The fear factor has spiked in recent weeks as a series of indicators signal that Wall Street's troubles are starting to spread to Main Street.
Housing price declines. Slowing job creation. Profit warnings from the country's biggest retailers. To an Econ 101 student, those are telltale signs of an imminent recession. Not surprisingly, the R-word has dominated talk among bankers for weeks.
"We're very close to stall speed in the economy," says Paul Kasriel, director of economic research at Northern Trust. And it's not just the usual Chicken Littles talking about it: Everyone from top auto executives to normally ebullient tech venture capitalists are making noises about the slowing economy. Former Treasury Secretary Larry Summers, now at hedge fund D. E. Shaw, is adamant that there's a greater than 50% chance of a recession.
So what's really happening? By most economists' terms, a recession is defined as two or more consecutive quarters of GDP decline -- something we haven't seen since 1991. By that narrow definition we're not even close. Of 50-plus economists surveyed by research firm Blue Chip Economic Indicators, not one is predicting a recession. They still expect GDP to grow 2.6% next year.
But the broader definition, one put out by the National Bureau of Economic Research, is simply a "significant decline in economic activity, spread across the economy, lasting more than a few months." By that measure, many say the sky is falling.
Until now, problems with the economy have remained within the financial sector, with most of the pain hitting mortgage companies and investment banks. But in recent weeks a few key signs show that Wall Street's problems are seeping into the rest of the economy.
Of course, the biggest driver has been the downturn in the real estate market. After 15 years of rising home prices, a cooldown was expected. But the sharp price drops this summer showed that the downturn is deeper and broader than previously thought. In July home prices fell 4.5% from a year earlier.
Housing is closely tied to overall consumer spending. With homeowners facing growing mortgage headaches, there's been a simmering fear that they will curtail discretionary spending. Many retailers had already warned that the second half of the year would fall short of expectations. Then, in a one-two punch in late September, Target (Charts, Fortune 500) and Lowe's (Charts, Fortune 500) issued profit warnings on the same day - news that sent retail stocks plummeting and created new fears of a broader slowdown.
Another key metric is employment. The unemployment rate, at 4.6%, is not a worry so far. But when August figures showed the number of Americans with jobs had fallen for the first time in four years, it raised fears that the weakness in the economy had spread -- and was probably the main factor behind the Fed's Sept. 18 rate cut.
In fact, that rate cut is one of the most telling differences between today's outlook and that of 1991. Typically recessions follow aggressive hikes in interest rates, a deliberate slamming on the brakes by the Federal Reserve designed to halt consumer price inflation. This time the Fed has raised rates gradually, from a very low level. But because of consumers' big debt binges in recent years, the slightest tightening of the money supply may simply have been too much.
To be sure, not everyone is saying a recession is coming. After all, the S&P 500, driven by tech stocks, is trading close to its all-time high. Dean Maki, chief economist for Barclays Capital, says a surprisingly large proportion of overall personal spending comes from the wealthy, who are not likely to dial back their conspicuous consumption.
So where is the economy really headed? Some cooler heads say the more likely effect is a pullback to slower GDP growth. "It's much harder to get into a recession than people understand," says Drew Matus, senior economist at Lehman Brothers.
Others say recessions are an inevitable outcome of prolonged periods of growth and a way to wring excesses out of the economy. As anyone who balked at paying $1 million for a two-bedroom condo in a hot market would agree, there's nothing wrong with the economy that a few months of stalled growth wouldn't fix.
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Friday, September 28, 2007
Recession chatter gets louder
Gold prices: Nowhere to go but up
The dollar is declining and inflation is lying in wait. Market conditions are waving red in the face of gold bulls.
So far this year, gold prices are up about 22 percent to nearly $750 an ounce - helped by the declining dollar and growing interest from institutional investors.
And given a confluence of factors, including heightened seasonal demand, analysts believe that prices for the precious metal will move higher still and are poised to shatter its all-time record.
Historically, gold has been considered a safe-haven for investors jittery about inflation or the economy.
With skittish investors diversifying their portfolios with commodities, demand for gold has shot up. During the summer's market meltdown, prices remained modestly higher compared to the start of the year before moving higher in recent weeks. Just last week, gold hit $744.80 an ounce - its highest level in 27 years.
Many analysts say the biggest driving factor has been the weakening dollar. A weaker greenback makes gold, which is priced in dollars, more attractive to buyers outside the United States.
At the same time, worries about inflation have also stoked gold prices, according to Jon Nadler, an analyst with Kitco.com.
Indeed, gold typically attracts investors looking for a hedge against inflation. That factor has become especially important now with oil prices near record highs and after the Federal Reserve cut interest rates last week for the first time in four years.
And gold could find even more support at the consumer level. Typically, the period from September through year's end sees demand for gold climb in the United States amid the holiday shopping season. Demand is also high in India, the world's largest consumer of gold, because the next few months are a popular time for weddings and mark the celebration of the Hindu new year.
Of course, if interest by institutional investors or hedge funds wanes or consumer demand for jewelry slackens amid weakened consumer spending, gold prices could move right back down, according to experts.
How high?
By some analysts' estimates, gold prices are headed for $750 an ounce by the end of the year.
Peter Spina, an analyst with GoldSeek.com, speculated the price could even top its all-time high of $850, set in January 1980.
Ethanol - India Story
WHAT IS FUEL ETHANOL
Ethanol (ethyl alcohol, grain alcohol, ETOH) is a clear, colorless liquid with a characteristic, agreeable odor. In dilute aqueous solution, it has a somewhat sweet flavor, but in more concentrated solutions it has a burning taste. Ethanol, CH3CH2OH, is an alcohol, a group of chemical compounds whose molecules contain a hydroxyl group, -OH, bonded to a carbon atom. The word alcohol derives from Arabic al-kuhul, which denotes a fine powder of antimony produced by distilling antimony and used as an eye makeup. Alcohol originally referred to any fine powder, but medieval alchemists later applied the term to the refined products of distillation, and this led to the current usage.
ETHANOL AS A FUEL
Ethanol is used as an automotive fuel by itself and can be mixed with gasoline to form what has been called "gasohol" FUEL ETHANOL- the most common blends contain 10% ethanol and 85% ethanol mixed with gasoline. Over 1 billion gallons of ethanol are blended with gasoline every year in the United States. Because the ethanol molecule contains oxygen, it allows the engine to more completely combust the fuel, resulting in fewer emissions. Since ethanol is produced from plants that harness the power of the sun, ethanol is also considered a renewable fuel. Therefore, ethanol has many advantages as an automotive fuel.
Most industrial ethanol is denatured to prevent its use as a beverage. Denatured ethanol contains small amounts, 1 or 2 percent each, of several different unpleasant or poisonous substances. The removal of all these substances would involve a series of treatments more expensive than the federal excise tax on alcoholic beverages (currently about $20 per gallon). These denaturants render ethanol unfit for some industrial uses. In such industries undenatured ethanol is used under close federal supervision.
Ethanol has been made since ancient times by the fermentation of sugars. All beverage ethanol and more than half of industrial ethanol is still made by this process. Simple sugars are the raw material. Zymase, an enzyme from yeast, changes the simple sugars into ethanol and carbon dioxide. The fermentation reaction, represented by the simple equation C6H12O6 2 CH3CH2OH + 2 CO2 is actually very complex, and impure cultures of yeast produce varying amounts of other substances, including glycerine and various organic acids. In the production of beverages, such as whiskey and brandy, the impurities supply the flavor. Starches from potatoes, corn, wheat, and other plants can also be used in the production of ethanol by fermentation. However, the starches must first be broken down into simple sugars. An enzyme released by germinating barley, diastase, converts starches into sugars. Thus, the germination of barley, called malting, is the first step in brewing beer from starchy plants, such as corn and wheat.
ETHANOL IN INDIA
India imports nearly 70% of its annual crude petroleum requirement, which is appox. 110 million tons. The prices are in the range of US$ 50-70 per barrel, and the expenditure on crude purchase is in the range of Rs.1600 billion per year, impacting in a big way, the country's foreign exchange reserves.( Oil Prices touched a record high of $76 per barrel )
The petroleum industry now looks very committed to the use of ethanol as fuel, as it is expected to benefit sugarcane farmers as well as the oil industry in the long run. Ethanol (FUEL ETHANOL) can also be produced from wheat, corn, beet, sweet sorghum etc. Ethanol is one of the best tools to fight vehicular pollution, contains 35% oxygen that helps complete combustion of fuel and thus reduces harmful tailpipe emissions. It also reduces particulate emissions that pose a health hazard.
10% blending from October 2008: The Government is serious of considering 5% doping mandatory with immediate effect & are willing to increase it to 10% from October 2008. This decision will be directly benefiting the sugar cane producing states like Uttar Pradesh, Maharashtra, Karnataka, Tamil Nadu, Andhra Pradesh, Gujrat & Bihar. As all these states are facing a serious problem of excess sugarcane cultivation for the current year and also could face the same in future too.
Hard Road Ahead: The policy is now clear but still the question of comfort zone of Oil Marketing Company is important. The ethanol producers should concentrate on the technologies by bringing the cost of production at lower end & here Brazil’s input is important.
The Indian Sugar Mills and the private stand-alone ethanol manufacturers should cut the cost of production by using good technologies requiring less utilities like steam, water and electricity and they should also concentrate on co-generation through effluent generated by Sugarcane Juice & Molasses Route. The lower cost of production can still bring the ethanol prices down from the current Rs. 21.50 per liter. Suppliers from Maharashtra are supplying at Rs. 19.50 per liter. The ethanol suppliers should now focus on producing large quantum as this could drop the production cost creating a Win-Win Situation.
ETHANOL WORLDWIDE
Other countries are either producing and using ethanol in large quantities or are providing incentives to expand ethanol production and use. Brazil and Sweden are using large quantities of ethanol as a fuel. Some Canadian provinces promote ethanol use as a fuel by offering subsidies of up to 45 cents per gallon of ethanol.
India is initiating the use of ethanol as an automotive fuel. A move has been made by distilleries in India to use surplus alcohol as a blending agent or an oxygenate in gasoline. Based on experiments by the Indian Institute of Petroleum, a 10 percent ethanol blend with gasoline and a 15 percent ethanol blend with diesel are being considered for use in vehicles in at least one state.
In France, ethanol is produced from grapes that are of insufficient quality for wine production. Prompted by the increase in oil prices in the 1970s, Brazil introduced a program to produce ethanol for use in automobiles in order to reduce oil imports. Brazilian ethanol is made mainly from sugar cane. Pure ethanol (100% ethanol) is used in approximately 40 percent of the cars in Brazil. The remaining vehicles use blends of 24 percent ethanol with 76 percent gasoline. Brazil consumes nearly 4 billion gallons of ethanol annually. In addition to consumption, Brazil also exports ethanol to other countries.
Sweden has used ethanol in chemical production for many years. As a result, Sweden’s crude oil consumption has been cut in half since 1980. During the same time period, the use of gasoline and diesel for transportation has also increased. Emissions have been reduced by placing catalytic converters in vehicle exhaust systems which decrease carbon monoxide, hydrocarbon, and nitrogen oxide emissions. To address global warming concerns, the amount of carbon dioxide produced while burning fossil fuels must be reduced. Ethanol-blended gasoline and ethanol-blended diesel are being considered as viable alternatives to further lower emission levels.
Benefit to Common People
Comparative Current prices as in Brazil (per gallon) -
1. Pure alcohol (95% purity) ethanol = 1.35 R$ = 29.70 RS.
2. Gasoline with 25% ethanol mandatory by law = 2.46 R$ = 54.12 RS.
3. Gasoline with 25% of ethanol + additives (octane boosters)= 2.56 R$ = 56.32 RS.
Thursday, September 27, 2007
The rising rupee, foreign trade & inflation
As the popular saying goes, the difference between a pessimist and an optimist is that whereas the former sees the glass as half-empty, the latter perceives it as half-full. The reality is the same; it is the inference that matters.
Take the figures for the first quarter of 2007-08 in regard to foreign trade. Exporters rightly crib about the lower realisations consequent to the appreciation of the rupee against the dollar - by more than 10% over the same quarter of last year. Imports have accelerated, and may be attributed to the cumulative impact of an economy growing at a robust rate and possibly the lower price tag for overseas goods in rupee terms, which has also fuelled demand.
To those who see these issues in perspective, what is a cause for concern is the sharp drop in the import purchasing power of exports - from 71% to 61% - during the latest three-monthly period over that of the previous fiscal. In another era, the burgeoning trade deficit that has nearly doubled to $21 billion may be viewed as very troubling; now the context is different; with forex assets at more than $200 billion and swelling weekly, we are in a position to make light of it.
However, there is another angle to the steady climb of the Indian currency against the greenback, namely the possibility that its impact on inflation may be benign. In its latest monetary policy review, the Reserve Bank of India drew comfort from the fact that the pass-through effect of monetary, fiscal and supply-side measures, in conjunction with seasonal factors has brought the inflation rate to below the stipulated threshold limit - 4.4% from 5.9% as of end-March 2007. Perhaps this assessment was too laconic to permit an elaboration of the role of strengthening rupee vis-à-vis the dollar in influencing the inflation rate on a downward course. We shall revert to this topic later.
Let us dwell upon the several strands of the issue one by one. Exports have fared badly during the April-June 2007 period, rising by a meagre 7% in rupee terms, though in dollar terms, the growth rate is definitely better at 18%. The setback in terms of rupees is easily explained; the foreign buyer, finding that he has to fork out more dollars to buy Indian rupee-dominated goods, has tuned to other markets seeking price advantage. This has adversely impacted on the export performance. The exporters too are despondent that the declining fortunes of the dollar have meant diminished earnings in terms of rupees. This trend is a distinctive to our export effort and to the realisation of the target of $125 billion set for 2007-08. But gyrations in the forex market must be taken in stride and overcome through conscious drive for quality and cost-cutting to retain and expand overseas markets.
The second point to note is that our imports have maintained a high order of increase during the first quarter of the current fiscal - 34% in dollar terms and 22% in rupee terms. Despite a negligible rise of 4% in oil imports when denominated in dollars -in our currency, oil imports have recorded a negative growth rate -it is the non-oil imports that have really soared - by 50% in rupee terms and much more in terms of dollars. This is possibly a sequel to the high rate of economic growth that has led to a keen demand for capital goods, non-ferrous metals and export-related imports such as pearls and precious stones, chemicals and cashew. With the dollar weakening against the rupee, imports also became cheaper and hence the boom in overseas purchases. Seen in this context, this development is not a cause for worry.
The third fall-out of the firming up of our currency against the dollar may well be the easing of inflationary pressures of late. Unfortunately, the nexus between the two has not been highlighted in the RBI policy statement. In reality, this is quite simple. When the rupee strengthens in the forex market, it means lower prices of imported goods in terms of our currency. In turn, the cost of imported items tends to fall in the home market. They figure as intermediaries, raw materials and capital goods for which, in rupee terms, we pay less now than, say a year ago. Of course, bulk consumption goods like pulses and edible oils too which figure in our imports, for which we pay less rupees per dollar. The cumulative impact of all these factors is the moderation in the inflation rate.
In sum, the strong showing of the rupee in relation to the dollar is not an unmitigated evil as it is made out to be. It is not and the taming of the beast of inflation may be a direct sequel to this trend.
Thursday, September 20, 2007
Indian rupee breaks through 40 per dollar level for 1st time since 1998
The Indian rupee rose to a nine-year high against the U.S. dollar Thursday amid strong demand from foreign funds investing in one of the world's fastest growing economies.
The rupee rose 0.7 percent to 39.88 per dollar, breaching the psychologically crucial 40-per-dollar mark for the first time since May 1998.
The rupee has appreciated more than 10 percent against the dollar so far this year as global investors have flocked to India, where the economy is growing about 9 percent annually and the stock market has been climbing to record highs.
Analysts expect the rupee to remain strong through this quarter, although that could hurt exporters, especially the country's hugely profitable outsourcing industry.
"It will stay around 40 for some time," said Agam Gupta, head of foreign exchange trading at Standard Chartered Bank in India.
The rupee's strength has come despite measures by the Reserve Bank of India to counter a surge in foreign money into the country that also has fueled inflation. Last month, the central bank installed several curbs on overseas borrowing by Indian companies and ordered banks to hold more cash in reserves.
But Gupta said the central bank can do little to stem the flow of money from other sources.
"A lot of inflows have been in the form of foreign direct investment and investments in stocks and bonds," he said. "Those inflows will continue."
Foreign institutional investors have bought US$10.1 billion in Indian stocks and bonds so far this year, according to the Securities and Exchange Board of India. That money is on top of a record US$16 billion India received as foreign direct investment in the last fiscal year that ended March 2007.
The rupee got a boost after the U.S. Federal Reserve made a bigger-than-expected cut its key interest rate Tuesday, stoking expectations that investors will bring in more dollars to take advantage of higher interest rates here and a bull run in the stock market. The rupee gained about 1 percent against the U.S. dollar in Wednesday's trading.
India's benchmark interest rate is now 7.75 percent, 3 percentage points higher that the Fed's key rate, and it's unlikely that the Indian central bank will cut rate soon.
Market players will likely revise their projections for the rupee-dollar rate following the Fed move, Gupta said. Most foreign exchange traders earlier expected the rupee-dollar rate to average around 41 during the October-December quarter.
That is bad news for exporters, whose overseas earnings are eroded by the strong rupee.
Indian Commerce and Industry Minister Kamal Nath said the rupee's strength was "a cause for concern" and the government may have to revise the export target of US$160 billion set for the current fiscal year.
Trade data released earlier this month showed exports growth have already begun to decelerate.
"It is a new situation and requires a new response," Nath said, adding the government would explore measures to help exporters tide over the impact of a stronger rupee.
Tuesday, September 18, 2007
Subprime Lending Crisis and It's impact on the Emerging Markets
What is Credit Report?
credit report is, in many countries, a record of an individual's or a company's past borrowing and repaying, including information about late payments and bankruptcy. The term "credit reputation" can either be used synonymous to credit history or to credit score.
When a customer fills out an application for credit from a bank, store or credit card company, his or her information is forwarded to a credit bureau, along with constant updates on the status of his or her credit accounts, address, or any other changes made since the last time he or she applied for any credit.
This information is used by lenders such as credit card companies to determine an individual's or entity's credit worthiness; that is, determining an individual's or entity's means and willingness to repay an indebtedness. This helps determine whether to extend credit, and on what terms. With the adoption of risk-based pricing on almost all lending in the financial services industry, this report has become even more important since it is usually the sole element used to choose the annual percentage rate (APR).
What is subprime lending?
Subprime lending, also called B-paper, near-prime, or second chance lending, is the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history. The term also refers to paper taken on property that cannot be sold on the primary market, including loans on certain types of investment properties and certain types of self-employed individuals. Subprime lending is risky for both lenders and borrowers due to the combination of high interest rates, poor credit history, and adverse financial situations usually associated with subprime applicants. A subprime loan is offered at a rate higher than A-paper loans due to the increased risk.
Subprime lending encompasses a variety of credit instruments, including subprime mortgages, subprime car loans, and subprime credit cards, among others. The term "subprime" refers to the credit status of the borrower (being less than ideal), not the interest rate on the loan itself.
Subprime lending is highly controversial. Opponents have alleged that the subprime lending companies engage in predatory lending practices such as deliberately lending to borrowers who could never meet the terms of their loans, thus leading to default, seizure of collateral, and foreclosure. Proponents of the subprime lending maintain that the practice extends credit to people who would otherwise not have access to the credit market.
About Current Subprime Lending Crisis
The institution giving out the home loans in the subprime market does not stop here. It does not wait for the principal and the interest on the subprime home loans to be repaid, so that it can repay the loan it has taken from the bank.
It goes ahead and securitises these loans. Securitisation essentially involves, converting these home loans into financial securities, which promise to pay a certain rate of interest. These financial securities are then sold to big institutional investors. The interest and the principal that is repaid by the subprime borrowers through equated monthly installments is passed onto these institutional investors who buy these financial securities.
The institution then takes the money that it gets from selling the financial securities and passes it on to the bank, it had taken the loan from, thereby repaying the loan. And everybody lives happily ever after. Well, not really.
This part we had already seen in the last article. The entire problem arose because institutions giving out subprime home loans could easily securitise it. Once an institution securitises a loan, it does not remain on the books of the institution. Hence that institution does not take the risk of the loan going bad. The risk is passed onto the investors who buy the financial securities issued for securitising the home loan.
Given the fact that institutions giving out the loan do not take the risk, their incentive is in just giving out the loan. Whether the individual taking the home loan has the capacity to repay the loan, isn't their problem. Hence chances are that proper due diligence to give out the home loan is not done and loans are given out to individuals who are more likely to default.
Other than this, greater the amount of loan the institution gives out, greater is the amount it can securitise and, hence, greater the amount of money it can earn.
After borrowers started defaulting, it has come to light that institutions giving out loans in the subprime market had been inflating the incomes of borrowers, so that they could give out greater amount of home loans. As explained above, by giving out greater amounts of home loan, they were able to securitise more, issue more financial securities and hence earn more money.
These loans were floating rate home loans, once interest rates started to go up the equated monthly installment (EMI) to repay these loans, went up as well. The borrowers who had bad credit ratings in the first place, could not service the higher EMIs and started defaulting.
Another advantage of securitisation, which has now become a disadvantage, is that money keeps coming in. Once an institution securitises the first lot of home loans and repays the bank it has borrowed from, it can borrow again to give out loans. The bank having been repaid and made its money, does not have any inhibitions in lending out money again.
And so the story continues. Till, that is, one fine day when borrowers stop repaying. Investors who bought the financial securities cannot be serviced. So to make up their losses in the subprime market in the United States, they go out and sell their investments in emerging markets like India. Since the amount of selling in the market far outweighs the amount of buying, emerging markets like India have been falling.
Dollar drops after Fed cuts more than expected
The dollar fell against its major counterparts Tuesday, hitting a new record low against the euro, after the U.S. Federal Reserve cut its benchmark federal funds rate more than many investors had expected, thereby lowering the return on dollar-denominated assets.
The central bank cut the fed funds rate for the first time in more than four years to 4.75% from 5.25%, and also cut its discount rate by half a point. Most economists and investors had expected the Fed to trim its benchmark federal funds rate at least 25 basis points, with some predicting the 50-basis point reduction.
The dollar index, which tracks the greenback against a basket of six major currencies, was at 79.375, down from 79.645 before the announcement.
The pound sterling was at $2.0122, compared to $1.9982 earlier.
The dollar was up at 115.65 yen, down from 115.80 yen earlier.
While lower interest rates are dollar-negative in the long term, rallying stock prices after the Fed's policy decision provided daily support for the U.S. currency Tuesday.
"Expect further dollar weakness in the days to come and expect further strength in the stock market and carry trades," said Kathy Lien, chief strategist at Forex Capital Markets. Carry traders refer to the practice of borrowing funds in lower-yielding currencies and investing them in higher-yielding ones.
Stocks were trading solidly higher Tuesday, and surged after the Fed's announcement. See Market Snapshot.
Crude-oil futures were higher after the Fed move, after earlier touching a new front-month contract high of $81.50 a barrel on hopes that the expected interest rate cut will boost energy demand. See Futures Movers.
