Wednesday, July 30, 2008

IMF Warns World Credit Risks Remain High

"Year After Subprime Crash, Risks Remain Elevated, Says IMF"
"IMF Gloom Over 'Fragile' Markets and Global Risk"

In the International Monetary Fund’s (IMF) Global Financial Stability Report Market Update, released July 28, the IMF warned that the U.S. subprime market crisis continues to trigger turmoil in the global financial markets. As a result, the resilience of emerging markets is being tested and policy trade-offs between inflation, growth, and financial stability are becoming increasingly difficult for policymakers around the world. The IMF addressed three areas in the report; 1) slowing global growth, 2) growing U.S. problems, and 3) governmental responses.

The IMF expects global growth to slow considerably in the near future because of high energy prices and concerns about rising inflation. The inflation risks have caused policymakers to become less supportive of actions to stabilize the financial markets which could lead to higher inflation. The IMF also noted that the U.S. housing market has not stabilized and “a bottom for the housing market is not visible.” This combined with a softening of the housing market in Europe will likely lead to future loan losses. According to the IMF, global financial institutions have written off around $400 billion in bad loans since last August and predict that this cycle could total $945 billion in losses. While these institutions have successfully raised large amounts of capital to cover the losses, the IMF cautioned that additional write offs and slowing worldwide growth could make it more difficult to raise capital.

The IMF did praise the extraordinary steps that central banks in mature markets have taken to prevent systematic risk from spreading. This included the support the U.S. has given to Freddie Mac and Fannie Mae, which the IMF noted would have dire consequences if allowed to fail. According to the IMF, further interventions by governmental authorities, especially in the U.S., will be necessary to prevent systematic risk and preserve the financial stability. Jaime Caruana, Director of the IMF’s Monetary and Capital Markets Department said that, “prompt and transparent government responses, however, will go a long way to relieving the uncertainties.”

1) With the IMF’s predictions that less then half of the losses associated with the current crisis have been realized, have we seen the worst of the credit crisis or is the major shock yet to come?
2) Should the multilateral financial institutions such as the IMF and World Bank get involved in the policy making decisions to protect the financial stability of the global markets or should these decisions be left only to individual countries?
3) Between the competing interests of controlling inflation and providing governmental assistance to control financial instability, which should be more important? Since this decision will have worldwide effects, should it be left to each individual country or should a international regulator step in and set up the parameters?

Tuesday, July 29, 2008

Increased Investment in “Frontier Markets”

Source: Financial Times

Investment experts are beginning to see a shift from a focus on emerging markets such as China and India to frontier markets found in the Middle East and Africa. For instance, emerging markets have seen a net outflow (withdrawal of funds) of $22bn while frontier markets have seen a net inflow (investment) of over $1.3bn. It will helpful to explain what the terms emerging and frontier markets mean.

The term emerging market is used to describe countries that are experiencing rapid industrialization. Countries that experts consider to be emerging markets are thought to be in a transitional phase between developing and developed countries. Typically investors put money in these emerging markets because they promise high growth potential and short term gains for the investors.

Frontier markets, on the other hand, are usually smaller, less accessible countries in the developing world. These countries have not yet experienced the rapid growth of emerging markets yet are stable enough for investors to put money into their markets. Though the term frontier market is not constrained by any geographical area, the majority of these markets are located in Africa and the Middle East. It might be helpful to think of frontier markets as “pre-emerging markets” – markets that will eventually reach the level of growth and development of established emerging markets.

As early as the beginning of this year, emerging markets were seen as safe havens for international investors and a source of high returns. However, as emerging markets like China and India experience increased inflation and falling equity markets, investors are shifting money into frontier markets. While emerging markets offer short-term returns, investors in frontier markets are looking for more long-term growth prospects. Frontier markets cannot accept the quantity of investment that emerging markets can sustain, but these markets are less susceptible to global fluctuations such as the current credit crisis. As frontier markets in Africa and the Middle East become more stable and develop more industries experts expect investment to continue to increase.


Frontier investments are often long-term investments. Does this mean that there is less risk associated with these types of investments or does this reflect the different types of industries that exist in frontier markets?

As more money flows into frontier markets will this spur social and political change in countries that have not gained a level of stability to be considered safe frontier markets? For instance, if Zimbabwe sees its northern African peers benefiting from foreign investment will this encourage Mugabe to clean up his act? Will stable neighbors help other countries reach a higher level of stability themselves?

Saturday, July 26, 2008

Regulation: An End to Laissez-Faire Capitalism?

Sources: Wall Street Journal, New York Times

After nearly thirty years of deregulation throughout the U.S. economy, law makers and key financial leaders are looking to reverse the trend, if only temporarily. On Thursday, the House Financial Services Committee held a hearing where SEC Chairman Cox solicited more power to control investment banks and their parent companies. Mr. Cox stated that the system can be modernized by expanding what has worked in the past and learning lessons from failed regulation. The New York Fed President Timothy Geithner went a step further proclaiming his belief that the entire financial regulatory structure be reviewed.

The Federal Reserve Vice Chairman Alan Blinder frames the move toward more regulation as a “backlash against the laissez-fair” viewpoint. He believes the creativity fostered in such an environment is what led to the mortgage and credit crisis. According to a Wall Street Journal/NBC News poll, his thoughts are paralleled by the public. Roughly a decade ago, Americans disfavored government involvement in the economy by a ratio of two-to-one. Now they desire more government action by a 53% to 42% margin.

The Fed has already given billions of emergency funds to Bear Stearns, Fannie Mae, and Freddie Mac. Some economists, however, believe the increase in regulation will be short-lived. Kevin Hassett of the American Enterprise Institute compares the Fed’s recent actions with the $125 billion expenditure following the collapse of savings and loan banks in the 1980’s. He noted that the government involvement in the financial sector stopped as soon as the situation stabilized.

1. Who has a more accurate viewpoint: Mr. Cox or Mr. Geithner? Can lawmakers work with the current regulation to satisfy the public's desire and stabilize the financial sector of should lawmakers start from scratch?
2. How will increased regulation affect new businesses within the U.S.? Will it foster growth by providing a more stable environment or hinder growth by creating barriers?
3. Will this swell in regulation and government involvement continue or will it subside as it did in the 1980’s?

Thursday, July 24, 2008

IMF Warns of Tough Policy Choices for World Economy

"Tough Choices for World Economy, Says IMF's Lipsky"
"Perspectives on the Global Economic Landscape and the Role of the Dollar"

In a speech at the Brookings Institution in Washington D.C. on July 22, the first deputy managing director of the International Monetary Fund (IMF), John Lipsky, said that policymakers around the world faced tough decisions on how to react and correct the current economic climate. He stated that high oil prices had created imbalances throughout the global economy creating new risks and misalignment. Lipsky expressed his comments and recommendations on seven specific areas of the global economy; 1) advanced economies, 2) emerging markets, 3) financial markets, 4) reducing global imbalances, 5) oil markets, 6) exchange rates, and 7) prospects a reserve currency.

In addressing advanced economies, Lipsky stated that the key objectives of policymakers need to be managing inflation while stabilizing the financial system. If this is not accomplished, the efforts to control inflation over the past decades could be lost. For emerging markets, the focus should be on controlling inflation. Lipsky stressed that although many of these countries have tightened their monetary policy, real interest rates remain negative causing inflation to get out of control because of surging commodity prices and growth in domestic demand. Advanced economies such as the North America and Europe need to play a large role in the stabilization of the global financial markets. As the world economy worsens, credit deterioration is widening and banks are getting squeezed. Inflation concerns have reduced much of the flexibility of policymakers to ease stress on the financial markets but they still need to improve policies that allow the banks to deleverage and rebuild capital. To reduce global imbalances, Lipsky stated that countries need to achieve better balance in demand growth. This balance will reduce global payment imbalances and help boost confidence. To adapt to the high oil prices, emerging markets need to pass through the higher international prices without subsidies while advanced economies need to control demand through conservation and efficiency. Lipsky also noted that the depreciation of the dollar and inflation has led to increased stress on the countries with inflexible exchange rates. As far as the world reserve currency, Lipsky said the dollar will likely continue to play a large role as the most popular but forecasted more diversification, with the euro becoming a major player.

1) The goal of controlling inflation is often in direct conflict with increasing economic growth. With the global growth downturn, is it more important for policymakers to try to control inflation or attempt to increase growth?
2) The dollar has fallen 25% since 2002, making this one of the largest sustained depreciation episodes in its history. Will the dollar rebound, keep depreciating, or has it been overvalued in the past and the current climate is the correct valuation? If the dollar keeps depreciating, how long before the currencies that are pegged have to adjust?

Tuesday, July 22, 2008

Burma Cyclone Update:


Financial Times

(This is an update on a previous post concerning Cyclone Nargis that hit Burma in early May.)

According to an assessment completed by the United Nations and the Association of South East Asian Nations, Cyclone Nargis caused a total of $4bn worth of damage to Burma. Cyclone Nargis, the worst Asian cyclone since 1991, destroyed almost a half million homes, damaged 350,000 more and left many communities without schools and medical centers. The Burmese government now estimates that over $1bn will be necessary to provide emergency services to its people over the next three years.

That Burma allowed unfettered access to the UN and other international aid organizations to complete the assessment is seen as a minor political victory. As the previous post explained, Burma’s military junta was initially slow to allow the international community to enter Burma to offer aid, assistance, and badly needed food and water. However, some two months later the UN reported that aid money is being well spent and applauded Burma cooperation in the compressive assessment.

Burma’s recent cooperation is a step in the right direction towards regaining its standing with international aid organizations such as the World Bank. However, experts are quick to note that many of the political realties from before the cyclone still exist. It is unlikely that the recent cooperation alone -- without additional human rights reform -- will put Burma back in the World Bank’s good grace. Putting those issues aside, with the assessment providing a blueprint for future aid, many are optimistic that Burma will receive the aid it desperately needs.

How long do you think the military junta will continue to cooperate with international aid organizations? Is this a good sign that Burma is ready to reform or do you think cooperation will decrease as Burma’s situation improves?

Thursday, July 17, 2008

U.S. Executive Ban on Offshore Oil Exploration Lifted

Sources: Financial Times, BBC

President George W. Bush put the future of offshore oil drilling in Congress’s hands this week when he lifted the Executive Order issued in 1990 prohibiting offshore oil exploration. Now Congress alone has the key to releasing an expected eighteen billion barrels of oil. This oil, which rests under eighty percent of the U.S. coastal waters, is said to be enough to match current U.S. oil production for ten years. Congress’s legislative ban on coastal drilling has been in place for twenty-eight years and is seen as a protective shield to the potential environmental harm associated with oil drilling.

With oil prices hitting a new high of $147 per barrel last Friday, this move by the Republican president throws another coal onto the political fire. Republicans predict that offshore drilling will signal a reduction of American dependence on expensive foreign oil, a welcome idea to those paying more than $4 per gallon of gas. Democrats, including the likely presidential nominee Barack Obama, say that the effects of drilling will be far from immediate. Mr. Obama further stated that, "It would merely prolong the failed energy policies we have seen from Washington for thirty years." Environmentalists agree and fear widespread destruction of U.S. coastlines.

As the presidential election approaches and oil prices remain high, Congress will be pressed to take a stance. Sources disagree as to the position Democratic legislators will take. Some foresee Capitol Hill following the wishes of two thirds of its constituents who favor coastal drilling. Others expect Congress to remain within party lines to show support for their respective candidate.

1. Will Congress vote on the issue of lifting the ban? If it does, do you think the ban will be upheld?
2. If the ban is lifted, will it significantly change oil prices in the U.S.? Will the exposure to oil below eighty percent of U.S. coastlines change the U.S. economy beyond oil prices?

Wednesday, July 16, 2008

IMF to Abolish Offshore Financial Center Assessment Program

"IMF to End Offshore 'Stigma'"
"IMF Executive Board OFCAP with FSAP"
"IMF Background Paper"

On July 9, the International Monetary Fund (IMF) announced it will no longer classify offshore financial centers (OFCs) as separate from onshore financial centers. On May 30, 2008, the Executive Board of the IMF approved integration of the OFC Assessment Program into the Financial Sector Assessment Program (FSAP). This move effectively eliminates the divide between offshore and onshore financial centers. The IMF directors stressed that the combination will not lead to diminished focus by the IMF on the OFC’s compliance with international standards.

The directors noted that because of the integration of the world’s financial systems, the distinction was no longer relevant. In 2000, the IMF originally defined an OFC as 1) jurisdictions that have relatively large numbers of financial institutions engaged primarily in business with non-residents, 2) financial systems with external assets and liabilities out of proportion to domestic financial intermediation designed to finance domestic economies, and 3) centers which provide some or all of the following services: low or zero taxation; moderate or light financial regulation; banking secrecy and anonymity. The IMF stated that the globalization of finance has blurred this definition and made it difficult to draw the line in a credible manner.

Forty small countries view the elimination of the OFC Assessment Program as a victory. They have complained that the distinction has unfairly discriminated against their financial systems. The Society of Trust and Estate Practitioners, which represent business in many OFCs, have referred to the definition as a “discriminatory stigmatization.” The IMF even noted that a motivating factor was a desire to “eliminate the need to maintain a potentially discriminatory list of OFC jurisdictions.” The IMF also noted that the nine or ten OFCs that account for the overwhelming volume of financial transactions will be assessed more often to insure compliance.

1) With the current credit crisis in the world, most countries have called for more regulation and transparency in the financial markets. Will this move by the IMF lead to less transparency and regulation of OFCs?
2) How much of an impact can the IMF have in removing the stigmata associated with OFCs? Will this integration make any difference or will investors still associate these financial centers with the OFC stereotype?

Thursday, July 10, 2008

The Food Crisis at the G8 Conference

Sources: World Bank, Financial Times

Last week, the G8 held a conference in Hokkaido, Japan. One of the most important discussion topics at the conference was agriculture, including the rapidly rising food prices. The last time agriculture made the G8 discussion docket was in 1981. While the World Bank previously proposed a ten-point plan to change the direction of food prices, some believe that the plan will be insufficient to truly address a growing problem.

In a statement at the G8 conference, World Bank Group President Robert B. Zoellick emphasized again the importance of the three pillars behind his ten-point plan to end the food crisis. Zoellick contends that, “for globalization to succeed and to achieve its promise, it must be both inclusive and sustainable. We must protect the most vulnerable even as we offer a pathway to opportunity.”

He plans to first meet pressing needs by creating a food delivery network encompassing as many means as possible. He also plans to double funding for the World Food Program. Second, Zoellick believes that providing farming supplies can increase immediate food production in Southern and Western Africa where the farming season takes place between September and December. Last, the World Bank President recommends reducing or eliminating barriers and tariffs to make food cheaper and more accessible. Thus far, twenty-six countries have taken at least some action.

Commentators believe that the green revolution, the infusion of agriculture in developing countries, is over. In fact, they blame the revolution, in part, for the current crisis. Since the initial boost in agriculture in the second half of last century, population growth has superseded agricultural growth. Critics say that past agricultural development led to a decrease in investment and eventually a slowdown in productivity, as food quantities appeared sustainable. These commentators believe that the G8 conference will push for measures to recreate the short-term effects of the green revolution. They find it unlikely, though, that countries will go beyond reducing barriers to actually enforcing long-term policy changes.

1. Given some nations’ reluctance to decrease biofuel development in the name of food production, are long-term policy changes a feasible resolution to the food crisis? Will nations come together to end the problem through policy?
2. Will Zoellick’s three pillars supporting his ten point plan go beyond addressing the immediate problem or will support be discontinued after immediate obligations have been fulfilled?

Tuesday, July 08, 2008

Asian Development Bank to Invest in Carbon Credits

Financial Times
ADB Website

The Asian Development Bank (“ADB”) recently announced that it would start a fund to invest in carbon credits that will be generated after 2012. 2012 marks the end of the Kyoto Protocol. The ADB hopes to invest close to $200mil. Many investors have not financed projects set to take affect after the dissolution of the Kyoto Protocol given the uncertainty surrounding the potential new agreement. However, the ADB hopes that its investments will spur other developmental and commercial banks to follow suit.

The Kyoto Protocol created a carbon emissions program trading where developed nations trade carbon credits between themselves or with developing countries in order to meet their emission goals. For instance, if a nation is producing more carbon byproducts than their emission goals allow for, they can buy carbon credits from other countries to compensate for their overproduction. In other words, if an over-producing country purchases carbon credits from under-producing countries then the net emissions will be within the overall emissions goal. The ADB plans to utilize this carbon trading system to invest in carbon credit producing enterprises in developing nations that can sell their carbon credits to more developed countries.

The ADB plans to offer funding for such carbon credit producing enterprises by offering upfront investments for developing nations. The majority of ADB projects are “pay-on-delivery,” which means the countries must be able to put up initial capital in order to secure ADB financing. This typical method does not work well in the carbon credit industries because the industries often require large initial capital investments and a reliable, structured financing system in order to be successful. In addition to the up-front financing, the ADB plans to offer technical assistance to the carbon credit start-ups. This, the ADB hopes, will make private investment in the start-ups less risky given the ADB’s technical expertise.


Some critics feel that when developing countries pursue lower emissions in order to create credits it leads to the developing countries taking actions that are not in the best interest of its citizens and the environment. For instance, in some countries “old-growth” forests (which absorb lower levels of carbon) are cut down in order to encourage new plant growth that will absorb larger quantities of carbon. Should the ADB carefully monitor such trade-offs before investing in a project? Is it worth it to reduce greenhouse gas emissions at the expense of developing countries?

The United States did not officially sign the Kyoto Protocol and was not bound to its emission goals. The US has stated that it will not sign a new version of the protocol unless China and India agree to it as well. Do you think major players such as the US, China, and India will have a negative effect on the carbon credit market if they do not agree to a plan in 2012? Is the ADB banking on the US to join the new emissions agreement?

Tuesday, July 01, 2008

Investment and Aid Developments in Africa


Private Equity Increases

G8 not Clear on Aid Goals

The G8 is set to meet in Hokkaido, Japan in July. An initial draft of the summit’s agenda fails to mention it target goal of increasing African aid to $25bn a year by 2010. This annual African aid goal was set back at the G8’s summit in 2005, and was again repeated in Germany last year.

The failure to explicitly list its target aid goal is seen by critics as a failure to honor the commitments it made in 2005. A majority of the G8 countries’ aid budgets have decreased and this may mean that they are unable to live up to their promises of increasing aid abroad. This comes at a time when many health organizations are relying on the aid to implement their plans designed to reduce Aids, malaria, and tuberculosis in Africa.

While aid from the G8 is likely to fall behind past benchmarks, foreign investment in African private equity is increasing rapidly. Private capital flow to sub-Saharan Africa has increased four-fold from previous years to a level of $53bn. The investors cite the spread of stable democracy and rapid economic growth as reasons for the rise of private equity across Africa. There is also an emerging middle class in Africa with higher levels of disposable income that create attractive investment opportunities across the continent.


It is likely a good thing for Africa that private foreign investors are becoming more willing to invest in the region. However, foreign investors are likely to invest in service oriented industries such as telecommunications. Will this type of investment make up for reduced foreign aid that is often designed to help the continent’s poorest people?

Did the recent events in Zimbabwe influence the G8’s willingness to offer aid to Africa? Would it be right to offer less aid to poor citizens in warring countries as a way to punish the totalitarian leaders? Would foreign private investors be more successful in applying pressure to these rogue nations? Would they have any incentives to do so?