A genuine worry for financial reforms or something more...

The ongoing spat between the government and the financial regulatory bodies throws into limelight a lot of serious issues. The latest mandate assigning financial development powers on the FSDC (Financial Stability and Development Council) has not gone down well with the RBI and SEBI, which feel that it is an encroachment on their autonomy. The reasoning given by a government official is that the current regulatory bodies are inflexible when it comes to growth. A really important point to be considered however is that it was the same "inflexibility" that helped avert a disaster during the global financial meltdown. If our banking and regulatory systems weren't so strong, then even we would have had exotic instruments floating about in our economy, sub prime loans and all the nonsense that has severely retarded the growth rate of a lot of economies world wide.
And to call the regulatory bodies inflexible is unfair. They have introduced reforms as and when were needed. Our primary and secondary market development is testimony to the same. Our banking system is seriously making inroads on the issue of rural inclusion. Recent issues involving MFIs , MFs and insurance providers, though disruptive in the short term on the growth of these institutions, are concrete steps towards better regulation. That such problems have come to the fore is itself a mark of an evolving regulatory system. For example: With the IRDA-SEBI spat, ambiguities regarding the governing principles of these bodies and the governed institutions are being addressed, something which is needed in an economy which is touted to grow at 9% this fiscal year.
Such oversight comes with experience and our regulatory bodies have been around long enough for intelligent functioning. So the accusation of inflexibility is an unfounded one. The government should learn to make more responsible statements.

Reversed !

(I would like to credit the idea for this topic to my friend Khyati Dedhia.)

A mortgage, as everyone knows, is a secured loan with land /property/building(normally houses) as collateral. The collateral over here is referred to as real property(Wikipedia describes it as land and any human improvements made on it). The loans taken are then paid over a specified period of time, normally in installments.

However, the same concept has been applied in a different manner for quite some time now,especially in the United States, to help senior citizens, with no or less income, to obtain financial security in their old age. This concept is called reverse mortgage and this facility was made available in India from 2007, through the Finance Minister's annual budget speech.

The whole process of reverse mortgage can be described as follows:

A senior citizen (usually above 60 years of age) can mortgage his house/property with a banking or a housing finance company for a fixed payment every month/quarter/half year/year. So unlike a normal mortgage where you are expected to pay a monthly EMI to repay your loan, here the bank gives you the loan in installments. So in short, rather than give you a loan in one go, the bank/finance company divides the loan into parts (as decided by you) and pays you the money so that you can have a steady source of income during your years of infirmity. Other advantages of this scheme include the provision to stay in the house till you die or move away . The loan can even be taken jointly with your spouse , if she is more than 58 years of age at the time of taking the loan. Even after one spouse dies, the other one can continue living in the house.

Repayment of the loan can happen when the loan borrower dies. In the case the bank has two options: ask the legal heirs to repay the loan amount and take back the property or sell the house, use the proceeds to recover the loan amount and then give the excess money back to the heirs. The recovered loan amount includes the principal , interest and other expenses as stipulated by the bank.

Revaluation of the property has to be done every 5 years to account for any appreciation in price of the property. This can hen be adjusted in the monthly payments in case of an appreciation/depreciation in the house price. Also, the loan amount is not treated as an income and hence the loan amount is not subject to taxation.

There are some restrictions on this scheme though. The person has to be necessarily over 60 years of age to be eligible for this scheme. The loan amount was earlier for a maximum of 15 /20 years (though the National Housing Bank has increased it to a lifetime of payments). Though the RBI has stated the loan amount to be a maximum of 60% of the property value, banks have placed a cap on the loan amount given (normally Rs. 50 lakhs).

How has this scheme fared in India?

The social conditions in India make it difficult for this financial product (which has enjoyed a successful run so far in the US) to succeed here. Firstly, as with all good financial option (like the New Pension Scheme), general awareness about this product is low. So, the project is not a runaway success like in the US.

Also, the social mindset in India dictates that being in debt of any kind is not good. We are, by default, a risk-averse country and would not want the burden of a loan at the fag end of our lives. Also, passing on the loan to our heirs is not something that many parents will want to do.

Without enough awareness, people won't want to mortgage property (in many cases, their only possession of immense value). Also the general tendency of mistrust at such an age is common in our nation, thus keeping the utilization of this scheme at a low. Another possible problem is the attachment to their property, which maybe ancestral/inherited.

A cap on the amount that can obtained in lieu of the property is something that is unfair. Ideally, the property valuation should yield the amount that should be given.

But what can also help the initiative succeed is the general self-respect of people in many parts of the country. People normally wish to live off their own money and this will give old people a chance to fund their own expenses rather than ask their children for money. Also, in this era, where children are too busy to take care of their old parents, this incentive will help prevent senior citizens from being dumped into old age homes.

Banks in India offering this scheme

The National Housing Bank (NHB), the State Bank of India (SBI), Central Bank of India, Punjab National Bank and some others (about 23 banks in all, according to a recent report in Business Standard) currently offer this financial product. According to NHB, as of March 31, 2010, around 7,000 RMLs of Rs 1,400 crore have been sanctioned (as per the same Business Standard report). A conference was held recently under the aegis of NHB on their lifetime reverse mortgage loan scheme, which was part of their promotional strategy to make people aware of this product.These initiatives will hopefully help in convincing senior citizens, in dire conditions, of this lifeline post retirement.

Decoupling a couple!

It is a commonly known fact that various financial instruments are co related and this becomes evident when you determine their relative values. For example : Gold and the dollar. When the value of the dollar falls, the gold price rises. (Can be explained by this: if say for $1200 dollars, you get 10 gm of gold and if the value of the dollar falls, then gold (10gm) won't be equal to $1200 anymore. It will cost you more). Similarly, between currencies (eg:when the dollar appreciates, the value of the rupee as an exchange medium w.r.t the dollar decreases).

Even economies are coupled. The biggest example is that of the EU, which is a massive exercise in having a linked economy amongst various countries to aid progress in the region.

This coupling effect has become more pronounced with a rise in globalisation. With improved trade between nations, the possibility of an economic shock in one nation spreading to others is very high, as was visible during recession, when all Western nations faced tremendous problems, the after effects of which are visible in monetary and fiscal policies throughout the world even today.

However, during the recession, it was seen that emerging economies like India and China did way better than their Western counterparts, posting envious growth figures. The world looked upto us for a speedy economic recovery. All this led to talks of the possibility of these economies getting decoupled from the Western(especially the US) economies. There are hundreds of web pages solely dedicated to this topic and discussions have ofter led to the same conclusion: There is no credible evidence to prove that decoupling exists. It is not surprising considering the settings under which these economies post such remarkable growths:

1. The too-big-to-fail banks, who were allegedly the main proponents of the global crisis, had a small presence in India thus preventing a massive backlash here, similar to a one seen in the US.
2. The use of varied financial instruments is constantly regulated by a vigilant central bank in India.(In fact, we have a lot of the central bank policies to thank for a lack of major problems during the recession).
3. India always had a strong domestic demand, which is evident in the way demand picked up during the past few months, leading to strong results by various companies, especially the auto industry.
4. Even now, India is partially insulated from the global economy. Its largest trading partner is China, unarguably the fastest growing economy today(though beset by its problems) .India's service industry, which contributes to more than 50% of India's GDP , was never deeply troubled by the crisis and has bounced back strongly (the industry , especially the IT sector, took immediate measures to ensure that they remained safe. The only casualty was Satyam, I guess, and it was for altogether different reasons).
5. Even in China's case, an undervalued currency continued to provide China an edge over the other nations in exports and it went on to become the world's largest exporter, dethroning Germany.

But all these factors do not prove decoupling. Sample this:
1.The stock markets in Asian countries fell heavily in the wake of the crisis, suggesting an existing co relation with the Western economies.
2. It was not as if problems didn't exist in India. WPI inflation started growing out of control crossing double digit figures and created a head ache for the ruling government.
3. Though the food inflation was due to a number of reasons other than the crisis, India still suffered due to this problem, showcasing its vulnerability even further.
4. India's dependence on the global economy is growing stronger day by day with more Indian firms out on a foreign acquisition spree. As such an increased exposure by these companies to foreign markets can create potential trouble in the future.
5. Our neighbour (China, not the other neighbour :D) is not doing well either. A suspected asset bubble in real estate followed by rising inflation, a possibility of hardening government stance on credit availability are just a few of the problems troubling China right now. In fact, the EU is banking on a strong Chinese growth to pull the world out of the slump created due to the Greek crisis. Looks like that wish might not be fulfilled.

So economic decoupling is something which cannot be proved with the available data.

However, there have been possible cases of a decoupling of the values of gold/silver and the dollar. There was a simultaneous increase in the value of both gold and the dollar. The reason for the increase in dollar value was obviously a weakening Euro. There was a flight of capital towards dollar backed assets as investors started losing (and are still losing) confidence in the Euro. This has helped the dollar gain strength, though it is potentially risking US exports and an increasing fiscal deficit there. At the same time, in such times when you cannot trust a single currency to help you out of a crisis like this, investors look out for an instrument which has no debt content and which is a true currency (the dollar and other currencies are simply paper notes backed by some underlying asset). Hence they invest heavily into gold to protect their funds thus driving up gold prices and showcasing a decoupling effect. A similar explanation can be given for silver.

Out of the frying pan and into the fire

The year 2008 heralded the start of one of the biggest financial crises ever in the history of mankind, details of which are commonplace now (especially for the thousands of students who graduated that year and the next one. One word summed up all their problems - ' jobs '! ). The second half of 2009 reversed some of the pessimism amongst global economists and toned down the doomsday predictions of the dethroning of the dollar and the death of the global economic order as we know it. (Remember the rebound of the stock market from the depths of 4 digit figures to the current levels?)

However, the crisis it seems is far from over. And obviously we have the Euro drama to blame for it (Not to hard to remember; it is basically everywhere in the news; I guess even India TV might have come up with a conspiracy theory for it by now :D) Here are some quick pointers to the Greek problem for the uninitiated:

1. Greece went on borrowing money from the global markets to facilitate a spending spree during the economic boom era (early 2000s).

2. The borrowings went on increasing and so did the deficit.

3. This mismanagement ultimately led to Greece facing so many problems. As the economy went bonkers after the Lehman fiasco, banks and financial institutions around the world became more careful in issuing credit (Finally they woke up!!!). Greece was viewed as a potential defaulter due to all the debt that it had raked up.

4. Under normal conditions, all Greece had to do would have been to devalue its currency, take some tight measures to cut down on spending , raise taxes etc. But this is not possible because Greece is a part of the European Union, which uses the common currency, Euro. So devaluation is strictly out of question (For beginners : Devaluation basically involves decreasing your currency's value so as to decrease its purchasing power; so automatically things like your imports become expensive. So spending decreases; as a result your deficit will decrease. Greece couldn't do this since the Euro rate is common throughout Europe and can't be controlled by one nation).

5. The EU's strict rules were to prevent any country in this union from raking up such a huge debt. However this has clearly failed and now other countries like Portugal, Spain and possibly Italy with similar debt issues are under the scanner. (The combination of Portugal, Italy, Ireland, Greece and Spain has been called PIIGS by the global media. Nice name, eh?)
In addition to these nations, UK too has come under the scanner.

6. Greece needs the help of other cash-rich countries like Germany to bail it out of this problem. However, initially none of the other EU nations, especially Germany, were ready to monetarily help Greece (If your neighbour did something stupid, why should you pay for it?) In fact, the dithering by Germany in coming to Greece's aid is what is generally regarded as the reason for the problem worsening so much.

7. In the meantime, the lending rates for Greece increased, trust in the bonds issued by the Greek govt. waned (a ' junk' rating given by rating agencies didn't help matters) and questions were being raised about a contagion effect (the possibility of the crisis spreading to other nations).

8. Greece was slowly being viewed as the 'Lehman' of Europe (To quote several newspapers).

9. The EU experiment of having a common currency for all of Europe was slowly being regarded as a failure.

10.The Eurozone announced a Euro 110 bn package to bail Greece out. But global markets, which were already a lot of stress due to the Greek crisis, didn't respond well.

11. As a result, with a bit of prodding from the Obama administration, a $1 trillion rescue package was announced by the EU in association with the International Monetary Fund to prevent the damage from spreading further.

12. However, what the EU and the IMF plan to do is to offer loan guarantees if needed, to struggling economies. At the same time, the European Central Bank agreed to buy lots of govt bonds (which is more debt). So, as many sources have quoted already, this debt crisis is being countered with more debt! Not exactly a smart move.

13. In lieu of these funds, the privileged economies (and atleast for now, all the European nations) will face strict austerity measures to cut down on spending and to stabilize their debt situation. However, Greek citizens have already revolted against such measures, very recently and hence the success of these proposed measures is highly unlikely.

14. At the same time, nations like Germany might find internal resistance to such a package as a lot of people believe it isn't necessary to take upon themselves Greece's burden.

Immediate fallout of the package:
1. Global markets rose on the 11th of May,2010 - one day after this huge package was announced. However the next day markets were back to their jittery selves.

2. Gold prices are surprisingly rising, despite a similar rise in dollar prices. (Normally gold follows a reverse price trend w.r.t the dollar; however this rise is not surprising - more on this in another post)

3. Investors are still flocking towards dollar backed assets, appreciating the dollar's value. (This may hit US exports though. The US is already in deep trouble, but more on that later).

4. Now news of the Chinese government cutting down on real estate prices and making lending dearer has hit the global markets hard and has given them another reason for a free fall. (The Chinese story is a huge one...will cover it soon :D )

All this prompts us to ask a question: Is the global crisis of 2008 really over? Opinions differ. However one thing is for sure.: the road ahead is surely a bumpy one.