Colombia and Peru Plan Stock Market Merger

FT: Peru suspends integration with Chile, Colombia

FT: Colombia and Peru plan bourse merger

FT: Peru’s bourse wins tax stand off with congress

WSJ: Colombia, Peru Stock Exchanges Plan Corporate Merger

Reuters: Colombia, Peru stock markets to merge

Reuters: Peru Congress passes bill on stock mkt integration

NASDAQ: Direct Trading Between Chile, Colombia, Peru Bourses Delayed

Colombia and Peru are planning to merge their stock markets in the first cross-border union of stock markets in Latin America. The two stock markets have agreed, in a memorandum of understanding, that Colombia will have 64-percent control and Peru will have 36-percent control in the new exchange. Initially, the companies that trade in the new market will have a cumulative value of $378bn. The merger proposal still needs to be approved by regulatory bodies as well as the exchange boards, but if all goes well, the merger may occur as early as March.

Both Colombian and Peruvian officials are optimistic about the merger. The president of the Colombian exchange expects the merger to strengthen both countries’ positions in the international economy. By combining the two stock exchanges it will allow investors to more easily trade within both exchanges and will simplify a future merger with Chile.

Later this year, Colombia, Peru, and Chile plan to integrate trading between their stock markets in a project called Mila, which is separate from the Colombian and Peruvian merger. Nonetheless, the Colombia-Peru merger is expected to strengthen the three-country stock-market integration when it occurs. Mila will be Latin America’s second largest stock exchange behind Brazil. It will have 563 companies with an estimated worth of $614 billion. Similar to the merger between Colombia and Peru, Mila will make trading between the three stock exchanges easier. Shares will be cross-listed on each exchange, allowing investors direct access to the other markets. Officials also say that the integration will make it easier for companies to receive financing in the three countries.

If tax rates in Columbia, Peru, and Chile were not standardized for locals and foreigners, Peruvian investors would be at a disadvantage because investors in the other countries would receive a lower tax rate on their gains. Therefore, near the end of 2010, Peru’s stock market threatened to withdraw from Mila if the Peruvian Congress did not agree to more favorable tax rates for capital gains. However, in a late Congressional session, Peruvian lawmakers voted to standardize the tax at 5 percent for locals and foreigners alike. Before, other Latin American countries had lower capital gains tax rates than Peru. The chairman of the committee explained that the favorable tax rate will help create symmetry among the three exchanges.

The heads of the stock markets stress the large scale of the two merger projects and recognize the obstacles ahead in completing them. For example, the test period for Mila was extended another six weeks because of the capital gains standoff in the Peruvian congress. The complexity of the project, as well as the amount of technology needed to complete it, will also cause further delays. Although these mergers will face obstacles, the presidents and managers of the exchanges remain optimistic about the integrations and foresee them benefiting each country.

Discussion: Will this move make Peru, Colombia and Chile more competitive on a global scale, or only more competitive within South America? What other issues may delay the integrations?

Japan’s Credit Rating Downgrade a Symptom of Continued Economic Woes

Sources:

Asahi: Japan's Sovereign Rating Lowered a Notch

FT: S&P Downgrades Japan on Debt Worries

Bloomberg: Japan’s Credit Rating Cut to AA- by S&P on Debt Load

NY Times: S&P Downgrades Japan as Debt Concerns Spread

This week Standard & Poor’s downgraded Japan’s government bond ratings because of insufficient government efforts to improve Japan’s economic performance and decrease national debt. Over the past decade, Japan’s economy has struggled with deflation and anemic economic growth. Japan’s total sovereign debt now stands at $11 trillion (943 billion Yen) and the downgrade announcement comes at a time when Japan is attempting to overhaul its tax and social security systems.

Standard & Poor’s lowered its rating of Japan’s long-term government bonds from AA to AA-. A bond rating reflects the quality and safety of a bond and a downgrade indicates that investors have less confidence that a borrower will meet its repayment obligations. Once a country’s debt has been downgraded, investors normally require a country to pay higher interest rates to account for the increased risk.

Japan differs from many countries in that 95 percent of its government bonds are owned by Japanese citizens and institutions, so even if the downgrade frightens foreign investors, there will likely be little impact on its bond market. In contrast, at the time of Greece’s crisis, 70 percent of its sovereign debt was held by foreign investors. Because of this distinction, Japanese markets have reacted calmly and media attention has been relatively light compared to other recent government bond downgrades.

Credit rating agencies themselves have been criticized in their handling of sovereign debt ratings. The Secretary General of the Organization for Economic Cooperation and Development (OECD) complained that ratings agencies exacerbate the economic instability of the countries they rate by quickly downgrading without warning and not working together with governments to share the concerns of bond investors. This is also not the first time Japan’s rating has been cut. In 2002, its credit rating was significantly cut, but the downgrade had no effect on long-term interest rates.

Discussion Questions:

1. Are bond ratings agencies in effect giving policy prescriptions to lawmakers when they downgrade ratings?
2. What other factors contribute to the media giving European bond downgrades much more attention than Japan’s?

Youth Unemployment Highest in the World for MENA

The Nation: Jobless Youth Tell of Their FrustrationsCNBC: Bleak Jobs Picture in the Middle EastThe Nation: Davos Focus on Jobs for YouthGulf New: Middle East Joblessness World’s HighestDeloitte: Wanted: A National Labor Force

On January 25, 2011, the International Labor Organization (ILO) released the Global Employment Trends 2011 report, finding that the Middle East and North Africa (MENA) region has the highest unemployment rate in the world, at 10.3%. The unemployment situation is exacerbated for youths between the ages of 15–24 who also face the highest rate of unemployment in the world, at 23.7% in the Middle East and 23.8% in Northern Africa, according to a November 2010 study by Deloitte. Even those that are employed receive meager wages. According to an ILO study, 40% of the Middle East working population and 32% of the North African working population live on less than $2 a day. Furthermore, the unemployment numbers do not reflect the number of youths who are unemployed and have given up looking for work.

As highlighted at the World Economic Forum in Davos, lowering the alarming level of youth unemployment is essential for increasing social inclusion and future economic security in the region, given that youths comprise a staggering 60% of the regional population. While the issue of job creation is not new, recent political unrest in Tunisia and Egypt have drawn attention to the problem. Commentators like Monica Malik, Chief Economist at EFG-Hermes, have stated that youth unemployment is the “biggest challenge facing the region.”

There are inherent inadequacies in the growth and development of the labor market in MENA countries. While the region as a whole faces similar concerns, MENA can be divided into two groups: (1) countries that have an accumulation of wealth driven by oil revenues (including Bahrain, Kuwait, Oman, Saudi Arabia, Qatar and UAE) and (2) import countries that do not have the oil-revenue buffer (including Egypt, Jordan, Lebanon, Morocco, Syria, and Tunisia). In oil-exporting countries, job creation has grown at a constant rate of approximately 100,000 jobs annually, yet unemployment for nationals remains high because many of those jobs are filled by expatriates. While oil-exporting countries have the resources to invest into job creation, the existence of oil revenues does not necessarily translate into lower youth unemployment rates. For example, Saudi Arabia, a large exporter of oil, has a youth unemployment rate of 25.9%.

Another problem for both oil importing and exporting countries is that the skills required by private companies do not match those acquired through the vocational and higher education systems. With university graduates remaining unemployed for an average of three years after graduation, both governments and employees must make efforts to lower unemployment rates. Private companies should provide skills guidance while governments must make greater efforts to provide for educational opportunities that match employer needs.

Discussion Questions
1. Do companies operating in the region have a responsibility to create opportunities for employment to nationals or should the government of the respective country be largely responsible?

2. What government programs initiatives would be most effective in eradicating youth unemployment?

3. Should oil-exporting countries assist non-exporting countries in developing youth employment opportunities, to avoid regional disruption?

The Global Recession Forces U.S. States into Financial Dire Straits: Is Bankruptcy the Right Solution?

Sources:

WSJ: State Bankruptcy Is a Bad Idea

WSJ: A Bankruptcy Law—Not Bailouts—for the States

WSJ: Reports of Looming Municipal Defaults Are Overstated, Study Says

FT: California’s Potholed City Presents View of the Future

NYT: A Path Is Sought for States to Escape Their Debt Burdens

Few individuals or entities have managed to escape financial hardship brought about by the current global economic crisis. State and local governments in the U.S. are no exception. A consistent decline in tax revenues and a fiscally detrimental habit of overspending have led some states to the brink of insolvency. Simply put, the states’ tax revenues have not been able to keep up with the cost of providing public services, such as law enforcement, education, health care, etc.

Some experts have identified bankruptcy as a possible solution. They claim that it is the only viable means through which states can restore their solvency. The pro-bankruptcy commentators insist that allowing states to file bankruptcy is the only way to fundamentally renegotiate union contracts and restructure states’ bond debt and their unsustainable pension benefits. Additionally, these experts argue that bankruptcy is the sole alternative to a federal government bailout of insolvent states.

Currently, however, the bankruptcy code does not allow states to declare bankruptcy. Some consider such a legislative change unnecessary anyway because states already have the means for bridging their budget gaps by instituting layoffs, freezing wages, and even cutting wages through involuntary furloughs. The availability of these alternatives in cutting costs puts pressure on unions to either make concessions or see their members unemployed.  

Before politicians and scholars on both sides of this issue take a stand, they should study closely the example of the City of Vallejo, California, which declared bankruptcy in 2008 and is planning to emerge from it this year. Unlike states, cities can declare bankruptcy under the present version of the bankruptcy code. Vallejo discovered, however, that even in bankruptcy public pension agreements are difficult to modify. Additionally, the city’s legal bills are nearing $10 million. Vallejo’s experience should serve as a warning for those states that see bankruptcy as an easy way out of their fiscal problems.

Discussion Questions:

1. Could politicians at the state level find the political will to impose fiscal austerity, even if such a measure would endanger their re-election? If not, do we have the right people in office?

2. Allowing states to declare bankruptcy seems contrary to the idea of fiscal responsibility. Should Congress give states the option to file bankruptcy or should it teach them a lesson they will surely remember?

Mexico and U.S. Move Closer to Agreement on Cross-Border Trucking

Sources:
Bloomberg.com: Mexico: US 'Really Put Out' by Retaliatory Tariffs
Bloomberg.com: Pig Farmers May Top Truckers' Gains on Mexico Border Rule
Eluniversal.com.mx: EU da nueva opción en tema transporte
NYTimes.com: U.S.-Mexico Trucker Dispute Takes a Step Forward

When the North American Free Trade Agreement (NAFTA) came into force on January 1, 1994, the parties failed to resolve a contentious provision allowing the free flow of truckers across borders. Without such an arrangement, Mexican truckers were not allowed to take their shipments all the way from Mexico to their final destinations in either the United States or Canada. As of today, Mexican truckers are still not allowed to do this, but Mexican President Felipe Claderón announced recently that President Obama has drafted a new proposal to resolve the long-standing dispute.

The current shipping system is highly inefficient. Mexican truckers are only allowed within 25 miles of the U.S.-Mexico border, at which point they must detach their load so that an American trucker can take it the rest of the way. Mexico hopes that allowing Mexican truckers to enter the U.S. will increase efficiency and decrease the cost of trans-border shipments. The lower transportation costs would make Mexican goods cheaper and therefore more competitive in the U.S. and Canadian markets. Ultimately, Mexico believes this will increase its exports while creating quality jobs for Mexicans.

Despite the obvious benefits for Mexico, the U.S. has consistently balked at any proposals to solve the problem. It complains that Mexican trucks and drivers do not meet U.S. safety and environmental standards, but most observers say that politics are the cause of the delay. The Teamsters truckers union in the United States, one of the largest and strongest supporters of the Democratic Party, has vehemently (and so far successfully) opposed any greater access into the U.S. for Mexican truckers by raising not only the safety and environmental concerns raised by politicians, but also the concern that American trucking jobs will be lost to the cheaper Mexican truck drivers. The Union has even claimed that the cross-border trade in drugs and the flow of illegal immigrants will increase if the provision is put in place, even though it does nothing to reduce border security standards.

The dispute has flared up at various times since the mid-1990s, including when Mexico sought arbitration under NAFTA’s dispute settlement procedures (read the decision here). Though the panel determined that the U.S. was in breach of NAFTA for having a blanket ban on applications for licenses from Mexican-owned trucking firms, the decision caused little, if any, change.

In 2007 the U.S. started a pilot program allowing a small number of Mexican truckers to enter the country with the hope that it would eventually become a permanent solution. Only 157 Mexican truckers participated in the pilot program before a Democrat-led Congress terminated it in 2009 by voting not to include funding in the annual budget. Mexico responded 6 days later by placing retaliatory tariffs on nearly 100 U.S. products coming from 40 different states. The tariffs are estimated to cost U.S. exporters $2 billion per year. President Calderón says that the tariffs will remain until the U.S. allows Mexican long-haul truckers to enter the U.S.

These tariffs have caught the attention of U.S. lawmakers. Congressmen from Texas have been clamoring for a resolution to the dispute to stop the damaging effects of the tariffs on Texan exports. This argument is surely more persuasive today than ever after President Obama announced a goal of doubling U.S. exports by 2014 in his State of the Union Address; a goal that will be difficult to meet as long as significant trade barriers exist between the U.S. and one of its largest trading partners. Nevertheless, President Obama still must confront the Teamsters Union and its claim that American truckers will lose jobs if they are forced to compete for positions with cheaper Mexican drivers—an equally strong argument when the national unemployment rate hovers just under 10%.

Even if Mexican truckers were allowed to ship across the U.S., many Mexicans are doubtful there would be any immediate impact on trade because it is hard for Mexicans to obtain diesel fuel and trucks that meet U.S. standards. President Obama’s proposal also includes a provision requiring that Mexican truckers learn English and meet U.S. licensing requirements, neither of which can happen overnight. Ultimately, this new proposal is merely a new beginning to a lengthy negotiations and implementation process. NAFTA’s ultimate goal of completely free trade in North America is still years away from accomplishment.

Discussion:
1) For which country is this issue more important? Why?
2) How might an agreement on this highly contentious issue improve U.S.-Mexico relations, specifically in terms of NAFTA compliance? How might a failure to agree on this issue negatively impact those relations?
3) The U.S. has delayed resolution of this issue from the beginning of NAFTA. Why then did it even agree to include the provision in the trade agreement in the first place?
4) How might gains in U.S. exports make up for any potential job losses to the Teamsters?
5) If the two countries are still unable to come to an agreement, what more should Mexico do to push its agenda, considering it already used retaliatory tariffs?

Canada Debates Whether to Establish a National Securities Regulator

Sources:
Bloomberg: Canada Needs Single Regulator, IMF’s Hockin Says
Montreal Gazette: Canada Will Suffer Without a Sole Regulator: IMF
The Globe and Mail: Lack of National Regulator Cited as Investment Barrier
CBC News: Banks Call for Single Securities Regulator
The Financial Post: Quebec's Court of Appeals Weighs in on National Securities Regulator Issue

This week, Canada’s executive director at the International Monetary Fund (IMF), Tom Hockin, expressed growing concern over the country’s financial stability. Canada currently does not have a national securities regulator. This is uncommon for a major industrialized country; Canada is the only G7 nation that lacks a federal regulator. Currently, the twelve provinces each have their own capital market regulating body. Critics say the system promotes inconsistent policies and creates problems and complicates the monitoring and assessment of capital flows.

In 2009, the Canadian government appointed a committee to investigate whether the country should create a securities regulator. The committee recommended that an oversight body be established, concluding that a federal regulator would reduce costs and boost the confidence of both investors and issuers. The committee also believed that a federal regulator would be able to manage broad systemic risks better than the current system, enabling the nation to respond better in the event of a financial crisis. The IMF has expressed concern about Canada’s ability to respond to a financial crisis without a federal oversight body. It believes that a single federal regulator would lead to better enforcement of the securities laws and more accountability. Both the committee and the IMF also agree that establishing a federal regulator would attract more international investors in Canada’s capital markets.

The committee’s report prompted Canada’s federal government to advocate for the creation of a national regulating body. Last May, Canadian Finance Minister, Jim Flaherty drafted the Canadian Securities Act, which would establish a federal oversight body. Flaherty then submitted the bill to the nation’s Supreme Court for a ruling on whether it is constitutional. The Supreme Court is expected to start hearing arguments in April on whether the federal government has the authority to create a securities regulatory body.

Three of the twelve provinces, Quebec, Manitoba, and Alberta, have been adamant in their opposition to the creation of such a regulating body. Several other provinces have been non-committal over the federal government’s plan, and only two, Ottawa and Ontario, have been vocal in their support. The opposing provinces argue that the existing regulatory system is effective and warn that allowing the federal government to establish a regulatory would set a dangerous precedent of federal intrusion into the provinces’ jurisdiction. If the Supreme Court rules that the federal government does have jurisdiction to establish a regulatory body, the government would like to have it fully operational by July of 2012.

Discussion:
1. Should Canada establish a securities regulatory body at the federal level?
2. What are some advantages of Canada’s current regulatory system?

China Increases Economic Ties with Central Asia

Sources:
NYT: China Quietly Extends Footprints Into Central Asia
FT: China: Beijing Puts Its Huge Piles of Cash to Work
China Daily: Central Asia Benefits from Peaceful Development Policy
Central Asia Newswire: China's Support for Euro Good News for Central Asia

China has been showing interest in increasing its economic stake in Central Asia. Trade between the five Central Asian nations—Kazakhstan, Tajikistan, Uzbekistan, Turkmenistan, and Kyrgyzstan—and China has risen from $527 million in 1992 to $25.9 billion in 2009. Several recent projects reflect these growing ties. President Hu Jintao of China visited Turkmenistan in 2009 to symbolically open a gas pipeline between the two countries, Kazakhstan has agreed to increase crude oil exports to China with a pipeline that has given Kazakhstan an alternative to Russia, and Tajikistan is constructing a trade depot to accommodate increased import of Chinese goods into the region.

These economic advances may signal that China is looking for diplomatic ties to Central Asia. With China’s fast expansion, it will look seriously at oil and gas reserves located in countries geographically closer and that have been more politically stable than some Middle Eastern oil-producing countries. Alliances and economic development between Central Asia and Xinjiang, the western region of China that borders Central Asia, would also benefit China politically. Increased trade and employment in China’s western provinces may help quell unrest in Xinjiang between Uighurs, the Muslim population, and the ethnic Han.

The strengthened relationship between Central Asia and China benefits both parties, but is in no way exclusive. Central Asian consumerism is rising and the region needs the economic investment that China offers. However, the region still needs resources and technology that come from Europe and the U.S., two regions that have expressed interest in Central Asia’s oil and gas resources and its strategic military location. The United States uses Central Asia as a staging area in its war efforts in Afghanistan, and the region is generally a transportation hub between Europe and Asia.

China concurs with Central Asia’s view of the relationship—the country is not diminishing its relationship with other emerging nations in favor of Central Asia. China has increased its exports to Brazil, Russia and India, with heavy direct investment in Brazil. It is seeking to diversify its investments away from the U.S. dollar amid fears of inflation, and is not restricting its investment opportunities to any region.

Discussion Questions:
1. Could China’s interest in Central Asia encourage Europe and the U.S. to increase competition for the region’s resources?
2. What are the benefits to China in developing healthy trade with its geographic neighbors?

Indian Inflation

Sources:
Economist: Bringing Tears to Indians’ Eyes
Bloomberg: Bank Bonds Off to Worst Start since 2007 as Inflation Rises: India Credit
Economic Times: Indian Long End OIS Rise Tracking Bond Yields

India’s economy is slated to grow at 9% of GDP for the next two years; a great achievement for what is still a developing nation. Nonetheless, the big economic and political problem in India is inflation. India is an anomaly as many nations, especially the rich ones, are concerned about the opposite problem: deflation. Even when India’s 8.4% inflation rate is compared to other developing nations it is still high.

However, India is not a nation plagued by constant high inflation. In fact, wholesale price index (WPI) inflation was negative year-on-year in June and July last year and was below 2% for every month between March and September. Inflation is more volatile in India, but economists do not know why this is.

The increase in inflation is affecting the Indian bond market as Indian banks’ dollar-denominated bonds are heading for their worst January since before the credit crisis. Indian consumers are buying gold and property; two commodities that are inflation resistant. Bonds are unpopular in inflationary environments as inflation can make the real interest− rate returns on the bonds very low or negative in some cases. As market interest rates rise with inflation, the value of existing bonds falls because investors can get higher returns on new issuances. Thus the value of older issuance bonds goes down.

As bonds are less attractive, Indian debt has become more expensive to finance because consumers demand higher interest payments in an inflationary environment. A ten year U.S. Treasury Bill is 482 basis points lower than a ten year Indian bond, up from 463 at the end of December. One basis point equals 0.01%, so if the difference in interest rates is 2.5% between two bonds, financial analysts say the difference is 250 basis points. If investors choose to invest in gold and property instead of bonds, they could cause a liquidity crunch in the banking sector because less money is available.

Although India faces a seriously inflationary threat, there is political and economic tolerance for higher inflation. Real rates of economic growth are high, population growth is slower than ever before, and real incomes are rising quickly enough to compensate for inflation. Indian policymakers fear they will debilitate India’s recovery from the global economic crisis if they increase interest rates to lower inflation by decreasing the money supply. K.K. Chakabarty, deputy governor of the Reserve Bank of India, said that inflation was a difficult but manageable situation.

Discussion:
1. India is a huge market of consumers and producers. What effect would increased inflation have on western investment in India?
2. If India does face a liquidity shortage, then will this shortage spread to other nations, or even the rest of the world?

In the U.K., Debate Over the Future of the Banking Sector Wages On

The Guardian:Banks Go On the Defense as Commission Gears Up
The Guardian: Nick Clegg Signals Support For Banks Breakup
FT: Clegg Calls For Overhaul of UK Banks
Finance News: Talks Between Government and Banks to Set Lending Targets are Delayed

U.K. Deputy Prime Minister Nick Clegg recently said that he would support the break up of British banks into a high-risk sector and a low-risk sector. Clegg said that there is a "strong case" for insulating high-risk, casino-type banking institutions from low-risk, High Street retail banking. This separation would help prevent banks from becoming "too big to fail" and protect the U.K. economy from having to bail out the banking sector again. Clegg's comments represent the most drastic call for the overhaul of the U.K. banking sector since he took office.

Clegg's remarks came on the heels of a speech from Sir John Vickers, the chairman of Britain's Independent Commission on Banking, which is currently conducting an independent review of the banking sector in the U.K. The Commission was put in place to evaluate the structural stability of the banking sector, and has a mandate to consider whether the universal banks (firms that combine retail and investment branches) need to be altered to prevent a future taxpayer bailout. The commission will also analyze whether there is enough competition in the banking sector, currently dominated by Lloyds Banking Group. It will make its final reform recommendations in September, 2011.

Vickers suggested that he would recommend an overhaul of the banks, though he stopped short of condemning high-risk investment banking. Rather, he suggested that retail banking operations could be required to make structural changes that would make them better equipped to handle a future crisis. Vickers further stated that it is unlikely that the Commission will propose radical forms of limited-purpose banking, although large banks may still be concerned that Vickers' comments will prompt the government to to require banks' retail operations to hold more capital, which could be costly.

HSBC executive Mike Geoghegan has already spoken out against the speech, challenging the logic behind the suggestion that larger banks should be required to hold more capital. Rather, Georghegan argues that capital requirements should be linked with the riskiness of the business model, not the size of the bank. Other investment banking executives have spoken out to defend their practices, including outgoing Barclays executive John Varley, who claims that Barclays does not do "the work of a casino," but rather, provides a "real economy service."

The debate over the future structure of U.K. banks is also being waged on another front. The government recently announced that discussions with the banks, the so-called Merlin Project, have reached a stalemate. These discussions are the government's attempt to get banks to agree to lending targets and pay disclosures in order to resolve some of the perceived problems that caused the financial crisis in 2008. One major source of disagreement has been David Cameron's vision of a "Big Society Bank" which would fund social enterprises and charities. However, the talks will likely resume next week.

Discussion Question: Should the government split up U.K. banks to help minimize risk? If this is the best move for the British economy, will the government be successful in achieving it?

Mexico Receives the Largest Line of Credit Ever Issued by the IMF

Sources:
Financial Times: IMF Approves $72bn Credit Line for Mexico
Bloomberg Businessweek: IMF Extends Mexico Credit Line to Record $72 Billion
NASDAQ: IMF Approves Expansion of Mexico Flexible Credit Line

On January 10, the International Monetary Fund (IMF) approved a $72 billion line of credit to Mexico. The credit line, good for two years, is the largest of its kind ever issued by the IMF. The new line will replace a previously issued one-year $48 billion line of credit that is set to expire in April of this year. The line of credit that Mexico is getting is a new type of credit arrangement called a “Flexible Credit Line,” which was established by the IMF in 2009 and is reserved for countries that are pursuing what the IMF considers “strong” economic policies.

Although Mexican officials have stated there is no current need to draw on the line, the line of credit will give Mexico an additional source of reserve assets in the event that additional funds are needed to finance obligations to external creditors arising from possible balance-of-payment problems. Reserve assets, like this line of credit, allow nations to service debt that is denominated in other currencies by giving them the means to purchase the foreign currency.

Assistance from the IMF can sometimes indicate economic trouble, but the issuance of the line is not a signal of weakness in the Mexican economy. Indeed, Mexico has experienced relatively strong economic growth recently. After suffering an economic contraction of over 6% in 2009, the Mexican economy is projected to have grown by more than 5% in 2010. Nevertheless, there are concerns that the Mexican economic recovery is a fragile one, especially given the economic uncertainty that exists in the rest of the world. Mexican officials are particularly concerned about volatile foreign capital flows and pressures in certain industrialized countries to correct fiscal deficit problems. Should these problems cause foreign investors in Mexico to remove their funds (a phenomenon called “capital flight”), it would flood the foreign exchange market with pesos as those investors repurchase their home currencies, which would result in a depreciation of the peso. A cheaper peso means that it will be relatively more expensive for Mexico to pay any foreign denominated debts. Thus, to prevent an excessive devaluation of the peso, the credit line exists to provide Mexico with a ready source of emergency funding to intervene in the foreign exchange market and thereby stabilize the value of the peso and the Mexican economy.

Aside from the record level of the issuance, the line of credit is noteworthy because of its potential impact on trade relations. This additional source of funding has reinvigorated public confidence in Mexico’s ability to handle its debt obligations and stabilize its economy. This has resulted in an appreciation in the Mexican peso versus other currencies. The appreciation of the peso tends to have a positive impact on the current account (i.e. a nation’s net exports) balances of Mexico’s trading partners, including the U.S., since it makes it relatively cheaper for Mexico to import goods and services from those countries.

Discussion Questions:
1.) An IMF report indicated that if Mexico fully utilized the line of credit, the impact on the IMF’s liquidity would be “very large,” and would thus hamper its efforts to meet the funding needs of other nations. Given Mexico’s relatively strong economic performance and its stated intention not to use the line, is it a wise decision by the IMF to extend Mexico the largest line of credit it has ever issued? Wouldn’t those funds be put to better use if they were reserved for countries that have not performed as well?
2.) The flexible line-of-credit arrangement that Mexico received from the IMF is one that the IMF will only issue to those countries that are pursuing “good” economic policies. Therefore, a country that wishes to receive this funding source must necessarily adopt policies that the IMF has determined to be “good.” Does this precondition amount to a strong-arm tactic by the IMF to induce countries to adopt policies that those countries may not have adopted otherwise?

One Year After Earthquake Reconstruction for Haiti Looks Slow

Sources:
BBC.com: Haiti PM Criticises Post-Earthquake Rebuilding Efforts
TheWashingtonPost.com: Foreign Aid Keeps the Country from Shaping Its Own Future
CIRH.ht: Interim Haiti Recovery Commission, Mission Statement
CNN.com: Charges Filed Against ‘Baby Doc’ Duvalier in Haiti
Economist.com: The Year of Surviving in Squalor

Ten days ago marked the one-year anniversary of the 7.0 earthquake that rocked Haiti, killed an estimated 250,000 thousand Haitians, and left over a million homeless. The international community responded by pledging $5.8 billion toward the reconstruction of Haiti. However, one year after the earthquake, not much has changed since that devastating day. Nearly one million Haitians remain homeless and are living in tents sprawled across the nation’s capital, Port-au-Prince. If anything, the situation has worsened given the cholera outbreak that claimed the lives of more than 3,000 Haitians and infected more than 150,000 others. The nationwide rioting following the failed December 2010 elections and the recent return of former Haitian dictator, “Baby Doc” Duvalier, only highlight the Haitian government’s inability to cure current problems and free itself from past problems.

Haiti’s unstable government has deterred investors and donors from investing in the country because they dont know if the funds will be properly managed and allocated to areas that need it most. The unstable government has earned it the moniker “Republic of NGOs,” connoting how investments into Haiti bypass the government and go directly to support NGOs in the country.

Many blame the unstable government for why over half the pledged aid has not been delivered to the country. Thus far, the majority of outside funding has gone to pay the country’s debt and not for reconstruction efforts. In an effort to speed reconstruction and build investor confidence, the Haitian Government created the Interim Haiti Recovery Commission (“IHRC”) by presidential decree on April 21, 2010. Co-chaired by Haitian Prime Minister Jean-Max Bellerive and former U.S. President Bill Clinton, the goal of the IHRC is to develop a reconstruction plan for Haiti by assessing the needs and investment priorities of the country, coordinating reconstruction efforts, and allocating donor investments accordingly.

Unfortunately many criticize the IRHC’s action plan as “more of the same” old policies focused on making Haiti a source of cheap labor in the region and reducing protective tariffs on imported goods—policies Haitians claim failed to work for the country in the past. Critics further allege that although the IHRC is comprised equally of both foreigners and Haitian members, Haitians are largely left out of planning reconstruction policies. Without incorporating Haitian people into the creation of a plan for reconstruction, many believe foreigners will encourage policies that continue to fail. However, some see signs of hope. Pamela Cox, a World Bank official who sits on the IHRC, claims that although IHRC efforts toward reconstruction should have started earlier, reconstruction is indeed happening and the economy has “held up.”

Discussion:
1) IHRC member and World Bank official, Pamela Cox claims that the commission has made progress toward reconstruction. Given that nearly 1 million people are homeless and living in tent shanty towns, should Haitians continue to trust the commission to provide actual and substantial reconstruction for the country?2) There has been rioting in the country over the December elections. Should funding and aid continue to bypass the Haitian government and go directly to NGOs while the state of the government is so precarious?

Brazil’s Government to Take Steps to Curb Appreciation of Currency

FT: Rousseff to tackle sharp rise in the real
FT: Brazil continues to wrestle with dilemma over interest rates
WSJ: Brazil Rates Are Focus as Inflation Edges Higher
Economist: Waging the currency war

The value of the real, Brazil’s currency, rose 4.6 percent in 2010 after a 34-percent gain against the dollar in 2009. Although the strength of the currency makes buying foreign products cheaper, the appreciation is being blamed for hindering Brazil’s manufacturing competiveness because it makes exports more expensive. While analysts expect a drop in the currency, they warn against expectations of a large decrease in its value against other currencies. Therefore, Brazil must act now to stop the appreciation in its currency.

Issues affecting Brazil’s currency are high interest rates, rising inflation, and high government spending. In the past, Brazil lowered its interest rate to 6 percent during the first term of President LuizInácio Lula da Silva. However, in his second term in 2008, government spending increased dramatically to fight the global financial crisis and continued throughout 2009, causing interest rates to rise. Another cause of the rising interest rates is the country’s low savings rate, a factor that keeps Brazil’s economy dependent on foreign capital.

Although Brazil is currently dependent on foreign investment, the government is taking steps to deter foreign capital inflows. Brazil introduced and then raised a tax on bonds bought by foreigners. While this strategy seems counterproductive, Brazil hopes to decrease the amount of foreign capital in its reserves, thereby decreasing the value of the real and encouraging its exports. Economists warn that this strategy is dangerous if the move discourages foreign investors completely. Instead, they suggest that the government rein in its spending to solve this problem.

Even though interest rates are a prominent issue, the central bank, with de facto autonomy from the government, continues to raise interest rates due to the high inflation and government spending. Analysts expect an increase from 10.75 percent to 11.25 percent after a two-day meeting that ended Wednesday. Although rate increases are normally an appropriate way to fight inflation, some policymakers argue that decreased government spending would be more beneficial. After the presidential election last year, the central bank published a study that found that most economists who had studied Brazil thought that trimming the government budget by one percentage point of GDP would have the same effect on inflation as increasing interest rates by one percentage point.

When she took office on January 1, 2011, Brazil’s president, DilmaRousseff, promised to make dealing with Brazil’s appreciating currency a priority of her administration. Although the government has taken some steps, neither she nor her administration has offered a concrete and long-term plan of how to decrease spending and by how much. Many critics fear that because the majority of her economic advisers came from the previous government, there will not be any real changes.

Although the government introduced capital controls to contain appreciation of the real, the measures will only have a temporary effect. Brazil’s finance minister (whom Rousseff appointed from the previous administration) says the government is decreasing interim budget spending by one third and is planning more cuts to fight appreciation. Many economists say real and lasting budget cuts are necessary.

Discussion Question: Should the Brazilian government address dangerous levels of foreign capital inflows by cutting government spending or by imposing capital controls?