Wednesday, July 22, 2009

IMF responds to global crisis with SDR allocation plan

International Monetary Fund: IMF Executive Board Backs US $250 Billion SDR Allocation to Boost Global Liquidity
Reuters: IMF backs $250 bln plan to bolster members’ reserves
Unlikely SDR allocation will affect inflation
Financial Times: How the Fund can help save the world economy

On August 7, the IMF will vote on a plan to allocate $250 billion worth of special drawing rights (SDR) to bolster reserves in member countries. The allocation would improve liquidity in the IMF’s 186 member countries, and provide $100 billion for emerging economies. In order to pass, the plan requires approval from 85 percent of member countries, which it is widely expected to receive.

World financial leaders have debated such an allocation since the Group of 20 summit in April of this year. A successful allocation of this size could increase confidence in cooperative, international solutions to global recession. IMF Managing Director Dominique Strauss-Kahn hopes the allocation will highlight an expanded role for the IMF as it provides “significant support to its members in these difficult times.”

If the allocation garners the required support on August 7, member countries could receive their allocations, disbursed in proportion to each member’s IMF quota, as early as August 28. Countries are free to lend or exchange their SDRs for hard currency. Many developed countries, which have the largest quotas, are expected to loan or donate their SDRs to their poorer, liquidity-strained neighbors.

Some financial analysts are wary of the proposed allocation, citing concerns about increased inflationary pressure. Isabelle Mateos y Lago, an advisor in the IMF Policy and Review Department believes inflationary problems are unlikely, given the small scale of the allocation relative to the global economy. The proposed $250 billion represents only one-third of a percentage point of global gross domestic product. The IMF has emphasized however, that the allocation should not weaken member countries’ pursuit of prudent macroeconomic policies or postpone necessary policy adjustments.

1. The SDRs will provide funds to emerging and poor countries at current, low interest rates. If interest rates should later rise, the possible long-term cost to poor countries would be significant. How should this potential interest liability affect the way developing countries chose to use their SDRs? Should they hold them or spend them?
2. A substantial amount of the allocation will go to developed countries that may not need the additional funds. Are IMF officials right in assuming that countries will donate, trade or loan the SDRs? Should the IMF consider allocating SDRs out of proportion to the IMF quotas?

Friday, July 17, 2009

Paulson Receives Bitter Reception from Lawmakers at Hearing

Sources: Lawmakers Blast Paulson for His Response to Crisis; UPDATE 2-Lawmakers slam Paulson on BofA-Merrill deal

In a hearing before the House Committee on Oversight and Government Reform on Thursday, House Republicans and Democrats scolded Former Treasury secretary Henry M. Paulson Jr. for his response to the financial crisis. The hearing was convened as lawmakers investigate the government’s push for Bank of America’s acquisition of Merrill Lynch. Although the companies arranged in September to merge minus government aid, they did not settle the deal until January when the Treasury agreed to check Bank of America’s losses on a range of problem loans, and invest $20 billion.

Federal Reserve Chairman Ben S. Bernanke and Bank of America chief executive Kenneth D. Lewis had previously testified to the House Committee that the bank nearly backed out of the deal. Paulson’s version of events largely corroborated the accounts of Bernanke and Lewis. After conferring with Bernanke, Paulson had warned Lewis of the possible removal of senior management if the bank abandoned the deal. Paulson further assured Lewis that the bank would receive the aid needed to proceed with the acquisition.

Republicans on the committee have argued that the government compelled Bank of America to move ahead with the deal when the company decided to walk. Democrats, on the other hand, have suggested that Lewis worked one over on the government to obtain additional financial support in threatening to drop out of the deal.

Democrats and Republicans alike have questioned the lack of public disclosure by the bank and regulators of information pertaining to the negotiations. Internal Fed documents that seem to reveal that regulatory agencies were purposefully kept in the dark have captured the attention of the committee. These agencies include the Securities and Exchange Commission and the Financial Stability Oversight Board, an interagency team Congress created to manage the government’s handling of the financial crisis. The committee will next hear from these groups.

Discussion Questions:
1) Where should Congress draw the line of financial oversight by the government during times of crisis and times of economic strength?
2) What benefits does financial oversight during crises afford?

Sunday, July 12, 2009

G8 pledges $20 billion for agriculture in the developing world

Reuters: G8 pledges $20 billion in farm aid to poor nations, African leaders to ask G8 to honour pledges, G8 summit pledges $20 bln to boost food output
Financial Times: G8 to commit $20 billion for food security

According to United Nations reports, the number of malnourished people worldwide will exceed 1.02 billion this year. This represents a dramatic reversal, as the current global recession erodes decades of progress in reducing malnutrition. 103 million more are predicted to suffer before the end of the economic downturn. In response to these predictions, and near the end of a summit frustrated by discord, the G8 announced a pledge of $20 billion to fight hunger in the developing world.

On July 10th, the G8 promised to deliver $20 billion over the next three years, investing in agriculture to promote food security. The pledge is smaller than past aid commitments but has the potential to effect real change, according to development experts, because of its clear focus. Jacques Diouf, director general of the U.N. Food and Agriculture Organization, responded optimistically to the pledge, calling it “the biggest shift in strategy [he’s] seen over the past two decades.” The new strategy highlights the need to help hungry and poor people produce their own food. Emergency food aid, though necessary to help impoverished countries withstand food crises, is only part of the equation, according to Ajay Vashee, president of the International Federation of Agricultural Producers. The new G8 pledge aims to improve food security through investment in infrastructure- reaching small farmers with new seeds, irrigation technologies and farming methods to improve agricultural productivity within developing countries.

Leaders from Algeria, Angola, Egypt, Ethiopia, Libya, Nigeria, Senegal and South Africa joined G8 members later in the summit for a half-day meeting, discussing food security, past aid commitments and a proposal for climate change compensation. Led by Ethiopian Prime Minister Meles Zenawi, the African leaders were initially positive in their response to the $20 billion pledge but asked the G8 to live up to their commitments. Some remain wary, hesitant to rely on new promises from the G8 while member countries fail to follow through on 2005 aid commitments. Nigerian Agricultural Minister Abba Ruma called the pledge “very commendable,” especially in view of the current global recession, but called for the funds to be disbursed expeditiously.

NGOs have responded to the pledge with a mixture of hope and skepticism. Many view the pledge as a potentially significant policy shift, but are wary given the G8’s track record. According to ActionAid, a British aid organization, total food aid must reach $23 billion per year by 2020 to reach the millennium development goal for world hunger reduction. The G8 pledge does not reach that goal independently, but for many it is a welcome step in the right direction.

1. U.S. president Barack Obama, discussing the G8 pledge, said "there is no reason Africa should not be self-sufficient when it comes to food.” What are the reasons that Africa has not been self-sufficient in food production in the past?
2. Can G8 leaders responsibly pledge additional aid when some are failing to meet existing aid commitments? Does the current recession affect the likelihood that G8 countries will follow through on the pledge?

Monday, July 06, 2009

China Advocates Fundamental Reform of the Global Monetary System, and Works to Ease Dependence on U.S. Dollar

Sources: China Ratchets Up Pressure on the Dollar; China Officials Call for Displacing Dollar, In Time

As the G8 summit in Italy approaches—the summit begins on Wednesday—China has heightened its call for the fundamental reform of the international financial system. In its push for the replacement of the U.S. dollar as a reserve currency, China acknowledges that it will take time to overhaul to current system. Chinese officials maintain that the IMF unit of special drawing rights (SDRs) may provide a viable alternative to the dollar.

The dollar comprises an estimated 70 % of the $1.95 trillion China holds in official foreign exchange reserves. Accordingly, China remains cautious not to make statements which may hurt its investments.

To reduce its dependence on the dollar, China stated last week that it would permit its exporters and importers to settle international trade agreements with the renminbi. Prior to this action, companies have had to exchange renminbi for U.S. dollars or alternative currencies when settling cross-border transactions. Starting July 2, the People’s Bank of China (PBoC) would invite banks to offer settlement services tied to the renminbi.

The renminbi’s projected regular appreciation next to the dollar provides the incentive for Hong Kong companies to use it in settling trade agreements. Even though China has limited the renminbi’s appreciation since July 2008 to assist exports, the mainland currency has risen 21% since 2005 when a dollar peg was cast aside. Investors are betting it will strengthen less than 1% to 6.77 per dollar in the next year. Since July 1, 2008, the central bank has maintained a range of 0.08%.

Other initiatives also aim to promote the renminbi’s regional usage. For instance, China said in May that it would endorse the issuance of renminbi bonds by locally incorporated foreign lenders.

Still, in spite of the disfavor with the dollar-centric global financial system, the IMF announced on June 30 that the portion of dollars in international foreign exchange reserves reached 65% during the first three month of 2009, rising to its highest level since 2007.

Discussion Questions:
1) What short and/or long-term effects might China's promotion of the renmindi as a regional currency have on the dollar as well as other currencies?
2) How might China's efforts fuel discussion concerning the reserve currency at the G8 summit in Italy on Wednesday?

Saturday, July 04, 2009

Unauthorized Trading Causes a Spike in Oil Price

Sources: BBC, Can Rogue Trading Move a Market?; Reuters, Oil Brokerage PVM Names Rogue Trader Behind Oil Spike; AFP, Oil Prices Drop Further as 'Rogue' Trader Probed; BBC, Rogue Trades Cost Oil Broke $10m

Early Tuesday morning, the price of Brent North Sea Crude spiked to $73.50 a barrel when a London trader purchased the equivalent of 9 million barrels of the oil. Steve Perkins, a crude futures trader at the PVM Oil Futures brokerage, conducted this unauthorized trade, which is now under investigation by PVM as well as the Financial Services Authority. When PVM discovered the unauthorized trading, which was unusual as it took place at a time when most London traders are asleep, it unwound the futures positions at a cost of nearly $10 million.

The trade caused a spike of nearly $2 in the oil price, but this quickly reversed, and contracts for 16 million barrels of oil changed hands in a very short period of time. The early hour and relatively low levels of trading meant that one large trade could greatly affect the price of oil, but that the price could also drop quickly. The drop in price was what accounted for PVM's loss in such a short time when it sold the contracts – by Friday morning, the price had fallen to a little over $66 a barrel, due largely to loss in confidence in a U.S. recovery after the release of poor employment numbers.

Brokers at PVM are authorized to link up large banks and hedge funds as trade counterparties, but they are not allowed to take positions in the crude markets directly. Perkins' motivations are unclear, but PVM—the world's largest independent broker—is conducting a full investigation. Though technology makes it more and more difficult for brokers to engage in this sort of unauthorized speculation, enough money changes hands regularly at a large firm like PVM that it may not be picked up on immediately. In this case, the lost was relatively small, unlike rogue trading at Societé Generale or Barings.

This incident may prompt renewed calls for regulation in the area of oil speculation, which has been a priority for many since last year. Regulation would focus on the OTC and futures markets. The US, for example, would like to reduce the amount with which a single broker can legally speculate, and the UK would be likely to follow any U.S. regulatory changes. There is some disagreement on just how much speculation can really affect markets over the long-term, but activity like this is undoubtably cause for some concern.

1) Do you think that an isolated incident like this should be enough to prompt regulatory changes over oil speculation as a whole, or do you think that the market is best left alone?
2) As technology advances, how do you think speculators who want to engage in rogue trading will react? Will technology ever make unauthorized trading impossible, or will more regulatory loopholes simply open up along with financial innovation?

Wednesday, July 01, 2009

Rethinking Reserve Currency

The recent financial crisis highlights a need for effective management of international liquidity. The use of the dollar as an international reserve currency dates back to the 1944 Bretton Woods conference, when the U.S. was the largest international creditor and by far the largest economy in the world.

Recently, Chinese leaders and other international policymakers have become increasingly interested in transitioning to an alternative reserve currency. Critics of the dollar argue that the use of national currencies to manage a global economy is troublesome; the U.S. Federal Reserve inevitably places domestic policy goals above the needs of the international economy.

While there is no clear alternative to the dollar, Chinese officials propose the expansion of IMF Special Drawing Rights (SDRs). Today's SDRs are based on a basket of four currencies - the US dollar, yen, euro and sterling - and they are used as a unit of account by the IMF and other international organizations. The Chinese proposal would involve expanding the SDR basket to include all large economies and establishing a settlement system between SDRs and other currencies, so the SDRs could be used more easily in international finance and trade.

Some argue that the IMF SDRs will never function effectively as reserve currency because of institutional limitations on their use. Many other national currencies simply lack the economic longevity and credibility of the dollar.

Should SDRs replace the U.S. dollar as the international reserve currency?

Leave your comments below and cast your vote here, in the UICIFD poll.

Nigeria allows foreign bank ownership, aims to acquire more than capital


Financial Times: Nigeria to lift ban on foreign bank takeovers,
Nigeria’s top banker to boost transparency
Reuters: Nigeria may lift ban on foreign bank ownership

Nigeria, a country of 140 million people, is Africa’s most populous nation and the continent’s second largest economy. There are 24 banks in Nigeria today, operating approximately 23 million accounts. The country’s large population and growing economy make it a massive potential market for retail banking. Large companies also view Nigeria as a desirable, strategically-located base for launching regional operations elsewhere on the continent.

For more than 30 years however, foreign acquisition of more than 5 percent of any Nigerian bank has been subject to approval by the governor of the country’s Central Bank. Foreign banks have also been prohibited from owning more than 10 percent of any Nigerian bank. These limitations date back to the 1970s, a period of strict nationalism under military rule, and have outlived their purpose, according to recently appointed Central Bank Governor Lamido Sanusi.

Recent financial turmoil has caused contraction in foreign credit lines, a stock market collapse and an overall tightening of liquidity in the Nigerian banking system. Sanusi sees increased international participation as an important step toward improving the health of the country’s banks, calling the old rules “unnecessarily restrictive.”

By opening doors to foreign banks, Governor Sanusi hopes to do more than simply shore up Nigeria’s capital base. He aims to improve the banking system’s disclosure requirements and tighten bank supervision, and he’s counting on foreign expertise to advance those goals. In the short to medium-term, Nigerian banks will undoubtedly benefit from capital influx, but exposure to the skills and management strategies of large foreign banks could reap even greater rewards in the future. During this period of recovery and potential growth, Sanusi brings an open perspective to his post as governor of Nigeria’s Central Bank. “What you want to do,” he says, “is open up all the possibilities.”

1. How will continued unrest in Nigeria’s oil delta impact the involvement of foreign banks in Nigeria?
2. Should the Central Bank maintain some lesser degree of control over the bank acquisitions as they occur? Are there risks that offset the sizeable benefits of foreign involvement?