Strong Chinese Yuan Does Not Guarantee USA/Europe Economic Recovery

Saturday, Dec 31 2012

We are not in the era of 70’s or 80’s. In the early 70’s USD was clobbered as President Nixon decided to cancel the direct convertibility of USD to gold that essentially ended the existing Breton Woods system of international financial exchange. Until then gold was fixed at USD 35 per troy oz. Then, one USD would fetch yen 360, GBP 0.42, Swiss franc 4.30, and Deutsche mark 3.60. Today, the parity versus is YEN 76.87, GBP 1.5545, CHF 0.9389 & EURO 1.2955. 

This suggests that US Dollars weakened substantially during all these years, but the US economy continued to suffer and despite weaker USD, which led to global financial crisis having contagion effect because all the effected economies are faced with similar type of issues.

The major cause behind this suffering is over leveraging and over valuation of assets that was helped by the following………

-Weak regulation
-Allowing Spending to Exceed Revenue Collection
-Rating agencies failure to timely identify the risk
-Allowing changing of Accounting Rules
-Bailing of Failed Banks for their Wrong Doings
-And most importantly Non-Disclosure and Hiding of Real Numbers (e.g BIS in one of its 2009 report mentioned about DERITIVES amount of $ 743 Trillion) There is No News.

Therefore demand for Strong Chinese Yuan is a political excuse by the world leaders to cover their mistakes and gain some mileage.

If we go back to the 1980-90 era the European growth was lackluster ranging between 1% to 2%. Until 1990 Japan’s economy was commonly known as “Miracle Economy”, but it lost its gloss as the economy crumbled into recession, it’s been a decade and yet it is struggling to come out long recession. During this period the Britain’s economy was performing poorly.

In 1980, US Public debt was $909 Billion. Today US debt has reached $ 15 Trillion. Until the mid of 1990, the US economy was considered as the world’s leading economy, but there after cracks started to appear. The hole in the US economy is so large that truly speaking it unlikely to get back on track with the current window dressing approach. Changing accounting rules, Nationalization of large corporate sector, using taxpayer’s money and by maintaining low interest rate combining it with injection of liquidity through quantitative easing is only a temporary solution. Substantial cut in spending and huge revenue collection by imposing tax on profitable business is the only solution to the problem.

European economy too has fell into a trap is facing a similar situation. They too are following the footstep of USA, which has failed to produce the desired result. ECB's independence is questionable, as it had compromised on many issues such as it was not suppose to give concession but allowed to lending to junk grade. It was not supposed to purchase bonds directly but it is buying bonds from secondary market. Earlier Euro zone rules did not allow assistance to governments to finance deficit, but they have been breached. So Europe is required to drastic measures to get out of the mess.

Comparison between China & West

The Western policy of past to shift its business to East for cheap labor has backfired. This has only helped the Western countries to maintain artificially high growth rate and high standard of living, which is no more manageable in real sense without cash money, they are now paying a very high price, because the cycle has shifted. Job situation is getting from bad to worst. Their older generation may have enjoyed the best of times by leaving smaller jobs for immigrants, but immigrants are now a cause of big concern. Although, modernization is one area that West or so called Developed Economies can boast of making gains.

China that had Fx reserve of $ 2 Billion in 1978 during all these years played smart. It was concentrating on growth and was less involved in global politics. The IMF’s, the World Bank and other Global institution was praising the Western policy and criticizing China. Since 1980 with a broad smile on its face was growing between 9-10 pct. It took advantage of its cheap labor and currency and concentrated on exports. Today, unlike desperate West, China enjoys foreign exchange reserves of $ 3.3 Trillion and its economy is still performing well.


China’s growth is based on Western model, but the key to the success is its ability to modify it according to the country’s culture and specification. Chinese leaders that were responsible for launching China’s economic model had the intention to make China big and strong. In 1981 the poverty rate in China was 64 pct that has come down to below 10 pct. The world is struggling to raise its national savings rate. China enjoys a savings rate in excess of 40%. Imagine China’s determination, its ability and future prospect. In 2009, China produced 560 million watches and in the same year Switzerland produced 22 million watches.

China is always keen to discuss new economic models. Today, China has engaged USA in vendor finance, providing money that helps finance the huge US fiscal and trade deficits, allowing Americans to buy more goods than they sell.

However, China’s economic slowdown is now visible and indications are that for the first time since 2001 China’s growth could fall below 9 pct. Strong Chinese Yuan and global slowdown could hurt its exports. 

Furthermore, its banking system is at huge risk, as lending in recent years by Chinese banks has surpassed USD 7 trillion. Evidence of economic slowdown is clearly visible because it’s small to medium size private export business houses are showing signs of nervousness. China’s external debt is not a cause of major concern, but there is an increase risk of default to funding of roughly USD 1.7 trillion that has been provided for construction or infrastructure by local the government could disturb its banking structure. Though in case of solvency, Chinese government would certainly step in to rescue its financial system. In such a scenario the possible risk could be that investment to GDP (size 5.9 Trillion) could be badly hurt, which is roughly over 45 pct and this could be the melting point for the Chinese economy. 

Despite all the difficulties, I still see growth potential in one area that could provide temporary boost to China from absorbing any sudden jerk and i.e. it’s the domestic consumer market due to its 1.3 billion populations. China’s consumer spending is a major contributor to its GDP, which is around 36 pct. 

However, the honeymoon period will not be forever, it all matter of time. Though very difficult to predict the estimated time due to frequent engineering of economy at all levels, but one thing is for sure that I know is that China’s economy will surely burst and the cracks  could start appearing within next couple of years.  

http://www.forexstreet.net/profiles/blogs/strong-chinese-yuan-does-not-guarantee-usa-europe-economic

Euro Could Test Parity, But Gold May Hit $ 1385

Weekly Fx -Gold Outlook Monday Nov 28-Dec 02  

Sunday Nov 27 - GMT  13:22  - Pak 6.22 pm

Despite disagreement between the “Super Committee” members, on finding a solution to cut USA’s over 1 Trillion debt, which was a big news was clearly ignored, as all eyes were watching news from the European market. It was a terrible last week with flurry of bad financial news coming from the European market. Failure of German bond auction last week, which is considered safest European asset, further worsened the market condition. We are once heading for another nervous and uncertain week, as another Euro 19.5 billion bond auction is due this week to meet the borrowing requirement of Italy, France, Spain and Belgium. Italian bond yield is already hovering above 7% suggesting that bond auction will be bigger test for the investors.

Meanwhile, Germany is unwilling to compromise on the proposal for joint issuance of bond for the 17-member European countries, arguing that economic condition greatly differs from one country to another country and therefore, it does not support common interest rate structure. This is one major factor that hinders in reaching some sort of understanding between the European countries. Neither Germany favors extraordinary ECB intervention to support the bond market.

Probably Germany/Merkel also wants tighter fiscal control in the Euro region, but is well aware that this measure may not be enough to meet the future debt requirements. Germans worry should be that its growth may not be large enough to cater their own debt due in 2012, so how can they take another country’s debt.

With the piling of so much of negative news that includes enormous amount of EU Debt, surging Borrowing Cost, Bank Capitalization issue, Slashing of various EU Country Ratings and Change of Governments in Euro zone. Yet, there is clear disagreement between the European leaders on many issues.

Furthermore, last week’s German Bund auction failure is quite a worrisome factor signaling that the Investors have started keeping distance from German bonds, what does that indicate? Last week why did the Asian Investors/Central Banks off load their German Bond holdings? Are investors shying away from Europe? How would the investors respond to this week’s auctions? If we look at the quantum of European problem, the most important question in every one’s mind would be the future of Euro. How will Euro as a currency survive? Is Euro ripe for a crash? If this week’s auction fails, will Euro crash? Or will ECB use its backdoor strategy to make this week’s auction successful to save Euro from testing is parity?

View on Gold: Although gold may look attractive due to global financial problems and lesser available alternate, but it may continue to struggle unless it technically creeps beyond $ 1798. The demand for gold in India is on the decline and the current levels looks quite heavy. Central Banks long in Euro must be worried about future of currency, as market to market of Euro at current levels suggest book loses. Whereas, gold holding means ZERO return for the holders of metal and investment in gold against borrowing means investors have to pay the borrowing cost. Most importantly there is a huge risk for further cash crunch, which could mean further asset sale and pressure on gold.   

Sliding of Indian Rupee is bad news for gold. For the expatriate Indians the current levels are too attractive to send remittances at home that offer better return, as correction possibility is always there. While from Indian domestic market perspective 15% depreciation of Indian Rupee means for the local buyer’s gold has become expensive by that percentage. Deteriorating global financial market and increased risk of recession could exert more pressure on Indian Rupee.

Meanwhile, China’s economic slowdown is visible, which could thin down gold demand from Chinese Central Bank/Investors. With high inflation and possible global recession, 10 pct growth rate story since last 20 years may be on its last leg. Its banking system is also at huge risk and in last 3-years lending by Chinese banks surpassed USD 7 Trillion, lessons can be learnt from European debt crisis. It’s all about that when does it happen, if Europe can escapes current dilemma then China may get some breathing space.    

Therefore, I am expecting 15 pct - 20 pct fall in gold prices, which is $ 1385, unless gold pushes beyond $ 1790 convincingly. However, we are going to witness volatility. We are often going to witness either way $ 100 moves. So follow me I will keep you posted about the coming moves.

  

 Gold $ 1680 – Gold should hold $ 1760 as I am looking for a downside break of $ 1610, which would pave way for $ $ 1555. Only break of $ 1798 would delay the move. Ranges for the week $ 1580-$ 1760

Euro 1.3237– Only break of 1.3480 would delay Euro’s downside move, as risk remains high for a test and break of 1.3140, which would push Euro further down to test 1.2950. Ranges for the week 1.3480-1.2910

GBP 1.5440. Pressure could mount due to weak economic conditions. Once 1.5350 is cleared Cable could test 1.5250 or else 1.5580 before down again. Range for the week 1.5580-1.5180

JPY 77.71 –Yen is likely to trade in a tight range between 77.10- 79.40

CHF 0.9299 – SFR has strong resistance at 0.9070, which may not succumb as Swiss Franc would follow other currencies. Break of 0.9435 would encourage for a test of 0.9520. Ranges for week 0.9050-0.9520

DISCLAMER : The commentary/information presented is not intended for trading purpose. The idea is to exchange views with the members/readers. Therefore, I accept no responsibility or liability for any losses incurred due to position taking.

Will 150 basis points cut spur growth?

Tuesday October, 11 2011

GMT 5:44    PAK 10:44 am

Why is that a 150 bps cut will not stimulate economy? This is true that a discount rate cut is generally helpful for the economy, but in our case, however, it doesn't. Time will prove that despite slashing discount rate to 12 percent, Pakistan's economy will still not get the much-needed boost.

The real beneficiary of this cut will be the borrowers of running businesses that have been paying an exorbitantly high rate on their bank borrowings or government will get some relief due to cost reduction in its debt servicing. I do not see any increased business activity for two broad reasons.

First, 12 percent is too attractive and too safe a rate for the banks to invest their cheap deposits in government securities, while the second factor is that if we look at the corporate sector lending graph of last 5 years, it is on a constant decline as there has been no new major corporate lending. Five years ago, scheduled banks' Advance to Deposit ratio attained a peak of 77 percent, which had dropped to 62 percent by June 2011 and after the adjustment of Rs 400 billion of inter-agency circular debt of energy sector Advance/Deposit ratio will take a further dip of 58 percent.

In the last five years, Pakistan suffered one of the highest rates of inflation. If we go by the books, high inflation is always considered useful from perspective of growth. But this theory proved to be absolutely wrong in our case. The declining trend of advance/deposit ratio for the last five years is parallel in line with a declining trend of country's GDP growth, which clearly depicts the true picture of our economy, further confirming the fact that high inflation rate was harmful and it was a meager effort on the part of SBP to boost growth and create jobs.

However, if we look at the bank's investment trend in government securities, which has surged sharply in the last couple of years, it clearly tells the true story and exposes the central bank's reluctance to support growth. It would not be wrong to say that for the last one year and a half, State Bank of Pakistan's monetary policy is a mix, as it was maintaining tighter policy stance while simultaneously managing liquidity through unannounced quantitative easing by injecting liquidity to encourage banks to invest in government securities.

It is unfortunate the SBP did not inject liquidity to support growth. The sheer purpose of rupee injection was to encourage investment in government securities to reduce government borrowing. It is extremely important to strike a balance between revenue collections and spending, which is the only way out to survive.

Since there is no real money available in the banking system and the deposit growth is largely the result of interest income on accrual based growth, therefore, the current discount rate is still too high to discourage new businesses and still too attractive for the banks to invest in government paper. It is more likely that by the end of FY 12, advance to deposit ratio will further fall to below 55 percent instead of inching up from the current level.

Hence, if SBP really wants to see growth in private sector and create employment, it has to slash its discount rate by another 200-300 basis points and take advantage to align borrowing cost. SBP is also required to correct the rate imbalance that it has created by maintaining so many different rates, which is doing no good to the economy.

Impact of cut in discount rate The impact of the rate cut saw a positive response from the Karachi Stock Exchange, both in terms of trend and volume. But this bullish tone may not last for a long period of time unless new liquidity is made available to the stock market.

Meanwhile, six-month KIBOR opened at 11.96 percent. In the interbank money market, banks still have appetite to purchase T-bills and PIBs in hope that the SBP would continue its unannounced quantitative easing strategy and inject more funds to meet the increased demand for government paper. Banks were aggressively bidding one-year T-bills around 11.88 percent yield and PIBs around 12.04 percent yield, which clearly indicates that the market is expecting a further discount rate cut. Moreover, the demand for government securities will not subside.

The much-awaited unsettled pending issue of Rs 400 billion of inter-agency circular debt of energy sector has been lingering on since May, 2011. In the past, on two occasions banks were notified of circular debt deal settlement in writing, but due to some unknown reasons the deal could not conclude. No bank was informed about its fate. This clearly indicates a weak co-ordination between the SBP and MoF, as the deal structure is yet to be finalised since there are quite a few technical glitches. A direct deal with banks also questions the credibility of the system, because there are foreign investments in the government securities and direct negotiation with banks would amount to interference in price mechanism.

In simple terms, Ministry of Finance should have asked SBP to finalise and conclude the transaction. SBP would have been a safe negotiator for government and as well as for the banks. Delay is also a blessing in disguise for the government because it is expected that the settlement of transaction will be based on average of current and past yields, which is also in the national interest. This circular debt deal has its own pros and cons because on one side it will provide space in the balance sheet of the customer, whereas PIBs held by banks will worsen their capital adequacy ratio.

Interestingly, PIBs yield after hitting the high of 14.45 percent in February/March started sliding on huge demand, which came mainly from the government of Sindh due to its bond maturity. It is estimated that so far it has purchased 10-year government paper of up to Rs 45-50 billion to hedge its employees' gratuity and provident fund. Insurance companies are the other major buyers of PIBs. This clearly indicates that there is a plenty of appetite for more buying as this buying was not projected in the earlier PIBs targets. Therefore, until next monetary policy announcement yield of T-bills and PIBs could decline by another 50-100 basis points. The trend of buying 12-month T-bills is likely to continue. In the coming PIB auction due on Wednesday, October 12 corporate interest would dominate the banks.

I do not expect any major move in the interbank foreign exchange market. In the coming days, however, I see rupee gaining strength against USD, as it is important to understand that the normal theoretical linkages between interest rate and exchange rate do not hold true for Pakistan as it is not convertible on capital account nor is the economy exposed to substantial short-term foreign investments, which could have had impact of major interest rate moving either way.

Cut policy rate by 150 to 200 basis points

Friday, October 07, 2011

Last week, a report carried by a section of press quoted Defence Minister Chaudhry Ahmed Mukhtar as saying that the government is likely to bring down interest rate by two to three percent in the near future and that he has discussed this matter with President Zardari who, according to him, was in favour of a rate cut.

Although, this subject does not pertain to the Ministry that he heads, but being a successful businessman Chaudhry Mukhtar definitely understands the urgency of drastic rate cut, as higher discount rate is one of the major damaging factors for economy.

I strongly support and endorse the view, as it has now become evident that high discount rate is no more sustainable. It has been causing a great harm to economy. There is a global war against high interest rates and despite higher inflation all the major debt ridden global economies have either slashed or are in the process of reducing high interest rates to protect their economies.

The truth is that the global norms have changed, as major economies do not go by the book anymore. For the last few years printing of notes in tons and real interest rates in the negative is no more considered a sin and is practiced all over Europe and the USA to support their economies. In the UK, despite inflation breaching its 2 percent target limits, which is currently hovering around 4.5 percent, the Bank of England has kept its interest rate at 0.5 percent due to poor health of Britain's economy. In the US, despite CPI at 3.8 percent FED has opted for a loose monetary policy by keeping its rate at 0.25 percent. Similarly, Euro zone's inflation, rate already at 2.5 percent, is expected to rise further. ECB kept its rate unchanged at 1.5 percent.

More importantly, to save Europe from a financial collapse, Germany, which is considered one of the most modern democratic countries, went to such an extreme extent that its parliament voted in favour of bailout expansion despite opinion polls were suggesting that 70 pct of the population does not favour bailout expansion.

The State Bank of Pakistan will be announcing its monetary policy on Saturday, October 08. Now it is SBP's turn to shoulder the responsibility. The Central Bank should have anticipated the quantum of damage that its continued tighter stance is inflicting on the nation. Pakistan's economy has already paid a very high price at the expense of growth to contain inflation by keeping its discount rate in double digits, which is in its fourth consecutive year.

The worrisome factor is that despite maintaining tight monetary policy for the last five years, inflation hovered between 13 percent and 15 percent. During this period, the economy could not produce new jobs to keep pace with the population growth, thus widening the gap. Instead, the market witnessed death of economic activity, which is ultimately leading to cause social unrest and tensions in the country. It is, however, understandable when SBP through its monetary policy blames a lack of fiscal support as a major cause of high inflation because without fiscal support monetary management is less effective and makes no sense.

But the point to ponder is that if food, oil and energy prices in Pakistan are compared with the prices in international market, they are either low or at par, whereas inflation abroad is too low. So why are inflation numbers constantly so high in Pakistan? Is this because the basket of inflation not balanced? This could be a factor, but resistance to documentation of economy is the real culprit. If we look at inflation graph of under-developed economies, most undocumented economies suffer from high inflation.

However, State Bank of Pakistan has to realise that it is the Central Bank's responsibility to stimulate economy. It has to strike a delicate balance. The list of issues has attained to a dangerous level, which needs to be corrected without any loss of time. Tightening for the sake of fiscal discipline makes no sense.

SBP's top priority should be to provide such a healthy environment that helps businesses in the country to flourish. It should ensure ample of liquidity for new business opening, as banks are only keen to fund running business. Due to higher interest rate policy, in the last four years private sector growth has been choked, causing a lot of damage to the business sector resulting in an alarming surge in NPLs. A large part of the money has been diverted to the government sector.

Flaws in SBP's policy stance are clearly visible. Instead of supporting growth in the private sector, it is injecting liquidity by using two of its monetary tools to provide liquidity to the banks to encourage banks and financial institutions to purchase government securities. For the last two months, the market has witnessed a huge liquidity injection through Central Bank's open market operations (OMOs) and so far SBP has injected over Rs 300 billion of liquidity to meet the government securities target. The second tool that the Central Bank has been employing for the last 5 or 6 months clearly negates its tighter monetary policy stance. It has created such an environment that in the last six months, forward premiums fell sharply to 260 paisa, which means that at this rate if a bank carries out a Rupee/Dollar Sell/Buy swap the Rupee cost would be 7 pct. Then banks were investing in T/bills at 13.25% yield. Presently, 6-month swap is trading at 330 paisa, which makes Rupee available at 8.5 percent. Exporters are also blaming a sharp drop in forward premium as one of main factors behind the recent drop in the value of Pak Rupee against Dollar, which forced them to hold their foreign currency in hope for recovery, putting pressure on Rupee. However, Rupee's weakness was more due to widening gap between interbank market rate and Kerb market rate.

In August 2009, SBP introduced Interest Rate Corridor to reduce short-term interest rate volatility to bring more transparency in the implementation of its monetary policy. 3-day Repo facility was renamed as Reverse Repo Facility, which is known as "Ceiling" and Repo Facility became "Floor", which means that based on current discount SBP will lend funds to banks at a ceiling rate of 13.5 percent and will absorb excess funds from the market at 10.5 percent ie, floor rate. The gap between floor and ceiling is 3 percent.

Another major factor that is causing difficulty in containing inflation is the disparity caused due to a 5 percent floor on savings rate, which makes no greater sense as banks can pay maximum of 5 percent on savings account; banks can invest in treasury bills at around 13 percent and have another window facility to place excessive funds at the corridor floor rate on a daily basis.

SBP in its monetary policy announcement should adjust the savings floor rate at par with the corridor floor rate at which SBP absorbs funds from the interbank market or should make a realistic adjustment between the savings floor rate and corridor floor rate. This rate disparity is the hidden culprit behind rising inflation, which goes unchecked. It is also one of the major causes of high currency in circulation that has surged to 1.570 trillion, which is not manageable. Low saving floor is also responsible for a low national savings ratio, which also inflates the incidence of currency in circulation.

My greatest concern is the bank exposure to government securities. The latest talk on circular debt settlement, which is almost a done deal, will be added to banks investment portfolio. It is extremely alarming that after the settlement of Rs 400 billion circular debt trough T/bills and PIBs, a new dimension will be created in the banking system. Presently deposit of schedule banks is Rs 5.9 trillion and advances is Rs 3.8 trillion. Circular debt adjustment entry will reduce bank advances, which means schedule banks advances will drop to Rs 3.4 trillion, but investment in government securities will surge to Rs 3.5 trillion.

It means that for the first time in the history of banks investment in government will exceed banks' advances portfolios. Current holdings as of now are T/bills 2.315 trillion; PIB Rs 550 billion; and Sukuk Rs 185 billion. With an unfunded debt portfolio of 1.52 trillion, are we not falling into a debt trap? It will also have negative repercussions as it is most likely that rating agencies will chop banks rating due to excessive investments in government securities.

Furthermore, there is every reason to believe that Pakistan will not get foreign support. IMF is done with USD 7.3 billion loan to Pakistan. Kerry/Lugar bill to give Pakistan USD 1.5 billion annually for 5-years now sounds more like a gimmick than a possibility of any kind, as the country did not get any money after the release of its initial tranche. Japan has been kind enough to provide goods worth USD 10 million after last month floods in Pakistan.

Keeping in view the global trend and country's economic condition and inflation numbers dropping to 10.56 percent, this is an ideal opportunity to slash the rate by 150 to 200 basis points on October 8 and slash another 100 to 150 basis point in the next MPC.

There is a wrong perception that a sharp cut in discount rate will have a negative impact on Rupee. It will have no adverse impact on country's trade if we take into account the past two major moves, in which Rupee appreciated (2002-03) and Rupee got the beating (2008-09). This is because Pakistan's large chunk of import is oil based, which depends on international oil price movement and prices are adjusted by the local market.

Similarly, textile is the largest export component and past trend suggest that it's mostly driven by the domestic market sentiment. Exchange rate mostly reacts to shifting in balance of payment position (Negative or Positive). Or moves are witnessed when the parallel market, ie, Kerb market behaves disorderly. Therefore, there is hardly any time left for the SBP; this is a wake-up call. A 50 basis point cut will be too little and too late. Zardari is thinking in the right direction.

SFR Warning

12.45 Sfr 0.7831 Watch out SNB checkinh Forward Rates

SFr could re-test & break 0.7920 for 0.0820

Secret behind the strength of Gold & Swiss Franc

                            Unending love of women, states for yellow metal

                                                                       Asad Rizvi

Gold is on a constant rise for last 10 years, gaining 16.5 percent only in 2011. It can be argued that the shifting of wealth from the West to the East could be one major factor, triggering a surge in gold prices.

But any delay in reaching understanding on America's debt issue in enhancing the borrowing limit and European debt crisis is considered a bigger issue in the pipeline, which many still believe could have a contagion effect as it is likely to spread to Spain and Italy, as the bond yield of the two European countries does not bode well and is the key driver behind the current rally.

Gold's biggest boost could have come from the central bank buying, as latest IMF monthly report disclosed that Russia, Thailand and Kazakhstan purchased gold in June. IMF data also suggest that Thailand bought gold for the 3rd time in last 12 months. And interestingly South Korea purchased gold for the first time in over ten years.

Gold lovers will be keenly watching rating agencies, as US growth is in question. Therefore, FED policy measures will be keenly watched. If the US central bank goes for a third time quantitative easing, it could blow the whistle.

Central bank's gold buying interest around current levels is a very dangerous sign and could be a huge driving factor behind gold's next big move, as investors will have no intervention fear. It is rather a signal to investors that central banks are themselves looking for investment opportunities and are diverting their portfolio from currency to solid asset. Presently, the average holding of gold by the global central banks is 11 percent. This is enough reason for the market to rush for gold, unless there is a clear-cut policy announcement by the IMF or the concerning body.

A technical chart suggests that next barrier is at USD 1840 or probably USD 1940, with support at USD 1520 and major support at USD 1440. However, the rally could continue and buyers will emerge on dips. USD 2200 is a good future possibility if gold goes unchecked.

SNB cuts rate to defend SFR

In a surprise move, Swiss National Bank (SNB) slashed its rate by 50 basis points and threatened to supply SFR to halt its currency rise. Soon after the intervention SFF, that gained 10 percent against euro in two months, lost three percent of its value against the USD.

According to OECD calculation, Swiss franc is the most over-valued currency in the world. It is over 43 percent overvalued against the US dollar. With such formidable strength, it becomes extremely difficult for the Swiss exporters to remain competitive.

But in an environment where majority of the developed countries are struggling to survive against debt trap, what more options do the investors have to put their money? Size-wise Canada, Australia, New Zealand, Indonesia, Singapore, HK or Nordic countries have a small product to offer. The US is in a debt trap. Europe is taking a breather after arrangements made for Greece and Ireland with longer maturities, which are not a permanent solution. Spain is next in queue to fall in the debt web trap. European recovery is not going to happen anytime soon, whereas Euro Zone debt crisis remains an unresolved issue.

Investors are so desperate that despite Japan - though already bitten by the recession is again suffering due to March's Tsunami - are still buying Japanese yen around all time high levels and Bank of Japan (BoJ) had to intervene to defend its currency. The problem is quantitative money. With zero - 0.25 percent Fed rate and Fed is printing money at will. So where should the money flow? In a $60 trillion global economy with 3 percent annual average growth, $180 billion cash money is generated. Global consumer purchase represents more than 50 percent, which means over $30 trillion. So, some part of money will certainly look for better investment portfolios.

Look at the commodity prices. Did you ever think that in a short span of 41/2 years, gold from $450 would hit $1660? There is no food shortage in real terms, but food prices are surging due to speculative forward buying. The demand for US treasuries is incredible.

While Swiss Franc has traditionally been considered a safe haven currency because Swiss National Bank has never delayed fighting inflation, which is currently below one percent. Its debt-to-GDP is 39 percent. In the last two years, SFR gained 20 percent and so far in first seven months of 2011 it has gained 16 percent.

This is an extremely tough situation for the Swiss business community, especially exporters, as they are told to tackle strong Swiss franc. Its exports constitute 50 percent of its $523 billion GDP. Presently, although SNB has taken measures, its inability to intervene and defend its currency is due to the heavy losses it had to suffer about couple of years ago, as it was unable to halt SFR appreciation and instead Swiss Central Bank had to incur a record loss. It is extremely difficult for any central bank to defend alone its currency by intervening in the market unless the intervention effort is a co-ordinated one. Switzerland's stock market is six percent behind the European stock. The economy is showing signs of a slowdown. Election is due in October. However, I believe that this is a testing time for the SNB, as another break of 0.7650 would push it towards 0.7480 or even 0.7020. Only an upside break of 0.8450 would reverse the sentiment.

SBP Governor Kardar, I told you the job is tough....

I told you the job is tough

July 18, 2011

ASAD RIZVI

 

In an article carried by Business Recorder on Sept 14, 2010, I mustered courage to come up with a note of caution for Shahid H. Kardar, making it clear to him that this is not a TV talk where he can provide objective analyses to viewers on issues ranging from central bank's monetary policies to National Finance Commission Award with relish.

While welcoming him to the real world of real economy, real finance and real GDP, I also sought to caution him that from now onwards he would be required to inform the government in particular about the power of economic tools that he had spent past several decades learning. Reports suggest that he resigned due to his differences on opinions on a variety of issues that mainly pertained to fiscal and monetary matters. Disputes between central bank and Ministry of Finance (MoF) take place all over the world, although globally, there is no such firm practice or law for Central Bank autonomy.

Price stability is the primary objective of a central bank. Central banks and ministries of finance are supposed to co-ordinate, exchange information and prepare joint strategies for the government. Creation of money and managing exchange rate should be insulated against political interference and Government Treasury.

A central bank is granted autonomy with a view to ensuring that there is no political interference. There are many examples of differences between central banks and ministries of finance. For example, in India RBI commonly faces the music. US Federal Reserve during Paul Volker (1979-87). Tussle between BOJ and MoF is a common occurrence.

Honestly speaking no SBP Governor was ever able to address the real issues. Inflation remains very high and is unlikely to reduce to a single digit in the next couple of years due to central bank's willingness to accept incremental government securities auction target averaging at 12 percent to make quarterly T-bills and Pakistan Investment Bonds (PIBs) auction successful to help in reducing government's fiscal deficit target instead of focusing on growth to create jobs. Hence, growth prospects continue to remain bleak in the absence of any money flow to private sector.

A lack of initiatives in relation to unchanged monetary policy stance has not produced the desired results in pulling down the inflation numbers that continue to remain a worrisome factor. Extended periods of sharp hike would have slowed down inflation and by now SBP would have been in a better position to reduce discount rate that could have given boost to the ailing business community. Monetary policy did not contribute to the jump in export earnings, which has witnessed a slump, however modest, in size. The surge in export earnings is in fact due to rise in commodity prices in the international market.

Higher discount rate is fast becoming a pain in neck, as the rise in debt is at a very alarming pace. Funding of domestic debt at an average of over 12 percent for the next three years means that another Rs 2.2 trillion to be added to the debt stock. External debt financing will resume in last quarter of 2012, so what is the strategy.

Another dangerous development is the accrual deposit growth in the banking industry at roughly 8 percent per annum, which means a fall in discount rate by 3 percent could see a collapse of many banks unless floor of 5 percent is removed.

Despite Discount rate of 14 percent, the SBP failed to come up with a policy to force banks to offer depositors better return as the banking spread remains above 7.5 percent. Another such area is central bank's failure to arrest the rise in currency in circulation, which is comfortably hovering over Rs 1.5 trillion. Circular debt remains an unresolved big mystery. It is also worth mentioning that the efforts of the then Governor SBP, Salim Raza's, to develop debt market received a setback as Kardar decided to close down the department.

Kardar's sudden departure, fifteen days ahead of issuance of monetary policy statement, takes away the flexibility available to the Monetary Policy Committee of SBP. If the SBP policy rate is cut steeply, the market will see it as a quid pro quo for appointment of the new governor and a dent on the autonomy of SBP. As a consequence, MPC's hands in a way are now tied. It will now be up to the Central Board of Directors of SBP to do what is right. Show spine by acting as independent directors and not as governmental appointees.

Copyright Business Recorder, 2011