 4 in India after a year

 

Call it sheer competition from rivals or to the growing demand for the smartphones, Apple’s iPhone, the pioneer in touch screen smartphone has finally launched its much awaited predecessor iPhone 4 in India, after its initial launch in US a year ago.

With Indian mobile market already flooded with smartphone makers from Samsung, LG, HTC, Blackberry and Nokia, the entry of iPhone will surely intensify the already crowded market.

Telecom Analysts believe that India is touted as the second largest market for smartphones and with the implementation of new technologies like 3G, will further boost the sales of iPhone in India — the darling of millions worldwide.

As of now, Google’s Android seems to be the market leader with already 6 out of 10 smartphones being powered by Android Operating System, one has to wait and watch how Microsoft—Nokia combine, who promise to bring the best of hardware capabilities, courtesy Nokia, and Microsoft which is already making waves for its Windows 7 Mobile OS compete against giants like Apple and Google. However, the only way Microsoft can compete against Apple is to churn out millions of Addons, probably for free and mimic the Apple iStore concept to stay in the race.

Operator in India

Apple has tied up with India’s most trusted air carrier — Airtel to launch its iPhone 4 in India and is priced between Rs. 34,500 with a memory capacity of 16 GB and Rs. 40,990 with 32 GB capacity and boasts of new exciting features like Facetime for VideoChat, Retina Display and five mega pixel rear camera with LED flash capable of HD recording.

“The iPhone 4 boasts a higher-quality screen and longer battery life than the previous model” said Airtel CEO, PD Sharma who heads the West Bengal and Orissa Operations in India and added, “With the high number of mobile users, smartphone market will grow in the country.”

To check out the latest features, log on to: http://www.apple.com/in/iphone/

Keep watching this space as we bring more from the tech world.

Venky, Signing Off!

You can reach the author at: businessbanter@gmail.com

Google forays into Mobile Payments through Wallet

“In the past few thousand years, the way we pay has changed just three times—from coins, to paper money, to plastic cards. Now we’re on the brink of the next big shift,” exhorts Google, the undisputable king of Online search.

In what could certainly be a bad news for rivals, and which could further mark its growing dominance of the fast-growing mobile arena, more importantly, m-Commerce, Google yesterday unwrapped its soon-to-be launched mobile payment application, Google Wallet. The application, the search giant promises, will transform your tiny phone into your wallet. “You’ll be able to tap, pay and save using your phone and near field communication (NFC),” a communiqué from the Mountain View, California-based behemoth said. Google Wallet is currently under field test now and the company is planning for its commercial launch soon.

Google Wallet is a key part of the Online search major’s ongoing efforts to extend its Web dominance to the fast-growing yet still-to-explode field of mobile commerce or m-Commerce. According to the company, while its new application is aimed at further enhancing the convenience factor for the customers and save them from the hassles of carrying a number of cards from credit/debit cards, gift cards, coupons, loyalty cards etc, it also aims to give merchants more ways to offer coupons and loyalty programs to customers, as well as bridging the gap between online and offline commerce.

“When you tap to pay, your phone will also automatically redeem offers and earn loyalty points for you,” it says. And the 800-pound Search gorilla hopes that ‘Someday, ‘even things like boarding passes, tickets, ID and keys could be stored in Google Wallet.’

However, the new service is only limited to United States of America and will roll out in United States and other European Countries in the near future. For users residing in the US can enter their zip code, in the image below, to check the availability of the Google Wallet in your area:

http://www.google.com/wallet/where-it-works.html

While the world awaits the formal launch of Google Wallet, you may also expect some more exciting moves by the giant as it straddles across the Web and Mobile spaces swiftly to protect and extend its dominance. Rivals better watch out!

Keep watching this space, as we bring you the latest from the technology world. 

With inputs from Venky, its Amy, Signing Off!
 
(Image courtesy: Google)

Celebrating 50th Anniversary of Manned Space Mission: Yuri Gagarin

Russian Cosmonaut Yuri Gagarin created history on this day in 1961, becoming the first man to orbit the Earth in Vostok Spacecraft. We celebrate the 50^th anniversary to commemorate the achievement of the “World Citizen” — Yuri Gagarin (March 9, 1934 - March 27, 1968).

Watch out these memorable photos during his space odyssey:

Yuri with his wife Valentina in 1957 and two daughters Galina and Yelena.

Venky, Signing Off!

Image Courtesy: Rex Features, Barcroft, Novosti / Science Photo Library,

IAEA Reported flaws in Fukushima Plants 2 years ago: Wikileaks

  

One might wonder how the world’s third largest economy could not foresee the flaws in its power supply and stand-by operations at the 6 reactor Fukushima Daiichi Plant, until the powerful tsunami and earthquake rattled the country on March 11 2011.

The latest revelation from Wiki leaks states that IAEA had insisted that the safety and security procedures in 2009 at the Fukushima Daiichi Plant was out-of-date and would pose a “serious threat” in the advent of earthquake or tsunami, if not upgraded. However, it also reveals that Japan had commissioned an Emergency Response Center at the same Plant to withstand any threat from the natural disasters like earthquake up to a magnitude of 7.0 Richter scale.

Unfortunately, the quake that hit the country on March 11, 2011 measured 8.9/9.0 on Richter scale has completely shut down the nuclear plant, that is now threatening a radiation leak forcing its residents in and around 20 Kms radius to leave the city.

Meanwhile Japanese military helicopters and fire trucks are pouring water on the overheating spent-fuel pool at the No. 3 reactor, which is at a greater risk of spewing radioactivity in the atmosphere, causing serious hazards to humans, while US  Scientists believe that the fourth reactor might have run out of water, posing higher threat of radiation leak into atmosphere. 

On the other hand, rescue operations are on as engineers are trying  to fix one km long power cable from the main grid to restart the water pumps to cool the spent-fuel pipes, however, officials were unsure if the motors would work, especially after the explosion occurred during the couple of days.

Already countries like USA and India are sending air crafts to bring their citizens back home, as IAEA states “the situation continues to be very serious”. 

Amidst this scenario, Indian IT companies like Infosys has stated that it will continue serving operations to their clients, as Infosys COO Shibulal said, “Business will continue. The servicing given to clients will continue because they are very very important,” he clarified to media and added, “We have capacity all over India, Japan's works happen in many of our developing centres, it could be Mysore, Bangalore, Chandigarh. People are going back to wherever is the base location of the corresponding programme,” he said

Commenting on the Japan’s nuclear disaster French President Nicolas Sarkozy said, “the accident in Japan had "provoked across the world a number of questions about the safety of nuclear power stations and the energy mix,” and added, “France would continue to rely on nuclear energy, which is an essential element of its energy independence and the struggle against greenhouse gases. I remain convinced of the relevance today of those choices." France is currently the second largest producer of nuclear energy  after United States of America.

Venky, Signing Off!

Global Imbalances: Are we heading for another crisis?

To keep the global economy on the growth track, balancing the global imbalances is need of the hour. If not there will be a weak world recovery; at worst, the seeds of the next financial crisis will be sown.

The outline of the Group of 20 nation’s summit of financial leaders in Paris limited both optimistic and pessimistic views on global economic recovery. The two-day financial summit issued a statement on February 19, 2011 saying that economic recovery was strengthening, but is still uneven, although there was a “persistent misalignment" of exchange rates. Given that, the G20 finance ministers have arrived at a cooperation deal to correct global economic imbalances while expressing concern over excessive commodity price volatility impacting the world food security, an issue pressed by India. The world’s mighty group, The G20 was formed in 1999 and accounts for 85% of worldwide trade.

One of the main reasons behind threatening global imbalances is: as major economies are rationally pursuing their own self interest, these actions had collective consequences which threaten the sustainability of the recovery in global demand. Mervyn King, Bank of England’s Governor, has warned that a failure in addressing this issue will lead to another crisis. He suggests that policymakers should reach in an agreement on the right speed of adjustment to the real pattern of spending and should take many policies in addition to exchange rate changes.

It is often said that the key cause of the global financial crisis is regulatory failure in the mortgage and finance industry. However, along with regulatory failure there was a large global imbalance between East (mainly China and rest of Asia) and West (mainly US and UK) caused, or at least exacerbated, by the financial crisis in the recent past. The graph on current account balances of different countries clearly explains this dichotomy. Economists say the persistency of global imbalances is mainly the policies of the US economy. The world’s largest economy is depending on capital inflows to sustain its ever-rising current account deficits mainly because the rest of the world is dependent on the US market and its buoyancy for growth.

China’s Connection

During the last decade, both advanced and developing nations have grown in fundamentally different ways. The trade and financial relationship between China and America (the consumer of last resort) has been best illustrated for growing global imbalances. China invests a large portion of its surplus in the US debt, implying that it essentially lends to America the capital to buy Chinese exports. This results into the enduring imbalance between the two and also involves a trade imbalance and an imbalance of financial flows. Thus, the dragon has an excess of savings after investing in its burgeoning economy, while the US national debt has grown to about $14 trillion, equivalent to about 100% of its GDP. Similar imbalances are then replicated as many countries such as the UK and Spain run deficits, and Japan, Germany and the major oil-producer countries run surpluses. Thus the growing imbalances between nations have come to be seen as particularly taxing because of their role in the financial crisis.

Rebalancing or Restructuring?

Thus rebalancing is one of the key concerns that global policy makers are facing today. Most emerging nations blame the advanced world’s slow recovery from the financial crisis, on the other hand, the US criticizes China’s yuan policy. But on the whole, there seems little commitment to make the necessary restructuring changes. Against this context, economists suggest that it would be better to have the aim of restructuring and rebuilding rather than rebalancing. And through these efforts a more balanced economy is likely to emerge soon.

Jany, Chief Economist

China: Now, world’s #2, and soon to be no.1?

Is China going to surpass the US as the world economic leader by 2025? It’s not that easy task as the world’s largest economy controls about a fourth of the wealth in the world – more than China, India, Japan and the rest of Asia combined.

China came a long way after it initiated the reforms process in 1970s. The transformation from a closed economy to a market economy paved the way to become the world's second biggest economy. The economy is predicted to become the world's biggest, surpassing the United States, within the next decade. Leading analysts at the World Bank and Goldman Sachs predict that China may overtake the US as the number one economy by 2025.

The cheap and abundant labor attributed to phenomenal economic growth in China. On the other hand, Japan with the rising strength of its currency (which reached 15 year high against the US dollar) was hit badly as Japanese exports dwindle. Burdened with an aging population and consequent decline in consumer demand, Japan has now relinquished its position as the world's second largest economy to China after having held the title of the world’s second largest economy for long 42 years. In 2010, Japan’s nominal GDP, (before adjustments for prices) totaled 5.47 trillion US dollars blanching before China's 5.8 trillion US dollars.  Masamichi Adachi, JPMorgan's senior economist in Tokyo is of the view that “China's population is 10 times the size of Japan's, and China's growth was more than 10 percent last year. Japan's economy has been sluggish. So it was inevitable that China would overtake Japan.”

Implications

Economists worry that China's new ranking will shift attention away from the delicate work ahead. Liu Baocheng, a professor at the University of International Business and Economics in Beijing, suggests that “It is high time for China to keep its head cool and shift its focus from the pursuit of mere GDP figures to the quality of its growth pattern.” With overheating economic conditions currently, the Chinese economy may face the challenge of having to reform its economy toward greater domestic consumption over foreign demand indications in the coming years. Besides, it has to deal with the ever-present threat of environmental catastrophe that could derail its development.

Skeptic argues that China's rocketing economic growth looms as an alarming challenge to the Americas' global economic leadership. The view is also echoed by the majority of Americans who believe their country has already lost the challenge, and relatively few are confident that the situation will be reversed in 20 years. However, the US economy is yet to show strong recovery from the financial crisis which will decide its economic competitiveness going forward.  Whether it would wholly alter cynic’s perceptions that the US now trails China in global economic power battle remains to be seen.

Jany, Chief Economist.

Cockroaches to drive future generation Robotics!

Little did we know that one day our robots could find a cue or two from cockroaches internal mechanics Yes, you heard it right, the insect that we love to hate in our homes. Researchers at Tel Aviv University are so mesmerized by the six-legged houseguests that they confess that cockroaches might be the key for the future advancement in artificial intelligence.

Amir Ayali of Tel Aviv University's Department of Zoology and his team of fellow researchers are busy studying the insect’s nervous system and crack how sensory feedback from one leg is communicated to the other legs.

The researchers have collaborated with Princeton University to construct models and simulations of insect locomotion and are studying how this insect utilizes the information from the environment that helps them to move forward, the sensors gives them a clear picture about the terrain and suggests their movement.

The scientists believe if they help crack this locomotion system, they can soon apply the same technique in artificial intelligence. It was recently showcased at the International Neuroethology conference in Spain and at the Israeli Neuroscience Meeting in December 2010.

If they successfully decode this program, then it will be a great advancement in the making of robotics!

Keep watching this space for more on robotics!

Venky, Signing Off!

Image Source: Honda Asimo Robot.

Valentine’s Day: Celebrating Love, and Business Too!

Valentine’s Day is fast turning out to be a multi-billion dollar business in India.

While millions of lovers across India, and the globe, would be busy sharing flowers/roses, chocolates, gadgets and several other gifts with their valentines, guess who would be actually laughing all the way to the banks: no points for guessing the people in the businesses of selling these gift items.

According to a latest study by India’s leading industry body, the Associated Chambers of Commerce and Industry of India (Assocham), the Valentine's Week, this year alone, has been estimated to be a staggering Rs.12,000-crore ($2.6 billion) business!

The Assocham’s study, under the aegis of Social Development Foundation, was conducted in 10 major cities of India involving 1200 respondents which included professionals and college- and school-going students in schools and colleges from December 2010 to January 2011. The respondents said they’re willing to spend anywhere between Rs.5,000 and Rs.1,50,000 for Valentine's Day celebrations, depending upon their individual capacity to spend, an IANS news said citing the said report.

The study estimates the spending on this year’s Valentine's Week to grow by 120 percent over the previous year. "Owing to the improved economic situation this year and increased spending power of individuals, youths and eligible bachelors are gung-ho about breaking all previous records as they are likely to spend almost over 120 percent as compared to the previous year," the news agency quoted D.S Rawat, Secretary General, Assocham, as saying.

According to Youhan Aria, Head of Corporate Communications, Archies Limited, a leading player in India’s greetings cards market, “We have 171 new greeting cards designs exclusively for Valentine's Day and the price range is between Rs.50 and Rs.699.” “Moreover, we have introduced about 220 special gifts like jewel boxes, heart-shaped soft toys, photo frames, mugs, quotation books, bags, vases, scented candles, metal candle-holders and crystal pieces,” he said in an interview.  

This annual celebration of love is a week-long affair beginning with Rose Day on February 7, followed by Proposal Day on February 8, Chocolate Day on February 9, Teddy Day on February 10, Promise Day on February 11, Kiss Day on February 12, Hug Day on February 13, and finally the Valentine's Day on February 14.

Amy, Chief Editor

You can contact the author at businessbanter@gmail.com

Gold Prices – Poised for a fall?

The yellow metal is seen as a safe invest against runaway inflation and a falling US dollar. However, skeptics concern that the yellow metal has gone too high, too fast and a serious correction could be round the corner.

From the time when the global financial crisis started (2007), gold continued its safe heaven status for many people. During the last couple of years, real estate stagnated and most currencies lost their value, while the prices of gold rose to the sky and became a favorite among the investment community. Now with the emerging signs of inflation creeping in, the yellow metal even becoming more admired as investors reflect on safety and looking for the best way to hedge against inflation.

It is well known fact that during the times of war, falling currencies and inflationary pressures, gold is always the popular safe haven. Thus the yellow metal is not only a currency for the elite, but it actually holds real worth, unlike the US paperback dollar whose value can fluctuate as wildly as we have seen during the last couple of years.

But on the other hand, skeptics feel that the yellow metal has gone too high, too fast and a serious correction could be round the corner. We have seen global bullishness of the yellow metal in 2010 – as prices soared 30% from January 2010 to their December peak. But as prices dissipated in recent weeks, analysts say the short-term deliberate interest has turned more negative towards gold driven by improved sentiment on the US economy recovery and the concerns over euro zone sovereign debt abating. Amidst this, analysts at Citi rated their gold price outlook downside with sings of the past three years’ risk-trade frittering away and as resilience is apparently restored in the developed markets.

Nevertheless, turmoil in Egypt would not have come at a better time for gold. Moreover, the growing demand from Chinese New Year celebration (the largest consumers of late) and growing geopolitical risk has provided a new support.  The US-based Donald Trump, the largest high profile investors who openly argues his bullish outlook on gold and strongly condemns US policies said in an interview recently, “I think gold will go up as long as people don’t have confidence in our president and our country. And they don’t have confidence in our president.”

Analysts foresee that a bit of downward pressure in the near term, but as economic woes continue to drive investors into safe-haven and thus the prices of yellow metal will be headed higher in 2011. However, think a while, is the latest gold craze is way overcooked? It remains to be seen whether the yellow metal may loose some of its appeal as a safe heaven in 2011.

Jany, Lead Economist

CoCo: A New Kid on ‘Banking’ Block

A proposal by Britain’s Barclays to use CoCo as a remuneration tool is being watched closely by peers.

Don’t confuse it with a new Swiss candy or a soft drink brand. CoCo is a bold, new concept which is being explored by banks in Europe as a revolutionary tool to revamp their compensation mechanism (read: bonus). The British financial giant, Barclays is reportedly looking to issue CoCos, subject to regulatory approval, to its senior employees in a bid to overhaul its compensation strategy that could help it navigate any crisis-like situation, such as the global financial crisis of 2008, better. Crisis-hit big European and US financial institutions (remember AIG) had recently come under scathing attack from the regulators and experts for issuing fat bonuses to their senior management even as they had to be bailed out by their respective governments. Now by using CoCo as a ‘bonus currency’ (as some experts call it), the issuers might hope to buy peace with critics. However, the utility of CoCos goes beyond as a mere compensation tool as several banks in Europe are looking to issue such bonds to recapitalize them to meet tougher Basel III and regulatory norms in their own nations.

CoCos or Contingent Convertible bonds are a kind of hybrid instruments. According to David Bishop, Ethan Zuofei Liu, Patrick Murray and Téa Solomonia of State University of New York, “Contingent Convertible bonds (CoCos) are debt instruments that must transform into shares of equity or are written off upon a triggering event.” The trigger event, they suggest, could be determined either by regulatory assessment or objective bank losses. So, the bonds become effectively worthless if the financial viability (a major trigger) becomes questionable. That means the employees have every incentive to make sure their institution’s remain financially strong. It also serves as an effective recapitalization tool if the issuer’s tier-I capital falls below a threshold or specified limit.

So far, two financial institutions which have issued CoCos include Lloyds Bank and another by Rabobank. In case of Lloyd Bank which issued these bonds in November 2009, the conversion is contingent upon the trigger event of Core Tier 1 leverage ratio falling below five per cent, while in case of Rabobank, in case trigger event happens it would lead to write-off of 25% of the principal amount.

“[They] are interesting as a pay device on two counts,” FT quoted a leading European banker as saying, who further added, “They (CoCos) give an employee downside and don’t incentivize strategies that would ramp the share price in the short term, as equity can. At the same time, they could count towards core capital.”

As regulators and bankers across the globe look for preemptive measures to prevent a repeat of the 2008 financial cataclysm, CoCos appear as a ray of hope. But will they deliver? “An inherent problem within banking finance is the risk of panic: when a bank needs to convert hybrid debt into equity, it sends a clear signal to investors that the bank is in trouble. These investors are then tempted to withdraw their investments, making the initial problem much worse. CoCo bonds are emerging as the most concrete new idea for solving these inherent problems,” comments peo.cambridge.org.

However, CoCos do suffer some drawbacks. A major concern about CoCo’s effectiveness is about the trigger event. According to Prof. Theo Vermaelen of the prestigious INSEAD, France, is that “how should the trigger be set?” “In the case of Lloyds the trigger is based on regulatory capital ratios, which are only computed once every quarter. Such a mechanism will not work in a situation where a bank capital structure deteriorates rapidly,” he writes in his article, “Message to Basel: Another way to avoid bank bailouts,” published in Wall Street Journal. “For example, Citibank had a Tier 1 capital ratio that was measured at 11.8 per cent in December 2008, at the height of the financial crisis. This means debt holders are not likely to get their money back, which makes the bonds very expensive, and reduces their attractiveness as an alternative to simply issuing equity.” He proposes a new framework, Call Option Enhanced Reverse Convertible or COREC in which the trigger is based on market values, and not "old" capital ratios and also, the design protects equity holders against dilution caused by manipulation and/or market panic. 

Whatever, European banks, for now, it seems, are liking CoCos.

Exclusive Analysis by

Amy, Chief Editor

www.businessviewsreviews.blogspot.com

You can reach the author through email: businessbanter@gmail.com