Tuesday, February 28, 2012
AFP: World Bank Encouraged on Myanmar
Reuters: World Bank Says Reengaging with Myanmar After 25 Years
Wall Street Journal: World Bank Supports Reforms in Myanmar
World Bank: Myanmar and the World Bank
The World Bank stopped lending to Myanmar, formerly known as Burma, in 1987 due to the country’s lack of economic and social reform, as well as failing to make payments owed on World Bank loans. The former military government recently handed power to a new civilian government that is reopening communication with the international community. The World Bank, based on Myanmar’s recent openness, has begun discussions with the country about potentially initiating developmental programs in the near future.
Myanmar, once known as the “rice bowl of Asia” due to its strong agricultural sector, had a strong economy before economic mismanagement and civil war transformed the country into one that is now deeply impoverished. For example, the World Health Organization ranks Myanmar’s health system as the worst in the world. The military government gave up power in an attempt to reverse the country’s negative economic and social trends. This new government has initiated dialog with outside countries and organizations, began speaking with the political opposition and ethnic minorities, and released some political prisoners. Additionally, to boost economic development, Myanmar is planning to offer eight-year tax-exempt status to all foreign investors.
The World Bank is satisfied with the country’s recent political and economic decisions, and is now considering new lending programs to Myanmar. However, World Bank regulations do not allow it to provide funding to any country that is behind on debt payments. Therefore, before Myanmar will be able to receive new World Bank loans, the country must first make arrangements to pay its past due debts to the World Bank. While the World Bank has not released exact numbers, financial experts estimate that Myanmar owes $700 million in arrears to the World Bank.
If Myanmar and the World Bank solve the issues surrounding Myanmar’s past debts, new World Bank projects would likely focus on improving public services (such as education and sanitation), upgrading the antiquated banking and finance sectors, and facilitating private sector job creation (for example, by promoting open communications throughout the country). World Bank programs will also support sustained peace, especially in regions where ethnic fighting has torn communities apart since the country gained independence from Britain in 1948, by developing jobs for past combatants. If the World Bank and Myanmar can agree on financial action that will improve the lives of Myanmar’s citizens, it will provide hope to the citizens of other oppressive governments that the international community is willing to help if a peaceful government can be installed.
Monday, February 27, 2012
For the first time in twenty-five years, it appears the U.S. business tax code will undergo significant change. President Obama proposed dropping the U.S. corporate tax rate from 35% to 28% in an effort to align America’s corporate tax structure with other developed economies and encourage economic growth in the U.S by incentivizing companies already on U.S to soil remain and making America more attractive in the global competition for business investment and development.
President Obama’s proposal seeks to eliminate subsidies and loopholes in the business tax code that give preferential treatment to certain industries and cost the U.S. government billions in lost tax dollars. The plan eliminates unfair and outdated industry-specific tax breaks and deductions for U.S. companies that relocate abroad. As an economic stimulus, the plan calls for permanent incentives in the form of tax deductions and depreciation benefits for U.S. manufacturing companies, tax credits for companies that return off-shore or overseas operations back to the U.S, and a new minimum tax for foreign earnings (currently foreign earnings are not taxed if they are kept abroad). To encourage small business growth, the proposed business tax code would simplify and reduce taxes on investment in and by small companies. Analysts estimate that the President’s current proposal will cost nearly $1 trillion; however, President Obama claims the elimination of tax breaks will pay for the plan without adding to the deficit.
Proponents of the business tax code revision note that the U.S. corporate tax rate is the second-highest in the world behind Japan and that failing to substantially revise and reduce the business tax code will hinder economic growth and competitiveness. Detractors claim that changing the corporate tax rate will dramatically reduce government revenues and increase the national deficit. Critics also claim the revisions fail to account for cheaper labor markets in other countries that play a role in luring businesses abroad.
While there is a general consensus that the business tax code should be reformed, political posturing during an election year makes it unlikely that Congress will approve President Obama’s proposal. Despite nearly a year and half of work on the proposal by the U.S. Treasury Department, critics are already demanding greater detail while also claiming the proposal is too complicated. Some observers negatively compare President Obama’s proposal to presidential candidate Newt Gingrich’s proposal of a flat corporate tax of 15% with no exemptions or deductions. While the national debate over the exact nature of U.S. corporate tax reform appears to have just begun, there is no disagreement that reform is indeed necessary.
Tuesday, February 21, 2012
Bloomberg: China to Get 'More Involved' in Europe Rescue, Holds Euros
China Daily: Hu Vows to Further Cooperation with EU
Forbes: China Gets on Board with Euro Bailout, Stocks Jump
Reuters: China to Keep Investing in Euro Zone Debt: China Central Bank
Europe is currently in the midst of a deep financial crisis. In the past, China (and other emerging markets such as Brazil and Russia) has contributed money to help fund the European bailouts with the hope of alleviating the European sovereign debt crisis. On the heels of new austerity measures in Greece that led to intense rioting and projections that Greece could face a prolonged and severe economic recession, China made an announcement that it plans to continue investing in Europe and contribute to future bailouts, which is positive news for Europe.
In recent international discussions, the Chinese government has indicated that it is ready to play a larger role in solving the sovereign debt crisis, which would ease the burden on the European Financial Stability Fund (EFSF) and the International Monetary Fund (IMF) to raise funds for future bailouts. China also noted its support for the measures the EFSF and IMF have taken thus far, and that it will continue coordinating with these organizations in the future.
The Chinese Central Bank, which holds approximately $800 million in euro-denominated financial instruments, recently reiterated its belief that the future prospects for the euro as a currency are strong—a statement that strongly increased market confidence in the euro. As evidence of that belief, China will not seek to reduce its exposure to changes in the euro exchange rate by selling its euro-denominated holdings.
Observers believe that China, with $3.2 trillion in foreign exchange reserves, may have the financial power to single-handedly bail out some troubled European governments. China, however, is reluctant to make economic decisions simply to help struggling economies. It is willing to invest in Europe, but only if the investments are liquid, secure, and will increase in value. For example, China currently believes that “hard assets” (buildings, businesses, inventory, etc.) are more appealing than European government bonds because hard assets can be sold in a worst case scenario to recover some of the initial investment, an option not available for government bonds.
China, however, is not suggesting that it will invest in “hard assets” to the complete exclusion of European government debt. China is committed to investing in European governments and will continue to encourage its companies to invest throughout Europe. European leaders hoping that China will use its vast foreign exchange reserves to fund a very large percentage of future European bailouts will likely be disappointed, as China views the risk associated with such a bailout greater than the potential monetary reward.
While some are disappointed in the role China has decided to play, China’s recent support of Europe is a positive sign. China’s willingness to invest in European assets and contribute some additional funds to future bailouts (if European countries send a clear message that they are working to get their finances in order) gives hope that Europe will be able to avoid a financial catastrophe. While China may not solve the European sovereign debt crisis on its own, the signal that China is prepared to work with Europe to solve the crisis should alleviate some European fears.
Friday, February 17, 2012
BBC: Greece MPs Pass Austerity Plan Amid Violent Protests
FT: Greece Passes Vote as Violence Erupts
Spiegel: Violent Clashes as Parliament Passes Austerity Bill
On February 12, Greek lawmakers approved a series of tough austerity measures aimed at clearing the path for a second rescue package worth €130 billion. The measures are part of the conditions set forth by the European Union (EU) and the International Monetary Fund (IMF) in providing Greece with the bailout package. Greece needs the rescue package to make its next payment on its debt, which is due on March 20. Without such aid, the country will default on its debt. Such a “messy” default could endanger the Eurozone’s financial stability and even lead to dissolution.
European leaders set two conditions for Greece to receive the €130 billion aid package. First, all Greek political party leaders must agree to the austerity and reform program designed by the “troika” (a group composed of the European Commission, the European Central Bank and the IMF in charge of monitoring the economic situation in distressed countries). To satisfy the first condition, Greek leaders passed an austerity package providing for €3.3 billion ($4.35 billion) in budget cuts this year, including 15,000 layoffs in the public sector, €300 million in pension cuts, and a 20% cut to the minimum wage from €751 to €586 per month. However, for those under the age of twenty-five, the minimum wage will be cut 30%, which means living on €525 a month. The plan also states that public sector salaries will be frozen until unemployment drops from its current 20.9% to 10%, and the government will liberalize labor laws to make it easier for employers to lay off workers.
The second condition of the €130 billion aid package calls for Greece to negotiate with its private bond creditors (which currently own about €200 billion in Greek debt) to take a “haircut” (loss) of at least fifty percent of their claims. The goal of this is to ensure that the country’s debt, which currently stands at 163% of GDP, will fall to 120% by 2020. As part of the bill passed on February 12, Greece will provide a bond swap for private creditors that will cut the value of their bond holdings by about seventy percent. In a bond swap, creditors will exchange their current Greek bonds for new bonds worth seventy percent less than the exchanged bond. Thus, by enacting measures to satisfy both conditions, economists expect Greece to receive the bailout package.
Economic Times: Africa Losing Out Billions in Trade: World Bank
Herald Sun: Africa Losing Out Billions in Trade
World Bank: Africa Loses Billions in Potential Trade Earnings, Falls Short of Vast Promise in Cross-Border Business―New World Bank Report
A new World Bank report explains how African countries are losing out on billions of dollars in potential trade earnings due to high trading barriers between African countries. Currently, it is easier for African countries to trade with the rest of the world than within the continent. To remedy this situation, many African leaders are calling for an African free trade agreement by 2017.
The African free trade agreement is particularly important because of the global economic slowdown, especially the European sovereign debt crisis. The European debt crisis alone is projected to reduce Africa’s growth rate by 1.3% in 2012 due to the decreased demand for African goods within Europe. Despite Europe’s pessimistic outlook, the World Bank report finds room for significant economic growth in the trade of food, basic manufactured items (leather, wood, paper, etc.), and services between African countries. Only 10% of African economic revenues come from regional trade, as compared to North America where 40% of trade occurs with regional partners, and 63% for Western Europe. The report finds that an African free trade agreement would create larger markets for African goods, increase economic diversification (a larger market to sell goods will allow producers to diversify into many different types of goods, including goods that were not economically possible in a smaller region due to a lack of available consumers), reduced production costs (increased opportunities to take advantage of a specific region’s ability to produce a good at a lower cost than other regions, and then export that good throughout Africa), improve productivity (when specific goods can be produced in very large amounts and exported throughout Africa, producers are able to specialize in that item and increase the efficiency of its production), and reduce poverty (reduced unemployment and increased growth are associated with increased trade).
Current trade restrictions are especially difficult on poor traders, many of whom are women. Many women whom engage in cross-border trade deal with violence, threats, corruption, and sexual harassment. For example, one female egg trader who lives in the Congo but buys her eggs in Rawanda has to bribe custom officials with eggs, often forcing her to give away thirty eggs on each trip. Because an African free trade agreement would focus on reducing governmental corruption, it could reduce or eliminate the need for such cross-border bribes along with reducing other costs.
To unlock the advantages of free trade, the World Bank has recognized the need for African countries to pursue changes in three areas. First, countries need to improve cross-border trade by limiting the number of border agents, reducing corruption among the remaining border agents, and increasing cross-border technologies (such as cross-border mobile banking). Second, countries should remove non-tariff barriers to trade, which would include lifting restrictions on goods based on where they come from, removing import and export bans, and ending costly import and licensing procedures. For example, one African grocery chain spends approximately $20,000 per week on permits required to distribute meat, milk, fruits, and vegetables purchased in other countries. Finally, countries need to reform immigration policies that significantly limit the ability to travel and work throughout Africa, harming the flow of information and reducing investment in the service industry due to the lack of skilled workers to fill a specific service oriented position in certain regions.
To support regional integration the World Bank has increased its investment specifically pertaining to economic integration within Africa from a total of $2.1 billion in 2008 to $4.2 billion in July 2011, and expects total investment to increase to $5.7 billion by July 2012. Such investments have focused on increasing trade by improving infrastructure, implementing new immigration procedures, and eliminating the trade barriers listed in above. The World Bank believes increased continent-wide economic integration will ultimately reduce unemployment and poverty, and increase most African’s standard of living.
Thursday, February 16, 2012
Chicago Tribune: Factbox: What Does Henrique Capriles Want for Venezuela?
Miami Herald: Henrique Capriles Wins Opposition Primary
NYT: Opposition Voters in Venezuela Pick a Challenger for Chavez
WSJ: Chavez Opponent Surges in Venezuela
Henrique Capriles Radonski, the current governor of the state of Miranda in Venezuela (one of the country’s most populous states), won a primary election on February 12 to become the opposition candidate to run against President Hugo Chavez in Venezuela’s upcoming presidential election. For the first time during President Chavez’s 13-year tenure as president all of Venezuela’s opposition parties have agreed to support the winner of the primary election. In previous years, President Chavez has won elections by distinguishing himself from his opponents, whom he has characterized as outdated and out of touch with the needs of modern-day Venezuelans. Experts believe, however, that President Chavez, age 57, will find it difficult to implement this strategy against Mr. Capriles, age 39.
Mr. Capriles, however, lacks the billions of dollars of state funds to spend on social programs for the poor and control over virtually all of the country’s media that have contributed to President Chavez’s popularity with voters. Under President Chavez, quality of life among the poor has generally improved. As a result, analysts conclude that around thirty percent of Venezuelans remain strong supporters of President Chavez, and a substantial number of Venezuelans will likely vote for him in the coming elections. His approval rating is around fifty percent. The rating, however, may not indicate how Venezuelans really feel about President Chavez since many fear losing their jobs if they speak out against him.
Nonetheless, Venezuelans have shown their support for Mr. Capriles during political rallies and the primary election. Mr. Capriles has won voters’ support by promising them many of the same social benefits they have enjoyed under President Chavez, but with what he claims will be better management. He cites as examples of his commitment to social welfare programs the health clinics built and food programs implemented by his administration in the state of Miranda. He has also promised not to discriminate between beneficiaries of social programs based on their political beliefs, as President Chavez’s government currently does. As a result, Mr. Capriles has won the support of Venezuelans who are dissatisfied with President Chavez’s regime, particularly the high crime rate, food and housing shortages, corruption, and President Chavez’s increasing control over political and civic affairs.
Mr. Capriles, who has characterized himself as business-friendly but socially conscious, has also promised greater economic development in Venezuela. He wants to fund development projects by boosting oil production and encouraging foreign investment in the oil industry, but critics note that Mr. Capriles has not released any detailed plans for achieving these changes. Economic development, Mr. Capriles argues, can only occur when the fear of nationalization is gone—when investors and entrepreneurs believe that opening a business in Venezuela does not carry a large risk of nationalization. Mr. Capriles, however, has stated that although he opposes more nationalization in Venezuela, he will not privatize the state oil company PDVSA if he wins the election. Furthermore, Mr. Capriles insists that, because nationalizations cannot be undone quickly, his government would study state-run companies and projects on a case-by-case basis to determine whether privatization would be the best course of action.
Wednesday, February 15, 2012
Time: Rain Forest for Ransom
Global energy consumption and demand for alternative energy sources continue to shape national debates, international trade negotiations, and impact world economies. While the U.S is focusing on natural gas shale drilling, oil remains a major energy source worldwide. South America has one-fifth of the world’s proven oil reserves and, with global oil prices and demand continuing to increase, oil companies are targeting South American reserves for exploration and drilling.
While most oil rich countries welcome the financial boom that accompanies oil extraction and drilling, one country has taken the opposite approach. Ecuador, an economically poor country sitting on billions worth of oil reserves, is generating global attention due to an innovative proposal to prevent oil drilling and preserve natural resources while still generating significant income. Despite Ecuador’s economy—which is highly dependent on oil exports—President Rafael Correa wants to preserve Yasuni National Park, a 10,000 square kilometer area and one of the world’s most pristine and bio-diverse areas, through a plan called the Yasuni ITT initiative. Ecuador has asked the global community to help save its rainforests by paying Ecuador to shut the doors of Yasuni to the oil companies.
Correa is hoping to convince more economically developed countries that might value rain forests and conservation of natural resources to pay $3.6 billion (approximately half of what the oil reserves are estimated to be worth) over thirteen years to preserve Yasuni Park. The United Nations Development Program would collect the funds from interested governments and devote the monies to preservation and settlements in and near the park. In return for the payments, Correa pledges that Yasuni will remain a National Park and oil companies will not be permitted to drill there.
While critics see the initiative as environmental blackmail (pay up or lose the rainforests), Ecuador points out that it is willing to forgo “the most financially lucrative option” in favor of the global environmental advantages that all nations would enjoy if Yasuni remains untouched. To date, the success of the initiative has not been promising as few governments and organizations met the December 31, 2011 deadline to pledge $100 million to the program. In better economic times, the governments of European nations, the U.S., Japan, and others might be more willing to pledge funds to the initiative. However, given the current financial circumstances of national governments around the world, the Yasuni initiative has been a hard sell to citizens facing economic hardships, austerity measures, and financial uncertainty.
Sunday, February 12, 2012
Spiegel: Merkel Seeks Euro Zone Investments from Beijing
WSJ: Wen Rejects Fears China Is Out to 'Buy' Europe
Last week, during her visit to China, German Chancellor Angela Merkel sought to persuade the Chinese government to increase its investment in Europe. China has approximately $3.18 trillion in foreign exchange reserves, putting the country in a strong financial position to make significant contributions to help alleviate the European debt crisis. European leaders want China to purchase bonds from economically weaker countries in the Eurozone. An increase in Chinese bond purchases could help restore investors’ confidence in Europe as it would signal that a financial powerhouse (China) believes that European leaders are on the right path to overcoming the crisis. China already has been acquiring bonds from the economically stronger European countries.
Chinese officials are currently examining whether the country should increase its participation in Europe by investing in the region’s two rescue funds—the existing European Financial Stability Facility and the newly created European Stability Mechanism. In addition, Prime Minister Wen Jiabao also stated that China is considering working with the International Monetary Fund (IMF) to channel contributions to Europe. In other words, China would lend funds to the IMF, which in turn would relend the money to European countries in need. This lending scheme would effectively transfer a significant portion of the risk of any European debt default to the IMF—allowing China to shield itself from the risk of lending to unstable European economies. It would not be the first time countries have used such a lending approach to aid Europe. In December 2011, Russia lent the IMF $20 billion to assist Europe, while Britain is also currently considering sending more money to the organization to help with the region’s troubles. Lending through the IMF is attractive to these countries because of the conditionality and oversight powers of the institution. An IMF loan is provided under an “arrangement” which specifies conditions and measures that the country must implement to receive the entire loan. The country receives the loan in installments and the IMF oversees the implementation of the conditions before each installment is disbursed. Thus, the IMF ensures that European countries are implementing the necessary measures to combat the crisis.
It is in China’s best interest to help Europe overcome the debt crisis. Europe is China’s largest export market and China imports the vast majority of its technology from Europe. However, due to the European crisis, Chinese exports have decreased. As instability in Europe worsens, the demand for Chinese goods will continue to decrease with consumers further cutting down on spending. Lower demand will in turn negatively affect the Chinese economy—which relies heavily on exports to Europe. Thus, by aiding Europe in its debt crisis, China is also helping its own economy by maintaining a stable import and export sector.
Saturday, February 11, 2012
Friday, February 10, 2012
BBCNews: Haitians in Brazil Get Visas but Border Checks Increase
NYT: Haitians Take Arduous Path to Brazil, and Jobs
Washington Post: Brazil’s Rousseff: Thousands of Visas for Haiti, Plans to Draw Down Peacekeeping Troops
Following the devastation caused by the 2010 earthquake in Haiti, many Haitians have travelled to Brazil in search of work. They have made a dangerous journey through Ecuador, Peru, and Bolivia—often at the mercy of human traffickers and corrupt government officials—to arrive in Brazil’s border towns in the Amazon. After arriving, many of these Haitians have been stranded while waiting for the government to grant them humanitarian visas to work in Brazil.
As Haitian immigration to Brazil continues to grow, Brazil’s government has announced that it will grant residence and work visas to approximately 4,000 Haitians already in the country, including Haitians who are in the country illegally. During a recent trip to Haiti, Brazilian President Dilma Rousseff promised to issue an additional 1,200 visas each year to Haitians over the next 5 years. However, Brazilian officials have announced that, from now on, Haitians seeking the work visas promised by President Rousseff will need to apply for one of one hundred work visas available per month at the Brazilian embassy in Port-au-Prince, Haiti. Haitians will not be allowed to enter Brazil without a visa. By requiring visas to enter the country, the government hopes to cut down on the cost of feeding and housing Haitians at the border while their visa applications are processed. Brazil has not dealt with an immigration crisis in the past. Before its economic success in the last decade, workers generally sought to leave the country, rather than enter it.
Although economic growth in Brazil has slowed, the country still requires workers for a number of infrastructure and building projects, and Haitians are beginning to fill vacancies in these sectors. Manual laborers are in high demand to complete many of the construction projects that are planned for the 2014 World Cup and the 2016 Olympic Games. With unemployment at a historic low of 5.2 percent and salaries increasing for poor Brazilians, it has proven difficult to find Brazilians willing to leave their stable jobs to fill these positions. Furthermore, the current workforce is engaged in massive projects already underway, like building two dams in the upper Amazon River Basin, leaving few workers for other enterprises.
Employers in the border towns and throughout Brazil are, therefore, hiring a number of Haitian workers. Some companies, like a swimming pool manufacturer based in southern Santa Catarina State, are sending managers to the border towns to hire Haitians. Many Haitians are travelling to São Paulo in search of work—a city that serves as the financial capital of Brazil and is often compared to New York City.
Thursday, February 09, 2012
In the wake of the U.S financial crisis and the continuing European debt crisis, the price of gold has climbed to all-time highs and the slightest dip in prices creates significant demand. The recent financial turmoil has led governments, central bankers, and investors to turn to gold as a safe haven for investment and protection against volatile financial markets. After years of decreases in gold reserve holdings (gold held by a central bank or nation intended as a store of value), global reserves are steadily on the rise. Despite the high price of gold, concerns about the global economy continue to drive investor demand.
Some U.S. state legislatures are echoing the concern, as thirteen states are exploring the possibility of introducing gold and silver coin currencies as alternatives to the U.S. dollar. Four years of economic turmoil coupled with the threat of spillover from the European debt crisis has generated a lack of confidence in the U.S financial system leading several states to explore alternative currency options. Legislatures have taken this unusual step to protect local economies in the event of a collapse of the Federal Reserve or the U.S. dollar. The argument in favor of gold and silver coin currency is rooted in the value of the metals themselves rather than a paper currency which derives its value from the guarantee of the issuing country.
Although the U.S. Constitution prohibits states from issuing or printing their own currency, they are expressly permitted to make “gold and silver Coin a Tender in Payment of Debts." Last year, Utah became the first state to introduce an alternative currency by making gold and silver coins issued by the U.S. mint acceptable forms of payment. The law provides that the coins may be exchanged at market value, rather than the face value (for example, a $50 American Eagle gold coin is worth approximately $1700). Several states have since followed Utah’s lead and seven states are considering broadening the scope of alternative currencies by introducing legislation that would allow the use of any gold or silver coin to be tendered based on market value.
Proponents of the legislation point to ongoing economic problems, lack of federal intervention, and—although highly improbable—the potential breakdown of the Federal Reserve System. State lawmakers further cite their obligation to protect their constituents’ economic interests where the federal government is unable to do so. However, those opposed to the legislation claim that alternative state currencies would debase the U.S. dollar by decentralizing U.S. monetary policy-making decisions and shifting power from the Federal Reserve System to individual states. Opponents claim that states are not in a position to replace or compete with the U.S. Federal Reserve System, which is a highly-evolved, complex oversight mechanism of U.S. monetary policy. While the practicality and outcome of recent state legislation remains to be seen, the issue is one with broad implications for the U.S. economy and currency.
Tuesday, February 07, 2012
Bloomberg: Greek Debt Wrangle May Pull Default Trigger
The Street: Goldman Sachs Fears Massive European Bank Run
As negotiations to restructure Greece’s debt continue, mounting fears at U.S. banks and financial institutions have prompted significant activity in the credit default swap (CDS) markets. Many U.S. financial institutions have sold CDSs on Greek debt and could face huge payment obligations if Greece defaults. CDSs are essentially bets on the likelihood of default of a given bond issuer. Investors use CDSs to hedge, speculate, or reduce losses on their bond holdings that run the risk of default. The CDS buyer essentially receives full protection on his or her investment because the CDS seller promises to pay the buyer the full amount of the buyer’s investment in the event of default. The CDS buyer pays a fee to the seller to purchase the CDS on a particular bond. Currently, the cost of a CDS on Greek debt is extremely high because of the high likelihood of default.
In an effort to avoid default, Greek bond holders, including private creditors, banks, insurers, and hedge funds, have been negotiating an orderly debt restructuring with the Greek government. Greece must successfully restructure its debt as a condition for securing the €130 billion bailout package from the International Monetary Fund and European Union that was announced last October. Pursuant to initial negotiations, Greek bondholders were expected to take a fifty percent haircut (voluntarily give up fifty percent of their claims) among other provisions, however, negotiations have stalled. Due to the lack of progress on the Greek restructuring negotiations, financial institutions that sold CDSs (that is, guaranteed Greek bonds) are becoming increasingly concerned that Greece may default on its debt, which would trigger massive payment obligations.
This risk is magnified by the fact that hedge funds are taking the other side of this bet. Of the €200 billion of outstanding Greek bonds, it is estimated that hedge funds own €70 billion. While Eurozone finance ministers and the IMF are pressuring investors to accept greater losses, hedge funds that have purchased CDSs on Greek debt stand to profit from the failure of the negotiations. Many hedge funds have employed a controversial investment strategy using CDSs where they are assured profits if Greece defaults and possibly even if it remains solvent. For example, because Greek bonds are trading so cheaply, investors can purchase Greek debt with a face value of €100 million at a significant discount, say €30 million. By purchasing CDSs (which cost less than the bonds) on the same bonds, the investor stands to recoup €100 million on a €30 million investment (plus the cost of the CDS) in the event of a default. If Greece does not default, the value of Greek bonds will likely increase and hedge funds would profit on the bonds they hold. However the cost of the CDS will be a total loss thereby reducing or wiping out any profit. Thus, these investors have no incentive for the restructuring negotiations to be successful and stand to make large profits if Greece defaults. Although this example is highly simplified, it shows the complexity of the situation and the continuing problems complex financial instruments can create when used for speculative purposes.
Although most central bankers and analysts are fairly confident major U.S. financial institutions will not face massive losses if Greece defaults, they cannot be certain. Despite the harsh lessons of the U.S. financial crisis, it appears many U.S. financial institutions have significant exposure to the Greek debt crisis in the form of CDSs. Three years after the U.S. financial crisis, the CDS market still lacks transparency. Thus, Wall Street banks, financial institutions, investors, and regulators all find themselves watching nervously from the sidelines as negotiations regarding the restructuring of Greek debt continue. Ultimately, the culprit in the potential downfall of the Greek negotiations and cause of significant losses for U.S. financial institutions may be the same one that played a major role in the U.S. financial crisis three years ago–the CDS.
Sunday, February 05, 2012
Economic Times: World Bank Approves New Financing Instrument
The Financial: World Bank Approves Program-For-Result - New Financing Instrument
World Bank: Putting Results First: PforR to Link Disbursements to Development Outcomes
On January 5, 2012, the World Bank Board of Executives approved a new financing instrument named “Program-for-Results” (PforR). This new instrument will link the disbursement of funds directly to the achievement and verification of defined and specific results. The World Bank believes PforR financing will result in greater accountability and compliance in the countries receiving aid, which in turn will deliver improved and sustained results to further the Bank’s goal of accelerating development globally. PforR lending was not created to replace the World Bank’s other lending instruments (Investment Lending and Development Policy Lending), but instead was designed to give another funding option to developing countries.
PforR was developed to fight problems that have sometimes occurred under previous World Bank programs. For example, under other development models an initiative might acquire funding to build a school, but fail to address the problem of finding qualified teachers for the new building. Another example is providing financing for a brand new health clinic, but taking no provision for how to ensure the clinic has the needed medications or supplies. The World Bank believes that providing specific and defined incentives tied to the disbursement of funds will push a country towards those specific results and help mitigate the types of problems described above. For example, PforR, instead of only providing financing for the new school, would instead fund the new school building and tie additional funds disbursements to a specific result, such as improving literacy.
Considering how important development information is to PforR, a main challenge will be compiling accurate information. The World Bank will handle this problem with a country-by-country approach. In each country the World Bank will create a network of government agencies, statistical or audit entities, and third-party groups such as nongovernmental organizations (NGOs) to gather information and track each program’s progress. The World Bank believes these measures will allow it to quickly and accurately compile the information needed to determine if the project is achieving the required results.
PforR will also include new anti-fraud guidelines to decrease corruption in the disbursement of funds. These new guidelines give the World Bank the ability to investigate any allegations of fraud in a program, not just those instances related to bank financing, as is the case under current rules. The new anti-fraud guidelines will also create provisions on how cases of fraud and corruption should be handled. In certain instances, combating corruption will be one of the conditions that must be met to trigger future disbursement of funds.
Under PforR the World Bank will also engage in an assessment to ensure that a program will not have a large adverse environmental or social impact. For this reason, PforR will not be available to finance projects that pose the risk of significant and irreversible impact on the environment or people, such as large dams, ports, or power plants. Programs that do not fall into this category must still pass a social and environmental assessment, including consultations with the groups that will be most affected by the project before approval. Once the assessment is complete it will be available to the public.
While not available for all types of projects, PforR is a flexible financing instrument with many potential uses. For example, PforR could be used to provide the funding necessary to increase post-birth care for mothers and newborns, provide clean sustainable water supplies, increase education, or reduce the number of households in poverty. A key factor of PforR is that is allows the World Bank to provide only a fraction of a large development project’s funding, with additional funds provided by governments, private investors, and many other sources, while still allowing the World Bank to apply its technical and environmental expertise to the entire project.
The World Bank developed the exact methods for the implementation of PforR over a twelve-month trial period with input from thirty-four client countries and seven donor countries. Included in the trial were government officials, development partners (other international institutions with similar goals such as the Global Alliance for Vaccines and Immunizations), civil society organizations (such as the Center for International Environmental Law and the World Resources Institute), private sector actors, and academics. With this extensive trial, the World Bank is confidant PforR is ready for use and will further the World Bank’s goal of global development.
Saturday, February 04, 2012
Economist: “A Deal, But to What End?”
EU: Treaty on Stability, Coordination and Governance in the Economic and Monetary Union
Washington Post: Britain, Czechs snub Europe’s fiscal pact but won’t forge an alliance of critics
WSJ: Europe Tightens Fiscal Ties
On Monday, European leaders agreed on a new fiscal plan to combat the region’s debt crisis and restore investor confidence in the Europe. The plan sets tough budget and deficit limits as well as strict enforcement mechanisms to prevent Eurozone countries from accumulating the large amounts of debt that have put the entire region in jeopardy. As of now, twenty-five member countries have agreed to sign the treaty, including all seventeen Eurozone nations and eight other European Union (EU) countries. The United Kingdom and the Czech Republic are the only two EU countries that have yet to approve.
The new “fiscal compact” treaty states that member countries must maintain their structural deficits (deficits over a prolonged period of time) either balanced—meaning deficits cannot exceed 0.5% of the country’s gross domestic product (GDP)—or in surplus. In addition, the pact will require governments to reduce their total debts to 60% of GDP or below over time. If a country’s debt-to-GDP ratio is significantly below 60%, it will be allowed to have a deficit of up to 1%. At this time, the Stability and Growth Pact (which currently controls the deficit and debt limits of countries in the European Monetary Union) limits annual budget deficits to 3% of GDP and government debt to 60% of GDP. However, the SGP has shown to be ineffective in its enforcement mechanisms, as countries have been able to accumulate large amounts of debt and reach deficits well above the 3% limit without consequences.
Another important aspect of the new fiscal plan is that if a country deviates significantly from the agreed limits, a correction mechanism will be triggered automatically. The European Court of Justice will have the power to impose fines of up to 0.1% of GDP to countries that have excessive deficits, which means, for instance, that Italy could have to pay fines as high as $2 billion. However, countries will be allowed to deviate from the set limits in exceptional circumstances such as during periods of severe economic decline.
The treaty will likely come in to force on January 1, 2013. However, countries are not expected to immediately abide by the rules. Instead, the European Commission will establish the time frame under which governments need to comply on a case-by-case basis to take into account each country’s economic situation.
Thursday, February 02, 2012
Colombia Reports: Colombia’s Central Bank to Target Inflation in 2012
El Tiempo: Inflacion en el 2011 fue de 3,73%, y de 4,35% para los pobres
MercoPress: Colombia Aims to Become Latam Third Largest Economy by 2015
WSJ: Colombia Targets Inflation as Economy Booms
Currently, Colombia is Latin America’s fourth largest economy and hopes to become its third largest by 2015. Colombia has been less affected than other Latin American economies by the global financial crisis that has caused an economic slowdown throughout the region. Colombia’s successful efforts at making the country safer from guerrillas have led to an increase in foreign investment to approximately $13 billion a year. Increased foreign investment in Colombia’s energy sector helped stimulate 5.5% growth in 2011.
Although Colombia’s Central Bank President, Jose Dario Uribe, announced that the European debt crisis may cause some slowdown in Colombia, he believes that Colombia’s economy will benefit from various profitable sectors, including oil, coal, construction, financial services, and public infrastructure spending. Growth in 2012 is predicted to reach about 5%.
Experts are concerned that rapid growth will lead to an increase in inflation as consumption rises faster than production, thus pushing up prices due to supply and demand principles. In 2011, inflation averaged 3.7% and, although this is among the lowest inflation rates of Latin America’s major economies, Colombia has not had an inflation rate this high since 2008. Experts, therefore, speculate that Colombia’s Central Bank will raise its benchmark interest rate from 4.75% to 5.25% by the end of 2012 to combat rising inflation by increasing the costs of borrowing and discouraging spending, which lowers consumption.
The inflation rate among Colombia’s minimum wage earners was 4.35% in 2011. A large amount of the poor’s earnings are spent on food, and food prices have been especially high because of a decrease in production caused by cold weather and damage to roads due to increased rainfall that prevented food from being delivered to market. However, the impact of higher prices on Colombia’s poor was likely less than could have been the case. In 2011, Colombia’s minimum wage increased by 5.8 % and, as a result, so did the purchasing power of the poor.