Tuesday, 12 April 2016

Inflation Will Rise More Than Expectation

The competitiveness of the country’s export is determined by the trade weighted critical real effective exchange rate in the international market. The real effective rate exchange rate may even depreciate when the nominal exchange rate is falling down. The best example is that of an appreciation of Pak Rupee in terms of US dollars from 100 to 105.
Hence we can say, the competitiveness of a country’s trade may take worst situation even when the nominal value of the country’s currency is lost.
The data of State Bank of Pakistan shows that since 2010, country’s trade weighted nominal exchange rate (NEER) has depreciated by 7%. During the same period of time, Real Effective Exchange Rate (REER) has appreciated by 23% till January 2016. Over the last two years the appreciation in REER has been much more noticeable. This is the time period that coincides with the continuous decline country’s exports.

Exports of Pakistan have dropped in terms of dollar by 14.4% during the first half of the fiscal year 2016. The result is further worsening of balance of trade by 4.3%. 
There have been numerous reason behind such structural reasons. Energy crisis can be jotted down on top of the list that has adversely affected the export growth. The recent back fall has been faced due to the loss of competitiveness of the domestic prices in the international market.
Unfortunately very less attention has been paid to the dynamics of exchange rate as a source for poor performance of the exporting sector. The composition of the export basket and entire structure of the economy has made the overall REER more vulnerable.
At the same time, with appreciation in REER appreciation, the total import demand has been increased due to the relative decline in the import prices. The data of State Bank of Pakistan suggests that the imports of Pakistan have been sharply increased in terms of US dollars since fiscal year 2013.
The REER of Pakistan has appreciated between fiscal year 2014 to 2015 from 5.6% to 8.8%. This has put worst impact on competitiveness of the local products. With inflation rate set as target by State Bank of Pakistan below 6%, devaluation of the currency can be one of the solution to achieve set inflation target through demand and cost effect.

Sunday, 10 April 2016

Stock Market and Oil Prices Correlation: Why From 25% to 91%?

Oil and water do not mix together but stock prices and oil prices does!
Both, the oil prices and stock prices were declining with the correlation of about 91% when oil prices dropped down to $40 per barrel in December 2015. Leo Chen who is the quantitative analyst at Cumberland Advisers called this correlation a “black swan”. According to him this correlation between oil prices and stock prices is not usual.  
From past five years the correlation between S & P Index and the oil prices was negative 71.8%. This shows that the stock prices and oil prices move in opposite direction. If oil prices rise, the stock prices fall and vice versa. However, from past twenty years this correlation has not been more than 25% as compared to current 91%.

Now the question here is what is so few and far between now and then?
As we know that these days the oil prices have been declining from the last quarter of 2015 in the international market. However globally this drop is not being considered as a good news. But why?  Why this decrease in oil prices is not welcomed in the economy?
It’s quite complicated!
There are many reasons behind this and different analysts and investors hold different view point. Some believe that this drop in oil prices is bad news for the corporates as it would affect their profits in the long run due to less demand of oil. This also includes productive economies like China, where the growth productivity has gone slower. Another school of thought relates it to prevailing trend of dollar in the exchange rate markets.
In order to understand the phenomena behind the swift dropping of oil prices, you may visit my article Dropping Oil Prices: An Alarm for Saudi Arabia. To get more information on current trend of dollar in the exchange market, visit my article
We may believe that there are several other ingredients involved in this oil and stock curry which are adding flavors to confuse the whole recipe. We may also say that if the investors would take a flight from commodity markets due to prevailing uncertainty and high risk aversion then the volatility in the stock market may also be another reason for the stock market and the oil prices to move in same direction against the norm.

However, the good news is that recently the slight temporary boost in the oil prices also raised the sentiments on Wall Street and the Dow moved up sharply. The blue chip companies got up with 153 points. 

Friday, 8 April 2016

What Put Gold Market On Fire?

Gold price is on fire. It looks like something big has happened in the gold market. There was a magnificent change of trend in the gold prices from the mainstream during the first quarter of 2016. This shows that the investors are having insecurity about stock market and they are finding a way towards safe investment somewhere else… gold market may be…
Over the past several years gold market the gold market has been agonized by the decline in the outflow of gold from Gold ETF’s and Funds. This decline in the new outflows brought a drastic change in the international gold market in first quarter of the year.

According to Gold Demand Trends of World Gold Council the entire gold market suffered the net outflows from Gold ETF’s and such similar funds except for the small outflow of 25 metric ton that was built during first quarter of 2015. In the first quarter of 2016, this out flow was built up to 363 metric tons which is actually recorded to be the second highest build in the history of Gold ETF’s and Funds.
The first highest metal inventory was built at Global Gold ETF’s and Fund in first quarter of 2009. This was the time when stock markets were crashing down at their lowest levels. AT that time, the Global Gold ETF’s and Fund inventories rushed at 465 metric ton which was the highest ever.
There three important factors that act as driving force for bringing major change in gold markets are:
  1.  Net Sales and Purchases by Central Bank
  2.    Demand of gold coins and bars
  3.         Gold ETF’s and Fund Flows

When the Central Banks in West dumped 663 metric tons of gold in the market by the year 2005, the result was decline in the demand of total gold investment that reached 58 metric ton. This can be compared to the situation of gold investment demand of the year 2012 when it reached 2174 metric ton. This was an outrageous swing in the investment demand of gold with the difference of 2232 metric tons from 2005 to 2012. This catalyzed the prices of gold to hit as high as $ 1669 in Q1 of 2016.
In current situation, the investors need to realize that the popping up of wide Bonds and Stocks markets by Fed and other central banks won’t last forever. There might even be the possibility that Gold ETF’s and Fund Flows won’t even be having the gold that has been declared on records. The evidence of this is massive investments in paper gold. The investor only invests in the certificate and never gets to have gold in physical form. Most of the demand of gold investment is fulfilled this way. What investors really need to know is that if the flow of the mainstream investors would sign of things to come in future the things are really going to take new twists and turns by the year 2017.

Thursday, 7 April 2016

WHo Are The Real Victims of Panama Papers?

For as much time as the companies and influential individuals would keep hiding their wealth in the offshore companies, the developing countries would continue to have money loss that could have been used in order to provide the basic public services that could help to alleviate and assuage poverty from developing economies.
This Saturday almost 11.5 million secret documents suspected to have connection with Mossack Fonseca, a Panama based law firm were leaked as an anonymous source transferred those documents to Süddeutsche Zeitung, a German newspaper. The newspaper then shared these documents with International Consortium of Investigative Journalists (ICIJ).
These files are the clear evidence that how there are countless ways exiting at the disposal of rich authorities to secretly offshore the wealth even through organized tax regimes. The names of several companies, celebrities and politicians have been high lightened  among which some of the high profile names include Ex- Prime Minister of Iraq, Ayad Allawi, the President of Ukraine, Petro Poroshenko, the former President of Sudan, Ahmad Ali al-Mirghani etc.

 Some of the news sources have mentioned that former Prime Minister of Iceland, Sigmunder Gunlaugsson who recently resigned was the first victim of Panama papers.
However, according to some experts view point, the game in which there is massive avoidance of tax does not only involve elite and influential tycoons. The actual victims of Panama Papers are the remaining 9.5 million people who have total net worth of less than $1 million   and they are simply categorized as “Everyone else “in the global wealth table of Tax Justice Network.
According to John Christensen who is the co-founder of Tax Justice Network, UK, Panama papers are an abuse to human rights. According to him the actual victims are the ordinary people because if the rich person is evading tax it means ordinary people like us are actually paying the deficit created by his pocket. The same happened in several countries where value added taxes have been imposed but still the public services are not provided the way they should have been.
There have been global efforts going on for the uplift of the countries like Sudan, Nigeria, Malawi but these efforts are badly hindered due to tax evasion. This happens because in most of the cases the tax avoiders often transfer their money through the countries where there is unfair tax policies and pacts. These are those countries which are also poor economies and have no law and order. With this they have less to spend on infrastructure, healthcare, education, shelter etc.
This explains the hemorrhage of foreign aid that these economies receive.
To make complex things simple, in order to manipulate the taxes, the companies that are working in developing countries set up the subsidiary in the tax haven. After this they sell their products to this subsidiary at lower prices in order to reduce their tax burden. Ultimately this subsidiary sells the products in the market at higher rates and huge profits are secured at either lowest or no tax rates.
In other words we can say that the companies first manipulate the prices of their products in order to avoid tax and the outcome of this is borne by the countries with unfair tax policies leading them into vicious circle of poverty because due to less tax revenues they are unable to feed their own economies. In Africa it has been estimated that 60% of the capital flight of the nation is due to this practice.
Malawi is one of the poorest country of the world with 50% of its population living in poverty. The tax revenues that are meant to develop and restructure the economy is diminishing at an increasing rate. Similarly, 30% of the African economy’s wealth is held offshore in tax havens and is leaving Africa with tax revenue loss of $ 14 billion per year. Nigeria has been experiencing one of the most illegal outflow as percentage of GDP (Gross Domestic Product).

Tax avoidance game has adverse consequences on developing economies where a single buck contributed to tax revenues can become source of development and improvement in the basic infrastructure, healthcare and education. Each dollar paid as tax can lead the economy towards self-sufficiency where they would no longer be relying on foreign aid. 

Wednesday, 6 April 2016

Wall Street Once Again Wagering Upon Dollar: Will Dollar Rise or Fall?

Once again Wall Street is betting that the great dollar correction is going to begin. So is it true that dollar is actually in the middle of great correction? Or it is just that it’s a normal news trying to take hype in the exchange markets?

The trend of the market strategists, brokers and investors tend to be on the latter side of the wager. The reason behind this notion is driven by the fact that all the largest central banks of the world have simply given up on making efforts to make exchange rate to be correctly influenced by the monetary policy. This has happened due to large number of reasons that have its linkages from the past.
However, in this interim, the most recent uptick in the inflation rate of United States is engulfing the real interest rate differential which is the difference between the returns on the US dollar denominated assets and the prices of those assets in the foreign currency after inflation adjustment.
To make long story short, with the rise in the inflation, the returns on US denominated assets will decline as compared to their relative prices in the foreign currencies and the dollar would become less attractive for the local as well as foreign investors and dollar would be weaken even more.
The data reported by Futures Trading Commission this Friday shows that the aggregate of the total bets on the notion that dollar will appreciate has dwindled to its lowest level since the mid of July.
The head of the global currency strategy, Vasileios Gkionakis stated at UniCredit Bank that the central banks of the world are stepping back from their obsession of currency and that they are coming out of this massive overvaluation of dollar.
 According to Vasileios Gkionakis at first, the dollar appreciation wagering was fueled by the expectations of the investors that with the increase in the interest rates, the US dollar will go up as the relative interest rates of other countries would go down which will broaden the interest rate differential of US with the rest of the world. However, even these expectations swiftly got out of hands. In the first half of year 2015, the pair of Euro-Dollar bottomed out to as low as USD 1.50. This value was much lower to even justify than the expectations for the policy divergence.
After this entire scenario the investors are re-assessing the stance for their greenback currency. The head of the global currency expects the dollar to drift downwards in the upcoming years even in the condition when the US interest rates would boost up. This may be because the dollar has already been priced in standardization in monetary policy more than what the returns on treasury bills reflect it to be.
There is no coincidence. The weakening of dollar is happening just because of the pitfalls of the ultimate shifts in the way monetary policies are designed and conducted by the central banks for negative interest rate. Moreover there are further potential risks that are yet to be foreseen due to the negative rates of other countries. According to Bill Gross, one of the great bond investors, the negative rates would do nothing but put out downward pressure on the entire financial system.
However, Gkionakis has keenly noted that there is an additional risk attached to his perspective. There could be a rebound in US growth more rapidly than expected as a result of the ongoing trend. For this the gains and returns on the investment have to be strong enough to influence the investors to invest in the speedy fluctuations of interest rate.
There are still a large number of currency strategists and investors who are with the notion that dollar will strengthen by the end of the year. They believe that weakening of dollar would be short-term and temporary. The global strategists of Bank of America believe that they foresee Euro finishing the year with equivalent fate as dollar.

However, the recent uptick in US inflation and expectations regarding pickup in inflation would probably continue to weigh the dollar in the near future. According to Bank of America, the current trend of the policy divergence would again drive the US growth to outperform. They believe that soon the world would see investors rushing towards the dollar with euro equally competing in the market for the first time since 2002. 

Monday, 4 April 2016

Dropping Oil Prices: An Alarm for Saudi Arabia

The continuous drop in oil prices is a threat for Kingdom Saudi Arabia as their economy is highly dependent on oil. If the kingdom would do nothing about it, they may run out of money by the year 2020 as anticipated by John Mauldin who is the chairman of Mauldin Economics. According to Mauldin the kingdom is taking appropriate steps to stay submerged however, they are acting like a company rather a kingdom in this matter. The kingdom has to realize that they are not company after all. The population will be greatly affected if they will continue the Federal cuts on spending. Those who work for the government would be adversely hit and surprisingly almost 90% of the people in the kingdom are working for the government.

Now the question comes why there is such drastic drop in the oil prices anyway?

It is simply due to the change in demand and supply phenomena. As the supply and demand of certain product affects its price, the lower would be the demand, the lower would be the price or otherwise, the more will be the supply, the lower will be the price.  Here comes the point that whether the demand of oil has been decreased or the supply has been increased so that Saudi Arabia is facing a difficult situation?

In order to understand this we first have to take a look at mid-2000s when the oil prices were rising in a very sharp manner because there was a surge in the global demand especially by the countries like China and there was not enough of the oil supply to meet the growing demand. This led to an increase in the oil prices and the oil price drifted around $100 per barrel during 2011 to 2014. With an increase in the oil prices many companies found this business profitable and started exploring and extracting oil. They even started drilling at the most difficult places. In United States the companies started using fracking and horizontal drilling techniques in order to extract oil from Texas and North Dakota. Similar was situation in Canada where the oil companies begun to heat gooey oil sands of Alberta with intense steam in order to extract the crude.

This situation led to a great boom in the constricted oil production. The United States alone contributed around 4 million new oil barrels per day to the international market since 2008. The global crude production increased significantly up to 75 million barrels per day. However, this boom in the US oil production did not bring much of the significant impact on global oil prices. The reason was that United States and European Union put oil sanctions on Iran whereas, Iraq was fighting external war with US and Libya was under severe civil war. Hence even though supply increased in one zone of the globe, at the same time it decreased from the other part of the world.

The tables turned after mid of 2014. There was an ease in the sanctions that were slapped earlier. By July the rebels in Libya opened two main export terminals that had been shut closed for almost a year. This raised the oil exports of Libya radically. During this time the oil demand dropped in Asia and Europe. Mainly China and Germany decided to slow down their demand. United States that was once considered to be the largest oil consumer faced greater cutbacks in oil industry due to recession in the economy. Moreover, countries like Iran and Indonesia decided to cut back their subsidies on oil. The overall low demand and high supply of oil caused drop in the oil prices from USD 115 per barrel in June 2014 to USD 80 per barrel in November.

Now comes OPEC that has a cluster of oil-producing countries that pump almost 40% of the world’s oil. In past, this lobby had made several attempts to influence the oil pricing to rise or fall through strong coordination to either cut back or increase the production of oil. On 27th of November 2014, 166th Meeting of OPEC took place in Vienna in which a heated debate took place among the OPEC members regarding fall in the oil prices. Some countries like Iran and Venezuela wanted the cartel to cutback the oil production so that the prices of oil increase. They specially wanted Saudi Arabia to cut back its oil production. The countries who were in favor of production to be cut back actually needed to have high oil prices to meet break-even point on budgets and pay off the government spending that have been piled up.

On the other hand, Saudi Arabia was in the opposing side of the house and they were against the motion. Saudi Arabia wanted to retain the oil production and was in favor of oil prices to be dropped. The reason for this was the event of 1980 when the oil prices were falling and countries cut back their oil productions to boost oil prices. The result was that the oil prices still kept declining and Saudi Arabia lost its market share. According to Saudi Arabia they can live with the falling oil prices as they believe that it is temporary and short lived. The Saudi government has already built up a huge foreign exchange reserve in order to finance the deficit.

In the end, the debate ended with the conclusion that there will be no change in the oil production and Secretary General of OPEC, Abdalla El-Badri declared that the oil will be produced at 30 million barrels per day. This caused the oil prices to drop further and the price went down from USD 80 per barrel to USD 70 per barrel, and reached below USD 60 a barrel by mid of December 2014. In the ongoing situation Mauldin predicts that as United States is a wildcard player so they will be able to get profits even at USD 40 per barrel due to its lower production and innovation in technology. However according to him even if now the oil price rises to USD 60 per barrel, Saudi Arabia would not be able to stand where it used to be in the good old days.  The situation is alarming as recently on 4th April 2015, the oil prices have dropped down below USD 36 per barrel.  

Monday, 30 November 2015

The Euro As Reserve Currency


The currency used by the official sector for the use as an international currency to perform operations is referred as reserve currency.There are three main components of foreign currency which are medium of exchange, store of value and unit of account.

Monetary authorities usually use this currency as exchange rate tool to obtain monetary objectives, to intervene in foreign markets and to safe keep wealth. The private sector has a separate use of foreign currency and mostly use for invoicing. The choice of international currency is not decided by Government. The private sector determines the choice of international currency to be used.
The reserve currency is dependent upon four factors:
1.      Share of the country in the international trade.
2.      Macroeconomic stability
3.      Market development in term of liquidity and breadth.
4.      Network externalities of how other countries are using any currency as reserve currency.

Status of Euro:

During post-war era Dollar was dominant because it macroeconomic stability, network externalities and financial development. In 1990 EMU started debate on the potential of the euro against dollar. Some researchers argued that the attractiveness I dollar is due to its liquidity in T-bills as compared to euro. It is believed that the major limitation on euro is to play international role is due to the obstacle in full integration of euro government bond market.
One view point is that having two currencies at a tie as international currencies would make system inefficient. Studies show that euro is more sound currency as medium of exchange than the store of value. Researchers also argued that after monetary union euro’s role would match dollar in international markets. International investors should invest in euro to diversify and hedge their macroeconomic risks.

Composition Of International Reserves:

Official reserve assets are being well diversified nowadays. The share of euro is increased after monetary union however still it is lower than dollar. In 1990 the nadir of US was 455 of reserves and deposits. By 2007 it increased to 70%. However, it declined to 59% by 2006.
The main reason of decline was adoption of euro and diversification of reserve currency. Studies show that the reserve managers in Asia respond asymmetrical to valuation effect. These managers respond to interest rate more than exchange rates fluctuations.
The reserve allocation of euro has increased significantly from 19% to 27 % from 1999 to 2003. However, the financial allocation is more in euro region than in Asia or America. Since 1970 the reserve managers tend to attract more towards instrument perceived portfolios due to risk-adjusted returns. Now reserve managers invest in longer –dated debt securities than deposits.

Role as a Medium of Exchange

Traditionally, reserve management has been guided by two basic reasons. One is to prepare for contingencies and the other is an emergent need to intervene in financial market. This requires for holding reserves in the most liquid form, which is referred to as ‘liquidity tranche’. It occurs due to the potential need to turn assets into cash on short notice and at low cost under different market conditions. This role of medium of exchange may arise in the foreign exchange market or in government securities market.

Foreign Exchange Markets
The choice of the currency for intervention in the FE market is mostly dependent upon the liquidity conditions in foreign exchange markets. Because when there is need to influence a bilateral exchange rate, it is sometimes more effective to do so in a third, more heavily traded currency. While the euro seems to be as liquid as its predecessor currencies, it is unclear whether the euro has become more or less liquid compared with the US dollar (Galati and Tsatsaronis, 2003). The results of the 2007 BIS Triennial Survey of Foreign Exchange and Derivatives Markets reveal that the euro entered on one side of 37% of all foreign exchange transactions in April 2007. The dollar’s share in foreign exchange markets was little changed between 1998 and 2007 at about 86%. Dollar/euro was by far the most traded currency pair in 2007, capturing 27% of global turnover.

Money and Government Securities Markets
The choice of intervention currency is influenced by liquidity conditions in asset markets. Reserve managers typically invest the bulk of their reserves in instruments with limited market and credit risk.
EMU increased the attractiveness of diversifying reserves from dollars into euros by creating the second largest government securities market in the world. However, there are certain advatages that Dollar has over Euro, which are discussed as under:
  • US Treasury market that makes it a relatively more attractive destination for reserves is the large bill market. The short-term segment of the US Treasury market is much larger than its euro equivalent, mainly owing to the limited issuance of treasury bills in the euro area.
  • The other advantage is in terms of homogeneity and high credit quality of the US Treasury market. There is one issuer, rated AAA. On the other hand, 12 different issuers participate in the euro government securities market. Furthermore, several euro area governments are rated below AAA, and so the average rating of outstanding euro government securities is AA1.
  • The most important advantage the US Treasury market has over its euro or yen equivalents is its tremendous liquidity. The daily turnover of US Treasuries greatly exceeds that of any other instrument. While turnover is not synonymous with market liquidity, it can be indicative of the depth of the market, i.e. the size of the order flow that the market can accommodate without moving prices (CGFS, 2000)
Hence we can safely assume that the US dollar retains several advantages over the euro as a medium of exchange. The US dollar is more widely traded in foreign exchange markets, and dollar government securities and repo markets are more liquid than their euro counterparts. This supports the continued pre-eminence of the US dollar as a reserve currency. Therefore,  for intervention purposes the euro is an increasingly attractive alternative to holding dollars.

Role As Unit Of Account
Broadly the Unit of account characteristic of reserve currency fall in two broad categories:
  • In private use this role is linked to the currency of choice for invoicing.
  • In official use it is linked to the choice of an exchange rate as a monetary anchor.
This role heavily depends on the direction of trade among the countries and relative stability of the macroeconomic policies of the host country which owns the currency. In summary, evidence from exchange rate co-movements suggests that the euro plays an increasingly important gravitational role. Ceteris paribus, this would tend to boost the euro’s share of global reserves over time. The US dollar, however, is still the most important currency along this dimension. Since 2002, the US dollar has depreciated against many currencies, and so the higher co-movement of currencies with the euro may reflect temporary dollar weakness rather than a long-term increase in the euro’s influence.

For this role of a reserve currency it is important for the reserve managers to choose a currency which has a rather reliable future in terms of its future purchasing power. Hence, this aspect mostly relies upon the future prospects of a country. The store of value aspect of reserve currency is directly related to the investment policies of the governing authority as well as the level of development of financial instruments available for investments in that currency for gaining exposure to, or hedging, these risks.

The main theme of this paper was to investigate how the euro’s role in international financial markets has influenced the use of euro-denominated assets as official reserves. The introduction of the euro in 1999 as a single currency for multiple countries, which were highly developed and extensively involved in trade, resulted in extensive debate in academia as well as professional circles regarding future role of Euro and fate of Dollar.  With extensive development of euro financial markets, there is a view that Dollar might lose its position as a dominant reserve currency at global level. Nevertheless, in terms of size, credit quality and liquidity, dollar financial markets still have an edge over euro markets. This is the main reason why Euro is currently not in a position to compete with Dollar in the international market.

 Author: Zarmeen Mushtaq , Sofia Khurrum