Jealous Guys: Eastern Europeans' Euro Dreams

♠ Posted by Emmanuel in , at 11/03/2008 09:20:00 AM
With apologies to John Lennon:

I was dreaming of euro cash
And my heart was beating fast
I began to lose control
I began to lose control...

Currency crises are endemic to developing countries like predictions of capitalism's imminent demise are to Marxists. At this time, many former Soviet satellites are now running gaping current account deficits, making them especially vulnerable to the credit crunch. Ukraine and Hungary has already been crunched, and others in the region appear to be in a precarious position such as the Baltics.

Former US Secretary of Defense derided Western European states that refused to participate in the invasion of Iraq as "old Europe" in contrast to Eastern ones that were more willing to pitch in the war effort. Today, however, "new Europe" is hankering for that aging symbol of European unity, the common currency. Simply put, no one is going to mount a run on the euro. Despite Eurozone members such as Spain, Portugal, and Greece running similarly large current account shortfalls, no is suggesting that they are IMF bound in the near future. Eastern Europeans now look at Slovakia with envy, that country having met preconditions for joining the monetary union before the current crisis. The thinking goes, "if only Hungary had adopted the euro before the current crisis, it wouldn't be in such dire straits." Perhaps, but it's too late now. From Reuters:
A Polish proverb "Jak trwoga to do Boga" (Run to God when in trouble) is a fitting description of how the financial crisis is shifting attitudes in much of the ex-communist central Europe toward the euro. Stung by rapid depreciation of their currencies, credit rating downgrades and capital flight in the last few weeks, many "New Europe" politicians are waking up to the status of the euro as sanctuary in economic hard times.

In Poland, Hungary, Czech Republic, Romania and the Baltic states, governments look with envy at Slovakia which, thanks to its imminent adoption of the single currency on January 1, has suffered none of the investor anxiety or capital flight that the global financial turmoil has inspired elsewhere.

The crisis engulfed Hungary, once an economic leader in the region, seeing it become the first European Union state in 30 years to be bailed out by the International Monetary Fund after years of overspending and living on credit. The plunge in the Hungarian forint and the drastic measures the beleaguered Socialist government in Budapest has had to take to save the country from financial collapse have sent shockwaves across the region.

Even eurosceptic politicians such as Polish President Lech Kaczynski have pointed to the Hungarian "events" as perhaps a good reason to pursue the euro after all. This in itself is remarkable. Since joining the EU in two waves since 2004, only a few of the 10 ex-communist EU members have pursued the euro vigorously -- despite committing to adopt it in their accession treaties.

Lulled by the fast economic growth that came with EU membership, a rise in the value of their currencies and access to cheap credit on global markets, governments of left and right assumed their risk profile was permanently hoisted above emerging market status. With no determined push to meet strict euro zone criteria, original plans to adopt the single currency in 2008-2009 were pushed back or dropped altogether, with the exception of Slovakia and tiny Slovenia, a euro zone member since 2007.

For their part, investors contributed to this false sense of security, ignoring the slippage of euro timetables and reform in favor of pumping billions of euros into the region's assets because the growth story was too good to be missed.

The benefits of eliminating currency risk, having lower borrowing costs, or being protected by the European Central Bank and wielding influence on the Ecofin council of EU finance ministers seemed too abstract for politicians and investors.

Even when the crisis started to bite hard in the United States and Europe, the region was considered a safe haven. But in the last few weeks of panic, it became clear to all that with the wafer-thin capital stock and the absence of ECB protection, the "new Europe" economies were still wearing a rather large emerging market badge on their sleeves. Those who were most exposed, like Hungary, were punished accordingly for its feeble and much delayed reform efforts.

"The biggest crime made by (Hungarian Prime Minister Ferenc) Gyurcsany was that his 2006 plan to rein in the budget deficit didn't have euro adoption as an end-game," said David Lubin, a veteran emerging markets economist at Citigroup in London. Hungary's current declarations that the euro should be adopted as soon as possible sound hollow given the tasks it faces just in stabilising its economy.

Of all countries converting to the euro gospel in the last few days, it is the region's heavyweight, Poland, that is making the most serious effort. The center-right government of Prime Minister Donald Tusk, a euro enthusiast, has adopted a formal goal of joining in 2012 and signs are emerging of necessary political consensus on the issue with Kaczynski and the opposition.

Poland is very close to meeting all the strict euro entry criteria on debt, deficit and inflation, but economists point out that, like Hungary, it had allowed the best opportunity to pass. "Some central Europeans missed the bus," said Witold Orlowski, chief economic adviser at PriceWaterhouseCoopers in Warsaw. "They can now sit and cry that they will not be joining with Slovakia on January 1, 2009."

The bitter irony is that just as political determination to adopt the euro is on the rise, the economic environment in which it must happen has deteriorated. Economists say several factors hamper euro adoption. Currency volatility is arguably the key issue. Prior to entry, countries must spend two years in the Exchange Rate Mechanism and maintain a narrow trading band around the euro, prior to entry.

Meeting this criterion may require costly interventions in the face of general volatility and poor prospects of capital inflows into emerging markets in the medium-term. Trying to defend the band in case of economic trouble can invite a speculative attack and end a candidate country's euro dream.

Slower growth is another risk. The next two years are set to see growth rates slashed and tax revenues fall, meaning some countries may bust the 3 percent of GDP cap on budget deficits and see debt rise above the 60 percent of GDP limit.

Meanwhile the appetite among existing euro zone members for expanding their club in the near term may evaporate. But none of these difficulties should discourage central Europeans for trying hard, economists say, even if eventual membership could come later than they now hope for.

PwC's Orlowski says the best time to enter the euro zone is two years after a recession at the start of the economic cycle when budget revenues are growing, inflation is low and currencies are typically in a mild appreciation trend. If the fallout from current crisis lasts into 2010, then such conditions, last seen in 2004-2005, will materialize around 2011-2012, making the earliest realistic entry around 2014. By that time, real convergence with the euro zone should go deeper across central Europe, making the process more palatable for the European Commission and the ECB.
And yes, I still think Eurosceptics are daft as even smaller Western European states are rethinking their decisions not to adopt the common currency.
Read More

PM Brown: How NOT to Ask Gulf for IMF Funding

♠ Posted by Emmanuel in ,, at 11/02/2008 12:32:00 PM
I don't mean to dump on UK Prime Minister Gordon Brown any more than is necessary. His troubles at home appear enough to ensure that a second term in office--which he would actually have to win at the ballot box--is a very iffy proposition. Being Blair's chancellor of the exchequer for the longest time, it is hard for him to escape the blame for the America Jr. mess he faces: a collapsing housing bubble, unprecedented household indebtedness, and the rest of it. However, Brown has not exactly held silent during this time of economic crisis, and a recent swing through the Middle East finds him suggesting that Gulf states ante up at the IMF. With any number of countries now in line to receive funding and global conditions not improving markedly by any stretch of the imagination, it is conceivable that the quarter of a trillion or so the IMF has will run out in the near future.

You may think, "That's a $%^&*£ fine idea. Let the petrodollars be put to productive use by helping less fortunate developing countries out." Perhaps so, but I believe that the Gulf states will be reluctant to participate in such a scheme given that, like many other LDCs, these countries have minimal say in global economic governance despite their growing economic clout. Let us spell out the issues:

(1) Europeans have disproportionate influence at the IMF - tradition dictates that the managing director is chosen by the Europeans. Moreover, Europeans have been quite reluctant to let developing countries have more voting shares at the IMF. At the IMF, the number of quota allocations a country has is roughly proportional to its voting power there. Despite efforts to make the IMF less "Western-centric" in governance, European countries have not been keen on relinquishing some of their voting rights to make way for fast-growing LDCs. On March 28 of this year, changes in quota allocations were proposed that were largely cosmetic, however. Unless representation and governance at the IMF become more cosmopolitan, it is right to wonder why Gulf states would be so excited to fund it.

(2) Gulf countries' sovereign wealth funds (SWFs) continue to be regarded with suspicion - I've already talked about past efforts to impose Western standards on LDCs with large pools of investible monies. The IMF has been at the forefront of these efforts with the so-called Santiago Principles. Somewhat infamously, French President Nicolas Sarkozy proposed the creation of European equivalents of these SWFs to ensure that European "national champions" do not fall into the hands of others. Although it would be good not to confuse Sarkozy's protectionist rhetoric with that of Brown and others, vestiges of protectionism remain that maintain a patronizing attitude. On the topic of SWFs, Brown suggested that they "play by our rules and operate in a commercial manner." Which, of course, is a big problem in a world where he who has the gold (usually) makes the rules.

(3) At the same time, Westerners keep talking about lessening oil dependency and cutting carbon emissions - telling Gulf states that you intend to undercut their breadwinner doesn't seem conducive to eliciting support.

It is thus doubtful the Gulf states will suddenly have an outpouring of generosity towards the IMF. The upcoming (US-sponsored, naturally) November 15 meeting in Washington to discuss changes in global economic governance should prove to be decisive in seeing if Western powers are truly interested in inviting others to the table. Or, it may perpetuate the status quo which is more reflective of the situation over half a decade ago than of current times.

UPDATE: The Guardian reports Brown is confident that Gulf states are amenable to the idea of funding the IMF, although there are no firm commitments (or dollar figures) to speak of as of yet. We should see in a fortnight or so when the G20 summit is held whether these commitments are substantial. Brown says that heightened oil prices in recent years have boosted Gulf states' revenues by $1 trillion in making his case:
Gordon Brown yesterday said he felt confident that he has successfully enlisted the help of Gulf states for international plans for an emergency bail-out fund, with both Qatar and Saudi Arabia indicating they will offer funds when leaders of the 20 most developed countries meet in Washington in a fortnight.

As the prime minister arrived in Qatar on the second leg of his whistlestop Gulf tour last night, the Qataris hinted they would contribute money to an International Monetary Fund bail-out fund - being billed as a "new Bretton Woods" after the initiative of 1944 - the details of which will be thrashed out in Washington on November 15. The prime minister, Sheikh Hamad bin Jassim al-Thani, said: "We are sharing the same world. Qatar is not excluded, so we have to work together."

Speaking after his three-hour private conversation with the King of Saudi Arabia on Saturday, Brown told the BBC's Sunday AM programme: "The Saudis will, I think, contribute so we can have a bigger fund worldwide." Yesterday Kuwait said it had still not made up its mind.

Brown's diplomacy appears to have been in the face of some disquiet among Arab leaders that they are being looked to to provide funds to shore up ailing countries. A senior government source involved in the talks said the Arab states did not want to be cast as the West's "cash cow" [that you are, bub]...

Though the trip has many ambitions, Brown has concentrated on securing Gulf support for the emergency IMF bail-out fund before the Washington summit. He believes the oil-rich countries in the Gulf have profited from the higher oil prices of recent years - something he put at $1tn - which he believes puts them in a position to contribute. He would like to see the $250bn in the IMF's pot increased by "hundreds of billions"...
Read More

The Great British Fire Sale, Fact Checking Mandy

♠ Posted by Emmanuel in ,, at 11/02/2008 11:05:00 AM
This is a continuation of the post immediately above. Brown's trip has another angle which makes it particularly interesting. As you probably know, UK PM Gordon Brown is touring the Middle East with just-appointed Business Secretary Peter Mandelson in tow, the latter better known to the British press as "Mandy." Joining these newly reconciled New Labour stalwarts are British business leaders seeking investment from various Middle Eastern states. The UK has not avoided a stock market rout like most other countries, doubtlessly helping prompt a foreign excursion by these fellows. Although oil prices have come down as of late, Gulf states are relatively loaded compared to pretty much everyone else. Hence, drumming up funds for capital-depleted British firms is one of this trip's objectives. From Bloomberg:
U.K. Prime Minister Gordon Brown urged sovereign wealth funds from the Persian Gulf to invest in British companies needing more financing because of the credit crunch. Brown arrived in Riyadh late yesterday with Business Secretary Peter Mandelson, Energy Secretary Ed Miliband and a delegation of business leaders to encourage funding from cash- rich oil producers.

``The Gulf states will have a vital role to play in agreeing the plans to get the world economy moving again,'' Brown told reporters before arriving in Riyadh. They ``are an increasingly important source of inward investment to the U.K. As long as they play by our rules and operate in a commercial manner, we welcome investment from sovereign wealth funds.''

Barclays Plc, Britain's second-biggest bank, earlier this week said it would raise 7.3 billion pounds ($11.8 billion) by selling securities to investors including funds in Abu Dhabi and Qatar. Sheikh Mansour Bin Zayed Al Nahyan, a member of Abu Dhabi's royal family, will become its biggest shareholder.

Sheikh Mansour will collect interest payments of as much as 14 percent and control 16.3 percent of the London-based bank after putting up 5 billion pounds ($8 billion), the company said in a statement yesterday. Barclays fell 13 percent after analysts at Sanford C. Bernstein & Co. said the bank was paying a ``fairly expensive'' price for the capital injection...
So far, matters are pretty straightforward. However, things become iffier when Mandelson says this:
Mandelson, a former European Union trade commissioner, said he wants more money from the region to go to the U.K. and that he didn't anticipate difficulties with political interference. ``We haven't had a problem with sovereign wealth funds in the past, so I don't see why it should be a problem in the future,'' he said in an interview. ``They want to generate a good return. They are the first to steer clear of politics.''
Lord Mandelson misspoke here. Considering that current British Petroleum CEO Tony Hayward is with Mandelson on this trip, this mistake is remarkable. Then again, Mandelson might be aware of the past, except that he's trying to be diplomatic and selectively recall history. It may surprise some readers that Baroness Thatcher, that towering champion of Anglo-Saxon economic governance, once forced the hand of the Kuwaiti SWF when it attempted to control a large stake in BP after the stock market crash of two decades ago. Instead of welcoming this influx of foreign capital, her administration asked the Kuwaitis to divest from BP. Contrary to the inviting words of Brown and Mandelson, there is much room for GCCs to be skeptical of investing in Britain lest history repeat itself. Protectionism it was in the form of unvarnished xenophobia. From a TIME article dated Oct. 17, 1988:
When the Kuwait Investment Office began putting money into British Petroleum stock last October [1987], Britain gratefully welcomed the new shareholder. The Thatcher government's ill-timed $12 billion public offering of BP shares had run smack into the worldwide stock crash, and the Kuwaitis were among the few investors willing to buy. Britain's relief turned to discomfort, though, as Kuwait's stake in the oil company kept growing, from 10% last November to a current level of 21.6%, making the Arab country by far BP's largest stockholder.

Getting nowhere with diplomatic requests that Kuwait unwind its investment, the Thatcher government last week ordered the OPEC member to slash its $5 billion stake in BP by more than half, to 9.9% of BP's shares, by next October. Under British laws regulating investments that affect the public interest, the government can legally force Kuwait to comply. Allowing a member of OPEC to have a major voice in BP's affairs, said the British Monopolies and Mergers Commission, is not in Britain's best interest.
Read More

The Zero-Conditionality IMF Loan

♠ Posted by Emmanuel in , at 10/30/2008 01:06:00 PM
The IMF has just come out with a new lending facility designed for countries that have a "strong track record" but are nonetheless experiencing balance-of-payments difficulties. Again, the IMF is presenting itself as adjusting with the times with this facility by hastening disbursement and removing conditionalities altogether for country borrowers that can avail of the so-called Short-Term Liquidity Facility (SLF). What remains to be seen is just how many countries qualify for this new facility to make it a usable one in these uncertain times. From the IMF website:
The IMF said it will create a new short-term lending facility to channel funds quickly to emerging markets that have a strong track record, but that need rapid help during the current financial crisis to get them through temporary liquidity problems.

In a press announcement, the IMF said the Short-Term Liquidity Facility (SLF) is designed to help emerging market countries with a track record of sound policies address the fallout from the crisis. The new facility, approved by the IMF's Executive Board on October 28, comes with no conditions attached once a loan has been approved and offers large upfront financing to help countries restore confidence and combat financial contagion.

"Exceptional times call for an exceptional response," said IMF Managing Director Dominique Strauss-Kahn. "The Fund is responding quickly and flexibly to requests for financing. We are offering some countries substantial resources, with conditions based only on measures absolutely necessary to get past the crisis and to restore a viable external position," he said.

Until recently, emerging markets were one of the few bright spots left in a world economy hit by massive deleveraging, failing banks, and corporate profit warnings. But now, the crisis is spreading beyond the advanced economies where it originated, with emerging markets all over the world suffering from the squeeze in global financial markets. The IMF has already reached outline financing agreements with Iceland, Hungary, and Ukraine, and is in advanced talks with several other countries.

The SLF will allow the IMF to help its members at a critical time. "Even countries that have excellent track records of implementing strong macroeconomic policies have been caught up in the global financial market crisis. They need support, and the IMF is ready to give it," Strauss-Kahn said.

"The SLF will support the authorities' efforts to reduce the impact of the crisis. Approval of a request for support under the SLF will help members fortify defenses against temporary capital account outflows, boost confidence and provide needed policy space," he said.

Despite the current surge in demand for IMF resources, there is a growing recognition that the Fund's traditional facilities may not be the optimal means of addressing short-term balance of payments pressures in every case.

"While existing Fund loan facilities offer flexibility, they are fundamentally used for countries that require both financing and policy adjustment [read: "structural adjustment"], and not for countries that despite strong initial macroeconomic positions and policies are facing short-term liquidity pressures. This facility addresses that gap in the Fund's toolkit of financial support," Strauss-Kahn said.

IMF First Deputy Managing Director John Lipsky told an October 29 news conference in Washington that the SLF "is designed to be easy to use and very rapid for those countries where use is appropriate."

The unique features of the SLF will address the needs of emerging market countries more directly than would a traditional IMF stand-by arrangement:

• Purpose. Provide large, upfront, quick-disbursing, short-term financing to help countries with strong policies and a good track record address temporary liquidity problems in capital markets.
• Eligibility. Countries with a good track record of sound policies, access to capital markets and sustainable debt burdens may qualify (the IMF's standard debt sustainability analysis should indicate a high probability that both public and private debt will remain sustainable). Policies should have been assessed very positively by the IMF's most recent country assessment.
• Conditions. Financing is made available without the standard phasing and loan conditions of more traditional IMF arrangements. However, borrowers are expected to certify that they are committed to maintaining strong macroeconomic policies.
• Size of loan. Disbursement of IMF resources can be up to 500 percent of quota, with a three month maturity. Eligible countries are allowed to draw up to three times during a 12-month period.
Read More

Currency Swapping: Hotter Than Wife Swapping?

♠ Posted by Emmanuel in , at 10/30/2008 10:56:00 AM
OK, so the post title is idiotic (but catchy!) I can explain the former, though the latter is beyond the scope of this blog's coverage. Anyway, to no one's real surprise, the US Fed has cut the federal funds rate to 1.00%. Skeptics like myself naturally ask, "If several economic commentators attribute the housing crisis to Greenspan cutting this rate to 1.00% and keeping it there for a while after the Internet bubble burst, how can this action help? You can of course say that, having been burned bigtime before, banks will be more circumspect this time around. I certainly hope so, but there is always the possibility that as money flows more freely once again, there will be another bubble in the offing: tech stocks...real estate...heaven knows what next.

While we await the results of this latest Fed reflation play, something that seems to have brought more immediate benefits is the Federal Reserve establishing $30B swap lines with the likes of Brazil, Mexico, South Korea, and Singapore. There are surely political-economic reasons for choosing these countries; While it's true that Mexico and South Korea have had their share of troubles in recent times, Brazil and Singapore are on more solid footing relatively speaking. Dave Altig at the (newly resurrected!) Macroblog has a neat explanation of how these currency swaps work. Basically, a country having trouble obtaining FX funding swaps the domestic currency for a foreign currency at the prevailing exchange rate to help tide over its current FX funding needs. At an agreed date, the process is reversed, with the future exchange rate determined by the interest rate differential between both currencies.

Brad Setser has already spoken of how beneficial these swap lines have been to European countries, enabling them to avoid funding problems currently afflicting many developing countries despite the former having problems with their financial institutions that are, if anything, larger than those of many LDCs'. To the FRB press release, then:
Today, the Federal Reserve, the Banco Central do Brasil, the Banco de Mexico, the Bank of Korea, and the Monetary Authority of Singapore are announcing the establishment of temporary reciprocal currency arrangements (swap lines). These facilities, like those already established with other central banks, are designed to help improve liquidity conditions in global financial markets and to mitigate the spread of difficulties in obtaining U.S. dollar funding in fundamentally sound and well managed economies.

In response to the heightened stress associated with the global financial turmoil, which has broadened to emerging market economies, the Federal Reserve has authorized the establishment of temporary liquidity swap facilities with the central banks of these four large and systemically important economies. These new facilities will support the provision of U.S. dollar liquidity in amounts of up to $30 billion each by the Banco Central do Brasil, the Banco de Mexico, the Bank of Korea, and the Monetary Authority of Singapore.

These reciprocal currency arrangements have been authorized through April 30, 2009. The FOMC previously authorized temporary reciprocal currency arrangements with ten other central banks: the Reserve Bank of Australia, the Bank of Canada, Danmarks Nationalbank, the Bank of England, the European Central Bank, the Bank of Japan, the Reserve Bank of New Zealand, the Norges Bank, the Sveriges Riksbank, and the Swiss National Bank.

Separately, the Federal Reserve welcomes the announcement today by the International Monetary Fund of the establishment of the Short-Term Liquidity Facility, which is designed to help member countries that are facing temporary liquidity problems in the global capital markets. The Federal Reserve is supportive of the IMF's role in helping countries address and resolve their ongoing economic and financial difficulties.
One of the principal discussions in IPE concerns hegemony, or if a single country still maintains the "rules of the game" which others must observe whether they like them or not (see the ever-useful "What is IPE?") It is of course no surprise that I am one of the naysayers in the argument over whether the US still maintains hegemony. OTOH, those of a different opinion that the US maintains this stature can reason that, by extending swap lines, the US can singlehandedly improve the economic fortunes of other countries. Certainly, the aforementioned countries with newly-established swap lines are now faring better. Here is news from South Korea:
South Korea's stock index rose by a record and the won surged after the central bank signed a $30 billion currency swap with the Federal Reserve and President Lee Myung Bak said he's ready to take more steps to aid the economy.

The swap line is part of the Federal Reserve's efforts to alleviate a credit freeze in emerging nations, with the U.S. also providing dollars to Singapore, Brazil and Mexico. Korean lawmakers today approved the government's $100 billion guarantee of bank debts to help lenders struggling to access foreign funds.

Korea's currency jumped 14 percent, the most in a decade, as policy makers' actions allayed concern the nation was headed for a repeat of 1997, when it needed an International Monetary Fund bailout to help repay offshore debt. The Fed's dollar provisions are part of increased global endeavors to thaw money markets, with Hong Kong and Taiwan lowering interest rates today following cuts yesterday by the U.S. and China.

``This is the strongest measure so far,'' said Chang In Whan, chief executive officer of KTB Asset Management Co. in Seoul, which manages the equivalent of $4.3 billion in equities. The Fed deal ``will create a buffer for Korea's foreign- currency supply and improve foreigners' confidence in the country,'' Chang said. ``It shows the Fed won't just sit back and watch overseas markets go down.''

Default protection costs on South Korean government debt fell by the most in more than four years. Five-year credit- default contracts on the country's external debt fell 130 basis points to 435, according to a Bloomberg survey of three dealers.
And here is news from Singapore:
Singapore stocks led the surge in Southeast Asian equity markets on Thursday, with financials in the spotlight, as investors cheered the Federal Reserve's rate cut and a slew of government efforts to boost bank liquidity.

The benchmark Straits Times Index closed 7.8 percent higher at 1,801.91, with a heavy 1.84 billion shares changing hands.
It will be interesting to see what happens in Brazil and Mexico when their markets open.
Read More

Yesterday Once More: Indonesian Rupiah Besieged

♠ Posted by Emmanuel in , at 10/28/2008 09:03:00 AM
I sometimes despair that we are revisiting the dark days of the Asian financial contagion. South Korea's plight has already been discussed [1, 2]; now let us turn our attention to Indonesia. Though Indonesia's fundamentals are reckoned to be much sounder this time around, there are several things roiling the country at the current time:
The default by the Netherlands-based Indonesische Overzeese Bank (Indover) had prompted some investors to ignore Indonesia’s relatively healthy economic fundamentals amid concerns that south-east Asia’s largest economy might be at risk of a sovereign default.

Credit default swap spreads over US Treasuries, regarded as a key indicator of a nation’s sovereign risk, have ballooned to 1,245 basis points, more than five times higher than a few months ago and several hundred basis points higher than the spreads for Vietnam and the Philippines.

Increasing liquidity pressures in the banking sector, pressure on government bonds, high interest rates, a prolonged billion-dollar solvency crisis in the business empire of Aburizal Bakrie, the welfare minister, and rumours of disunity in the government are exacerbating pressures driven largely by negative sentiment towards emerging markets.

However, the government has adopted a proactive approach to increasing liquidity in the banking sector and the country’s economy remains fundamentally robust. The country’s debt to gross domestic product ratio is among the lowest in the region at 28 per cent, while the banking sector remains well capitalised.

“Indonesia’s economy is in a lot better shape than 11 years ago [during the Asian financial crisis], said Fauzi Ichsan, an economist with Standard Chartered in Jakarta. “The question is how strong will it be in standing up to the deterioration of the global economy.”
In light of these difficulties, Indonesian President Susilo Bambang Yudhoyono (SBY) finds himself in the same position as any number of other LDC heads at the current time: pressed to find solutions in keeping bad times from getting worse. He understands that defending the rupiah is a reserve-depleting strategem that probably won't work in the long run. Then again, alternatives are limited. Hopefully, the Carpenters song Indonesians will be playing is "Only Yesterday" and not "Yesterday Once More." Bloomberg hints at plans in the offing to quell the forces battering Indonesia:
Indonesia's President Susilo Bambang Yudhoyono said the government plans to announce a policy tonight to boost the rupiah after the currency plunged as much as 29 percent in the past month. The rupiah fell as much as 8.7 percent today before recovering to trade down 0.9 percent at 11,050 against the dollar, the lowest since July 2001...

``The most effective measure would be'' the central bank selling dollars, said Aldian Taloputra, an economist at PT Mandiri Sekuritas in Jakarta. ``But this problem is of global scale, so what the government could do is to minimize the impact of the outflow...''

``We cannot always solve this through intervention,'' Yudhoyono told reporters in Jakarta today, referring to the central bank buying the local currency. ``If the decline is because of fundamental reasons, what we must solve is the fundamental reasons.''

The Jakarta Composite index has declined 59 percent this year. Government bonds have dropped 17 percent, according to data from HSBC Holdings Plc, the worst among 10 Asian nations. Overseas holding of bonds have declined 11 percent from a record in August.

The rupiah is declining even as the government said it expects the budget deficit to narrow to 1 percent of gross domestic product, from its previous forecast of 1.3 percent, on declining oil prices. Southeast Asia's biggest economy is forecast by the government to expand between 5.5 percent and 6 percent next year.

The government is also considering lowering subsidized fuel prices after crude oil futures fell to the lowest since May 2007, with the contract for December delivery dropping 93 cents to close at $63.22 a barrel in New York yesterday.

Indonesia's central bank had $57.1 billion of reserves as of Sept. 26. The nation paid back its last loan from the IMF in 2005, four years before schedule. The Washington-based institution had arranged a $25 billion package between 1997 and 2003 to help rescue Indonesia's banking system and rehabilitate the economy by restructuring private and government debt.
Read More

Sachs's 7 Steps to Avoid Global Recession

♠ Posted by Emmanuel in at 10/28/2008 08:49:00 AM
I hereby dub this week "Big Name Economists Try to Save the World" week. Hot on the heels of Joseph Stiglitz offering a five-point plan to fix the global financial crisis comes Jeffrey Sachs's own recipe for avoiding a global recession. Like Stiglitz, Sachs offers a rather Keynesian recipe. Notable wrinkles here are "pro-poor" measures such as low conditionality loans from the IMF and asking presumably loaded Middle Eastern countries to invest in other emerging markets. As if it weren't apparent before, we're in this together now. From the Financial Times:
Any co-ordinated expansion should include the following actions. First, the US Federal Reserve, the European Central Bank and the Bank of Japan should extend swap lines to all main emerging markets, including Brazil, Hungary, Poland and Turkey, to prevent a drain of reserves. Second, the International Monetary Fund should extend low-conditionality loans to all countries that request it, starting with Pakistan. Third, the US and European central banks and bank regulators should work with their big banks to discourage them from abruptly withdrawing credit lines from overseas operations. Spain has a role to play with its banks in Latin America.

Fourth, China, Japan and South Korea should undertake a co-ordinated macroeconomic expansion. In China, this would mean raising spending on public housing and infrastructure. In Japan, this would mean a boost in infrastructure but also in loans to developing nations in Asia and Africa to finance projects built by Japanese and local companies. Development financing can be a powerful macroeonomic stabiliser. China, Japan and South Korea should work with other regional central banks to bolster expansionary policies backed by government-to-government loans.

Fifth, the Middle East, flush with cash, should fund investment projects in emerging markets and low-income countries. Moreover, it should keep up domestic spending despite a fall in oil prices. Indeed, the faster a global macroeconomic expansion is in place the sooner oil prices will recover.

Sixth, the US and Europe should expand export credits for low and ­middle-income developing countries, not only to meet their unfulfilled aid promises but also as a counter-cyclical stimulus. It would be a tragedy for big infrastructure companies to suffer when the developing world is crying out for infrastructure investment.

Finally, there is scope for expansionary fiscal policy in the US and Europe, despite large budget deficits. The US expansion should focus on infrastructure and transfers to cash-strapped state governments, not tax cuts. This package will not stop a recession in the US and parts of Europe, but could stop a recession in Asia and the developing countries. At the least it would put a floor on the global contraction that is rapidly gaining strength.
Read More

Thriller: Will G7 Launch Coordinated Yen Effort?

♠ Posted by Emmanuel in , at 10/27/2008 09:45:00 AM
The G7 has just made a very terse statement which goes like this:
We reaffirm our shared interest in a strong and stable international financial system. We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability. We continue to monitor markets closely, and cooperate as appropriate.
The mighty yen is attributable in part to the continuing unwinding of the carry trade. Given the low interest rates on yen borrowing that have existed for quite some time to combat domestic deflation, many speculators have used the yen as funding currency to obtain higher yielding ones such as the Australian and New Zealand dollars, pocketing the interest rate differential. With risk aversion setting in, the carry trade is going the way of the dodo. The super-strong yen is hurting the prospects of Japan's export industries, and this is now causing further concern for G7 officials. From Reuters:
The Group of Seven warned on Monday the surging yen posed a threat to financial and economic stability, the latest coordinated effort by the world's richest nations to curb the worst financial crisis in 80 years...Japan was in focus with a brief G7 statement singling out the yen, fanning speculation of the first Bank of Japan currency intervention in four years...

The yen's rapid 12 percent ascent against the dollar has threatened Japanese exports as the world's second-largest economy lurches toward recession...The dollar, however, is rising against major currencies, except for the yen, so there was some skepticism about whether any coordinated action on the economy would be forthcoming.

Meanwhile, three of Japan's top lenders -- Mitsubishi UFJ Financial Group, Mizuho Financial Group and Sumitomo Mitsui Financial Group -- were said by Japan's media to be looking to raise cash to offset share losses...Prime Minister Taro Aso said after an emergency meeting the government would expand a scheme that allows banks access to public funds and tighten rules on short-selling shares.
Will (or can) the G7 get together and launch a Plaza Accord-style joint agreement to weaken the yen? Or, will Japan try to go it alone and intervene for the first time in four years? Lest we forget, it has the world's second largest pile of reserves at a trillion plus dollars. Then again, intervening may be a drop in the bucket in this day and age. It will be interesting to watch, although the expected size of any effective effort may preclude one from being launched. Here are some other comments to consider collected again by Reuters:

- "The G7 statement showed the group's willingness to stabilise foreign exchange rates, particularly to curb excessive volatility in yen moves, with an eye on a possible joint currency intervention," former Bank of Japan official Eiji Hirano.

- "Given the panicky and irrational movements of the yen of late, the Japanese authorities may conduct intervention independently," - Kazuyuki Kato, Mizuho Trust & Banking.

- "Launching intervention independently is like a drop in the bucket, and like fighting against the whole world," Ryohei Muramatsu, Commerzbank, Tokyo.

Bloomberg chips in a contrary quotation from "Mr. Yen" himself, Eisuke Sakakibara:
``Issuing such a statement is a sign of failure to intervene,'' said Eisuke Sakakibara, a professor at Tokyo's Waseda University who was the Finance Ministry's top currency official from 1997 to 1999. ``The Japanese government may have consulted with their counterparts in the EU and the U.S. and they couldn't persuade them to intervene.''
Certainly, things are getting really bad in Japan with the Nikkei reaching a twenty-six year low at 7,162.90. Bloomberg adds that the Dow Jones was at 965.97 back then and Michael Jackson's Thriller wasn't even released yet (yes, it is a milestone of sorts). The lyrics of the title song are oddly appropriate for Japan with its current situation: You're fighting for your life inside a killer, thriller tonight...
Read More

Ukraine Reaches $16.5B IMF Deal; Hungary Awaits

♠ Posted by Emmanuel in , at 10/27/2008 09:31:00 AM
Dear readers, I hope you visit this blog in the belief that I get a reasonable number of things right. Before many did, I called for Iceland to approach the IMF. Here's further proof: I was correct in believing that Ukraine would beat Hungary to the IMF's doorstep, reasoning that the latter would last longer due to its recourse to EU funding as a freshly minted member. It now transpires that the IMF has announced $16.5B worth of lending to Ukraine, with Hungary waiting in the wings:
The IMF said it has reached a tentative agreement with Ukraine to lend the eastern European country $16.5 billion to help it combat a series of economic problems tied to the international financial turmoil and announced broad agreement with Hungary on a set of policies designed to bolster near-term stability...

The IMF is moving quickly to help emerging markets battered by fallout from global financial turmoil and the sharp slowdown in the economies of advanced industrialized countries. It is in discussions with several other countries about possible new lending programs. The 185-member institution has more than $200 billion of loanable funds and can draw on additional resources through two standing borrowing arrangements with groups of IMF member countries.

On October 25, a 43-nation conference of Asian and European nations issued a statement calling for new rules to guide the global economy following the financial crisis triggered initially by the subprime meltdown in the United States. The Asia-Europe Meeting in Beijing, China, called on the IMF to take a leading role to aid crisis-hit countries. "Leaders agreed that IMF should play a critical role in assisting countries seriously affected by the crisis, upon their request," the statement said.

IMF Managing Director Dominique Strauss-Kahn said an IMF staff mission and the Ukraine authorities had reached agreement, subject to approval by IMF Management and the Executive Board, on an economic program supported by a $16.5 billion loan under a 24-month Stand-By Arrangement. Consideration by the Board would follow approval of legislative changes to Ukraine's bank resolution program.

"Ukraine has developed a comprehensive policy package designed to help the country meet the balance of payments needs created by the collapse of steel prices, and the global financial turmoil and related difficulties in Ukraine's financial system. The authorities' program is intended to support Ukraine's return to economic and financial stability, by addressing financial sector liquidity and solvency problems, by smoothing the adjustment to large external shocks and by reducing inflation," Strauss-Kahn said. "At the same time, it will guard against a deep output decline by insulating household and corporations to the extent possible."

"The IMF is moving expeditiously to help Ukraine, and this program is focused on the essential upfront measures needed to maintain confidence and economic and financial stability. The strength of the program justifies the high level of access, equivalent to 800 percent of Ukraine's quota in the Fund," Strauss-Kahn added.

On Hungary, the IMF said that an IMF staff mission and the Hungarian authorities, in close consultation with the European Union (EU), have reached broad agreement on a set of policies that will bolster the Hungarian economy's near-term stability and improve its long-term growth potential. The authorities' program will ensure fiscal sustainability and strengthen the financial sector.

"A substantial financing package in support of these strong policies will be announced when the program is finalized in the next few days. Participants will include the IMF, the EU, and some individual European governments, together with regional and other multilateral institutions," Strauss-Kahn noted.

"With Hungary's commitment to strengthened economic policies, we expect that banks and other financial institutions operating in the country will continue to provide adequate financing. "The Fund's assistance, in the form of a Stand-By Arrangement, will be considered by the IMF's Executive Board for approval under the Fund's expedited procedures. The policies Hungary envisages justify an exceptional level of access to Fund resources," Strauss-Kahn added...

Strauss-Kahn, who helped spearhead the international response to the global financial turmoil during the IMF-World Bank Annual Meetings in Washington on October 10-13, has emphasized the IMF's readiness to lend quickly to member countries that need help during the ongoing crisis through its emergency financing procedures...
What will be interesting to watch is if famed IMF conditionalities will be lessened this time around as promised by Dominique Strauss-Kahn. With the IMF standing accused of, among other things, causing thousands of tuberculosis fatalities in Eastern Europe post-Soviet era, this is certainly a sensitive issue. On this, the Economist adds:
In part, their reluctance is a sign of the stigma of an IMF bail-out. The delay can cost valuable time while countries scramble to find other sources of help. Governments also worry about the damaging domestic political fallout of being forced to accept tough conditions as part of a rescue package. Critics have argued that the IMF is overly hung up on conditionality—although, in countries like Pakistan and Ukraine, which have enormous deficits, the need for conditions is clear. More generally, however, the fund needs to be flexible and it has indeed rethought its approach in recent years. It now aims to impose policy prescriptions only when absolutely critical to a programme’s success. Details emerging from the talks with Iceland suggest these guidelines are being followed: there appear to be no punitive strings attached. That will help the IMF dispel concerns that it is too rigid in its ideology.
Read More

Stiglitz's 5 Step Fix for Financial Crisis

♠ Posted by Emmanuel in at 10/27/2008 08:54:00 AM
Nobel Laureate Joseph Stiglitz has come up with five items on his "to do" list in order to fix the current financial crisis. While most of these prescriptions concern American policymaking, we'll cut him slack as it is a TIME article. Never let it be said that Stiglitz fails to think big. The Economist has faulted him in the past for prescribing remedies that are, if anything else, too ambitious. Here, I would like have liked more discussion from Stiglitz about how steps 2 and 3 are going to be funded. After all, he is an economist, and "there's no such thing as a free lunch" remains operative. In step 5, he calls for a new global regulator. Here I have two questions. First, why can't we work with the current set of institutions like the Bretton Woods twins, the Bank of International Settlements, and so on? Second, why does he cite the French as inspirational in promoting new regulatory regimes when they are self-serving more often than not?

1 Recapitalize banks. With all the losses, banks have insufficient equity. Banks will have a hard time raising this equity under current circumstances. The government needs to provide equity. In return, it should have voting stakes in the banks it helps. But equity injections also bail out bondholders. Right now the market is discounting these bonds, saying there is a high probability of default. There needs to be a forced conversion of this debt to equity. If this is done, the amount of government assistance that will be required will be much reduced.

It's good news that Treasury Secretary Paulson seems to finally realize that his original proposal of buying what he euphemistically called distressed assets was flawed. That Secretary Paulson took so long to figure this out is worrying. He was so bound by the idea of a free-market solution that he was unable to accept what economists of all stripes were telling him: that he needed to recapitalize the banks and provide new money to make up for the losses they incurred on their bad loans.

The Administration is now doing this, but three questions are raised: Was it a fair deal to the taxpayer? The answer to that seems fairly clear: taxpayers got a raw deal, evident by comparing the terms of Warren Buffet's injection of $5 billion into Goldman Sachs, and the terms extracted by the Administration. Second, is there enough oversight and restrictions to make sure that the bad practices of the past do not recur and that new lending does occur? Again, comparing the terms demanded by the U.K. and by the U.S. Treasury, we got the short end of the stick. For instance, banks can continue to pay out money to shareholders, as the government pours money in. Thirdly, is it enough money? The banks are so nontransparent that no one can fully answer the question, but what we do know is that the gaps in the balance sheet are likely to get bigger. That is because too little is being done about the underlying problem.

2 Stem the tide of foreclosures. The original Paulson plan is like a massive blood transfusion to a patient with severe internal hemorrhaging. We won't save the patient if we don't do something about the foreclosures. Even after congressional revisions, too little is being done. We need to help people stay in their homes, by converting the mortgage-interest and property-tax deductions into cashable tax credits; by reforming bankruptcy laws to allow expedited restructuring, which would bring down the value of the mortgage when the price of the house is below that of the mortgage; and even government lending, taking advantage of the government's lower cost of funds and passing the savings on to poor and middle-income homeowners.

3 Pass a stimulus that works. Helping Wall Street and stopping the foreclosures are only part of the solution. The U.S. economy is headed for a serious recession and needs a big stimulus. We need increased unemployment insurance; if states and localities are not helped, they will have to reduce expenditures as their tax revenues plummet, and their reduced spending will lead to a contraction of the economy. But to kick-start the economy, Washington must make investments in the future. Hurricane Katrina and the collapse of the bridge in Minneapolis were grim reminders of how decrepit our infrastructure has become. Investments in infrastructure and technology will stimulate the economy in the short run and enhance growth in the long run.

4 Restore confidence through regulatory reform. Underlying the problems are banks' bad decisions and regulatory failures. These must be addressed if confidence in our financial system is to be restored. Corporate-governance structures that lead to flawed incentive structures designed to generously reward CEOs should be changed and so should many of the incentive systems themselves. It is not just the level of compensation; it is also the form — nontransparent stock options that provide incentives for bad accounting to bloat up reported returns.

5 Create an effective multilateral agency. As the global economy becomes more interconnected, we need better global oversight. It is unimaginable that America's financial market could function effectively if we had to rely on 50 separate state regulators. But we are trying to do essentially that at the global level.

The recent crisis provides an example of the dangers: as some foreign governments provided blanket guarantees for their deposits, money started to move to what looked like safe havens. Other countries had to respond. A few European governments have been far more thoughtful than the U.S. in figuring out what needs to be done. Even before the crisis turned global, French President Nicolas Sarkozy, in his address to the U.N. last month, called for a world summit to lay the foundations for more state regulation to replace the current laissez-faire approach. We may be at a new "Bretton Woods moment." As the world emerged from the Great Depression and World War II, it realized there was need for a new global economic order. It lasted more than 60 years. That it was not well adapted for the new world of globalization has been clear for a long time. Now, as the world emerges from the Cold War and the Great Financial Crisis, it will need to construct a new global economic order for the 21st century, and that will include a new global regulatory agency.

This crisis may have taught us that unfettered markets are risky. It should also have taught us that unilateralism can't work in a world of economic interdependence.
Read More