European Debt Crisis - How it All Started???

“EUROPEAN DEBT CRISIS”, THE MOST COMMONLY DISCUSSED MATTER TODAY IN FINANCIAL WORLD AS WELL IN JOB MARKETS. WHAT IS IT EXACTALY? AND HOW IT STARTED? IS IT THE RESULTANT EFFECT OF A COUPLE OF YEARS PROBLEM OR A LONG STRETCHED PROBLEM?

All these queries will be cleared in this Article. Hold your breath this Crisis is not a couple of years old, in fact it was spreading its roots tight since the Year 2000, yes MORE THAN A DECADE!!!

Meaning of Some Terms before we Start what is EUROPEAN DEBT CRISIS AND HOW IT ALL STARTED

Bailout: As a person is when arrested and seeks a Bail to come out from that arrest for some time. In the same way when a Company or a Country is when provided with an emergency financial help so that they keep running and working as before is called a Bailout. In India, Kingfisher Airlines is the recent example of this.

Austerity Measures / Plans: Austerity is a policy of deficit-cutting, lower spending, and a reduction in the amount of benefits and public services provided. Austerity policies are often used by governments to reduce their deficit spending while sometimes coupled with increases in taxes to pay back creditors to reduce debt.

European Financial Stability Facility (EFSF): It is a special purpose vehicle financed by members of the eurozone to fight the European sovereign debt crisis. It was agreed by the 27 member states of the European Union on 9 May 2010, aiming at preserving financial stability in Europe by providing financial assistance to eurozone states in economic difficulty.

Contagion: The likelihood that significant economic changes in one country will spread to other countries. Contagion can refer to the spread of either economic booms or economic crises throughout a geographic region. Contagion has become a more prominent phenomenon as the global economy has grown and economies within certain geographic regions have become more correlated with one another.

HOW IT ALL STARTED?

In 1958, an organisation called European Coal and Steel Community was formed. This evolved into the European Union (EU) which was established by the Maastricht Treaty in 1993. The European Union introduced the euro on January 1, 1999. On this day, 11 member countries of the EU started using euro as their currency. It benefited countries such as Portugal, Italy, Ireland, Greece and Spain (together now known as the PIIGS).

Before these countries started to use the euro as a currency, they had to borrow money at interest rates much higher than the rates at which a country like Germany borrowed. When these countries started to use the euro they could borrow money at interest rates close to that of Germany, which was economically the best managed country in the EU.

OVERBURDENED DEBT

The rest of Europe, in effect, used Germany's credit rating to indulge its material desires. They borrowed as cheaply as Germans could to buy stuff they couldn't afford.

Also other than the low interest rates, the inflation in the PIIGS countries was higher than the rate of interest. It means that if the borrowing rate is 3 per cent while inflation is 4 per cent you're effectively borrowing for 1 per cent less than inflation. You're being paid to borrow.

And the European peripheral countries (PIIGS) racked up enormous amount of debt in euros. Taking the case of Greece, their debt currently amounts to around 160 per cent of their GDP. With low interest rates these countries went on a borrowing spree and since they borrowed much more than their repayment capacity is, they are in a mess. Greece is the smallest of these countries and is in the biggest mess.

Other than the citizens, the governments also started to borrow. This helped politicians keep their constituency of voters happy.

GREECE

Taking the case of Greece, a job which now pays 55,000 euros in Germany, pays 70,000 euros in Greece, even with the fact that Germany is a more productive nation. To get around pay restraints in the calendar year the Greek government simply paid employees a 13th and even 14th monthly salary -- months that didn't exist.

The Greek government categorizes certain jobs as arduous. These jobs have a retirement age of 55 for men and 50 for women. As this is also the moment when the state begins to shovel out generous pensions, more than 600 Greek professions somehow managed to get themselves classified as arduous: hairdressers, radio announcers, musicians.

It means more and more borrowing by the government, when they already have so much debt.

SPAIN

Taking the case of Spain, it had the biggest housing bubble in the world. To put things in perspective, Spain now has as many unsold homes as the United States, even though the US is six times bigger. Most of these new homes were financed with capital from abroad. Spain's real estate debt comes to around 50 per cent of its GDP.

Every time there are default threats to the Countries, the European Central Bank (ECB), helps out with a bailout. Since the start of the financial crisis ECB has bought around $80 billion of Greek and Irish and Portuguese government bonds, and lent another $450 billion or so to various European governments and European banks, accepting virtually any collateral, including Greek government bonds. Of the 126 countries with rated debt, Greece now ranked 126th: the Greeks were officially regarded as the least likely people on the planet to repay their debts.

Germany keeps contributing the ECB rescue fund. The German government gives money to the rescue fund so that it can give money to the Irish government so that the Irish government can give money to Irish banks so the Irish banks can repay their loans to the German banks. In case of Greece, a lot of German and French banks which have lent money will be in trouble if Greece defaults.

HUNGARY

In 2004, interest rates in Hungary were at 12.5 per cent. This meant borrowing money was extremely expensive.

In Austria, the banks had started to offer loans and mortgages to their customers in Swiss francs. Rates in Austria, at 2 per cent, may have been lower than in Hungary, but in Switzerland, they were even lower at around 0.5 per cent. Why would Austrians borrow at 2 per cent when they could just as easily borrow at 0.5% per cent?

The same question applied to Hungarians, except that the difference was much bigger. So the Austrian banks, many of which also had branches in Hungary began to engage in the same business there, lending to Hungarian borrowers.

Now Austrian banks have lent 140 per cent of their GDP to countries like Hungary. Even though Hungary has put in austerity measures and is trying to repay, if there was a blow up, the Austrian government wouldn't be able to save the banks and ECB might have to step in.

Similarly, Swedish banks have also lent a lot of money to Estonia, Lithuania and Latvia, countries which aspire to have Euro as their currency some day.

ITALY

Using the example of Italy, Households and firms, anticipating that domestic deposits would be redenominated into the lira (Italy's currency before it started using the euro), which would then lose value against the euro, would shift their deposits to other euro-area banks. A system-wide bank run would follow. Investors anticipating that their claims on the Italian government would be redenominated into lira would shift into claims on other euro-area governments, leading to a bond market crisis . . . this would be the mother of all financial crises.

WHAT IS EXACTALY EUROPEAN DEBT DEAL?

Euro as a currency started operating on January 1, 1999. Before that the German currency -- Deutschemark -- used to be the premier currency of Europe. The Euro inherited the strength of the deutschemark. The world looked at the Euro as the new Deutschemark.

The Greek government over the years borrowed a lot of money to finance its fiscal deficit, which is the difference between what a government earns and what a government spends. A lot of this borrowing was from private investors like German banks to whom the Greek government currently owes Euro 8.6 billion.

So these private creditors of the Greek government have now agreed to take a 50 per cent haircut. It basically means is that for every 100 Euro owed to them, they have agreed to accept 50 Euro as repayment, primarily in the hope that Greece at least repays 50 per cent of what it owes to them.

So Greece is defaulting, though technically and we call it a haircut. The hope is that by doing this, Greek debt will come down to manageable proportions. Experts who have come up with this plan expect Greek debt to come down to around 120 per cent of its gross domestic product (GDP) in 2020, because of this plan. Otherwise it would have ballooned to around 180 per cent of its GDP.

If the German banks take a 50 per cent haircut on their outstanding debt of Euro 8.6 billion they lose around Euro 4.3 billion. A lot of money has been lent to the private sector in Greece. And if the government of a country is defaulting, how could one expect the private sector to pay up?

Greece is not the only country which owes money to Germany. Spain owes around $238 billion to Germany. Italy, Ireland and Portugal owe $190 billion, $184 billion and $47 billion, respectively.

These countries might turn around and say why we don’t get a haircut on our debt as well. And then there will be a bigger problem given that these countries are bigger and the money they owe to Germany is considerably larger.

Angela Merkel, the German Chancellor is supporting this policy due to an economic reason. Before Euro became a common currency across Europe, German exports stood at around $487 billion in 1995. In 1999, the first year of the Euro being used as a currency the exports were at Euro 469 billion. Next year they increased to Euro 548 billion. And now they stand at Euro 1 trillion. And all this was because of Euro being used as a currency.

Using Euro as a common currency took away the cost of dealing with multiple currencies and thus helped Germany expand its exports to its European neighbours big time. Also with a common currency at play, exchange rate fluctuations which play an important part in the export game, no longer mattered and what really mattered was the cost of production.

Since the beginning of the Euro in 1999, Germany has become some 30 per cent more productive than Greece. Very roughly, that means it costs 30 per cent more to produce the same amount of goods in Greece than in Germany. That is why Greece imports $64 billion and exports only $21 billion.

So the way it works is that German banks lend to other countries in Europe at low interest rates and they, in turn, buy German goods and services which are extremely competitively priced as well as of good quality.

And that is why Germany is interested in rescuing these countries or at least showing that it is trying to do something about it. Because if these countries in Europe collapse, then German exports will collapse as well.

One solution bandied around is that these countries which are in severe debt to Germany should be asked to stop using the Euro as its currency. But if they stop using the Euro as a currency, then the huge export advantage which Germany has had because of the Euro will also end. So Germany is jammed in from both sides.

A DILEMMA

The euro zone is a hybrid: a single currency with 17 national fiscal and economic policies. It has no common treasury, no tax-raising powers, no joint bonds and no central bank acting as lender of last resort. In good times, this did not matter. But in the worst financial crisis in decades, the flaws are glaring.

Countries cannot quit the euro without extreme economic pain, but nor is it easy to fix. Vetoes may be needed to maintain democratic consent, even if they make for poor crisis management. A blockage in one country endangers all. The markets are testing the ambiguities to destruction. Vague promises to “do whatever it takes” to save the euro are not enough. Will the ECB deploy its full resources to stop the crisis? How much intrusion into national policies are Greece and Italy ready to accept? How far is Germany willing to extend its credit? Will the euro zone’s states hang together or hang separately?

These are big questions, affecting the nature of the state, sovereignty and democracy. 

OLD DEBTS DOG EUROPE’s BANKS

European banks are sitting on heaps of exotic mortgage products and other risky assets that predate the financial crisis, adding to pressure on lenders that also are holding large quantities of euro-zone government debt.

Four years after instruments like "collateralized debt obligations" and "leveraged loans" became dirty words because of the massive losses they inflicted on holders, European banks still own tens of billions of euros of such assets. They also have sizable portfolios of U.S. commercial real-estate loans and subprime mortgages that could remain under pressure until the global economy recovers.

While the assets largely originated in the U.S. financial system, top American banks have moved faster than their European counterparts to rid themselves of the majority of such detritus.

Sixteen top European banks are holding a total of about €386 billion ($532 billion) of potentially suspect credit-market and real-estate assets. That's more than the €339 billion of Greek, Irish, Italian, Portuguese and Spanish government debt that those same banks were holding at the end of last year, according to European "stress test" data.

The old credit-market assets might turn out to be harmless for the banks. If real-estate markets hold steady or strengthen, for example, instruments made up of home loans could gain value and generate a steady stream of cash payments for their holders.

Still, the hefty holdings of debt from before the 2008 financial crisis compound the challenge facing the Continent's banks.

Many are holding tens of billions of euros of bonds issued by financially shaky countries. They are holding hundreds of billions more in loans to customers in those same countries, which are likely to go bad at an increasing clip if Europe's economy continues to struggle.

The situation is heightening fears that the banks lack enough capital to absorb potential losses and could require government support.

The banks generally have been holding the assets since before the financial crisis got under way four years ago, a time when real-estate assets in general had much higher prices. Some banks haven't fully written down these loans to reflect their current market values.

European banks, on average, have roughly halved their stockpiles of the legacy assets since 2007. Meanwhile, the top three U.S. banks—Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co.—have slashed such assets by well over 80% over a similar period. It will be another drag on the banks' capital and returns on equity.

France's BNP Paribas SA is sitting on €12.5 billion of asset-backed securities and collateralized debt obligations tied to real-estate markets. The assets are liquid and "priced very conservatively."

French banks in particular have pointed to such sales as a key part of their plan to address a cumulative €8.8 billion capital shortfall.

The assets could lose value due to a wave of selling by the banks. If the banks sell the assets at a loss, it erodes their profits and can dent their capital bases. But if they don't sell them, they're stuck with assets that consume significant quantities of capital.

Banks in the U.K., France and Germany are the biggest holders of such assets, even after chipping away at their exposures. The four biggest British banks reduced their holdings by more than half since 2007, while four French banks trimmed theirs by less than 30%.

Barclays PLC is sitting on about £17.9 billion as of Sept. 30, down from £23.9 billion at the start of the year. The assets, which landed on the giant U.K. bank's books before mid-2007, include collateralized debt obligations, composed of securities backed by assets like mortgages, commercial real-estate loans and leveraged loans that helped finance boom-era corporate buyout deals.

At roughly €28 billion, Crédit Agricole SA has the biggest portfolio of such assets among French banks. The bank's June 30 financial report includes €8.6 billion of CDOs backed by U.S. residential mortgages. On top of that, Crédit Agricole also has at least €1 billion of U.S. mortgage-backed securities, some composed of subprime loans. With the U.S. real-estate market still hurting, further losses are possible in all these securities.

Legacy assets are also haunting Deutsche Bank AG. The bank is holding €2.9 billion in U.S. residential mortgage assets, including subprime loans. It has an additional €20.2 billion tied up in commercial mortgages and whole loans. The bank says it has hedged nearly all of its residential mortgage exposure. Deutsche's exposure to such assets amounts to more than 150% of its tangible equity—a key measure of its ability to absorb unexpected losses.

Compared with European banks, U.S. lenders have moved faster to dump such assets. Citigroup, which required $45 billion of government aid in 2008, faced intense pressure from regulators to rid itself of risky assets, many linked to mortgages that got the New York bank in trouble. Its stockpile of such assets was down by 86% to $45 billion at Sept. 30.

EXPOSURE OF U.S. Banks

-      Goldman Sachs Group Inc., the fifth- biggest U.S. bank by assets, had $2.32 billion of “funded” credit exposure to Italy’s government, financial institutions and companies as of Sept. 30.

-     Morgan Stanley’s net funded exposure tied to Italy was $1.79 billion at the end of September, accounting for most of the $2.11 billion total from the five countries. 

-      Citigroup Inc.’s “net current funded exposure” tied to the PIIGS countries was $7.2 billion at the end of September, more than three times the exposure to Belgium and France. Total cross-border claims linked to Italy were $14.5 billion.

-    JPMorgan Chase & Co.’s exposure to Italy from trading, lending and securities available for sale was $11.3 billion as of Sept. 30.

-      Bank of America Corp.’s non-U.S. exposure linked to Italy was $6.54 billion at the end of September, almost 45 percent of the total linked to the five European countries.

PROBABLE CONSEQUENCES

The Eurozone is Over

If Greece did its own thing and Germany its own, you need to have separate currencies. If Maharashtra borrowed as much as the government of India on the assumption that it is a sovereign power, the Indian rupee would collapse, too. The rupee holds only because India limits the fiscal sovereignty of its states.

One can see the eurozone being restricted to Germany, France and the Benelux countries, or the emergence of two eurozones – with northern Europe being the stronger half with a stronger euro and southern Europe – assuming it sticks together – having a weaker euro. The southern euro, or successor national currencies, have to depreciate against the northern ones, assuming the euro itself stays.

As the western world goes into recession, it is the less externally-vulnerable countries that will benefit most.

America will benefit, because it imports more than it exports and it retains sovereignty over the dollar. A global slowdown will bring down the price of its imports faster than the slowdown in its export earnings.

India will benefit for the same reason – and for the fact that it will still be growing faster than many other countries. 

The oil-producers (including Russia) will gain because oil priced in dollars will not fall too much.

The biggest losers will be the highly export-driven economies of Germany and China

These Countries will now have to find markets in new areas. Or they will have to grow their internal consumption markets through a painful process of saving less and spending more. All of them will slow down dramatically – if not slip into recession.

LESSONS FROM THIS ALL

Globalisation and absolute sovereignty are inimical to one another. 

One or the other has to dominate. If we want free trade, we cannot have political barriers to trade – and by trade here means not only the export of goods and services, but also capital and labour. Globalisation will work perfectly only if all the factors of production move freely – and markets adjust constantly to this flow.

But this is an impossibility when political power remains national. The euro experiment is failing because Europe tried to graft a political project (to achieve a peaceful continent) based on economic interdependence. It would have worked if Europe also had a sovereign government which redistributed resources from the rich to the poor. In such a scenario, Germany would subsidise Greece and the other PIIGs to improve their economic conditions and competitive abilities. Eurozone is failing because this did not happen – and Germany hogged the benefits as long as it could.

Countries running excess fiscal and current account deficits over long periods of times will get into serious trouble. 

But the reverse is also true. Countries running external surpluses for long periods of time are equally the cause of the problem. This has been the world’s blind spot so far where exporters and surplus countries were hailed as heroes and the rest castigated as zeroes and wasteful. The latter characterisation is rubbish: borrowers need lenders, and if borrowers keep on borrowing, it is because the lenders benefit from it.

Put another way, it means when countries run prolonged deficits, both parties – the surplus economies and the deficit ones – must do opposite things. The adjustment cannot be done by the deficit people alone. By wrongly categorising Germany, China and Japan as surplus heroes a lopsided world is created in which they were being eulogised for being “virtuous savers” when the “profligate” spenders were actually responsible for their growth.

The world’s problems will be solved today only if the saver economies now agree to spend lavishly (instead of lending) to right the balance. They will have to do this by sacrificing some of their old firepower and growth.

Welfarism has serious limits 

Both the US and Europe are capitalist economies that took on excessive burdens on social security – Europe more than the US – which cannot be sustained by economic activity. The US economy is sinking under the weight of its unaffordable social security (mainly medical benefits) and pensions. Europe – where the welfare state is even worse. Till recently, Europe’s inflexible economy was willing to tolerate high unemployment by doling out more by way of state benefits. This is unsustainable.

A Very Happy Diwali and A Prosperous New Year!!!!!!!!

May the Gleam of Lights always brighten your lives,


May the Colors of Rangoli always fill your lives with beautiful colors,


May the Sweetness of Sweets always fill your lives with lots of sweetness,


May the Fragrance of Beautiful Flowers always fill your lives with lots of pleasing fragrances,


May this Diwali and New Year bring Lots of Happiness, Love, Success, Luck, Prosperity, Wealth and Health!!!!!

Headline inflation eases marginally to 9.72 per cent in September in India

Headline inflation remained close to the double-digit mark at 9.72% in September as all items, including food products, fuel and manufactured goods, grew costlier, a development likely to prompt the Reserve Bank to continue with its policy of monetary tightening.

Inflation, as measured by the Wholesale Price Index (WPI), stood at 9.78% in August. The rate of price rise was recorded at 8.98% in September, 2010.

Overall inflation in June this year was revised upward to 9.36% from the provisional estimate of 9.22%. On an annual basis, food items became 9.23% more expensive during the month under review. Onions grew 23.58% costlier, while fruit prices were up 15.98% and the rates for potatoes rose by 14.64%.

Overall, vegetable prices witnessed 14.04% inflation during September, 2011.

Inflation in overall primary articles, which have a share of over 20% in the WPI basket, stood at 11.84% in September, compared to 12.58% in August.

Non-food primary articles, which include fibres, oil seeds and minerals, became dearer by 14.82% in September, as against 17.75% in the previous month.

Prices of manufactured products, which have a weight of around 65% in the WPI basket, went up by 7.69% year-on-year in September compared to 7.79% in August.

Inflation in manufactured products has been steadily rising since February this year, when it crossed the 6%-mark. 

Among manufactured items, iron and semis grew dearer by 20.73%, edible oil prices rose by 13.45%, the cost of tobacco products moved up by 13.43% and cotton textiles became 12.55% more expensive.

In addition, wood and wood products became dearer by 8.18%, while prices of basic metal alloys and metal products rose by 10.94% year-on-year in September.

Inflation in the fuel and power segment stood at 14.09% on an annual basis in September, as against 12.84% in August. Oil marketing companies had hiked petrol prices by over Rs 3 per litre in mid-September and this seems to have been reflected in the numbers.

This is the tenth consecutive month when headline inflation has been above the 9%-mark.

Elevated inflation levels close to double digits are likely to put pressure on the Reserve Bank to continue with its policy of monetary tightening.

The apex bank has already hiked key policy rates 12 times since March, 2010, to tame inflation. The bank's next policy review is scheduled for October 25.

India Inc has said the string of rate hikes, which have raised the cost of borrowing, have acted as a dampener to fresh investment and hindered growth.

Growth in industrial production fell to 4.1% in August. Meanwhile, economic growth during the April-June period stood at 7.7%, the slowest expansion rate in the past six quarters.

IIP (Index of Industrial Production) growth slows to 4.10 per cent in India (WEDNESDAY, OCTOBER 12, 2011)

The industrial growth of the country slowed to 4.10% in August on account of the poor performance of the manufacturing sector and a decline in mining output, indicating an economic slowdown.

Growth in factory output, as measured in terms of the Index of Industrial Production (IIP), stood at 4.50% in August last year. During the April-August period this fiscal, IIP growth stood at 5.60%, as against 8.70% in the same period last year. Meanwhile, the IIP growth figure for July this year has been revised upward to 3.80% from the provisional estimate of 3.30%.

The output of the manufacturing sector, which constitutes over 75% of the index, grew by only 4.50% in August, compared to 4.70% expansion in the same month last year.

Mining output declined by 3.40% in August this year, as against a growth of 5.90% in the same month last year.

Growth in capital goods output slowed to 3.90% in August, in comparison to a growth of 4.70% in the same month of 2010.

Growth in production of intermediate goods slowed to 1.30% during the month under review, as against a growth of 5.80% in August, 2010.

Consumer durables output grew by 4.60% in August, compared to a growth of 8.10% in the corresponding month last year.

However, electricity production improved, witnessing growth of 9.50% in August this year, as against mere growth of a mere 1.00% in August, 2010.

Non-durable consumer goods (FMCG) production also grew by 2.90% in August, compared to growth of 1.80% in the same month last year.

Output of overall consumer goods increased by 3.70% in August this year, compared to a growth of 4.60% in August, 2010.

The IIP numbers for May have also been revised upward to a final figure of 6.20% from the earlier estimate of 5.90%.

The fall in the industrial production numbers, suggests continued sluggishness in the economy. 

India's economy grew by 7.70% in the April-June period, the slowest in six quarters.

India Inc had attributed the slowdown to rising interest rates, which have led to an increase in the cost of borrowings, thus hindering fresh investments.

The Reserve Bank has hiked interest rates 12 times since March, 2010, to tame inflation. Headline inflation has been above the 9 per cent-mark since December last year and stood at a 13-month high of 9.78 per cent in August.

Emerging markets from Brazil to Indonesia have cut borrowing costs to shield expansion as Europe’s debt woes and a faltering U.S. recovery hurt the world economy. In India, the fastest inflation in more than a year is sustaining pressure for higher rates even as consumer demand wanes.

The Indian rupee has weakened 8.9 percent against the dollar this year, the worst performer in Asia, threatening higher import costs.

Sales by companies including Maruti Suzuki India Ltd., the nation’s biggest carmaker, fell 1.8 percent in September, the third straight monthly decline, the Society of Indian Automobile Manufacturers said Oct. 10.

India’s manufacturing grew in September at the slowest pace in 2 1/2 years, according to the Purchasing Managers’ Index released by HSBC Holdings Plc and Markit Economics.

India’s merchandise export growth slowed for a second straight month in September. Shipments rose 36.3 percent to $24.8 billion from a year earlier. Exports gained 44.3 percent in August.

Q1 Gross Domestic Product in India dips to 7.7%

Confirming fears of a slowdown, India's economy grew by just 7.7% in the first quarter of the 2011-12 financial year, compared to 8.8% growth in the same three-month period last fiscal, which was mainly due to the poor performance of the manufacturing sector.

The government has projected overall economic growth in the current fiscal at around 8.5%, while the Reserve Bank has projected the growth to moderate to 8% from 8.5% in FY'11.

In the latest data released by the government, GDP growth for the April-June quarter of the 2010-11 fiscal has also been revised downward to 8.8% from the earlier provisional estimate of 9.3%.

During the quarter ending June 30, 2011, growth in the manufacturing sector dipped to 7.2% from 10.6% in the corresponding period of 2010-11.

In addition, the mining and quarrying sector grew by just 1.8% during the quarter under review, as against 7.4% growth in the first quarter of the previous fiscal.

However, farm output showed an improvement, expanding by 3.9% during the quarter under review, compared to 2.4% in the corresponding three-month period last fiscal.

Furthermore, the trade, hotels, transport and communications segments grew by 12.8% in the quarter under review, up from 12.1% in the year-ago period.

The services sector, including insurance and real estate, grew by 9.1% in the June quarter this year, compared to 9.8% expansion in the corresponding period last year.

The Indian economy expanded by 8.5% in the 2010-11 fiscal.

RBI releases Draft Rules for Bank Licences for Corporates (WEDNESDAY, AUGUST 31, 2011)

Pursuant to the announcement made by the Union Finance Minister in his budget speech and the Reserve Bank's Annual Policy Statement for the year 2010-11, a discussion paper on "Entry of New Banks in the Private Sector" was placed on RBI website on August 11, 2010. The discussion paper marshalled international practices, Indian experience as well as the extant ownership and governance (O&G) guidelines.

The Reserve Bank of India (RBI) released the Usha Thorat committe report on non-banking finance companies or NBFCs. The report speaks about the issues and concerns  of the NBFCs. (Thorat is a former deputy governor of RBI).

Some key recommendations of Thorat-committee:

Tier I capital of NBFCs to be at 12%

So far, NBFCs’ capital adequacy requirement is at 15% wherein there is no stringent stipulation of tier I or tier II capital. If the recommendation is accepted, every NBFC has to have a minimum tier I capital or equity capital of 12%.

Provisioning norms for NBFCs would be similar to those for banks.

In April this year, RBI increased provisioning norms for banks from 10% to 15% on sub-standard assets (where interest payments have not been made for two months) while restructured assets (where concessions have been given to the borrower to prevent the loan from going bad) too have to be provided at 2% as against 0.25-1% earlier. If accepted, NBFCs too have to follow this. NBFC heads feel such provisioning is good on a longer term basis. It has an income tax benefit. The proposed income tax deduction is seen as a big relief.

Liquidity ratio to be introduced for 30 days 

RBI has recommended maintaining a liquidity ratio for 30 days, which means an NBFC has to set aside cash balance equivalent to its debt payments due every month. This debt may include repayment of bank loans, interest payment to bond subscribers and others. Asset finance companies, especially those with longer repayment cycle, may be impacted. The measure is perceived to be important to check asset liablity mismatch of NBFCs.

Risk weights for NBFCs, not sponsored by banks may be raised to 150% for capital market exposures and 125% for commercial real estates

This reflects RBI’s intention to bar NBFCs from taking higher exposure in capital market and real estate. Two such sectors are considered to be risk-prone and inclusive of high volatility. However, asset finance companies which basically do business of funding asset purchases would not be impacted due to this.

NBFCs may be given benefits under SARFAESI Act 

Under Securitisation and Reconstruction of Financial Assets And Enforcement of Security Interest or SARFAESI Act, an NBFC would not move to the court to auction underlying assets to recover loan dues. It will just publish a newspaper notice before such auction. However, it hardly makes any difference for gold loan companies as gold is “pledged” against the loan.

The Reserve Bank of India released the Draft Guidelines for "Licensing of New Banks in the Private Sector". The Reserve Bank has sought views/comments on the draft guidelines from banks, non-banking financial institutions, industrial houses, other institutions and the public at large.

Final guidelines will be issued and the process of inviting applications for setting up of new banks in the private sector will be initiated. After receiving feedback, comments and suggestions on the draft guidelines, and after certain vital amendments to Banking Regulation Act, 1949 are in place.

Key features of the draft guidelines are:

(i) Eligible Promoters: 

Entities / groups in the private sector, owned and controlled by residents, with diversified ownership, sound credentials and integrity and having successful track record of at least 10 years will be eligible to promote banks. Entities / groups having significant (10% or more) income or assets or both from real estate construction and / or broking activities individually or taken together in the last three years will not be eligible.

(ii) Corporate Structure: 

New banks will be set up only through a wholly owned Non-Operative Holding Company (NOHC) to be registered with the Reserve Bank as a non-banking finance company (NBFC) which will hold the bank as well as all the other financial companies in the promoter group.

(iii) Minimum Capital Requirement: 

Minimum capital requirement will be Rs 500 crore. Subject to this, actual capital to be brought in will depend on the business plan of the promoters. NOHC shall hold minimum 40% of the paid-up capital of the bank for a period of five years from the date of licensing of the bank. Shareholding by NOHC in excess of 40% shall be brought down to 20% within 10 years and to 15% within 12 years from the date of licensing of the bank.

(iv) Foreign Shareholding: 

The aggregate non-resident shareholding in the new bank shall not exceed 49% for the first 5 years after which it will be as per the extant policy.

(v) Corporate Governance: 

At least 50% of the directors of the NOHC should be independent directors. The corporate structure should be such that it does not impede effective supervision of the bank and the NOHC on a consolidated basis by the Reserve Bank.

(vi) Business Model: 

Should be realistic and viable and should address how the bank proposes to achieve financial inclusion.

(vii) Other Conditions:

• The exposure of bank to any entity in the promoter group shall not exceed 10% and the aggregate exposure to all the entities in the group shall not exceed 20% of the paid-up capital and reserves of the bank.

• The bank shall get its shares listed on the stock exchanges within two years of licensing.

• The bank shall open at least 25% of its branches in unbanked rural centres (population upto 9,999 as per 2001 census)

• Existing NBFCs, if considered eligible, may be permitted to either promote a new bank or convert themselves into banks.

(viii) In respect of promoter groups having 40% or more assets / income from non-financial business, certain additional requirements have been stipulated.

These conditions may make it difficult for keen aspirants such as Religare Enterprises Ltd., Indiabulls Financial Services Ltd. and Reliance Capital Ltd. to qualify. Companies like Larsen & Toubro Ltd., Mahindra & Mahindra Financial Services Ltd., with a reasonably diversified shareholding, have a fair chance to gain banking licenses.

WHAT IS U.S. DEBT CEILING AND WHY WAS IT RAISED, WHAT ALL DID ROCKED THE FINANCIAL MARKETS ALL OVER THE WORLD IN LAST 15 DAYS?

The U.S. Treasury has borrowed trillions of dollars over the past decade, much of it from foreign investors, to help finance two long wars, rescue its financial system, and promote economic growth through fiscal stimulus. The government must be able to issue new debt as long as it continues to run a budget deficit--the current shortfall is about $125 billion per month. As the national debt approaches its statutory limit of $14.29 trillion, concern mounts over the consequences of congressional delay or paralysis in extending the government's ability to borrow. The United States has never failed to raise its debt limit, hence any failure to do so would have plunged the government into default and precipitate an acute fiscal crisis. Lawmakers from both parties conceded that there were dire consequences associated with a default, but some Republican members of Congress planned to use the debt limit as a negotiating chip to extract deeper spending cuts and long-term fiscal reforms from the White House.

What is the U.S. Federal debt limit?

The debt limit or "ceiling" sets the maximum amount of outstanding federal debt the U.S. government can incur by law. This number stood at $14.29 trillion in the spring of 2011. Increasing the debt limit does not enlarge the nation's financial commitments, but allows the government to fund obligations already legislated by Congress. Hitting the debt ceiling would hamstring the government's ability to finance its operations, like providing for the national defense or funding entitlements such as Medicare or Social Security. Under normal circumstances, the government is able to auction off new debt (typically in the form of U.S. Treasury securities) in order to finance annual deficits. However, the debt limit places an absolute cap on this borrowing, requiring congressional approval for any increase (or decrease) from this statutory level.

The debt limit was instituted with the Second Liberty Bond Act of 1917, and Congress has raised the cap seventy-four times since 1962.

When will the United States hit its debt ceiling?

On May 16, 2011, Treasury Secretary Timothy Geithner wrote a letter to Congress announcing that the United States had reached its statutory debt limit and that "extraordinary measures" would be taken to stave off a default until August 2.

How much would the debt limit need to be raised?

President Barack Obama's proposed budget for 2012 would require a nearly $2.2 trillion hike in the debt ceiling just to meet the government's obligations for next year. The proposed Republican spending plan would entail $1.9 trillion in new borrowing by October 2012.

What could the government have done if the debt limit wasn't raised?

The U.S. Treasury could take special emergency measures to forestall a default--the point at which the government fails to meet principal or interest payments on its debt. These include under-investing in certain government funds, suspending the sales of nonmarketable debt, and trimming or delaying auctions of securities.

On May 6, Treasury began implementing these measures by indefinitely suspending the issuance of State and Local Government Series (SLGS) Treasuries--bonds that help states and municipalities conform to certain IRS regulations. The SLGS window has been closed six times in the past twenty years. On May 16, Treasury announced it would begin a "debt issuance suspension period" as a result of the United States hitting its debt limit, including the suspension of additional investments of amounts credited to the Civil Service Retirement and Disability Fund.

If the debt limit is reached despite such measures, federal spending would have to plummet dramatically or taxes would have to rise significantly (or a combination thereof). However, Geithner warned that because the government's obligations are so great, "immediate cuts in spending or tax increases cannot make the necessary cash available." If Treasury is unable to issue new debt or take further emergency actions to bridge the deficit, the government would be forced to default on some of its financial commitments, limiting or delaying payments to creditors, beneficiaries, vendors, and other entities. Among other things, these payments could include military salaries, Social Security and Medicare payments, and unemployment benefits.

What are the implications for financial markets?

Most economists, including those in the White House and from former administrations, agree that the impact of a government default would be severe. Federal Reserve Chairman Ben Bernanke has labeled a U.S. default a "recovery-ending event" that would likely spark another financial crisis. But short of default, officials warn that legislative delays in raising the debt ceiling could also inflict significant harm on the U.S. economy.

Geithner has argued that congressional gridlock will sow significant uncertainty in the bond markets and place upward pressure on interest rates. He warns that the increase would not only hike future borrowing costs of the federal government, but would also raise capital costs for struggling U.S. businesses and cash-strapped homebuyers. In addition, rising interest rates would divert future taxpayer money away from much-needed capital investments such as infrastructure, education, and healthcare. Estimates suggest that even an increase of twenty-five basis points on Treasury yields could cost taxpayers as much as $500 million more per month.

What are the implications for the dollar?

A shrink in demand for U.S. Treasuries would push down the value of the dollar relative to foreign currencies.

While many U.S. exporters would benefit from currency depreciation because it would increase foreign demand for their goods, the same firms would also bear higher borrowing costs from rising interest rates.

A potential long-term concern of some U.S. officials is that persistent volatility of the dollar will add force to recent calls by the international community for an end to its status as the world's reserve currency.

Historically, the U.S. Treasury market has been driven by huge investments from surplus countries like Japan and China, which view the United States as the safest place to store their savings. A 2009 Congressional Research Service report suggests that a loss of confidence in the debt market could prompt foreign creditors to unload large portions of their holdings, thus inducing others to do so, and causing a run on the dollar in international markets. Others claim that a sudden sell-off would run counter to foreign economic interests, as far as those interests run parallel to a robust U.S. economy.

The U.S. rating agency Standard and Poor's (S&P) in April, threatened to reduce the U.S. credit rating from its long-held "AAA" status, downgrading its outlook from "stable" to "negative" for the first time. The agency said "there is a material risk that U.S. policy makers might not reach an agreement on how to address medium-and long-term budgetary challenges by 2013."

In July Moody’s warned of a possible downgrade too and said the review was prompted by the possibility that the U.S. debt limit will not be raised in time to prevent a missed payment of interest or principal on outstanding bonds and notes.

The global financial crisis, which was rooted in poor regulation of the US housing and banking sectors, already tarnished perceptions of the United States overseas.

United States is home to not only the world’s largest economy but also it’s most liquid and safe debt market, the repercussions of a US financial meltdown are potentially much larger than a more contained emerging-markets crisis.

If the United States had been downgraded, interest rates could rise, risking a new recession. The recovery is already being hampered as the threat of a debt default deals a further blow to consumer confidence.

Both Republicans and Democrats have become addicted to debt and it was just assumed the debt ceiling would get passed automatically.

In a given month the Treasury owes roughly about $30 billion as interest on its debt and the Treasury takes roughly about $200 billion in on average in a month.

Though the debt ceiling is getting all the attention, the real issue is the rapid growth of government debt.  The Federal government is borrowing roughly 44% of what it spends.  That is why it keeps running into the debt ceiling.  The debt ceiling is really just a technicality.  The long-term issue is the size and scope of government and growing debt is just a symptom of that.

Take a look at how much Federal spending has increased in just the past few years. 

Federal Budget Year                   Amount Spent

2008                                             $2.98 trillion

2009                                             $3.51 trillion

2010                                             $3.46 trillion

2011 (est.)                                   $3.81 trillion

Markets all over the World were in extreme fear, already the were battered by the European Debt Crisis and now it was U.S., the Super-Power. It was completely unbelievable for the markets to see U.S. in such a condition. This was the only reason, markets all over the globe witnessed a dismal sell off.

U.S. have raised the Debt Limit again this time, but if a deep insight is taken, this raising of Debt Limit has raised the Debt  available for U.S. The economy is currently standing on a Huge Pile of Debt, which one or other day, will drown the Whole World Economy to a new low.