Rising Northern India

Sources:
The Times of India: Once a Leader, South Now Lags in GDP Growth
Hindustan Times: Growth Rate Declining in Southern States: Report
The Times of India: Gujarat leads in growth, South India Needs to Catch Up: Report

McKinsey & Co., a global consulting firm, recently released a report at the conference “The Next Wave of Growth – South India,” which the Confederation of Indian Industry (“CII”) organized, saying that the traditionally strong Indian nouth’s economic growth was now lagging behind the poorer south’s economic growth. The report examined the last five years of Indian economic growth, and all four of the major southern states saw real GDP growth rates below the national average of 8.7%. Andhra Pradesh and Tamil Nadu both grew at 7.4%, Karnataka grew at 8.5% and Kerala grew at 8.1%. The data belie a recent Wikileaks quote from the Indian Home Minister to the U.S. Ambassador that “India’s growth would have progressed better if it comprised its southern and western parts only.”

Although southern Indian growth is slowing, its GDP base is much larger than the GDP base in the north. So while the news is not good for the south, for India as a whole it means there is greater regional equality. While greater regional equality is good for India, McKinsey revealed many real problems in the south that explain the recent five years of slow growth, citing, rising land prices, significant shortages of labor, infrastructural inadequacies and growing congestion, especially in Bangalore, Chennai, and Hyderabad.

In contrast, the northern region of Gujarat has taken steps to market itself as an attractive destination for investment by holding “Vibrant Gujarat” summits every year for the past eight years. Additionally, the north has grown across sectors because of investments in infrastructure and incentives for specific industries. For example, Gujarat is now a leader in the chemicals industry with a 35% share of all Indian investments in the chemical industry over the past five years.

The north, however, still faces challenges to its continued economic growth. Government policies on land acquisition are still burdensome and overly bureaucratic, and employees generally have a lower skill level than in the south. Because the labor supply for professional workers is so constrained, wages are rising which increases costs for businesses.
Both regions are also transitioning from the low end of the value chain, like off-shore IT work, to higher value research and production like building advanced medical equipment. The CII has issued a six-step agenda to implement the transition to higher value production, and various state secretaries and industry leaders will establish a steering committee that will monitor the transition’s progress.

Quinoa Exports Cause Dilemma in Bolivia

Independent: The Food Fad That's Starving Bolivia

NYT: Quinoa's Global Success Creates Quandary at Home

Increased global popularity of a South American food is causing adverse effects in Bolivia. For over 5,000 years, Bolivians have cultivated quinoa, a seed often cooked like rice that contains more protein than any other grain and all eight amino acids essential to humans in building proteins necessary to live. Bolivians traditionally have consumed quinoa at every meal, and it is a staple food in other South American countries as well. Quinoa has recently become more popular around the world, and demand for it has increased dramatically. This has caused its price to rise, and now many Bolivians are unable to afford this nutritious food.

Until recently, quinoa was a relatively unknown food outside South America, sold mostly in small health food shops. Although NASA declared it to be an ideal food for space missions because of its exceptional nutritional value, it failed to catch on. However, in the past few years it has become more popular in Western countries due to the recent trend in health foods generally and also because restaurant chefs have sought new and innovative ingredients from different cuisines.

This new popularity created a new demand for quinoa outside of South America, which has caused prices to increase dramatically. The price of quinoa has tripled in the past five years. This is encouraging some city dwellers in Bolivia to leave the city and purchase farm land to reap the benefits of farming quinoa. As a result, quinoa-growing areas are experiencing improved living standards. Previously, many Bolivians emigrated to Argentina and Chile to search for work, but now they are staying to farm quinoa because they can support themselves and their families.

While this price increase has benefitted quinoa farmers, local consumption of the nutritious food has decreased by 34 percent in the past five years. Many Bolivians are unable to afford to buy quinoa at these higher prices. In the regions where quinoa is grown, health officials warn of chronic malnutrition, especially in children. Bolivians have long experienced issues with malnutrition, but health experts warn that the problem is worsening as families turn away from quinoa and purchase cheaper, more processed, and less nutritious substitutes. In Bolivia, quinoa costs about five times more than an equivalent weight of noodles or white rice, both of which are far less nutritious than quinoa.

Another problem affecting malnutrition is the global spread of ideas and products. Many older Bolivians indicate that the younger generations do not want to eat the more nutritious quinoa and would rather have white bread and Coca-Cola. These changing cultural values also aggravate the malnutrition some villages are facing.

The Bolivian government is taking measures to increase domestic consumption of quinoa. Bolivia’s President recently announced a plan to lend $10 million to organic quinoa producers to provide more quinoa for domestic sale. It also is possible that increased demand for quinoa in general will encourage more production in Bolivia and elsewhere, which eventually may lower prices and make quinoa more affordable again to Bolivians. Also, health officials are including quinoa in a package of food given to pregnant and nursing women each month.

The recent global popularity of quinoa has created a difficult problem for Bolivia. Bolivian quinoa farmers are benefiting, but other Bolivians are harmed by their inability to afford this “super food” that has traditionally been a part of their daily diet. Unless the increased demand for quinoa is a temporary fad, or production can increase and lower the price of quinoa, Bolivians may have to find a way to replace this nutritious food in their diet.

IMF Expected to Activate Lending Fund to Assist Troubled Countries

Sources:
WSJ: IMF to Soon Activate Special Funding Pool
Bloomberg: IMF Said to Be Discussing Activation of $583 Billion Crisis Lending Pool
Reuters: IMF Chief to Activate Crisis Fund Next Week

As Portugal struggles to manage its debt crisis, and as similar crises linger over several other European nations, the International Monetary Fund is preparing to again offer its assistance. In anticipation that the IMF’s help will be needed, the head of the IMF, Dominique Strauss-Kahn, has recently requested the activation of the New Arrangement to Borrow (NAB).

The New Arrangement to Borrow is a lending facility available to assist countries by providing emergency funding. The NAB works in conjunction with the IMF’s other lending facilities and provides an additional source of liquidity for the IMF to use as it helps countries in times of crisis. The NAB is funded through contributions made by some of the IMF member-nations. The pool of funds in the NAB increased by over $500 billion last year when the IMF included nations from emerging markets in the group of countries that contribute to the fund.

The IMF can use the NAB only after it has been activated. The decision of whether or not to activate the NAB is reviewed every six months. Activation of the NAB is rare, with its last activation occurring 13 years ago, in 1998, when the IMF used it to assist Brazil. Thus, Strauss-Kahn’s request to activate the NAB underscores the potential severity of the crisis in Europe.

Although no formal requests for help have been submitted to the IMF, the fact that Portugal recently voted against measures intended to alleviate its debt problems makes such help from the IMF seemingly inevitable. It is expected that Portugal will need $60-$75 billion in funds to address its debt problems. In addition to helping Portugal, the IMF could also use the NAB to provide additional assistance to other countries in financial trouble, such as Greece, which has already received financial help.

U.K. Budget 2011: The "Squeezed Middle"

Sources:

WSJ: Soft U.K. Economic Data Show Tough Choices on Budget

The Telegraph: Budget 2011: No Help for the "Squeezed Middle"

CNBC: Britain's "Squeezed Middle" Feels Pinch Before Budget

Millions of low- and middle-income families in the U.K. have been dubbed the "squeezed middle" as they continue to face the harsh economic realities of inflation, tax increases, and government budget cuts. According to current estimates, six million families are in this group and over half of them have little to no savings and struggle to pay their bills. While this group consists of 1/3 of the working population, they only earn 22% of the national income, down from 30% in 1977. Because they make up such a large portion of the electorate, politicians worry about the "squeezed middle," fearing that they are more likely to switch parties than those who are either more wealthy or poorer.

Ever since the current Coalition government decided to eliminate the child-benefit credit for taxpayers whose total family income is over £40,000, it has been accused of making things more difficult for this group. For the time being, it looks like that trend will continue. Under the budget passed last week, the higher-rate tax threshold was reduced from £43,475 to £42,475, which will result in 750,000 more people paying higher tax rates. Additionally, families earning more than £41,329 will lose £2,500 worth of tax credits per year. Unemployment is expected to reach 8.1% by 2012. An increase in value-added tax (VAT) and inflation has also hurt consumers. Based on this, it is easy to see how the "squeezed middle" have been so severely affected by the measures that the government has taken to address its budget crisis.

However, one benefit that most U.K. citizens will receive in light of the most recent budget is an increase in their personal tax allowance. This allowance consists of the amount of income that individuals can make before it gets taxed. The amount will be raised by £600 to just over £8,000 per year. The budget also announced that the government will provide first-time homebuyers with a combined income of less than £60,000 with interest-free mortgages for five years if they make 20% down payments on a recently built home. The government hopes that this effort will help the housing market recover and jumpstart the construction business.

ECB Interest Rate Hike May Affect Non-Euro Eastern European Economies

Sources:
WSJ: ECB Rate Increase May Force Emerging Europe Into Hasty Tightening
Bloomberg: East European Central Banks May Ignore ECB Signal to Raise Interest Rates
AFP: Eurozone Private Sector Lending Stronger in February
Reuters: ECB Talks Rate Hikes, Braces as Portugal Crisis Deepens
Reuters: ECB's Bini Smaghi: Low ECB Rate Risks Distortions

In April, the European Central Bank (“ECB”) plans to raise its interest rate, which has been at 1% for almost two years. The ECB’s decision to raise the rate to 1.25% comes after concerns about inflation of the Euro, as well as worries that retaining low interest rates could induce some of the same problems that led to the recent global financial crisis. ECB executive board member Lorenzo Bini Smaghi explained that, “keeping rates so low makes monetary policy very expansionary and risks creating market distortions and encouraging excessive risk-taking by financial institutions.”

Inflation has been tough to battle for European nations because of rising oil and food prices due to turmoil in the Middle East and Japan. The ECB’s inflation rate is currently 2.4%, while its target rate is under 2%. A low and steady inflation rate is optimal. When the actual inflation rate is higher than the target rate, the central bank may raise interest rates in order to calm inflation. The interest rate hike will probably affect non-Euro Eastern European nations, whose small economies are vulnerable to changes in exchange rates. If these nations do not also increase their own interest rates, the differential could cause the Euro to rise against their currencies. This could then lead to higher import prices and inflation.

As of yet, Eastern European central banks have not signaled that they will raise interest rates along with the ECB. The Czech Republic has had an inflation rate under 2% and may not want to raise interest rates until later in the year. Czech rate setter Pavel Rezabek reported that the connection between ECB interest rates and Czech monetary policy “is not that automatic.” Bloomberg forecasters believe that Hungary, Romania, Poland and Russia will also temporarily retain their current rates. These small emerging economies are balancing their fear of inflation with the need to continue to stimulate growth with low rates and will all likely choose to delay a rate hike to promote continued growth.

A New Look at Mortgage Loan Modifications in the United States

Sources:

WSJ: States Push Banks to Fix Foreclosure Process

WSJ: Banks Face More Loan Write-Downs

BusinessWeek: States Test Mortgage Principal Write-Downs

More than 25 percent of all mortgages in the U.S. are "under water," which means that those mortgage holders owe more on their homes than what the homes are worth. A synonymous term is "negative equity." Some experts have identified negative equity as the biggest obstacle to the U.S. housing market’s recovery. Borrowers with negative equity in their homes have little incentive to stay current on their mortgage payments even if they are not experiencing financial hardship. Of course, it is much more difficult for homeowners experiencing financial hardship to justify their struggle to meet their monthly loan repayment obligations on their underwater mortgages. Some U.S. financial institutions have modified, though reluctantly, mortgage loans for homeowners in financial dire straits by reducing interest rates, increasing loan repayment periods, and even waiving overdue interest. The only thing most banks decline to do is write down the outstanding principal.

Banks advance several arguments in opposition to principal reduction. Doing so would force them to take losses, which would erode their capital reserves. Principal reductions would also result in lower profits. Most importantly, banks argue that principal write-downs would only encourage more defaults because borrowers would have an incentive to stop making their mortgage payments in hopes of negotiating better loan terms.

Not all experts, however, share the banks' concerns. On March 3, 2011, state attorneys general and several federal agencies sent a proposal to some of the major banks in the U.S. that may require the banks to reduce mortgage principals for distressed borrowers. This proposal does not impose any fines or penalties on the banks. Rather, it focuses on the ways banks should treat borrowers seeking loan modifications or facing foreclosure. Some of the features of the proposal would require banks to deny in writing loan modifications before referring homeowners to foreclosure, to provide distressed borrowers with contact information for a single employee assigned to their case, and to consider reducing the principal on underwater mortgages.

Up to this point, very few mortgage modifications have involved principal reductions. For example, the U.S. Office of the Comptroller of the Currency reported that only 4 percent of the loan modifications done in the third quarter of 2010 involved principal reductions. Since banks have tried, with little success, almost every other available tool for preventing foreclosures, some experts believe that reducing loan principals is the next logical step. Ocwen Financial, an Atlanta-based mortgage lender, estimates that homeowners whose mortgages have been modified without a principal reduction are almost twice as likely to re-default as homeowners whose modifications involved principal reductions.

Some of the states with the highest declines in home values, such as California, Nevada, and Arizona, are already experimenting with principal reductions. The U.S. Treasury and the banks that own the loans share the cost of these mortgage modifications. No more than 40,000 borrowers are expected to benefit from these pilot programs. Experts point out, however, that although the proposal may not help many borrowers, it will yield data to help banks and the Government evaluate the effectiveness of mortgage modifications involving principal reductions. 

AT&T’s Acquisition of T-Mobile Reshapes the U.S. Mobile Telecommunications Market

Sources:

WSJ: T-Mobile Deal Faces Antitrust Barriers

WSJ: AT&T to Buy Rival in $39 Billion Deal

WSJ: AT&T/T-Mobile Will Have 40% of Mobile Market

WSJ: Sprint Left Scrambling after AT&T Deal

FT: AT&T to Buy T-Mobile USA for $39bn

FT: AT&T to Help Provide Answer for D Telekom

Last Sunday, AT&T announced a $39 billion deal to buy Deutsche Telekom’s T-Mobile USA. AT&T’s offer values its rival at 7 times the company’s 2010 earnings before interest, taxes, depreciation, and amortization (known in the industry as EBITDA), and the amount is a staggering 5.2 times greater than AT&T’s 2010 EBITDA. According to the deal’s terms, AT&T will pay $25 billion in cash and the rest in stock. As a result, Deutsche Telekom will acquire 8 percent of AT&T’s shares and receive one seat on the company’s Board of Directors. Although the acquisition has been approved by the Boards of both companies, it may be as long as 12 months before the deal closes.

Upon successful completion of the transaction, AT&T plans to retire the T-Mobile name in the U.S., and will allow Deutsche Telekom to continue using it in its European operations. Most importantly, AT&T’s customer base will exceed 130 million subscribers or approximately 40 percent of the mobile market in the U.S. If the deal does not close, AT&T must pay a $3 billion breakup fee to Deutsche Telekom, provide T-Mobile USA with additional radio spectrum, and reach a 3G roaming arrangement with the Deutsche Telekom affiliate.

The deal announcement came as a surprise to many because Sprint Nextel Corp. and T-Mobile USA, the U.S.’s third and fourth largest mobile telecommunications providers, respectively, had been actively engaged in merger talks. Nevertheless, experts opine that AT&T’s purchase of T-Mobile USA is a more logical move because the two companies use the same wireless technology. Thus, AT&T will be able to alleviate its network congestion and spectrum shortage. The company will also reduce its costs by approximately $40 billion. Additionally, the resulting scale and technology advantages will help AT&T secure the highest profit margins in the industry. Yet another upside for AT&T is that the acquisition will allow the company to develop its next generation network, which would likely cover about 95 percent of the U.S. population.

The acquisition is also welcome by Deutsche Telekom. In 2001, the German telecommunications company paid $35 billion to acquire VoiceStream Wireless, the predecessor to T-Mobile USA. Over the next 10 years, Deutsche Telekom spent billions of dollars to expand T-Mobile’s network and spectrum. Despite this huge capital outlay, however, its U.S. affiliate was consistently lagging behind industry leaders. The German company reported that it would use the cash proceeds from the sale of T-Mobile USA to retire debt and to buy back some of its stock. Despite selling T-Mobile USA, however, Deutsche Telekom retains presence in the U.S. market through its ownership of 8 percent of the new AT&T.

Not everyone stands to benefit from the acquisition, however. Cell phone manufacturers are among the perceived losers because they will have one less company to which to market their devices. Sprint Nextel Corp. is another perceived loser. Not only did Sprint’s shares plummet immediately following the acquisition announcement, but the company now has the smallest market share among the national wireless carriers. Since Sprint can no longer rely on a merger with T-Mobile USA as a means of growing its customer base, it is left with only two options. The company can either offer itself for sale or start acquiring smaller wireless companies, such as U.S. Cellular and MetroPCS.

Some experts believe that a major obstacle to closing the AT&T-Deutsche Telekom deal is securing its approval by the Federal Communications Commission (“FCC”) and the Department of Justice. Approval may only be given if the acquisition is in the best interest of consumers and the economy overall. Also, regulators must conclude that the transaction will not adversely affect industry competition.

Experts claim that regulatory approval may be hard to obtain considering the FCC’s 2010 industry report, which concluded, for the first time, that there was no competition in the wireless telecommunications industry. AT&T’s confidence in the deal’s forthcoming approval, however, stems from the fact that if analyzed on a market-by-market level, the industry is fiercely competitive. For example, AT&T points out that there are at least five companies competing in eighteen of the twenty major markets in the nation. AT&T is also likely to put a political spin on this acquisition by asserting that it will allow the company to improve its wireless service, use more efficiently its scarce spectrum, and expand broadband access. Despite AT&T’s favorable odds for securing regulatory approval, Jonathan Chaplin, a Credit Suisse analyst, maintains that he has never before seen a “deal with more regulatory risk” in the U.S.

A Risk of Regulatory Arbitrage in Derivatives

Sources:
FT: US and Europe Divisions Emerge on Derivatives; Traders Seek Answers on US Derivatives Reform; US Banks Plead to Limit Range of Swap Rules; Fault Line on OTC Rules Emerging
Economist: Unlucky for Some

Last July, the U.S. Congress passed a historic financial reform bill, the Dodd-Frank Wall Street Reform and Consumer Protection Act. Title VII of the Act deals with regulating the previously unregulated, over-the-counter (OTC) derivatives market which “played a central role” in the global financial crisis in 2008. The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) are in charge of writing detailed rules and they have been trying to make the derivatives market “transparent, open and competitive.” However, as the EU’s approach to derivatives reform seems to be more lenient and the US is moving faster than Europe in finalizing the rules, there could be a risk of "enormous regulatory arbitrage" where market participants move to the place with more favorable rules, warned Jill Sommers, a commissioner at the CFTC. “Effective reform cannot be accomplished by one nation alone. It will require a comprehensive, international response,” said Gary Gensler, chairman of the CFTC before the European Parliament on Tuesday.

Both the US and Europe aim to require more market participants to trade on exchanges and electronic platforms and use clearing houses in processing derivatives contracts in order to increase transparency and lower risks. However, the differences between the US and Europe emerge over the following three areas: 1) how to define trading platforms; 2) ownership of clearing houses; and 3) brokers' access to membership of clearing houses to deal with OTC derivatives on behalf of their customers.

First, in the case of trading platforms, the US suggested new trading platforms called "swap execution facilities" (SEF) where dealers would be required to display prices publicly. The European Commission (EC), however, defines their new platforms, "organized trading facilities," more loosely so that dealers could continue to trade through private and bilateral deals. "Our idea is not to disturb existing business models for trading of OTC derivatives," said Maria Velentza, head of the securities market unit at the EC. Also, while the US plans to put limits on the ownership of clearing houses, the EC is not suggesting any limits. Lastly, unlike the EC, the US regulators have suggested reducing derivatives clearing house capital requirements to $50 million from $5 billion to give small brokers access to membership of clearing houses.

In addition, Europe and the US have different schedules to finalize their derivatives regulations, which could also increase the risk of regulatory arbitrage. While the CFTC and the SEC are scheduled to provide rules by July 2011, Europe will not finalize its rules until 2012.

U.K. Chancellor to Consider Closing Tax Loophole

Sources

The Guardian: Budget 2011: Chancellor Moves to Close Online VAT Loophole

The Guardian: The Hidden Cost of Online Shopping
FT: UK to Close Channel Islands VAT Loophole

The Independent: Budget to Close Jersey's Hidden Mail-Order VAT Loophole

In the U.K., a tax loophole that consumers and corporations have been taking advantage of for the past ten years may soon be closed. Currently, items that cost less than £18 qualify for a value-added tax (VAT) waiver if they are imported from outside of the European Union. This tax rule is called Low Value Consignment Relief (LVCR), and was written nearly thirty years ago. However, retailers have only been taking advantage of it over the past ten years with the arrival of the Internet and prevalence of online shopping. Retailers take advantage of this loophole by building storage warehouses on the Channel Islands. Then, when consumers order these items online, they are shipped from the Channel Islands, where VAT doesn't apply due to this loophole. The types of goods that retailers typically dispatch from the islands include CDs, DVDs, camera memory cards, contact lenses, and vitamins. Several prominent retailers, including Tesco, Amazon, HMV, and Sainsbury's all use warehouses in either the islands of Guernsey or Jersey, both of which are part of the Channel Islands. With the VAT increase (to 20%) that took place in January 2011, taking advantage of this loophole has become even more attractive for these retailers.

Many are now taking notice of this loophole and criticizing it, given the U.K.'s struggling economy. According to official estimates, the loophole cost the Treasury £130 million in lost VAT last year. With the VAT increase this year, these losses could be much greater if the government doesn't step in. Further, the loophole has contributed to the closing of hundreds of High Street businesses and small record shops because they were unable to compete with the online bargains their competitors can provide by avoiding the VAT. For example, the number of independent music and DVD stores in the U.K. has dropped from 985 to 446 between 2005 and 2009.

George Osborne, the Chancellor of the Exchequer of the U.K., has proposed to reduce the £18 threshold for LVCR eligibility to £15 by November, in time to collect VAT from Christmas sales. Osborne has also pledged that the government will consider additional options throughout Europe to prevent the exploitation of the tax loophole and limit its scope. He went on to say that if nothing changes as a result, he would reconsider the LVCR in 2012, suggesting that he intends to close this loophole one way or the other.

European Leaders Reach Deal Addressing Financial Reforms

Sources:

Financial Times: Eurozone Leaders Reach Deal on Key Reforms

Financial Times: Europe Debt Deal Spurs Relief Rally

WSJ: Debt Deal Provides Wrong Incentives

The 17 eurozone heads of government reached a deal addressing key financial reforms during an emergency summit in Brussels last weekend. Leaders were under additional pressure to come to an agreement on these measures. In the weeks leading up to the summit, new financial issues arose as much of Europe continues to suffer from financial instability. Moody's downgraded Greek debt and Greece removed its chief tax collector from office when the government discovered that he failed to raise tax receipts to the necessary levels in order for the country to close its budget gap. Net revenue in Greece fell from €3.15 billion in February 2010 to €2.85 billion this year, reaffirming that it is unlikely that Greece will meet its revenue target.

Further, interest rates on Portuguese debt are approaching 8% as Chinese rating agency Dagong downgraded the debt. Despite this fact, along with the fact that Portugal's economy has grown at a rate below 1% over the past ten years, Portuguese officials maintain that the country does not need a bailout. Moody's also gave Spain a negative outlook and downgraded Spanish government debt. Spanish officials admit that its banks need to rise just over €15 billion in capital, but Moody's estimates that a more accurate figure lies between €40-50 million.

Eurozone leaders reached an agreement that they hope will address these problems. They increased the lending capacity of the European Financial Stability Facility, the rescue fund that was created in 2010, to €440 billion. This will enable the Facility to bailout additional eurozone countries if necessary. While the Facility is set to expire on 2013, the leaders agreed on replacing it with the European Stability Mechanism, which will be able to lend as much as €500 billion. Some officials, including European Central Bank President Jean-Claude Trichet, argued that the Facility should be able to do more than just bail out struggling economies. However, the leaders settled on a more limited agreement: the funds can only buy bonds directly from a country in a financial crisis, and only once its government agrees to austerity measures.

The leaders also agreed to offer Greece and Ireland, the two countries who have already received EU bailouts, an easing in the terms of their loans in exchange for Greece and Ireland taking on additional austerity measures. Greece already agreed to the deal, and will sell €50 billion of government assets and receive an interest rate reduction on the EU's portion of its €110 billion bailout of one percentage point (to a rate of just over four percent). The leaders also granted Greece an additional three years to pay back its loans, giving it 7.5 years instead of the original 4.5 years. In spite of these adjustments, some have argued that due to the size of Greece's debt, these changes will have a very small effect on whether Greece eventually defaults. Ireland rejected the deal, as Edna Kenny, the new Irish Prime Minister felt that the proposed austerity measure—that Ireland increase its corporate tax rate, which is currently set at 12.5 percent—was too costly.

The deal also includes a pact (an agreement on principle with no enforcement mechanism) committing each country to measures that aim at increased economic coordination. This pact includes caps on government spending, increased monitoring of pension plans, and limits on wage increases for public sector employees. Finally, the deal includes a commitment to force countries to reduce their debts in order to comply with the EU's legal debt limit, which currently stands at 60 percent of gross domestic product. The leaders agreed to reduce debt levels by five percent each year.

At least in the short term, these measures may be successful. On Monday, the euro rose against most currencies and European bank bonds rose as well. Greece's stock market rose by 5.15 percent and its bond market saw its biggest increase in two months.

U.S. Reiterates Support for Russia’s WTO Bid

FT: Biden in Moscow to Cement Improved Ties
WSJ: Biden Decries Russian Corruption During Visit
NYT: Plain Speaking From Biden in Moscow Speech
Moscow Times: Biden Lukewarm on Putin’s Visa Idea

U.S. Vice President Joe Biden was in Russia this week for talks aimed at improving economic and political cooperation. The meetings are part of the Obama administration’s push to “reset” relations between the two countries. In a meeting with President Dmitri Medvedev, Biden summarized his goals, stating, “We have worked through trade disputes and we are working with US and Russian companies to create close ties, promote innovation and establish the conditions to attract foreign investment in Russia beyond the natural resources sector.”

To further these goals, the leaders presided over a $2 billion purchase by Russian airline Aeroflot of U.S.-manufactured Boeing 777 planes. Both leaders also praised the recently ratified Strategic Arms Reduction Treaty (START), which cuts the number of strategic missile launchers the two countries have in half. The tone of the meetings was generally optimistic and open, although some suggestions were not met with enthusiasm. In a meeting with Prime Minister Vladimir Putin, Biden had a lukewarm reaction to Putin’s suggestion that the two countries abolish their visa requirements. Putin believes the measure would boost tourism and business ties between the nations and create “an absolutely new moral atmosphere.” Biden replied that the idea was good, but denied having enough influence over foreign policy to announce support for the matter. Biden also did not hesitate to criticize Russia’s weak record of fighting corruption and lapses in the rule of law.

One of the strongest messages from the U.S. was a positive one. The U.S. renewed its pledge to firmly support Russia’s bid for membership in the World Trade Organization. Biden stated that the bid was a top priority and agreed that Russia should strive to join the WTO by the end of 2011. Originally, support for Russia’s bid did not come without hesitation from both the U.S. and the EU. Russia began the bidding process in 1993, and in 2009 Prime Minister Vladimir Putin accused the U.S. of purposely stalling the bid. However, Obama agreed to support the bid in June of 2010 and the EU announced its support in December of 2010. To prove that support, Biden promised to press Congress to repeal the Jackson-Vanik amendment, a Cold-War era sanction that denied “most favored nation” status to countries that restrict emigration.

Byzantine Asia

Sources:
Business Standard: FDI Plunges 48% in Jan; Apr-Jan Dip by 25%
Indian Express: Foreign Investors to Get More Options
AFP: FDI in India nearly halves in January
Economic Times: India Should Liberalize FDI Regime for Insurance, Retail: US

Slow recovery from the financial in the world’s rich nations, especially in Europe, has decreased foreign direct investment (FDI) in the rest of the world. Foreign direct investment is a long term participation by one country, usually a corporation of that country, in another country in the form of technology sharing, joint venture, or management. The UK, Singapore, Mauritius, Netherlands, Japan, Germany, and UAE are the major investors in India. Although the recovery for some of the investor nations is underway, they are still lagging behind the rest of the world. This caused from FDI in India to decline 25% to $17 billion in the ten month period of April 2010 to January 2011 from the same period a year ago.

However, the decline in FDI is not solely the result of the economic cycle. A slew of corruption scandals, an increasingly sclerotic bureaucracy, the specter of inflation, and a perception of government indifference or resistance to opening the economy have led to a fall in FDI. India’s left leaning Congress that was elected two years ago has not shown an inclination towards liberalizing investment policies. Companies have frequently complained that byzantine regulations and standards make operating a business in India unduly challenging.
India’s structural deficiencies, juxtaposed with its neighbor’s increased FDI, have led India’s central bank to conclude a “quantum leap” is needed in India’s investment policy. The U.N. statistics show that FDI in Singapore increased 120% compared to 2010 to $37 billion, it increased in China by 6.3% to $100 billion, and inflows to Malaysia increased by 410% to $7 billion. The United States also called for liberalization of India’s FDI scheme, especially in the insurance and multi-brand retail sectors, where American influence is greatest. On a global scale, foreign nations invest most in India’s financial services, telecommunications, real estate, construction, and energy. Instead of investing in India, foreign corporations are now investing in India’s neighbors.

Although mild reform is underway, India is still in desperate need of FDI. India needs to fund a $1 trillion plan over the next five years to overhaul its ports, airports, highways and other infrastructure. Infrastructure is a key element of economic growth because it allows businesses to operate efficiently and safely. Although India’ economy is projected to grow at 9% of GDP this year, lack of foreign investment is a bar to India’s continued rise.

Protestors in Panama Clash with President Martinelli’s Vision for Improving Panamanian Quality of Life.

Sources:
Central American Data: Panama Amendments to Mining Code Approved
Panama-Guide: All Foreigners Promoting Mining Ordered To Leave Indian Country
Panama-Guide: Panama Clashes: Guaymi Angry Over Copper Mining Law
Boquete Times: Panama Starts Subway Construction
Newsroom, Panama: Panama Cannot Respond to International Criticism of Mining Law-Minister
Newsroom, Panama: Panama Moving Forward on Offshore oil Investigation
Newsroom, Panama: Martinelli, Now a Twitterer, Inks Mining Code Law
Newsroom Panama: World Rail Builder Boss Checks in on Panama Metro Line

In Panama, construction on Central America’s first subway began earlier this month in Panama City’s historic Cinco de Mayo Plaza. The government contracted construction of the new subway, along with a contract to build a third canal lock to access the Panama Canal, to the Spanish company Fomento de Construcciones y Contratas (“FCC”) and Brazilian company Odebrechdt. Last week the Infrastructure Minister of Spain, José Blanco, and the Chairman and CEO of FCC, Baldomero Falcones, came to Panama to see the start of the construction on the new subway line. Panama’s General Secretary, Roberto Roy says completion of the subway is expected in 2014. At the opening day of the subway’s construction, President of Panama, Ricardo Martinelli declared he wanted to be remembered “as the person who transformed Panama’s transportation system and improved the quality of life of Panamanians.”

However, in the same week, the National Assembly passed a controversial mining bill that threatens to destroy the quality of life for Panama’s indigenous Ngabe-Bugle people. Critics claim this new bill, section 277 to the Code of Mineral Resources, will allow foreign copper mining companies to dig in Panama’s Cerro Colorado district in an area that contains the Ngabe-Bugle reservation. Although President Martinelli signed a Presidential decree stating he has “no intention of promoting mining activities in the Indian lands” because it is against Constitutional law, indigenous people continued to protest. The protestors point to copper companies coming into the reservation area to conduct positive public relations, as an indication that their community is in danger of becoming a mining zone, regardless of Presidential assurances. They also argue that the President and National Assembly’s minimal consultation with environmental groups and indigenous people when drafting and passing the bill, indicate a lack of authentic concern for the well-being of the environment and the lives of indigenous people. In response, the Minister of Government, Roxanna Mendez, announced that all foreigners who are promoting mining in the area must leave within two weeks.

While President Martinelli and Roxanna Mendez took measures to assure the indigenous people of Cerro Colorado that their communities will not be usurped, Secretary of Energy Juan Manuel Urriola stated that protestors should not be “too hasty” to call the government irresponsible for seeking tenders for mining or offshore drilling because there are benefits for Panamanians as well. Some of the main provisions of Bill 277 allocate percentages of fees and royalties from mining to construction for infrastructure, social development programs in communities close to mining areas, social security and the national treasury. Like copper mining, offshore drilling will come with major stipulations, including granting the Panamanian government royalties and a percentage of oil production for Panamanian consumption. However protestors against mining and offshore drilling argue that excessive exploitation of natural resources will lead to a severely deteriorated environment. President Martinelli’s vision of improving the quality of life for Panamanians includes revamping infrastructure, increasing tax sources for social spending, and making Panama more attractive to foreign investors. However, it seems the Panamanian people have differing views on what projects will actually improve their quality of life.

Japan's Budget Battle is Latest in Political Showdown over Government Debt

Sources:

Asahi: Lower House Passed Budget Despite Boycott

Asahi: Conservative Merger Expected from Political Supernova

The Economist: Japan's Budget Battle: Kabuki Comes Home

FT: DPJ Rebel Suspended over Japan Budget Vote

WSJ: Japan Passes Record Budget, but Major Challenges Remain

This week, the ruling Democratic Party of Japan (DPJ) passed a $1.12 trillion government budget for 2011. Budget disputes have intensified as the Japanese government’s debt of more than $11 trillion is set to reach more than twice the country’s GDP. Debt issuances now account for nearly 50 percent of all government revenues and are a larger source of revenue than taxes. To add to the troubles, last month Standard & Poor’s lowered its rating Japan’s long-term government bonds from AA to AA-.

However, while the budget sets out the amount of money the government plans to spend for the year, to fully implement the budget, additional legislation is required to specify a source of revenues. The recent budget showdown is expected to continue for several more months because support for the implementing legislation is unlikely to gain either the necessary majority vote of the upper house of parliament, or a two-thirds majority in the lower house. Japan's new fiscal year begins April 1 and without passage of additional bond issuances, the government could run out of money by the middle of this summer.

The Prime Minister Naoto Kan argues that failing to pass the implementing legislation will threaten Japan’s slow economic recovery. Commentators suggest that Japan’s government debt and political deadlock may weaken the country’s economic competitiveness.

The recent budget woes have led to a split within the DPJ in how to manage Japan's debt and economy. Prime Minister Naoto Kan and a majority of his DPJ favors raising taxes to address the debt and decreasing trade barriers with the U.S. to improve economic performance. Others within the DPJ are calling for tax cuts, a continuance of current trade policy with the U.S., and closer economic ties with China. Sixteen lawmakers of the DPJ abstained from voting with their party, leading the newspaper Asahi Shimbun to suggest that a realignment of the political parties may be underway.

Russia Attempts to Transform Vladivostok into a North Asian Trading Hub

Sources:

Monocle Magazine: Dark Horse in the East – Vladivostok

The Telegraph: Toyota in Deal to Make Cars in Vladivostok

BBC: Davos 2011: Medvedev Opens World Economic Forum with Call to Action

World Security Network: Russia’s Far East and Japan: Obstacles to Cooperation

Vladivostok is Russia's largest port city and is strategically located near Japan, the Koreas, and China. During the era of the Soviet Union, Vladivostok was home to many large defense manufacturers, but in the 1990s, the city became known for corruption and trade in mining resources. Recently, Russia has attempted to develop its Far Eastern territories to improve the country's political and economic status in the Asia-Pacific region. Key to this plan is transforming Vladivostok from a commercial backwater into one of North Asia’s leading trade centers.

In 2012, Vladivostok will host the Asia-Pacific Economic Cooperation (APEC) summit. To prepare for the summit, the Russian government is making vast investments in construction and infrastructure projects in the city. The central government is building a presidential palace in Vladivostok as a symbol of Moscow’s renewed interest in the region. The central government is also building new roads and bridges that will reduce the city’s traffic congestion and make it easier for businesses to access ports and railways. Once the APEC summit is finished, the hotels and conference halls that were built for the event will be converted into a new Far Eastern State University with an enrollment of up to 50,000 students.

Vladivostok is still primarily attractive to investors because of its easy access to mineral resources from Siberia. However, Vladivostok’s auto industry has boomed as foreign automakers attempt to bypass Russia’s recent increase in import tariffs. This month, Toyota announced that it will build a plant in Vladivostok as part of a joint venture with local automaker Sollers. This announcement follows the recent opening of an assembly plant for SsangYong jeeps from South Korea.

Shipbuilding, ports, and agriculture have also seen a recent flood of foreign investment near Vladivostok, primarily from South Korea. Daewoo is currently building a new shipyard to take advantage of Vladivostok’s many decades of shipbuilding expertise. Foreign companies are also finding success in building yachts and catamarans for export to Europe. Korea’s Busan Port Authority is building a new container port a short distance from Vladivostok. And in the area surrounding the city, Korean companies now farm more than 150,000 hectares of rice, beans, and corn that are then sold throughout Asia.

With all of the state and foreign investment though, Vladivostok still faces many obstacles to becoming Asia’s newest economic success story. First, Russia’s high import tariffs prevent Vladivostok from reaching its full potential in cross-border trade. Second, the abundance of state-led investment projects has led to a resurgence in corruption. For example, locals now refer to one of the new bridges under construction as Kickback Bridge. Third, Vladivostok is still littered with empty shipyards and military supply factories from the Soviet years. Finally, travel to Vladivostok remains prohibitively expensive and troublesome even though the city is just a short trip from Japan, the Koreas, and China.

The Role of Social Media in Middle East Uprisings

BBC: Middle East Unrest: All quiet in Saudi Arabia?

WSJ: Egypt's Revolution by Social Media

The Guardian: For Middle East Democracy, Send in the Geeks

FT: Is Social Media the Real Deal?

Social media is an increasingly popular term to describe a broad spectrum of media tools that have played a vital role in Egyptian and Tunisian revolutions. In the recent events in the Northern Africa, the role of social media is best characterized as an enabler—facilitating rallies and galvanizing participants. Social media is a set of tools that allows information providers to dispatch content to a wide audience, and for information consumers to receive the information instantaneously. The most common social media tools are Facebook, Twitter, and YouTube and relatively new social media sites like Diggs and Foursquare. Social media is not a communication forum in the traditional sense because few have discussion boards. The communication comes in the form of status updates and ad hoc statements. While discussion may be limited, the dissemination of information has been the most influential component of the upheavals in the MENA (Middle East and Northern Africa) region.

Commentators generally agree that social media outlets have enabled government overthrows in Tunisia, and particularly in Egypt. Facebook has played the most practical role, with certain pages providing information to demonstrators on the status, location, time, and other practical information on rallies and gatherings. YouTube was essential for spreading eyewitness reports and providing information to a broad range of users on the status of the demonstrations. It also evidenced the often-violent responses of government forces, further galvanizing the public. Twitter has similarly provided instantaneous eyewitness accounts of violence that galvanized opposition leaders.

Some commentators disagree that social media played an important role, noting that the Internet has only been marginally influential in countries where the percent of citizens with access to the Internet is relatively small, like in Egypt with 31% and Tunisia with 21%. Other commentators have rebutted that: while the percent of citizens with access to the Internet may be small, those Internet users spread the information gathered on social media websites to family members, friends and neighbors who do not have access to the Internet. In the events in Egypt, the role of social media is undeniable. In an effort spearheaded by Wael Ghonim, a Google Marketing executive originally from Egypt, hundred of thousands of users accessed information on both the location and time for demonstrations, as well as links to YouTube videos illuminating government atrocities against the public.

The next frontier for the role of social media is two-fold. First, social media tools are essential for a knowledge-based society, and for the economic and political development of newly liberated Tunisia and Egypt. Second, social media continues to have an inflammatory effect in other parts of the Middle East. For example, in Saudi Arabia, citizens are advocating for uprising on social media networks; the government is so concerned that it is blocking access to these sites. Even though Saudi government officials do not believe that the country will be “next” in the wave of revolutions, the government is keeping a close eye and ear to social media outlets.

Food Prices, the Middle East and World Bank Warnings at the G20 Meeting

FT: To End the Food Crisis, the G20 Must Keep a Promise

NPR: The Effect of Rising Food Prices on Arab

MSNBC: Hungry for a Solution to Rising Food Prices

FT: Chronic Hunger to Affect 1 Billion People

With an additional 44 million people facing extreme hunger because of rising food prices in recent months, a total one-sixth of the world’s population is “chronically hungry” according to World Bank President, Robert Zoellick. In developing countries, rising food prices can be catastrophic because the world’s poorest spend a high percentage of their income on food. According to World Bank estimates, prices are up almost 30 percent in the last year, with sugar and wheat prices up 20 percent, and fats and oils up 22 percent. Moreover, prices on wheat, corn, and soybeans are at a 30-month record high.

In Middle Eastern countries, where the population spends nearly half of their income on food, high food prices in Egypt, Tunisia and now Libya have contributed to the political upheaval, according to Zoellick. In other parts of the Middle East, like Jordan and Algeria, protesters have focused demands specifically on reducing food prices. For those countries in the Middle East that are going through “something between transitions and revolutions,” high prices on food could influence future political developments. Chief Economist at the U.S. Department of Agriculture, Joseph Glauber, noted that high prices contribute to the political pressure because governments subsidize the cost of food to the detriment of providing other services.

As noted by participants at the G20 February Summit in Paris, inflationary pressures around the world are a growing threat for global economic stability. While not a serious factor in the Middle East where unemployment is high, in countries with relatively low unemployment, employees are likely to receive pay raises to cover higher food prices, increasing inflationary pressure.

Various factors and events have contributed to increases in food prices. Most importantly, with a fast-growing global population, supply has not been able to satisfy demand. Commentators have also focused on other specific reasons for high prices. First, droughts in Russia and Argentina, coupled with torrential rains in Australia and Canada, caused crops to fail last year. Second, unregulated speculators have contributed to higher prices. Third, dwindling food stockpiles are creating uncertainty and pushing up prices as governments are infusing food into markets to satisfy demand. Fourth, governments continue to issue export bans (reserving food for domestic use) that reduce supply in the global market. Fifth, governments, particularly the United States, have put in place policies that promote crop use for biofuels, thereby shrinking the food supply for consumption. Finally, crop production is not currently maximized in tropical Africa because of under-investment.

Solutions for reducing prices are as varied as the factors that have contributed to their growth. At the G20 Summit in Paris, Brazil’s finance minster opposed regulation for prices while France advocated for greater involvement, including greater transparency of countries’ stockpiles, restrictions on export bans, and greater regulation of speculators. Commentators have noted that the G20 must promote greater food production. In 2009, G20 members pledged $22 billion for a World Bank fund to promote food security, but member countries have contributed just $305 million of the promised amount. The next step will be to see whether G20 countries will be able to overcome domestic political pressures to aid global food production as promised.

World Bank’s International Finance Corporation Lends $400 Million to Expand Phone Service in Iraq

Sources:
New York Times: A Big Push to Expand Mobile Service in Iraq
AME Info: IFC-Led Financing for Zain Iraq to Improve Telecoms Services, Support Growth in Iraq
Reuters: Zain Iraqi Unit Gets $400 Million World Bank Loan

In an effort to foster development and improve telecommunication service in war-torn Iraq, the International Finance Corporation (IFC) recently announced that it has finalized a 7-year, $400 million extension of credit to the telecommunications firm Zain Iraq. Zain Iraq intends to use the proceeds of the loan to update and improve the mobile phone infrastructure in Iraq, while expanding the mobile service coverage area to poorer regions of the country.

Currently in Iraq, approximately 21 million people have access to mobile phone services, which translates into a 77 percent penetration rate into the entire population. This rate lags behind the rates of some of Iraq’s neighbors, such as Bahrain, Saudi Arabia, Jordan and Kuwait, where penetration rates are nearly 100 percent. Nevertheless, the fact that 21 million Iraqis have access to mobile phone services is impressive considering that prior to 2003, while under the reign of Saddam Hussein, Iraqis did not have any access to mobile phone services.

The organization that sponsored the loan, the International Finance Corporation, is one of the organizations that comprise the World Bank Group (also known as the World Bank). The goal of the IFC is to promote economic growth in developing countries. To this end, the IFC provides developmental advice to the governments and businesses of developing nations. The IFC also facilitates investment in those nations by arranging loans to fund development projects. The IFC focuses especially on investment in the private sector, helping businesses like Zain Iraq. The funding for these loans comes not only from the IFC itself, but can also from private banks and other organizations. These private investment institutions are able to participate in IFC loans by lending the IFC money, which the IFC uses to fund the loan to the ultimate recipient. For example, the funding for the loan to Zain Iraq came from not only the IFC, but also from five other private investment institutions who participated in the loan.

The IFC is hopeful that the loan to Zain Iraq will contribute to stable economic growth in Iraq. By expanding and improving the telecommunications industry in Iraq, Zain Iraq’s project should help that industry serve as another source of employment for Iraqis. Iraq currently has little diversity among its sources of employment, relying largely on its oil industry to provide jobs. In addition, when finished, the project will give more Iraqis access to a reliable source of communication, which is essential to economic development and business growth, as well as economic integration with other countries. The IFC also hopes that this investment will encourage foreign investors to invest in the development of Iraq. To date, such investors have been reluctant to invest in war-torn Iraq because of its perceived political instability.

Would Rising Commodity Prices Lead to Inflation in the U.S.?

Sources:

WSJ: Fed’s Hoenig: Policy Plays Role in Commodity Price Surge

WSJ: Fed Finds Climbing Costs Hit Shoppers

WSJ: Commodity-Price Gains Dog Bernanke’s Inflation

The Economist: Inflation Lessons from the Asian Crisis

CNN Money: Coming Soon to U.S. Shores: Higher Prices

NYT: Companies Warn That Higher Prices Are Looming

Prices for cotton, wheat, iron ore, steel, wheat, sugar, beef, pork, oil, and many other commodities have been rising since last summer. Fearing that consumers were unlikely to pay higher prices, U.S. retailers and manufacturers have been absorbing these commodity price increases, thus sacrificing their profits, to keep prices steady. Experts claim that U.S. businesses can no longer do so. Companies such as Hanes Brands, Kellogg, and Whirlpool have already announced price increases. Others, including Kraft and Proctor & Gamble, expect to raise prices soon.

There are several reasons for the surge in commodity prices. Political turmoil and supply disruptions are major factors. Another factor is the rapid economic growth in developing countries, which has resulted in dramatic improvements in the quality of life there. Better living standards, in turn, have led to a higher demand for consumer goods, thus increasing the demand for commodities. Since the supply of raw materials has not kept up with demand, commodity prices have risen.

In addition to these external factors, some experts, such as Tomas Hoenig, the President of the Federal Reserve Bank of Kansas City, claim that U.S. monetary policy is also to blame for the rise in commodity prices. Mr. Hoenig asserts that domestic monetary policy has a global impact. According to him, the U.S. Federal Reserve must increase interest rates to prevent inflation. Other experts believe that to stave off inflation the Federal Reserve must also immediately end its $600 billion bond-buying program scheduled to wind down this summer.

During his recent semi-annual congressional report Mr. Ben Bernanke, the Chairman of the Federal Reserve, denied that U.S. monetary policy had any role in the surge in commodity prices. He also emphasized that rising commodity prices can cause inflation only if they lead to higher wages. When consumers experience or expect inflation, they are likely to demand higher wages. Higher wages lead to higher production costs and exert a further upward pressure on prices. Thus, rising prices would cause wage increases and vice-versa. This cycle, known as the wage-price spiral, continues until inflation “spirals” out of control.

Despite the recent surge in commodity prices, statistics support Mr. Bernanke’s skepticism regarding the threat of inflation. In December 2010, the annual inflation was 1.4 percent, and economists do not expect inflation to rise above 2.5 percent in 2011. Mr. Bernanke opines that inflation fears are unfounded for at least two reasons. First, with unemployment rates hovering around 9 percent, it is doubtful that consumers would be able to command higher wages. Second, since the price of raw materials represents a small share of the cost of consumer goods, passing the increase in commodity prices to consumers is unlikely to significantly increase the price of end products. Indeed, most experts agree that wages, and not commodity prices, are the bigger driver of inflation in the U.S. Therefore, higher commodity prices appear unlikely to lead to inflation.

Although inflation is of no real concern at this time, Mr. Bernanke has alluded to some of the other negative implications of rising commodity prices. For example, he fears that the increase in prices of raw materials may stifle economic growth by draining consumers’ purchasing power. Slower economic growth would, of course, significantly prolong the U.S. economy’s recovery.

Bolivian Oil Prices Have Uncertain Future

Economist: The Calle Gets Restive

Economist: Fuel on the Fire

Upside Down World: Gasolinazo Challenges Bolivia's 'Process of Change'

The Bolivian government has been facing a backlash since it announced an end to subsidies on fuel. Late last December, the Bolivian government ended its subsidies on many fuels, in a measure called gasolinazo. In the following days, gasoline prices rose 73 percent, workers went on strike, residents rioted, and food prices soared. Before withdrawing the measure altogether, President Morales announced that the government would increase wages for public sector workers, provide funds for infrastructure projects, and order the army to provide bread at pre-gasolinazo prices. Despite these extraordinary actions the government was forced to withdraw the measure after five embarrassing days of mass protesting that paralyzed almost every major Bolivian city.

President Morales came to power in 2006, riding a wave of popular support. He was reelected in 2009 with 64 percent of the vote. Since he announced gasolinazo and oil prices skyrocketed, he now faces a 30 percent approval rating.

Although Bolivians do not agree with the policy of ending government fuel subsidies, there are many reasons to support of it. Fuel prices in Bolivia have been frozen since 2004. To achieve this freeze, the government has heavily subsidized fuel to maintain domestic supply and imports. However, since 2004, the demand for fuel in Bolivia has increased, but Bolivian production of oil has decreased. This widened the domestic gap and thus increased demand for fuel imports, further driving up the cost of imports. The Bolivian government of course must pay the cost of the resulting dramatic increase in fuel subsidies. The Vice-President of Bolivia estimates that fuel subsidies cost the government $380 million last year and would cost $660 million in 2011.

President Morales argues removing fuel subsidies will prevent “bleeding the economy.” Currently the Bolivian subsidies primarily benefit smugglers and neighboring countries. Gas prices in neighboring countries are not subsidized and are two to three times as high as in Bolivia. The subsidized gas is smuggled out of Bolivia and then resold in the neighboring countries at prices higher than in Bolivia but lower than market prices. Analysts estimate $150 million of the government subsidies was wasted on gas smuggled out of the country, creating a further negative effect on the Bolivian economy.

The government also insists that the removal of subsidies will stimulate oil exploration and production within Bolivia. Bolivia oil reserves are almost depleted, but companies have been unwilling to invest in exploration of more Bolivian sources because crude oil prices in Bolivia are frozen at $27 per barrel (less than a third of the international price). By removing the subsidies, the freeze on domestic crude oil prices also can be removed, and companies will be more likely to explore for oil within Bolivia. This would also help Bolivia overcome its current dependency on foreign oil sources.

President Morales argues that the subsidy removal was a “patriotic measure” designed to benefit the economy and redirect the subsidies from wasteful sources into programs to benefit Bolivian social and economic programs. Although Bolivians will be spending more on fuel, they will spend less in other areas, and more money will remain inside the country. These arguments have yet to convince the Bolivian people, but they could have more impact if the government implements concrete programs.

While many analysts agree the subsidy removal happened too abruptly, they agree that the subsidies are unsustainable and the government must eliminate them over time. Morales remains committed to ending the fuel subsidy, and he says he is working on a revised policy “in consultation with the people.”

Others are proposing solutions as well. Unaderena, a group seeking alternatives to the gasolinazo, suggests that the government take full control over all Bolivian hydrocarbon production. While Bolivia is a major exporter of natural gas, it wastes an estimated $700 million per year when it sells natural gas to Brazil without first separating liquids from the natural gas that can be converted into petroleum products. Another group suggests developing new natural gas reserves within Bolivia that are only provided to the domestic market. By increasing the availability of natural gas within Bolivia’s market, the group hopes to decrease dependency on foreign oil.

The Bolivian government faces a precarious future of balancing spending cuts with placating the people. While President Morales will most likely act more slowly this time around, further change must also begin soon.

Russian Widens Floating Corridor, Strengthening Rouble

Sources:
WSJ: Ruble Hits 2-Year High Against Dollar
Bloomberg: Ruble Moving to Free Float Shows Emerging Inflation Concern: Russia Credit
The Financial: Russia's Cbank Widens Floating Corridor for Bi-Currency Basket to 5 Rbls
FT (blog): Russia: The Rouble Rises

Russia took measures this week that strengthen the rouble, help fight inflation, and bring stability to the central bank’s interest rates. Russia moved one step closer to a free-floating rouble by widening the “floating corridor.” Trading has shifted from 33.0-37.0 roubles against a euro/dollar basket, to 32.45-37.45, which increased the corridor from 4 to 5 roubles. First Deputy Central Bank Chairman Alexei Ulyukayev stated Tuesday that “the ruble is more likely to strengthen than weaken in the short term.” By Wednesday, his statement was confirmed as the rouble strengthened 1% against the euro/dollar basket. Morgan Stanley commented, "This is a bullish sign for the ruble, as it suggests that the central bank has increased its tolerance for ruble appreciation and will only be intervening in the market at stronger ruble levels than before."

However, the fiscal policies in Russia did not alone strengthen the rouble. Unrest in the Middle East also caused oil prices to rise, and since most of the oil production in Russia is state-owned, the profits flow directly to the government coffers. When the floating corridor was widened, the increased oil profits helped the rouble strengthen.

One of the reasons for the adjustment to Russia’s currency may be political. Russia is coming up on its 2012 presidential elections and either potential candidate currently in positions of leadership, Medvedev or Putin, would benefit from stability in the financial sector and a hold on inflation. Russia raised interest rates for the first time since 2008 and the currency is at its strongest since October of that year. The market is nowhere near its 2008 highs, however, with the currency still 20% lower than its peak prior to the global financial crisis. Furthermore, inflation had been running at a 9.7% annual rate before the widening of the corridor due to a crushing drought last summer. Thus, any positive moves to curb inflation have strong political benefits. Strengthening domestic currency benefits consumers by lowering the prices of imported goods, giving consumers more buying power and more confidence in the economy. The increased oil profits can support an increase in government programs that will also boost the political reputations of the candidates currently in power.

EU Pledges €90 to Address Climate Change in Pacific Island States

Sources:

Europa Press Release: Pacific Islands and Climate Change: Commission Takes the Lead to Help With Adaptation and Fight Poverty

Prevention Web: Pacific Islands-EU Relations: Focus on Climate Change

The Guardian: EU Pledges €90 Million in Climate Funds For Pacific Island States

Andris Piebalgs, the European Union's Commissioner for Development, traveled to the island nation of Vanuatu, located in the South Pacific Ocean, on Wednesday to present the EU's proposal to fund projects aimed at addressing poverty and other consequences of climate change in the region. In return, the Pacific Island states will vote with the European bloc at upcoming international climate negotiations. These nations will receive €90 billion from the EU. While this is not a huge amount in EU terms, it represents 19.5% of the nominal GDP of Vanatu. The Pacific Island countries are isolated developing countries that have suffered from frequent natural disasters and are particularly susceptible to the effects of climate change. Climate change has already had a visible impact on the area due to rising sea levels and increased erosion. These changes pose a serious threat to inhabitants' ability to engage in agricultural practices. This is significant, given their heavy reliance on natural resources. Further, 80% of the population lives near the coast, making them even more susceptible to displacement due to rising sea levels.

During his visit, Piebalgs made several proposals, including a program to strengthen Pacific economic integration through trade and a program to support climate change capacity development for Pacific Islanders. He also proposed to implement adaptation projects in the area, including reforestation of watershed areas and reduced-impact harvesting. Finally, he proposed €20 million for the Pacific Regional Program On the Reduction of Risks From Natural Disasters, an organization that helps prepare the nations for future natural disasters, while bolstering their ability to respond after a disaster has struck; €12 million to fund a program to reinforce the management of costal, terrestrial, and marine environments; and €4.3 million in humanitarian aid for the area's Disaster Preparedness and Risk Reduction Program. While in the Pacific, Commissioner Piebalgs will also visit projects that the EU has previously funded, including a wind farm in Vanuatu and the Vanuatu National Disaster Center and Meteorological Services.

The Pacific region receives more EU development aid per capita than any other region. However, the Pacific Islands are still not on track to meet most of the 2015 Millennium Development Goals (MDGs) put forth by the United Nations. Over two million Pacific Islanders are living in poverty. This region also has a very high infant-under-five mortality rate, with 64 out of every 1000 children dying before they reach the age of five. Delivering effective aid is also more difficult in this region due to the highly dispersed population, numerous languages, lack of infrastructure, and large distances between countries. Nevertheless, Piebalgs’ most recent visit suggests that the EU is going to continue to support the region in meeting the MDGs. Prior to his visit, Piebalgs noted that climate change and natural disasters have hindered the region's development, economic growth, and progress toward meeting the MDGs. However, he said that "it is time for us to take the lead in rallying substantial international community support for the Pacific's climate change adaptation efforts." He went on to call on all EU Member States to participate in the EU-Pacific partnership to fight climate change and poverty.

Foreign Banks Seek Ways to Avoid U.S. Federal Reserve Regulations on Capital Requirements

Sources:

Bloomberg: Barclays Deregisters U.S. Unit after Capital Requirement Change

WSJ: Banks Find Loophole on Capital Rule

Wolters Kluwer: FDIC Moves on Dodd-Frank Capital Requirements

Pillsburylaw.com: Dodd-Frank Act Significantly Changes Bank Holding Company Capital Requirements

Some overseas banks have decided to restructure their U.S. operations to avoid the burdensome requirements of the Wall Street Reform and Consumer Protection Act, also known as the Dodd-Frank Act. The Dodd-Frank Act, which President Obama signed into law on July 21, 2010, is named after the two congressmen who sponsored it—Senator Chris Dodd and Representative Barney Frank. The legislation introduces sweeping changes to U.S. financial regulations to prevent future financial meltdowns.

One of the most important provisions of the Dodd-Frank Act is section 171, or the so-called “Collins” Amendment, which carries the name of its author Senator Susan Collins. The provision subjects all U.S. bank holding companies owned by foreign banks to the same stringent capital requirements applicable to domestic bank holding companies not owned by foreign banks. It is common for foreign banks to use bank holding companies as a way to structure their U.S. operations. Since January 5, 2001, all foreign-owned bank holding companies in the U.S. have enjoyed an exemption from the Federal Reserve’s capital adequacy guidelines. The “Collins” Amendment, however, will effectively end this exemption regime when it takes effect in July 2015.

 Bank executives object to the Dodd-Frank Act, arguing that it forces banks to unnecessarily increase their capital reserves which will lead to a decline in profits without making the financial system safer. United States regulators, however, believe that an increase in the banks’ capital levels will help prevent a repeat of the most recent economic crisis. According to FDIC Chairman Sheila Bair, the Dodd-Frank Act, and particularly the “Collins” Amendment, will ensure that banks maintain sufficient amounts of capital to be able to withstand financial crises without government aid. 

Believing that the “Collins” Amendment is not in its best interest, Barclays PLC, the U.K.-based financial firm, has found a way to circumvent the new capital requirements. The Amendment’s provisions leave Barclays with two choices: (1) inject $12 billion into its U.S. bank holding company to comply with the new capital adequacy requirements; or (2) reduce the bank holding company’s assets to ensure that the current capital reserves are sufficient. Barclays has done neither. Instead, the firm deregistered its U.S. bank holding company and created two new entities. Barclays now conducts its credit card operations in the U.S. under an entity regulated by the Federal Deposit Insurance Corporation (the “FDIC”) and, therefore, needs no additional capital. The other new entity, which operates Barclays’s investment bank business in the U.S., is now regulated by the Securities and Exchange Commission. Through this recent reorganization, Barclays has completely sidestepped the “Collins” Amendment’s capital adequacy provisions. A spokesperson for the company, however, declined to characterize the reorganization as a direct response to the Dodd-Frank Act. Some commentators believe that many other foreign banks, such as Rabobank Groep NV and HSBC Holdings PLC, may follow Barclays’s example.