RBI Bond Sale Boom for Govt ... Curse for small time investors

From fiscal 2008-09 to 2013-14 RBI had been very aggressive in bond market as Purchasing bond is one of the tools it used to infuse liquidity into the system and hence RBI bought bonds worth more than Rs 5500 Billion is this period (over six years).

However, since last 9 to 12 months Bond yield have been falling due to lower oil prices, falling inflation and improved government finances by easing liquidity conditions. But the main factor would be bond sales conducted by RBI which in turn have implications on market sentiments that actually affects the bond yield to a greater extent.

On Friday 23rd Oct'15, RBI auctioned the first ever 40-year government bond, which witnessed huge interest from long-term investors including insurance companies and pension funds. Infect latest report suggest Bond worth Rs 1000 Cr. scheduled to mature in 2055 (40 years) saw bids participation worth more than Rs 6000 Cr.

RBI plans to sell bonds throughout the remainder of the year and partly sterilize the liquidity released by SLR cut. However the government will not continue to run surplus balance with the RBI (generated through bond sales); infect government will start spending to pull up the economic growth to attain sustainable GDP of 7% and above in long run.

Thus demand for government long term bond would naturally go up along with lower than expected inflation; falling trend in fiscal deficit and effective system liquidity. However this will have a cascading effect on the market sentiments & FII participation; as gradually volatility in bond market will increase generating a paradigm shift from stock market to bond market / Forex for short term purely because of supply & demand rather than a long term view on the bonds.

To add further any immediate (before Dec'15) rate hike from FED's will suck the liquidity out of the stock market even further and Indian markets could witness a correction of up to 4% in short term from current levels of 8350.

What will it mean for the yuan to get IMF reserve-currency nod?

Bonnie Cao in New York and John Quigley in Lima contributed to this story:

Many major economies, including the US, Germany and UK, say they’re prepared to back the yuan’s inclusion if it meets the IMF criteria

Washington: International Monetary Fund (IMF) representatives have given China strong signals that the yuan is likely to soon join the fund’s basket of reserve currencies, known as Special Drawing Rights, Chinese officials with knowledge of the matter told Bloomberg News this week. Here’s a primer on what that means.

What is a Special Drawing Right?

The fund created the SDR in 1969 to boost global liquidity as the Bretton Woods system of fixed exchange rates unravelled. While the SDR is not technically a currency, it gives IMF member countries who hold it the right to obtain any of the currencies in the basket—currently the dollar, euro, yen and pound—to meet balance-of-payments needs. So the ability to convert SDRs into yuan on demand is crucial. Its value is currently based on weighted rates for the four currencies.

How much of these SDRs are out there?

The equivalent of about $280 billion in SDRs were created and allocated to IMF members as of September, compared with about $11.3 trillion in global reserve assets. The US reported about $50 billion in SDR holdings as of August.

Why does China want this status so badly?

In a 2009 speech, People’s Bank of China Governor Zhou Xiaochuan said the global financial crisis underscored the risks of a global monetary system that relies on national reserve currencies. While not mentioning the yuan by name, Zhou argued that the SDR should take on the role of a “super-sovereign reserve currency,” with its basket expanded to include currencies of all major economies.

Chinese officials have since been more explicit. After meeting President Barack Obama last month at the White House, President Xi Jinping thanked the US for its conditional support for the yuan joining the SDR. Winning the IMF’s endorsement would allow reformers within the Chinese government to argue that the country’s shift toward a more market-based economy is bearing fruit.

Why is the IMF likely to approve this?

Global use of the yuan has surged since the IMF rejected SDR inclusion in the last review in 2010. By one measure, the currency became the fourth most-used in global payments with a 2.79% share in August, surpassing the yen, according to the Society for Worldwide Interbank Financial Telecommunication, known as Swift.

The IMF uses several indicators to determine if a currency is “freely usable,” the benchmark for inclusion in the SDR basket. IMF staff members said in a report in August that the yuan trails its global counterparts in major benchmarks, such as its use in official reserves, debt holdings and currency trading. But staffers have also stressed that the fund’s 24 executive directors, who will make the final call, will need to use their judgment.

Many major economies, including the US, Germany and UK, say they’re prepared to back the yuan’s inclusion if it meets the IMF criteria. Supporting the yuan may boost relations between China and countries such as the UK, which has sought to make London a major yuan trading hub.

Adding the yuan to the basket may also help the IMF improve its standing with the Chinese. China and other emerging markets were supposed to gain greater representation at the fund under reforms agreed to in 2010, but the U.S. Congress has yet to ratify the changes.

What’s likely to happen to yuan assets in the longer term?

At least $1 trillion of global reserves will migrate to Chinese assets if the yuan joins the IMF’s reserve basket, according to Standard Chartered Plc and AXA Investment Managers.

Foreign companies’ issuance of yuan-denominated securities in China, known as panda bonds, could exceed $50 billion in the next five years, according to the World Bank’s International Finance Corp.

“Once the Chinese yuan becomes part of the SDR, central- bank reserve managers and institutional investors will automatically want to accumulate yuan-denominated assets,” Hua Jingdong, vice president and treasurer at IFC, said in an interview in Lima earlier this month during the IMF and World Bank annual meetings. “It will be strategically important for China to welcome all kinds of issuers to become regular issuers in China’s onshore market.” Bloomberg

Regards,
Learn N Earn

The next yuan shock

China has cut interest rates for the sixth time in a year. Its latest rate cut shows that its economy continues to lose momentum despite a rapid decrease in borrowing costs. In the month of August 2015 also when the rate cut was done it was a 2 Step devaluation of the yuan stock which surprised the global markets. 

This time the move could be categorized as tinge of desperation; especially these rate cuts should be seen against the massive monetary expansion since 2007....because China has added more to its stock of broad money than the rest of the world put together, fueling an unsustainable asset boom.

The question worth asking right now is whether the world should be preparing for another yuan shock. The Chinese tried to sell the sudden move as a step towards making its currency more flexible. It was actually an attempt to spur the economy through an export push. Monetary expansion is, in effect, an attempt to make the domestic currency cheaper. 

Is another yuan devaluation around the corner?

China's Central Bank Cut Interest Rate... Investors Cheer !!! Economists Worry???

Although China’s surprise, middle-of-the-night move to cut benchmark interest and deposit rates Friday is yet another sign of weakness in the world’s second-largest economy, investors around the world are taking the news as a positive sign that Chinese central bankers are actively engaged in efforts meant to stimulate growth.

Markets in Europe and the U.S. rallied on the news. The FTSE index of European stocks climbed 1.1 percent on the day, and the S&P 500 erased the last of summer’s losses, bringing 2015 into the green again.

“This interest-rate cut is the latest card China’s government is playing in order to right its economic ship,” said Gregory Stoller, an expert on Chinese economics who is a senior lecturer at the Boston University Questrom School of Business.

The People’s Bank of China (PBOC) complements the rate cuts --- its sixth round in 11 months -- with measures easing bank reserve requirements.

Despite these repeated rounds of monetary-policy accommodation, strained Chinese businesses were still facing real interest rates on the rise, said Alessandro Theiss, a China economist at Oxford Economics. In its announcement, the PBOC said its moves were aimed “to create a favorable monetary and financial environment for economic structural adjustment.”

That means extending a helping hand to flagging industries. “The biggest downward pressures on growth are the downturn in real estate and the weakness in heavy industry,” Theiss said. “Most of the really highly indebted companies are in these sectors.”

Beijing’s official data show headwinds in the Chinese economy, with its growth in gross domestic product falling to a six-year low of 6.9 percent in the third quarter, compared with 7.3 percent in the same period in the previous year. And analysts point to evidence of a deeper funk. Chinese equity markets moved from correction to bear-market territory in the middle of this year. And the country’s producer price index fell to a historical low of -5.9 percent in September, signaling a steep decline in domestic demand.

China’s interest-rate cut came a day after European Central Bank President Mario Draghi opened the door for further monetary easing in the eurozone, citing continued economic unease and low growth.

The rate cut should appear on the radar screen of the U.S. Federal Reserve, whose chair, Janet Yellen, held onto expectations that the Fed’s rate-setting committee will opt to raise historically low benchmark interest rates by the end of the year. In the Fed’s September announcement that rates would remain near zero, Yellen cited falling demand from China as a potential economic hurdle in coming months.

For worried stateside investors, the prospect of cheaper Chinese credit could be welcome. “Internationally, the perception of these stimulative measures is generally positive,” Theiss said. “It shows that the Chinese authorities are aware of the weaknesses the economy is facing.”

But not everybody is sanguine about the move. Many analysts predict at least one more rate cut from China by the end of 2015, as growth continues to sag. “We’re still waiting for clear evidence of an economic turnaround,” analysts at Capital Economics wrote in a note to investors.

Others see evidence of China delaying the inevitable. Speculation in real estate followed by a rush into the stock market helped drive successive credit bubbles in China that have still not fully deflated. “We’re not close to the deleveraging,” Theiss said.

In a note Friday, economist David Levy took China’s rate cut as a sign of a coming global economic shakeup. He wrote, “China has been growing so long with huge overinvestment that it needs to slash investment so much that the other profit sources cannot make up the difference.”

Especial thanks to Owen Davis for his tweets on this articles. 

Regards,
Learn N Earn Team

What is Quantitative Easing (QE) & how it Effect's an Economy!!!

Quantitative easing (QE) is an action taken by a central bank to stimulate the economy that it presides over.

The action that the central bank takes is to buy financial assets. These assets are usually in the form of government, bank or business bonds.

In order to make these purchases, the central bank electronically creates more money – contrary to the associated term 'printing money', they do not actually print physical paper money.

What are the assets?

In order to understand how QE works, an understanding of what the actual assets are that are being purchased is essential.

Government and banks issue bonds to borrow money

When banks, businesses or governments want to raise money, they can sell an 'asset', usually in the form of a bond. You'll see that this is another way of simply borrowing money and the buyer of the bond is lending money.

When banks, businesses or governments want to raise money, they can sell an 'asset', usually in the form of a bond. When an institution sells a bond they pay the money back at a set date in the future and pay interest on it.

The buyer of the bond hands over money to the institution and the buyer receives the bond in return. The buyer will hold this bond for a set period of time, so in other words, the bond 'expires' on a set date in the future.

When the period of time is up, the institution pays the buyer back. Of course, the buyer would never purchase the bond if there wasn't a good reason to do so, and so the institution pays the buyer interest. So the bond buyer makes a profit.

Bonds are intangible – a contract agreement

A bond is not a physical thing, it's actually just a contract between two parties, but they can be sold and traded. As such, in a free market, they are subject to supply and demand, meaning that if there is not much demand for the bonds, then the institutions will lower the price of them and pay a higher interest rate to the buyers to entice them. If there is a lot of demand for these assets, then the price of the assets will go up and the interest rate that the buyer receives will go down.

The 'assets' that central banks purchase with newly electronically created money are usually the bonds of governments, banks or private firms.

Whatever the interest rate is, the seller of the bond has raised money to invest into other things and will make a return on those investments. But the higher the interest rate, the more money has to be paid out and the less money is left over after the seller has invested the money.

So when a Central bank states that they will purchase assets, they are effectively buying these bonds. To illustrate further, if a central bank states that they are about to undergo $50bn of quantitative easing, they are buying $50bn worth of financial assets or bonds. The seller of the bond can then use that money to invest into other things.

Quantitative easing is designed to stimulate the economy

Usually, the most powerful tool that the central bank uses to stimulate the economy is the lowering of the base interest rate it charges national banks. However, when the interest rate is already the lowest it can go, the central bank has to resort to other means to stimulate the economy and QE is one of them.

Quantitative easing stimulates the economy in the following way:

1. New money is created and used to buy financial assets of institutions.
2. These institutions get a fresh injection of cash that they can use to invest and spend.
3. The extra money injected into all these firms in the economy increases the money supply overall.
4. The price of financial assets go up under the new demand and the yields of the assets (the interest rate paid to the buyers) falls.
5. Institutions start buying assets of other institutions, further increasing the price and lowering the yields paid out.
6. With less money being paid out in interest, these institutions now have more money to spend, lend and invest.

Lower yields on assets lowers the interest rates for borrowing money overall

When central banks buy substantial quantities of assets, they force the price of them up and the amount of interest that needs to be paid (the yields) down. This means the sellers of bonds have more money to spend and invest.

When the yields of these bonds in the economy fall, this has a very clear benefit for everyone else, because it lowers the cost of borrowing for everyone else.

This is because, now that the institutions do not have to pay as much to the buyers of their assets in yields, they now have extra cash on hand. With the extra money that these institutions now have, they can invest into new things, hire more staff and expand. They generally buy other assets with the money they get to invest and grow.

Those companies that lend money, such as a bank or other financial institution, have more on hand to lend and can therefore afford to lend more and at a cheaper interest rate.

If you think about a single loan, where a bank lends money to a customer for a certain amount of interest (fixed or otherwise), this is essentially a so called 'financial product' that the borrower purchases from the bank. What the central bank has effectively done with QE, is allowed the supply of financial products on the market to increase as a whole (across all of the banks) – when the supply of something increases, then the price of it falls.

Of course the banks don't have to lend at a lower rate, they can lend at any rate they want to (above the base rate of the central bank sets). However, banks make money on the loans that it issues out to borrowers and they want to make as many loans as possible. But of course, all the other banks are able to make more loans at a cheaper rate too and as the bank will want to entice as many people to take out loans with them, they will lower the interest rates to compete with other financial institutions.

In theory, this lowering of interest rates is probably the most direct benefit that consumers feel from quantitative easing.

Lower borrowing costs encourages spending and stimulates the economy

When the cost of borrowing money falls, consumers and businesses borrow more money and buy more goods. The following – very rudimentary – example explains how this works:

If the cost of borrowing falls, people naturally borrow more and spending in the economy increases.

Say, for instance, the more vans you have for your delivery business the more you can expand. You consider a $20,000 loan to buy a van and the payments are $250 per month. If the cost of borrowing falls by half, then you can now be take out a loan for £40,000 to buy two vans for the same cost of $250 per month and so you are likely to buy two vans and expand your business even more.

More spending leads to inflation

As this effect starts to take place and spending and investment picks up across the whole economy, prices overall start to increase leading to inflation. This is either a good thing or a bad thing, depending on how high the inflation is.

Central banks will engage in QE if there is a danger of deflation. Deflation is bad for the economy because it encourages people and businesses to not spend and invest.

It is generally accepted that a small amount of inflation is a good thing for the economy, because it encourages spending and investment. If prices are rising, then investors are likely to buy or invest in assets because they believe they will get a return for it in the future. If prices do not rise, or even fall (deflation), then investors are more likely to hold onto their money, because they do not want to invest in something that is going to be worth less over time.

So, a direct result of quantitative easing is inflation and a central bank will engage in quantitative easing if it believes that there is a danger of deflation.

So you can see that quantitative easing has the same effect of lowering the interest rate, but can be used when the interest rate can go no lower.

The debate around QE

Quantitative easing and its benefits are heavily debated in terms of the actual effects and the extent of them, and so it is worth bearing in mind that the text book theory of how QE works remains under scrutiny.

For instance, it has been widely reported in the 2008 crises that QE did not in fact end up stimulating investment, but rather allowed big banks that lost money on heavy speculation in the sub-prime mortgage industry to re-capitalise their own balance sheets. So far from encouraging lending in the economy, banks sucked up the readily available capital to affirm their own footing in a financial crisis.

Regards,

Learn N Earn  Team