Asian Development Bank Extends Aid to India

ADB: Railway Sector Improvement Project: India
ET: Asian Development Bank to Provide a $150 million Loan to Indian Govt to Improve Rail Freight Services
India Government Bureau: India Gets $150mn ADB Loan for Rail Development
News Track India: Asian Development Bank Provides 67.6 Million Dollar Loan to Bihar Agribusiness
PIB: ADB Extends $150 million Loan to Develop India’s Railway System

On July 11, the Asian Development Bank (ADB) announced that it had granted a loan of $150 million to India as the first part of the Railway Sector Investment Program, to improve passenger transport routes and rail freight services. The total cost of the Railway Investment Program is $1.14 billion, of which the ADB will provide $500 million in four installments while the government of India will contribute a total of $644.6 million.

The Indian government will use the loan to lay down double-track line for about 840 kilometers (km) of rail routes and set up electricity through about 640 km all to help improve its rail services along some of the busiest freight and passenger routes in the country. The program will reduce fuel consumption and pollution as the tracks will allow easier passage of freight trains, while the electricity lines laid along the routes will help lower the amount of fuel needed and the emissions from using fuel, because electricity will power some items that had been powered by fuel previously. The program will also enhance railroad safety, as there will be more available tracks to use along the busiest routes so trains will not be congested into small areas of track. In addition, the program will increase the capacity of railway tracks as there will be double track lines laid, meaning that double the amount of traffic can transport goods along the lines. The increased capacity of the Indian railroad system to carry products and people will benefit consumers and producers of goods and services because it will make it easier for the goods and products to get to other areas of the country in a faster and more efficient manner.

The program is also set to improve energy efficiency, reliability, affordability of travel and environmental sustainability along some of the busiest rail travel routes. The program will improve energy efficiency because it will shift a large amount of the transportation of goods from road to rail, which is more environmentally friendly as a railcar can take bigger loads, which means fewer emissions into the environment. The program will improve reliability on rail travel routes because the laying of double tracks along busy routes will lead to less trains waiting to use certain tracks. The program will also improve affordability of travel because more trains will be able to travel along the routes since there is more track, therefore there is not as limited a number of tickets available each day. Thus, more trains means more tickets available for sale; therefore, consumers will be able to find cheaper seats as rail companies lower their prices to fill the extra seats available.

A $300,000 portion of the program provided by ADB will also promote sustainable transportation--a means of transport with low impact on the environment--by monitoring carbon emission reductions. The reductions in carbon emission will come from the shifting of a large amount of the transportation of goods from road to rail. The Railway Sector Investment Program will also pursue carbon credits, or a tradable certificate representing the right to emit one ton of carbon dioxide, under the United Nations Framework Convention on Climate Change (UNFCCC). The UNFCCC is an international environmental treaty was aimed at stabilizing greenhouse gas concentrations in the atmosphere at a level that is not dangerous to the climate of Earth.

The ADB supported the project because it believed that efficient transportation is essential for achieving higher levels of economic growth in India. The higher levels of economic growth will help sustain poverty reduction in the country and will contribute to more production and employment opportunities in India. Thus, the ADB is aiding India in modernizing their infrastructure and becoming more competitive in the global economy.

Potential Future Consequences for Venezuelan Spending Spree

Sources:

Bloomberg: P&G Bracing for ‘Large’ Venezuela Devaluation After Election

Reuters: Venezuela Inflation Slows in July for Seventh Month

WSJ: Venezuela Faces Economic Hangover

Over the past year, Venezuelan President Hugo Chávez increased spending in various social programs, including free government housing and cash stipends for the elderly and pregnant women. According to government officials, these spending tactics contribute to the nation’s forecasted 5% gross domestic product (GDP) for 2012—generally, government spending boosts economic activity because when the government spends, it purchases good and services, which raises the demand for such goods and services. To meet this demand, companies create more jobs, which leads to more income for consumers, and thus, more economic activity. President Chavez encourages spending for social programs in hopes of rallying support for his campaign before the country’s October election. However, analysts such as Boris Segura—of the international financial consulting firm Nomura—are skeptical of the future repercussions that this spending spree could have on Venezuela’s economy.

Analysts like Segura are concerned that President Chávez’s spending spree will affect the country’s debt as well as currency valuation. Although the exact allocation of government spending is unknown due to a lack of transparency in the government, analysts recognize that the recent spending spree increased Venezuela’s debt. Analysts expect the debt-to-GDP ratio to reach 52% by the end of the year, which is almost double the 23% debt-to-GDP ratio from 2008. Even though Venezuela never defaulted on its debt obligations under President Chávez’s leadership, the growing debt harms Venezuela’s credit rating—credit ratings affect how much an entity must pay in interest on their issued debt—because an entity with a large amount of accumulated debt is generally less able to repay that debt. According to both Standard & Poor’s and Fitch,—credit rating agencies—Venezuela’s current investment grade is a B+, meaning that adverse circumstances such as poor economic conditions could affect the country’s ability to meet debt obligations. Due to the country’s recent spending spree and increased debt, Fitch put Venezuela’s rating on review for a potential downgrade. A lower credit rating would hurt the country’s ability to obtain more money (debt) because investors would consider Venezuela to be a riskier investment and the country would have to offer investors higher interest rates (pay more money to investors) to be able to continue borrowing.

Due to this growing debt, Venezuela may need to devalue its currency—lower the value of the currency—to help the country service its debt; that is repay the interest and principal of a debt, . According to a group of fourteen analysts surveyed by Bloomberg, Venezuela will devalue its currency in January 2013 from 4.3 bolivars per dollar to 6.2 bolivars per dollar. By devaluing its currency, Venezuela will earn more bolivars for its exports (instead of selling its goods and services for 4.3 bolivars per dollar, the country now sells its goods and services for 6.2 bolivars per dollar). With more bolivars, Venezuela will improve its ability to pay its debt obligations. However, devaluing the currency will also likely increase inflation— a general rise in the price levels of goods and services. This is because imports become more expensive—more bolivars are needed to purchase the same quantity of dollar-denominated goods and services (instead of paying 4.3 bolivars per dollar of goods and services, the country now pays 6.2 bolivars per dollar of goods and services). Since Venezuela imports about 75% of its consumption, devaluing the currency would likely raise the country’s inflation rate.

Based on Venezuela’s growing debt and likely devaluation of its currency, some analysts suggest that Venezuela will experience a lower GDP in 2013. Normura’s analyst Boris Segura predicts a 1% GDP loss for the country, while Bank of America Merrill Lynch expects a 3.5% GDP loss. Other analysts like Russell M. Dallen Jr., managing partner at a local brokerage and research firm named Caracas Capital Markets, do not provide a GDP prediction as the country’s spending tactics could change after the October election. Nonetheless, most analysts will agree that the current spending tactics are not sustainable because of the potential lasting effects on the country’s debt obligations and inflation rate.

New Party in Japan Fights Major Tax Increase

Bloomberg: Ozawa Forms New Japan Opposition Party in Challenge to Noda
FT: Noda Must Pull Off More Than a Tax Rise
FT: Ozawa Breaks with Japan’s Ruling DPJ
Reuters: Japan Eyes Political Shakeup After Ozawa Forms New Party
RTT: Japan's Ozawa Forms New Party Named With DPJ's Campaign Slogan
WSJ: Japan's Ozawa Forms New Party

On July 11, veteran Japanese politician Ichiro Ozawa unveiled Japan’s newest political party, Kokumin no Seikatsu ga Daiichi (“People’s Livelihoods First”).With the new party, Ozawa plans to overturn Prime Minister Yoshihiko Noda’s proposal to double the nation’s consumption tax--a tax on the purchase of goods and services. The new tax hike bill proposed by Prime Minister Noda will increase the current sales tax from 5% to 8% by the year 2014 and to 10% in 2015. Ozawa claims the proposed tax hike goes against the 2009 election promise made by the Prime Minister and his Democratic Party of Japan (DPJ) to not increase the tax for at least four years. Yet, Prime Minister Noda insists that the tax increase is essential to confronting Japan’s high debt, which was 211.7% of gross domestic product (GDP) at the end of 2011, as well as to fund rising social welfare costs of Japan.

Political opponents of the Prime Minister argue that the tax increase will discourage consumption because it will make it more expensive for consumers to purchase goods and services and thus fail to increase government revenue. Critics also point out that Japan has low economic growth and an aging population that is generating soaring social security bills, so an increase in taxes will only slow the expansion of the debt mountain. The aging population means more people are drawing social security and depending on the government for income. Since economic growth is slow, the government is able to take in less money and does not have enough money to cover all of the social security costs and the country must take on more debt to cover such costs. The International Monetary Fund (IMF) stated that Japan needs to raise the consumption tax to at least 15% to begin lowering their debt. Even with Noda’s planned tax increase, Japan’s total outstanding government debt is still set to hit a whopping 292% of gross domestic product (GDP) by April 2016.

Ozawa’s new party has 49 upper-and-lower house members, all who left the ruling Democratic Party of Japan in protest against the tax hike bill. The party also has 37 lower-house members, who voted against the tax bill in rebellion of the Democratic Party of Japan before defecting from the party. Japan is a democratic constitutional monarchy where the power of the Emperor is very limited and mostly symbolic. The power of the executive branch lies with the Prime Minister. The Japanese legislature, called the Kokkai or Diet, consists of an upper house and a lower house, like the United States legislature. The lower house is the Shugi-in or the House of Representatives and it has 480 seats with members serving a four-year term. The upper house is the Sangi-in or House of Councillors and it has 242 seats with members serving a 6-year term. Generally, decisions come from a majority vote in both houses.

The new party aims to seriously threaten the Prime Minister’s power, although public opinion polls show that voters have low expectations for Ozawa’s party. The party will be the third largest in the lower house and it has the potential to remove the Prime Minister if the party joins with other opposition parties. The defection of some members to Ozawa’s party caused the DPJ’s majority to slip to 250 in the 480-member lower house, allowing the party to keep its majority by only 11 seats. This small majority means the DPJ and the Prime Minister could have trouble gaining a majority vote as they try to push their agendas on other divisive issues like the multi-nation Trans Pacific Trade Partnership free trade agreement—a regional trade pact that Japan is awaiting approval to enter into negotiations regarding.

Although the tax hike bill already passed the lower house, Ozawa has promised to block the bill when it comes to a vote in the upper house next month. However, the DPJ and the Liberal Democratic Party have agreed to pass the tax hike bill through the upper chamber, regardless of Ozawa’s opposition. To combat such opposition, Ozawa will likely reach out to other discontented DPJ members to try to delay, if not halt, the passing of the tax hike bill. Conversely, some critics and political opponents of Ozawa say that other parties will be reluctant to cooperate too closely with him given his history of creating and breaking up political alliances. Therefore, even with Ozawa’s new party it still appears as though the DPJ will have enough support and will retain enough power to pass their tax hike in the upcoming upper house vote.
 

Lack of Commitment by European Central Bank Sends Markets Tumbling

Sources:

Christian Science Monitor: Stocks Slump as Europe Dithers

NYT: Draghi Edges Closer to Bond Purchases, but Hopes Are Blunted

NYT: Markets Tumble as Europe’s Central Bank Disappoints

WSJ: Europe’s Bank Rattles Investors

On August 2, investors sold off European assets following European Central Bank (ECB) President Draghi’s announcement that promised few concrete solutions to the European sovereign debt crisis. This selloff comes only one week after  President Draghi encouraged investors that the European sovereign debt crisis would be contained by announcing the ECB would do “whatever it takes” to save the euro.

In his statement, President Draghi announced the ECB would consider buying bonds of troubled European economies, in particular Spain and Italy, but he did not announce when or how many bonds the ECB would buy. Yields (interest rates) on ten-year Spanish and Italian bonds are currently at 7.13% and 6.3%, respectively. When countries issue bonds, they receive money in exchange for those bonds that can be used to pay off debt. However, when interest rates on these bonds are high, it becomes more expensive for these countries to pay off debt as the countries have to pay back investors more money (in the form of higher interest rates) for the bonds.

Investors hoped that the ECB would announce concrete plans to buy these countries’ bonds in the secondary market—a market where investors who originally bought the bonds from the issuing country sell to other investors. If the ECB bought bonds on this market, it would have the effect of increasing demand for the bonds and raising their prices. When there is an increase in demand for bonds, the interest rate that such bonds pay to investors goes down, which decreases borrowing costs to pay existing debt for countries such as Spain and Italy. Investors fear that if borrowing costs remain high for these countries they may have trouble paying off their debt. The worst case scenario is that these countries default (declare they cannot pay) on their debt, which could potentially lead to widespread selling of the euro as companies and investors seek less risky assets.

Investors were further discouraged by the ECB announcing that before it would enter the bond market, struggling countries would first have to ask for assistance from the ECB and such assistance would come with strict conditions for the countries to abide by. Given the political and economic climate in Spain and Italy, where the unemployment is high and citizens are growing wary of the European Union’s (EU) influence, it is unlikely that leaders in these countries will ask for assistance any time soon. If the conditions, such as austerity measures (reduced spending and increased taxes), attached to bond buying are too strict, political leaders will be reluctant to risk the political backlash that asking for assistance would entail. Moreover, the ECB has stated that the EU’s bailout funds, the European Financial Stability Facility (“EFSF”) and the European Stability Mechanism (“ESM”), must first exercise their power to buy government bonds before the ECB would step in. However, all twenty-seven member-states of the EFSF and ESM would have to approve such an action.

After the ECB’s announcement, yields on Spanish bonds rose over half a percentage point to 7.2% and the Spanish stock market fell 5.16%. The situation was not much better in Italy, as yields on Italian bonds rose by 0.39 percentage points to 6.3% and the Italian stock market fell 4.64%. The euro also fell from a four-week high against the dollar from $1.24 to $1.21 following Draghi’s announcement.

Still, there were some positive messages in Draghi’s announcement. Draghi stated that the ECB would consider ending the requirement that it be a preferred creditor, meaning that it would get paid first in the event of default, on the bonds it buys. Further, the ECB said it would make public which countries’ bonds it has bought, which would have the effect of insuring investors that the ECB would not allow the country default.

Thus, although the ECB has not decided how it would specifically help economies such as Spain and Italy, it has provided a tentative framework. Nonetheless, many investors still believe the ECB should have done more to help ease the debt crisis.

Concerns with South Africa’s Improved Unemployment Rate

Sources:

Bloomberg:  South African Jobless Rate Falls to 24.9% in Second Quarter

BusinessDay:  Jobless Rate Dip Spoiled by Shocks at Factories

Ventures:  Economists Worry Despite South Africa’s Unemployment Dip in Q2

WSJ:  Growing Pains Strain South Africa

On July 31, 2012, Statistics South Africa—South Africa’s national statistics board—reported that the nation’s unemployment rate fell from 25.2% in the first quarter of 2012 to 24.9% in the second quarter. This drop in South Africa’s unemployment rate is a positive result for the country, which has not reported unemployment rates below 20% since the end of the Apartheid (a system of racial segregation in which the white-minority held all the power) in 1994. South Africa struggled with high unemployment rates since 1994 because its economy failed to grow quick enough to support the influx of workers that the white-minority rule previously prevented from holding employment.

Even though the recent drop in the unemployment rate seems positive for South Africa, independent economist Mike Schussler and STANLIB’s chief economist Kevin Lings—STANLIB is a top investment management firm in South Africa—argue that the drop in the unemployment rate is not as strong of an improvement upon deeper analysis. The first concern these economists have with South Africa’s unemployment rate drop is that the total labor force also dropped. The number of jobless South Africans dropped by 56,000 during the second quarter of 2012. However, the number of employed South Africans increased by only 25,000. Therefore, approximately 31,000 South Africans left the labor force. Economists like Schussler worry that this drop in the labor force hides unemployed South Africans. This is because the unemployment rate only includes South Africans that actively look for employment. If the unemployment rate also included those South Africans that stopped looking for work, then the unemployment rate would likely be even higher.

The second concern with South Africa’s dip in its unemployment rate is that the mining sector of the economy created 21,000 jobs despite increased costs and decreased global demand in such sector this past year. Thus, Schussler characterizes the new job creation in the mining sector as unusual. Moreover, Statistics South Africa admitted that it is possible their survey did not accurately depict the mining sector’s unemployment rate because the mining industry in South Africa is clustered—an industry cluster is a group of interconnected firms in the same geographic location with similar markets, customers, and value chains. Due to this interconnectedness and overlap among businesses, South African mining businesses could likely report some workers twice, which would result in a more optimistic unemployment rate.

The third concern is that South Africa’s unemployment rate will not continue to improve in the coming months because of a slowing economy. The loss of jobs in both the manufacturing and trade sectors of South Africa’s economy reflect the slowing economy. The South African manufacturing sector’s total jobs fell by 2.6% or 44,000 jobs, while the trade sector’s total jobs fell by 3.0% or 91,000 jobs. South Africa remains susceptible to further job losses in these sectors as Europe and China—South Africa’s main trading partners—will likely demand fewer exports due to a continuing debt crisis in Europe and slower growth in China. The World Bank also acknowledged the slowing South African economy when it adjusted its annual growth forecast for South Africa from a 2.7% increase in GDP to a 2.5% increase in GDP.

South African leaders such as the deputy director-general of social and population statistics of Statistics South Africa, Kefilo Masiteng, recognize that the unemployment rate in South Africa is a national crisis and that the country is far off reaching its goal of reducing unemployment to 14% by 2020. However, although the drop in the nation’s unemployment rate raises concerns, South African leaders also believe that the drop in the unemployment rate signifies hope for improving South African unemployment in the future.