World Monetary Exchange Reserve Safes
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World Monetary Exchange Reserve Safes
Investment From Abroad is Right or Wrong?
INTRODUCTION
One of the outstanding features of globalization in the financial services industry is the increased access provided to non-local investors in several major stock markets of the world. Increasingly, stock markets from emerging markets permit institutional investors to trade in their domestic markets. Indian stock market opened to Foreign Institutional Investors in 14th September 1992, initially with lot of restrictions. The regulation on them are liberalized and minimized now, since 1993 has received a considerable amount of portfolio investment from foreigners in the form if FIIs investment in equities. This has become a turning point of India stock market. The government of India announced the policy of the government to permit the FII investment in India capital market. According to the SEBI modified the regulation on 14-11-1995. In order to make investment in India equity market they wanted to register with Security Exchange Board of India as foreign institutional investors. It is possible for foreigners to trade in India securities without registering as Foreign Institutional investors, but such cases require approval from Reserve Bank of India or the Foreign Institutional Promotion Board. They are generally concentrated in secondary market.
Domestic market alone not able to meet the growing capital requirement of the country and financing from mutilated institution has lost primary in the emerging in the global order .Besides aimed primarily at ensuring non-debt creating capital inflows at a time of extreme balance of payment crisis. It was to tie over the balance of payment crisis in the early 1990s
Portfolio flows often referred to as ‘hot- money’ are notoriously volatile capital flows. They have also responsible for spreading financial crisis causing contagion in international market. Evan though, the FIIs have been plying a key role in the financial markets since their entry into this country. The explosive portfolio flow by FII brings with them great advantages as they are engine of growth, lowering cost of capital in many emerging market. This opening up of capital markets in emerging market countries has been perceived as beneficial by some researchers while others are concerned about possible adverse consequences.
Clark and Berko (1997) emphasize the beneficial effects of allowing foreigners to trade in stock markets and outline the “base-broadening” hypothesis. The perceived advantages of base-broadening arise from an increase in the investor base and the consequent reduction in risk premium due to risk sharing. Other researchers and policy makers are more concerned about the attendant risks associated with the trading activities of foreign investors. They are particularly concerned about the herding behavior of foreign institutions and the potential destabilization of emerging stock markets.
This study addresses these issues in the context of foreign institutional investors’ (FII) trading activities in a big emerging market – India. India liberalized its financial markets and allowed FIIs to participate in their domestic markets in 1992. Ostensibly, this opening up resulted in a number of positive effects. First, the stock exchanges were forced to improve the quality of their trading and settlement procedures in accordance with the best practices of the world. Second, the information environment in India improved with the advent of major international financial institutional investors in India. On the negative side we need to consider potential destabilization as a result of the trading activity of foreign institutional investors. This is especially important in an emerging country that has embarked upon reforms to open up its market.
OBJECTIVES The objectives of this study were as follows;
(1) To study the role of FII investment in the Indian stock market, ( 2 ) To examine the causal relationship between net FII investment and BSE sensex using granger causality test (3) To examine the causal relationship between net FII investment and NSE sensex using granger causality test (4 )To examine whether FIIs were a channel of global disturbance into the Indian stock market.
TOOLS: Study was carried out with the help of unit root test, co integration test, causal regression and F statistics for FII investment and index from BSE and NSE
LETERATURE REVIEWS
Gayathri Devi .R in 2003, she conducted study on “Causal Relationship between FIIs and Stock Market: A critical study”. It revealed that there was long run relationship between net FII investment and sensex, FII investment did not respond the short-run changes or technical-position of the market and they were more driven by fundamentals, and FII investments did granger cause India stock market. “Selen Serisoy Guerin” in 2006, conducted study on “The Role of Geography in Financial and Economic Integration: A comparative Analysis of foreign direct investment, Trade and Portfolio Investment Flows”.. It found support for the argument that most FDI among Industrial countries were horizontal, whereas most FDI investment in developing countries was vertical and our results indicated that portfolio investment flows compared to FDI, were highly sensitive to change in GDP per capita, this implied that if there was a negative output stock, portfolio investment flows would be more volatile than FDI. A.Julia Priya, D. Lazar and Joseph Jeyapual in 2005, they conducted study on “Role of Foreign Institutional Investors on stock market development in India”, Results revealed that sensex, market capitalization of NSE, Turnover of BSE and NIFTY without market capitalizations were influenced by Foreign Institutional Investors“Suchismita Bose and Dipankor coondoo” in 2004, they conducted study on “The Impact of FII Regulation in India”,. These results strongly suggested The liberalization policies had the desired expansionary effect and had either increased the mean level of FII inflows and/or the sensitivity of these flows to a change in BSE returns and /or the Parthapratim pal in 2004 conducted study entitled as “Recent volatility in stock markets in India and foreign institutional investors. Findings of this study indicated that Foreign institutional investors had emerged as the most dominant investor group in the domestic stock market in India. Particularly, in the companies that constitute the Bombay stock market sensitivity index, their level of control was very highinertia of these flows.
“sandhya Ananthanaryanan, Chandrasekhar krishnamurthi and Nilajan Sen in 2003 conducted study as “Foreign institutional Investors and Security Returns: Evidence from Indian Stock Exchanges”, It found strong evidence consistent with the base-broadening hypothesis.It did not find compelling confirmation regarding momentum or contrarian strategies being employed by FIIs.It supported price pressure hypothesis.
It did not find any substantiation to the claim that foreigner’ destabilize the market. J.S. Pasricha and Umesh.C.Singh in 2001, tried to analyze the impact of FIIs investment on Indian capital market. Their study revealed that FII are here to stay and have become the integral part of Indian capital market. Their entry has led to greater institutionalization of the market. They have brought transparency in the market operations.S.S.S. Kumar in 2001, attempted in his study to find the effect of FIIs on the Indian stock market. The inference analysis of the paper suggests that FII investments are more driven by market fundamentals rather than by short term changers or technical position of the market. As per K. Seethapathi and V. Subbulakshmi study entitled “Foreign investment: Need for focus”, They concluded that, the flows have to pick up. The political will is to be demonstrated by the government. In addition, the regulators have to identify the reasons for failure in converting approvals into actual investments and those issues are to be addressed immediately. E. Han Kim and Vijay Singal in 1997, they conducted study entitled “Are open market Good for Foreign Investors and Emerging Nations?”, Conclusion revealed as. Integrating the emerging stock markets into world markets has had benefits, and will continue to have benefits for both global investor and host countries. The end result of integrated markets a better allocation of resources, improved productivity of capital, and a higher standard of living.
THEORETICAL REVIEW
Between late 1990 and the middle of 1991, the economy faced severe balance of payment difficulties, coming close to defaulting on its external payment obligations in January and June of 1991. In January 1991, the Government negotiated with the International Monetary Fund (IMF) for loans. What followed was the implementation of the conventional IMF-World Bank prescription of short-term ‘stabilization’, consisting of devaluation, temporary import compression, fiscal and monetary compression with a rise in interest rates, followed by more long-term ‘structural adjustment’ measures, seeking to restructure the domestic economy.
The New Economic Policy was an outcome of implementation of the ‘structural adjustment’ program. The ‘economic reforms’ or ‘economic liberalization’ program, which began to be implemented with the announcement of the New Economic Policy (NEP), included wide-ranging changes in industrial policy, trade policy and foreign investment policy, a redefinition of the role of the public sector in the economy and redesigning the architecture of the domestic financial system. By narrowing down the topic, first it concentrates on capital account liberalization.
CAPITAL ACCOUNT LIBERALIZATION
The process of capital account liberalization in India needs to be situated in its wider context, for it was shaped by the reality in the national context and the conjuncture in the international context. In response to the external debt crisis, which surfaced in 1991, the government set in motion a process of stabilization, adjustment and reform. Economic liberalization and structural reforms sought to increase the degree of openness of the economy through trade flows, investment flows, technology flows and capital flows. The process began the introduction of convertibility on trade as quantitative restrictions on imports, except for with consumer goods were dismantled and tariff levels were reduced. It was combined with a liberalization of the regimes for foreign investment and foreign technology. And restrictions on international economic transactions, including capital movements, were progressively reduced. This process was also influenced by the gathering momentum of globalization which was associated with increasing economic openness in trade flows, investment flows and financial flows.
The approach to capital account liberalization in India was much more cautious. What was liberalized was specified. Everything else remained restricted or prohibited. The contours of liberalization of the capital account were, in large part, shaped by the salutary lessons of the external debt crisis which surfaced in early 1991 and brought India close to default in meetings its international obligations. The balance of payments situation, then, was almost unmanageable.
The vulnerability was accentuated by two factors: it became exceedingly difficult to roll-over short-term debt in international capital markets and there was capital flight in the form of withdrawals from deposits held by non-resident Indians. This experience dictated the parameters of capital account liberalization8. It prompted strict regulation of external commercial borrowing especially short-term debt. It led to a systematic effort to discourage volatile capital flows associated with repatriable non-resident deposits. Most important, perhaps, it was responsible for the change in emphasis and the shift in preference from debt creating capital flows to non-debt creating capital flows. To some extent, the liberalization that was introduced was also influenced by the perceived needs of the economy: financing the current account deficit, mobilizing resources for investment and attracting international firms. But capital account convertibility remained, fortunately, in the realm of rhetoric. The Mexican crisis in late 1994 was, ironically enough, a blessing in disguise for India. It was not just an early warning signal. It dampened the enthusiasm of those who advocated capital account liberalization with a big bang. It lent support to those who questioned the wisdom of capital account convertibility that would have been premature in every sense. The contours of capital account liberalization in India were determined by these factors.
In sketching these contours, it is necessary to distinguish between different forms of private capital inflows and outflows, as there are important differences between these categories in the nature and the degree of liberalization. A complete description would mean too much of a digression. For our purpose, it would suffice to consider the contours of liberalization in the following categories of capital account transactions:
• Direct investment,
• Portfolio investment, and
• Non-resident deposits.
Foreign Direct Investment
It is defined as a long-term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship consists of a parent enterprise and a foreign affiliate which together form a transnational corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate.
The liberalization of the policy regime for direct foreign investment began in July 1991 with two major decisions. First, direct foreign investment with up to 51 per cent equity was to receive automatic approval in selected high priority industries subject only to a registration procedure with the Reserve Bank of India. Second, a Foreign Investment Promotion Board was constituted to consider all other proposals for direct foreign investment where approval was not constrained by pre-determined parameters and procedures. In effect, this created a dual route for inflows of direct foreign investment. The approval was automatic, within the specific parameters, from the Reserve Bank of India, while all other inflows were subject to approval through the Foreign Investment Promotion Board. The access through the automatic route has been progressively enlarged over time. Needless to add, outflows associated with direct foreign investment are not subject to any restrictions, but this was so even in the era of capital controls.
Foreign Portfolio Investment (FPI)
Portfolio investment represents passive holdings of securities such as foreign stocks, bonds, or other financial assets, none of which entails active management or control of the securities’ issuer by the investor; where such control exists, it is known as foreign direct investment.
The liberalization of the policy regime was extended to portfolio investment in September1992. To begin with, foreign institutional investors such as pension funds or mutual funds were allowed to invest in the domestic capital market subject simply to registration with the Securities and Exchange Board of India. Guidelines issued by the Reserve Bank of India permitted such foreign institutional investors to invest in the secondary market for equity subject to a ceiling of 5per cent (subsequently raised to 10 per cent) for individual foreign institutional investors in a single Indian firm with an overall limit at 24 per cent of equity (later relaxed to 30 per cent of equity at the option of the firm) for total foreign institutional investment in a single Indian firm. Foreign portfolio investment further classified into
1. FIIs
2. ADR/GDR, and
3. Offshore funds.
Foreign institutional investors (FIIs)
One who propose to invest their proprietary funds or on behalf of “broad based” funds or of foreign corporates and individuals and belong to any of the under given categories can be registered for FII.
• Pension Funds
• Mutual Funds
• Investment Trust
• Insurance or reinsurance companies
• Endowment Funds
• University Funds
• Foundations or Charitable Trusts or Charitable Societies who propose to invest on their own behalf, and
• Asset Management Companies
• Nominee Companies
• Institutional Portfolio Managers
• Trustees
• Power of Attorney Holders
• Bank
Access was provided to foreign institutional investors in the secondary market for debt. Soon thereafter, foreign institutional investors were also allowed investment or placement in the primary market, subject to approval from the Reserve Bank of India, with a maximum limit of 15per cent of the new issue. It was some time before foreign institutional investors were permitted investment in government securities in the primary and secondary markets. This came in 1996-97 and was subject to the ceiling for external commercial borrowing. Subsequently, in 1998-99, foreign institutional investors were also permitted to invest in treasury-bills. There is no reserve requirements stipulated for, or taxes imposed on, these capital inflows. It also needs to be said that foreign institutional investors are allowed to repatriate the principal, the capital gains, the dividends, the interest and any other receipt from the sale of such financial assets, without any restriction, at the market exchange rate. The income tax rate for dividends on such portfolio investment for foreign institutional investors is 20 per cent, which is much lower than the corporate income tax rate for domestic or foreign firms. But foreign institutional investors are subject to a higher short-term capital gains tax at 30 per cent compared with 20 per cent for domestic investors, while the long-term capital gains tax is the same at 10 per cent. Sales of such financial assets for the purpose of repatriation are absolutely unrestricted, provided the sales are through stock exchanges. However, disinvestment through any other route, or in any other form, requires approval from the Reserve Bank of India.
Global Depositary Receipt:
Global Depositary Receipt A negotiable certificate held in the bank of one country representing a specific number of shares of a stock traded on an exchange of another country. American Depositary Receipts make it easier for individuals to invest in foreign companies, due to the widespread availability of price information, lower transaction costs, and timely dividend distributions. Also called European Depositary Receipt.
The option of portfolio investment was also made available to domestic corporate entities from September 1992. Indian firms were allowed access to international capital markets through global depository receipts or Euro convertible bonds which converted debt into equity after stipulated period. This access, however, was not automatic. Individual applications, drawn up inconformity with the general guidelines of the government, were subject to approval. This process remains unchanged.
Offshore Funds:
An offshore fund is a collective investment scheme domiciled in an Offshore Financial Centre, for example British Virgin Islands, Luxembourg, Cayman Islands or Dublin.
Similar facilities for portfolio investment were subsequently extended to Offshore funds, non-resident Indians (as individuals) and overseas corporate bodies, only for investment in shares or debentures through stock exchanges, on the same terms as foreign institutional investors, but subject to a ceiling of 5 per cent for individual non-resident Indians or overseas corporate bodies in a single Indian firm.
Among the various components of portfolio investment, FII comprises the bulk of portfolio inflows. The main objective of foreign institutional investors is to minimize risk and maximize returns by diversifying their portfolios internationally. Major determinants of investment decisions of FII are country and region specific.
Portfolio flows often referred to as ‘hot- money’ are notoriously volatile capital flows. They have also responsible for spreading financial crisis causing contagion in international market. Evan though, the FIIs have been plying a key role in the financial markets since their entry into this country. The explosive portfolio flow by FII brings with them great advantages as they are engine of growth, lowering cost of capital in many emerging market. This opening up of capital markets in emerging market countries has been perceived as beneficial by some while others are concerned about possible adverse consequences.
Among the most active FIIs are Morgan Stanely Asset Management, jardine Fleming, Capital International, J. Henery schorder, templeton, Warburg Pinkers, Internatioanl Alliance and Quantum fund.
Foreign Institutional Investors in India
India opened her doors to foreign institutional investors in September, 1992. This event represents a landmark event since it resulted in effectively globalizing its financial services industry. Initially, pension funds, mutual finds, investment trusts, Asset Management Companies, nominee companies and incorporated/institutional portfolio managers were permitted to invest directly in the Indian stock markets. Beginning 1996-97, the group was expanded to include registered university funds, endowment, foundations, charitable trusts and charitable. Since then, FII flows which form a part of foreign portfolio investments have been steadily growing in importance in India. Other than in the year 1998, the net flows have been positive. The nuclear tests and East Asian crisis did slow down the flows but as stated by Gordan and Gupta (2003), their effects were short lived. That the percentage of total net turnover of BSE, the share of average of FII sales and purchases increased from 2.6 percent in 1998 to 5.5 percent in 2002. The cumulative net FII investment in India as on August 2003 is approximately $17400 million. As of August 2003 net FII investment was 9 percent of the BSE market capitalization which is small compared to the size of the market. However, in the words of Banaji (2002), it is not the market capitalization that matters but what is important is the level of the free float, that is, the shares that are actually publicly available for trading. With floating stock in the Indian market being less than 25 percent, about 35 percent of the free float available has been bagged by FIIs – despite the fact that they invest in just a few highly liquid stocks.
Though India receives hardly 1 percent of the FII investments in emerging markets, the portfolio flows to India have been less volatile when compared with that of many other emerging markets (Gordan and Gupta, 2003). FIIs by adopting a bottom-up approach seem to invest in top-quality, high growth, large cap stocks (Gordan and Gupta, 2003). Sytse et al. (2003) provide empirical evidence that foreign institutional investors in India, invest in large, liquid companies which enable them to exit their positions quickly at relatively lower cost and also that the foreign institutional owners have a larger impact than foreign corporate owners when performance is measured using stock market valuation criterion.
India is one of the fastest growing economies in South Asia, promising a growth of over 9 percent, second only to China, it would not be a surprise to see increased FII flows to India in the future. FIIs are now looking at the economy as a whole, with the macro-economic factors also playing their role in attracting foreign investors. Factors like a strong currency, key reforms in the banking, power and telecommunications sector, increased consumer spending and stable policies are expected to play a major role in attracting FIIs to India. The Securities Exchange Board of India (SEBI) along with the Institute of Chartered Accountants of India (ICAI) jointly monitor the markets and announces the regulatory measures thus making the Indian companies more transparent and more disciplined.
According to the April 2005 report on corporate governance by CLSA Emerging Markets, India ranks fourth with a score of 55.6 percent. Banaji (2000) emphasizes that the capital market reforms like improved market transparency, automation, dematerialization and regulations on reporting and disclosure standards were initiated because of the presence of the FIIs. But FII flows can be considered both as the cause and the effect of capital market reforms. The market reforms were initiated because of the presence of FIIs and this in turn has lead to increased flows.
The Government of India gave preferential treatment to FIIs till 1999-2000 by subjecting their long term capital gains to lower tax rate of 10 percent while the domestic investors had to pay higher long-term capital gains tax. The Indo-Mauritius Double Taxation Avoidance Convention 2000 (DTAC), exempts Mauritius-based entities from paying capital gains tax in India – including tax on income arising from the sale of shares. This gives an incentive for foreign investors to invest in Indian markets taking the Mauritius route. Consequently, we now see investments coming from Mauritius while there were none before 2000.
The country wise distribution of the FIIs registered in India, with majority of them coming from USA and UK. Chakrabarti (2002) and Rao et al. (1999) point out the fact that due to existing inter-linkages, the source of the FII investment might not be the country from where the institution operates. Nevertheless, the figure gives us an idea of the country wise distribution of the FIIs in India. So as to encourage long term investments in the Indian market, Budget 2003 proposed that investors who buy stocks of listed companies from March 1, 2003 be exempt from paying tax on the gains they make on their investments, provided they hold them for more than one year. With so much to benefit from, the FII investment in India is likely to increase in the future.
Regulation on FII
Investment by FII was jointly regulated by Securities and Exchange Board of India (SEBI) through the SEBI (Foreign Institutional Investors) Regulations, 1995 and by the Reserve Bank of India through Regulation 5(2) of the Foreign Exchange Management Act (FEMA), 1999. The promulgation of legislation pertaining to foreign investment by SEBI in 1995 market a watershed for FII flows to India; this led to a significant increase in the level of FII equity inflows in the pre-Asian crisis period. The SEBI FII Regulations and RBI policies are amended and modified from time to time in response to the gradual maturing of the Indian financial market and changes taking place in the global economic scenario.
In order to trade in India equity market, foreign corporation need to register with SEBI as Foreign Institutional Investors. Without registration they can invest, but cases require the approval from RBI. They are generally concentrated in secondary market. FII are allowed to invest in
a) Securities in primary and secondary market including shares, debentures and warrant of companies, unlisted, listed or to be the listed in India.
b) Units of mutual funds
c) Dated government securities
d) Derivative traded in a recognized stock market and
e) Commercial papers
FII can invest their own funds as well as invest on behalf of their over seas clients registered as such with SEBI. These client accounts that the FII manages are known as ‘sub accounts’. FII sub accounts include those foreign corporate, foreign individual, institution funds or portfolio established or incorporated out side India.
FII may issue deal in or hold off share derivative instrument such as participatory notes (PN). The entities that can subscribe to the PN are : a) Any entity incorporated in a jurisdiction that requires filing of constitutional or other documents with a registrar of companies or comparable regulatory agency or body under the applicable companies legislation in that jurisdiction; b) Any entity that is regulated, authorized or supervised by a central bank, such as the Bank of England, or any other similar body provided that the entity must not only be authorized but also be regulated by the aforesaid regulatory bodies; c) Any entity that is regulated, authorized or supervised by a securities or futures commission, such as the Financial Services Authority or other securities or futures authority or commission in any country , state or territory ; d) Any entity that is a member of securities or futures exchanges such as the New York Stock Exchange or other self-regulatory securities or futures authority or commission within any country, state or territory provided that the aforesaid mentioned organizations which are in the nature of self- regulatory organizations are ultimately accountable to the respective securities financial market regulators.
Investment limit
As per the September 1992 policy permitted foreign institutional investment registered FII could individually invest in a maximum of 5% of a company’s issued capital and all FIIs together up to a maximum of 24%. From November 1996 are allowed to make 10 percentage investment in debt securities subject to the specific approval from SEBI as a separate category of FIIs or sub accounts as 100% debt fund investment such investment were of occurs subjected to the fund specific ceiling prescribed by SEBI and had to be within overall ceiling US 1.5 $. The investment was however, restricted to the debt instrument of companies listed or to be listed on the stock exchanges. In 1997, the aggregate limit on investment by FIIs was allowed to be raised from 24% to 30% by then board of directors of individual companies by passing a resolution in their meeting and by special resolution to that effect in the company’s Board meeting. In June 1998 the 5% individual limit was raised to 10%.In March 2000, the ceiling on aggregate FII portfolio investment increased to 49%.This was subsequently raised to 49%, on March 8 2001, Finance minister announced February 28 2002 that foreign institutional investors can invest in accompany under the portfolio investment rout beyond 24% of the paid up capital of the company with the approval of the general body of the share holders by a special resolution.
Benefits and costs of FII investments
The terms of reference asking the Expert Group to consider how FII inflows can be
encouraged and examine the adequacy of the existing regulatory framework to adequately address the concern for reducing vulnerability to the flow of speculative capital do not include an examination of the desirability of encouraging FII inflows. Yet, for motivating the consideration of the policy options, it is useful to briefly summarize the benefits and costs for India of having FII investment. Given the Group’s mandate of encouraging FII flows, the available arguments that mitigate the costs have also been included under the relevant points.
Benefits
Reduced cost of equity capital
FII inflows augment the sources of funds in the Indian capital markets. In a commonsense way, the impact of FIIs upon the cost of equity capital may be visualized by asking what stock prices would be if there were no FIIs operating in India. FII investment reduces the required rate of return for equity, enhances stock prices, and fosters investment by Indian firms in the country.
Imparting stability to India’s Balance of Payments
For promoting growth in a developing country such as India, there is need to augment domestic investment, over and beyond domestic saving, through capital flows. The excess of domestic investment over domestic savings result in a current account deficit and this deficit is financed by capital flows in the balance of payments. Prior to 1991, debt flows and official development assistance dominated these capital flows. This mechanism of funding the current account deficit is widely believed to have played a role in the emergence of balance of payments difficulties in 1981 and 1991. Portfolio flows in the equity markets, and FDI, as opposed to debt-creating flows, are important as safer and more sustainable mechanisms for funding the current account deficit.
Knowledge flows
The activities of international institutional investors help strengthen Indian finance. FIIs advocate modern ideas in market design, promote innovation, development of sophisticated products such as financial derivatives, enhance competition in financial intermediation, and lead to spillovers of human capital by exposing Indian participants to modern financial techniques, and international best practices and systems.
Strengthening corporate governance
Domestic institutional and individual investors, used as they are to the ongoing practices of Indian corporates, often accept such practices, even when these do not measure up to the international benchmarks of best practices. FIIs, with their vast experience with modern corporate governance practices, are less tolerant of malpractice by corporate managers and owners (dominant shareholder). FII participation in domestic capital markets often lead to vigorous advocacy of sound corporate governance practices, improved efficiency and better shareholder value.
Improvements to market efficiency
A significant presence of FIIs in India can improve market efficiency through two channels. First, when adverse macroeconomic news, such as a bad monsoon, unsettles many domestic investors, it may be easier for a globally diversified portfolio manager to be more dispassionate about India’s prospects, and engage in stabilsing trades. Second, at the level of individual stocks and industries, FIIs may act as a channel through which knowledge and ideas about valuation of a firm or an industry can more rapidly propagate into India. For example, foreign investors were rapidly able to assess the potential of firms like Infosys, which are primarily export-oriented, applying valuation principles that prevailed outside India for software services companies.
Costs
Herding and positive feedback trading
There are concerns that foreign investors are chronically ill-informed about India, and this lack of sound information may generate herding (a large number of FIIs buying or selling together) and positive feedback trading (buying after positive returns, selling after negative returns). These kinds of behavior can exacerbate volatility, and push prices away from fair values. FIIs’ behavior in India, however, so far does not exhibit these patterns. Generally, contrary to ‘herding’, FIIs are seen to be involved in very large buying and selling at the same time. Gordon and Gupta (2003) find evidence against positive-feedback trading with FIIs buying after negative returns and vice versa.
BoP vulnerability
There are concerns that in an extreme event, there can be a massive flight of foreign capital out of India, triggering difficulties in the balance of payments front. India’s experience with FIIs so far, however, suggests that across episodes like the Pokhran blasts, or the 2001stock market scandal, no capital flight has taken place. A billion or more of US dollars of portfolio capital has never left India within the period of one month. When juxtaposed with India’s enormous current account and capital account flows, this suggests that there is little evidence of vulnerability so far.
Possibility of taking over companies
While FIIs are normally seen as pure portfolio investors, without interest in control, portfolio investors can occasionally behave like FDI investors, and seek control of companies that they have a substantial shareholding in. Such outcomes, however, may not be inconsistent with India’s quest for greater FDI. Furthermore, SEBI’s takeover code is in place, and has functioned fairly well, ensuring that all investors benefit equally in the event of a takeover.
Complexities of monetary management
A policymaker trying to design the ideal financial system has three objectives. The policy maker wants continuing national sovereignty in the pursuit of interest rate, inflation and exchange rate objectives; financial markets that are regulated, supervised and cushioned; and the benefits of global capital markets. Unfortunately, these three goals are incompatible. They form the “impossible trinity.” India’s openness to portfolio flows and FDI has effectively made the country’s capital account convertible for foreign institutions and investors. The problems of monetary management in general, and maintaining a tight exchange rate regime, reasonable interest rates and moderate inflation at the same time in particular, have come to the fore in recent times. The problem showed up in terms of very large foreign exchange reserve inflows requiring considerable sterilization operations by the RBI to maintain stable macroeconomic conditions. The Government had to introduce a Market Stabilization Scheme (MSS) from April1, 2004.
With the foreign exchange invested in highly liquid and safe foreign assets with low rates of return, and payment of a higher rate of interest on the treasury bills issued under MSS,
sterilization involves a cost. With a rapid rise in foreign exchange reserves and the need for having an MSS-based sterilization involving costs, questions have been raised about the desirability of encouraging more foreign exchange inflows in general and FII inflows in particular. While there is indeed the issue of timing the policy of encouragement appropriately to avoid the pitfalls of throwing the baby with the bath water, there can not be a turnaround from the avowed policy of gradual liberalization, including the cap ital account. All modern market economies have evolved policies to reconcile prudent monetary management with the benefits of a liberal capital account. There is no scope for any diffidence in India also moving in the same direction.
CONCLUSION
The liberalization policies had the desired expansionary effect and had either increased the mean level of FII inflows and/or the sensitivity of these flows to a change in BSE returns and /or the inertia of these flows. On the other hand, the restrictive measures aimed at achieving greater control over FII flows also did not show any significant negative impact on the net inflows, it had found that these policies mostly render FII investment sensitive to the domestic market returns and raise the inertia of the FII flows.
Foreign institutional investors had emerged as the most dominant investor group in the domestic stock market in India. Particularly, in the companies that constitute the Bombay stock market sensitivity index, their level of control was very high. Data on shareholding pattern showed that the FIIs were currently the most dominant non-promoter shareholder in most of the sensex companies and they also controlled more tradable shares of sensex companies than any other investor groups .The sensex, market capitalization of NSE, Turnover of BSE and NIFTY without market capitalizations were influenced by Foreign Institutional Investors. FIIs investment was not across the shares listed in the stock exchange but instead it was very concentrated on the top few company’s shares. Though there was a role by FII on Indian stock market. It was to be taken very cautiously because their influences were on the very few shares in the stock market, which influenced the indicator included in the study but which might not help the Indian economy to grow
The influence of FIIs on the movement of sensex became apparent after general election in India, during this period sensex experienced its worst single-day decline in its history and in the three month period between April to June 2004, it declined by about 17 percent. Moreover, this study also showed that even sharp changes in sensex did not necessarily indicted a significant alteration of actual shareholding pattern of different investor groups even in sensex companies. The activities of foreign institutional investors in emerging economies following the opening-up of the capital account were not simply positive for these countries but could also exert adverse effects. The reasons were derived from asymmetric distributions of information between local and foreign investors and between fund holders and mangers. Foreign institutional investors could be assumed to have relatively little information on specific developments in emerging markets so that ‘diluted information’ and ‘illusive competition’ could result. Their influence on these markets was likely to worsen the relative position of local investors which leads to ‘unbalanced diversification’. Moreover, due to their incentives they were likely to amplify occurring imbalances or even trigger financial shocks leading to what they call ‘obscure risks’ and ‘booming contagion’. The was long run relationship between net FII investment and sensex, FII investment did not respond the short-run changes or technical-position of the market and they were more driven by fundamentals, and FII investments did granger cause India stock market. The FIIs investments are highly concentrate in terms of their market value in very small number of companies. There seemed to be a clear distinction in the FIIs shareholding in nifty and non-nifty companies. There was a wide gap between the actual investments by FIIs and the investments allowed as per the cap.The gap in their investments existed both in nifty and non-nifty companies
REFERENCES
1 “Parthapratim pal” in 2006, he conducted study on “Foreign Portfolio Investment, Stock market and Economic Development: A case study of India”,
2 “Selen Serisoy Guerin” in 2006, conducted study on “The Role of Geography in Financial and Economic Integration: A comparative Analysis of foreign direct investment, Trade and Portfolio Investment Flows”
3 Keneeth A. Froot and Tarun Ramadorai in 2005, they conducted study on “The information content of international portfolio flows”,
4 A.Julia Priya, D. Lazar and Joseph Jeyapual in 2005, they conducted study on “Role of Foreign Institutional Investors on stock market development in India”,
5 Keneeth A. Froot and Tarun Ramadorai in 2005, they conducted study on “Currency Returns, Intrinsic value, and Institutional-Investor flows”,
6 Megumi Suto and Masashi Toshino in 2005, they conducted a study entitled as “Behavioral Biases of Japanese Institutional Investors: fund management and corporate governance”
7 “Suchismita Bose and Dipankor coondoo” in 2004, they conducted study on “The Impact of FII Regulation in India”,
8 Lakshmi sharma in 2004, he studied, “A Gap Analysis of FIIs Investment-An estimation of FIIs investment Avenues in Indian Equity Market.
9 Parthapratim pal in 2004 conducted study entitled as “Recent volatility in stock markets in India and foreign institutional investors.
10 “Michael Frenkel and Lukas Menkhoff” in 2004, they conducted study on “Are Foreign Institutional Investor Good for Emerging Markets?”,
11 “Brian Bushee” in 2004, he conducted study on “Identifying and attracting the “right” investors: evidence on the behavior of Institutional investors”,
12 “Christophe faugere and Hany A. Shaby in 2003, they analyzed study on “Volatility and Institutional Investor holdings in a declining market: A study of NASDAQ during the year 2000”.
13 Gayathri Devi .R in 2003, she conducted study on “Causal Relationship between FIIs and Stock Market: A critical study”
14 “sandhya Ananthanaryanan, Chandrasekhar krishnamurthi and Nilajan Sen in 2003 conducted study as “Foreign institutional Investors and Security Returns: Evidence from Indian Stock Exchanges”,
15 Stuart L. Gillan and Laura T. Starks in 2003, they conducted study as “corporate Governance, corporate ownership, and the Role of Institutional Investors: A Global perspective”,
16 “Vihang Errunza” in 2001, he conducted study entitled as “foreign portfolio equity investments, financial liberalization and economic development
17 J.S. Pasricha and Umesh.C.Singh in 2001, tried to analyze the impact of FIIs investment on Indian capital market.
18 S.S.S. Kumar in 2001, attempted in his study to find the effect of FIIs on the Indian stock market.
19 “Rajesh chakrabarti” in 2000 conducted study on “FII Flows to India: Nature and Causes”
20 C.H. Rajeswar in 2000, he conducted study entitled “Foreign Institutional Investors – A new force of support and discipline”
21 As per K. Seethapathi and V. Subbulakshmi study entitled “Foreign investment: Need for focus”,
22 Ila Patnik and Deepa Vasudevan in 1998, their study entitled “foreign portfolio investment to India
23 “Rene M. Stulz” in 1999, he analyzed study on “international portfolio flows and security markets”.
24 Yung Chul Park and Chi-Young Song, they conducted study on “Institutional Investors, Trade linkage, Macroeconomic similarities and contagious Thai crisis
About the Author
NIDHEESH K B
LECTURER
COMMERCE DEPARTMENT
PONDICHERRY UNIVERSITY
PONDICHERRY
INDIA
The Future Of The U. S. Dollar
by futureofdollar.com ©
INTRODUCTION
The World is concerned that the dollar cannot play the role of the main reserve currency any longer after the financial crisis sparked by the collapse of the U.S. mortgage market led to the worst global recession since the 1930s. The Government’s stimulus packages, financial bailouts, the need to support liquidity in Treasuries, keeping interest rates at the lowest level under the circumstances of low economic growth, high unemployment and low tax collection make it print more dollars. This leads to a high risk of substantial inflation, or hyperinflation in a long-run.
With a $12.3 trillion national debt and $55 trillion in unfunded obligations for programs such as Social Security, Medicare and Medicaid, with total Federal Reserve and Treasury bailout commitments now at $11.8 trillion, of which $3.6 trillion has already been spent the U.S. need to take steps immediately to protect themselves from the potential loss of the purchasing power of their U.S. Dollars, inflation.us warns.
Although there is still no significant inflation data in the United States international stock and commodity markets grew abnormally within the last eleven months. Analysts called it the “flight from the dollar” or “diversifying risks.”
There are many factors evidencing against the future of the dollar as a global reserve currency. In the present article futureofdollar.com pays attention to the crucial points of analysis after conducting an extensive research on the topic.
Part I
WEAK FUNDAMENTALS OF THE U.S. ECONOMY
Nobel Prize winner Paul Krugman states that “a country whose fundamentals are persistently and predictably deteriorating will necessarily have a [currency] crisis at some point.” (1)
1. National Debt
In the middle of February 2010, President Obama signed into law the bill increasing the public debt ceiling from $12.394 trillion to $14.294 trillion. This is a second increase in the upper limit on the national debt in less than two months.
Last time, in December, House Majority Leader Steny Hoyer commented that the Congress simply had no other choice: otherwise the United States would have to default on their debt obligations what would be another catastrophe for financial markets. (2)
”The Financial Management Services of the U.S. Treasury estimated that the total obligations of the U.S. government exceeded $90 trillion,” David Ross from Radiant Asset Management indicated in his research. (3) They include hospital insurance, supplementary medical insurance, and social security. “[T]he collected money (which Treasury has borrowed and Congress spent) falls far short of what is required to fulfill the long-term obligations of those programs, even if it had not already been spent. Almost all of the $90 trillion are promised obligations with no established method of payment.” (4)
”Including unfunded obligations, the U.S. moves to 1st, well above Taiwan and Zimbabwe, for the highest debt to GDP ratio… U.S. total debt plus unfunded obligations total 625% of GDP.” (5)
The Peterson-Pew Commission on Budget Reform stated that “the United States would almost certainly experience a debt driven crisis,” that “could unfold gradually or it could happen suddenly, but with great costs either way.” “The excessive debt would. . . affect citizens in their everyday lives by harming the American standard of living through slower economic growth and dampening wages, and shrinking the government’s ability to reduce taxes, invest, or provide a safety net.” (6)
2. Unemployment
This past February, the economy lost 36,000 jobs after losing 26,000 jobs in January and 109,000 jobs in December, and the unemployment rate held at 9.7 percent. (7)
In January, the unemployment rate fell from 10.0 to 9.7 percent. According to Reuters “a sharp increase in the number of people giving up looking for work helped to depress the jobless rate. The number of ‘discouraged job seekers’ rose to 1.1 million in January from 734,000 a year ago.” (8) The number of discouraged workers rose to 1.2 million in February. (9)
Gallup reported in the end of February 2010 that “19.9% of the U.S. workforce was underemployed during the month of January, translating to close to 30 million Americans who are working less than their desired capacity.” (10)
In its March summary of commentary on current economic conditions by Federal Reserve Districts, the Beige Book, the government finds that “labor markets generally remained soft throughout the nation.” Although “[t]he pace of layoffs slowed in most Districts. . . hiring plans still remained generally soft.” (11)
3. Budget deficit
IMF’s Managing Director Dominique Strauss-Kahn noted at the 10th Annual Herzliya Conference in Tel Aviv that the global crisis had created a problem of fiscal sustainability for many countries that could take decades to fix because of the huge debts built up during the crisis, especially in developed countries. (12)
The United States reached a record budget deficit of $1.415 trillion in fiscal year 2009 that ended in September. (13) The deficit will probably again exceed one trillion dollars in the current fiscal year as it is already over $651 billion.
The excess of spending over revenue in the U.S. was $220.9 billion in February 2010, as opposed to a deficit of $193.9 billion in February 2009, the Treasury Department announced in its monthly budget statement. It was the 17th straight month in which the government posted a deficit, CNNMoney.com said. (14)
In the beginning of February 2010 Obama transmitted a $3.8 trillion budget for 2011 to the Congress with a record $1.6 trillion deficit. (15)
During the debate on the national debt the Senate “rejected a proposed bipartisan commission to recommend ways to reduce the U.S. budget deficit,” Bloomberg reported. “The legislation would have required that the panel’s recommendations be voted on by Congress without being amended.” (16) Instead of the initial idea of the commission discussed by Congress, President Obama is trying to establish a government-based deficit commission that would lack any requirement for Congress to act on its advice. Specialists consider it a symbolic rather than a concrete step.
4. Economic impact of U.S. international military operations
The cost of conducting wars in Iraq and Afghanistan pushed the budget into the red during the presidency of George W. Bush. The situation deteriorated after the beginning of the financial crisis when the government adopted measures such as stimulus packages, financial bailouts, the need to support liquidity in Treasuries, etc. Moreover, early in December 2009 it has increased its nonproductive expenses by approving 30,000 troops to be sent to fight in Afghanistan.
All economists agree that one of the basic nonmonetary reasons of inflation is the existence of significant nonproductive government expenses such as military expenses.
Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said Obama may have too much on his plate. “You can’t fight a war, a financial crisis, a recession, and add health-care coverage to the uninsured at the same time,” he said. “It is simply the recipe for disaster.” (17)
However important goals of the war could be, military operations are, undoubtedly, very costly for U.S. citizens especially at the time of the financial crisis and growing deficits. Moreover, the situation is not getting better considering that around 40 percent of the war financing has been borrowed from abroad, Joseph Stiglitz, the Nobel Prize Winner, shows in his research “The Three Trillion Dollar War: The Real Cost of the Iraq Conflict.”
Explaining why wars are expensive he points out that military expenditures are not only limited to direct operation costs but also include (the bigger part) human casualties, future disability costs, loss of income, increased oil prices, opportunity costs, veterans’ social welfare, nonproductive spending, loss of confidence in the future economic situation, increase in the national debt, and so on.
“The Obama administration has just asked Congress for a defense budget of more than $700bn… – almost 5% of GDP – for next year,” Guardian.co.uk reported in the end of February 2010. This is exactly 1/3 of total budget receipts for the FY 2009.
”If we try to stay the course, we are going to spend more and more money,” Stiglitz stresses. “The fact that we financed the war totally by deficits means that when 10 years from now we decide we want to repay that, which I don’t know if we will, the amount that we will have to raise our taxes will be that much larger because the debt will be that much larger.”
5. China’s peg to the dollar
So far China is enjoying low yuan rate giving its exports competitive advantage in relation to those countries with appreciating currencies against the U.S. dollar.
As the result China is actually “stealing” jobs from many countries since with appreciating currencies their companies are not able to compete with Chinese producers.
In relation to the United States this means that the country should not count on sooner recovery. China’s peg to the dollar makes imports into the U.S. cheaper. This supports high level of unemployment in America. Unemployment prevents the growth of GDP and reduces revenues.
Part II
LACK OF CONFIDENCE
Defining major reasons of currency crises Paul Krugman states that the most important is a lack of confidence. The “investor lack of confidence – is a defining feature of a currency crisis,” he argues. (18)
Below are opinions of a number of people from different parts of the world whom many of us know quite well. Their opinions concern the U.S. dollar and the U.S. economy.
Nouriel Roubini, the New York University professor who predicted the financial crisis, said that the greenback may weaken for the next three years. (19)
Warren Buffett, a successful international investor: “There is the likelihood of significant inflation down the road.” (20)
Robert B. Zoellick, the World Bank President: “There is little the United States can do about the sinking value of the dollar except restore growth in its economy.” (21)
George Soros, a successful international investor: “Irrespective of the situation in the stock markets or condition of the economy we shall see further shift from the dollar into real assets in a long run.” (22)
Jim Rogers, a successful international investor: “Printing money to help the U.S. economy will weaken the greenback and Treasuries in a long run.” (23)
Joseph Stiglitz, Nobel Laureate in Economics: The greenback will continue to head downward for the time being, given the huge U.S. trade deficit and global trade imbalance. (24) “[M]any factors going into the decline of the U.S. dollar. But clearly one of the factors is an overall loss of confidence, loss of confidence particularly in the future economic situation.” (25)
Fan Gang, a prominent economist and adviser to China’s central bank: “This crisis is a U.S. dollar crisis, which takes a relatively long time to clear up. The problem involves the U.S. currency and U.S. debt; eventually it has to be solved through U.S. dollar depreciation.” (26)
Yuri Luzhkov, City of Moscow Mayor, Russia: The world is on the brink of a radical devaluation of the American currency. Therefore, Russia has to abandon its dependency on the dollar as soon as possible. American currency reserves are supported by nothing and industrial production in this country is very low. (27)
The list of well-known people with similar thinking is endless. In its research futureofdollar.com faced a difficulty of finding successful investors, economists or foreign politicians with the opposite thinking. There are just a few of them. Most of them are the U.S. government officials whose job is to restore the confidence in the U.S. economy with a part of this job being speaking in ‘positive’ terms.
People in this group either believe that:
*the recession is over and the U.S. economy will have a sharp rebound, or
*that the dollar will remain the primary reserve currency for a long time because during this last financial crisis investors found the dollar a safe haven, or
*that there is no inflation threat, relying on the U.S. government data, or
*simply stating that “we will sink or swim with the dollar.”
For instance, Barack Obama is confident that the dollar is “extraordinarily strong” because investors are confident in the ability of the U.S. to lead a worldwide recovery. (28)
The Chairman of the U.S. Federal Reserve Ben Bernanke believes that U.S. asset prices aren’t out of line with underlying values, and central bank policy will ensure that the “dollar is strong.” (29)
The U.S. Treasury Secretary Timothy Geithner forecasts that the dollar will remain the world’s “dominant reserve currency.” (30)
Therefore, we came to a conclusion that, unfortunately, the U.S. economy and the dollar are losing confidence. The U.S. government must work even harder now to restore it.
Part III
DIVERSIFICATION OUT OF THE DOLLAR
Maurice Obstfeld and Kenneth Rogoff observe that “there is a long-term trend of official reserve diversification away from U.S. dollars, especially among the fast-growing, reserve-hungry emerging and developing economies, and this trend continues in recent data.” (31)
It is hard to argue that the future of the dollar nowadays significantly depends on such developing countries as China, India, Brazil, Russia, and others. These countries accumulate very large dollar reserves and U.S. debt.
Let’s explore their recent positions regarding the U.S. dollar with an attempt to predict its future.
1. China
Already for an extended period of time China was quite aggressive in diversifying its reserves and protecting from weakening dollar, recommending its private sector to do the same.
The Chinese Ministry of Finance started selling bonds worth 6 billion yuan in Hong Kong in late September 2009, a major step to internationalize its currency at a time of concern about the dollar. (32)
Same month China bought the equivalent of $50 billion of the first bond sale by the International Monetary Fund, a purchase that might raise Beijing’s standing in the fund and help the government’s quiet campaign to expand the reach of its currency. China took the unusual step of paying for the IMF bonds with 341.2 billion yuan — which is not traded on global markets — rather than dollars. (33)
The country signed currency agreement with Argentina and agreed to credit South Korea, Malaysia, Indonesia and Belarus with its own currency. (34)
In the mid-September 2009, the International Monetary Fund announced that it was going to sell 403 tons of gold. Chinese central bank showed its willingness to buy the whole offer. (35)
The People’s Bank of China showed its intention to decrease its dollar reserves. Chinese authorities will increase their euro and yen reserves. (36)
China and Brazil established international payments in national currency of the Republic of China. Zhuhai Geli corporation received a transfer of several million yuan from San Paolo in the fall of 2009. (37)
The country was seeking to expand its African oil reserves by bidding for up to a sixth of Nigeria’s crude reserves constituting approximately 6 billon barrels. Valuing near $30-50 billion Chinese offer is higher than that of the current owners. China has been buying oil resources around the World for the second year already. (38)
Chinese companies may invest about $4,4 billion into Peru’s mining sector within the next three years according to the statement made by the Prime Minister of Peru Javier Velasquez. (39)
Nearly 44% ($14,3 billion) of the total volume of China’s investments within the first nine months of 2009 were coming into mining and production sector. Representative of the Asian Development Bank noted that investing in the mining sector by purchasing stocks corresponded to a long-term strategy of the country to achieve resource security. (40)
China Investment Corporation (CIC), a sovereign wealth fund responsible for managing part of Chinese foreign exchange reserves, “has been quietly accumulating stakes in resource firms including Canada’s Kinross Gold Corp. and Potash Corp. of Saskatchewan according to a filing with securities regulators.” (41)
CIC chairman Lou Jiwei “recently said that CIC would focus on investing in emerging markets in 2010. In October, the CIC chairman said the fund had allocated $110-billion for foreign investments and had already deployed about half of that.” (42)
”In addition to its $3.5-billion interest in Teck, CIC has a $652-million stake in Brazilian iron ore and nickel giant Vale SA, a $4.7-million interest in copper miner Freeport-McMoRan, and a $9.1-million holding in steel producer ArcelorMittal.” CIC has also acquired stakes in a number of high-profile brand name companies in North America such as Research In Motion Ltd., Apple Inc., News Corp., and AIG Inc. (43)
China cut its holdings of U.S. Treasury securities by $34.2 billion in December 2009, but still remaining the largest foreign holder of U.S. debt. (44)
2. India
Suresh Tendulkar, an economic adviser to Indian Prime Minister, was urging the government in the summer of 2009 to diversify its $264.6 billion foreign reserves and hold fewer dollars. (45)
The IMF sold 200 metric tons of gold to India in the beginning of November 2009. The $6.7 billion sale is “the biggest single central-bank purchase that we know about for at least 30 years in such a short period,” said Timothy Green, author of “The Ages of Gold.” “The only comparable event was the U.S.’s steady purchases in the 1930s and 1940s.” (46)
3. Brazil
Brazilian Central Bank president Henrique Meirelles said the country is considering the gradual elimination of the U.S .dollar in trade with China, Russia and India. (47)
In October 2009, the Brazilian Central bank announced that an agreement was reached with Uruguayan economic authorities to apply the so called SML system in bilateral trade operations. (48)
Brazilian Finance Minister Guido Mantega said that Brazil would spend 10 billion US dollars on buying International Monetary Fund bonds to boost the fund’s resources. This “radical change” will help Brazil to diversify its resources, he added. (49)
4. Russia
The Central Bank of Russia increased the share of Japanese yen and Swiss franc in reserves in the middle of 2008. Japanese yen currently accounts for around 2 percent of Russia’s reserves. The franc’s share is smaller because of the limited liquidity.
Russian President Dmitry Medvedev said at the St. Petersburg International Economic Forum in June 2009: “We should not exclude the possibility of a scenario in which the dollar will be subject to a serious inflationary pressure.” (50)
Russian reserves consist now mainly of the U.S. dollar and the euro. However, it is quite possible that Russia will add Chinese yuan in there, said Alexei Kudrin, Russian Finance Minister. The lack of convertibility of the China’s currency and of the free movement of capital was the main current obstacle. (51)
Brazil and India are interested in settling bilateral trade with Russia in national currencies, said Alexander Potemkin, an advisor to the Russian central bank chairman, echoing Moscow’s drive for more use of national currencies and less of the U.S. dollar. “There was an initiative within the framework of the BRIC. These countries intend to create the conditions for direct payment for trade in national currencies,” he said. He also said that Russia had a reach experience of reciprocal payments in national currencies with China. He estimated that settlements in yuan and rouble already account for around 2 percent of Russia’s trade with China. (52)
Moscow also discusses trade in national currencies with other countries including Turkey and Vietnam. (53)
Russian central bank first deputy chairman Alexei Ulyukayev said in November 2009 that Russia was going to add the Canadian dollar to its gold and forex reserves in the next few months, but its share would be insignificant. (54)
Russia, Belarus and Kazakhstan, members of the Customs Union of the Commonwealth of Independent States, can adopt a single currency as early as in 2012 according to Russian First Deputy Prime Minister Igor Shuvalov. (55) Specialists estimate that Russia, Belarus and Kazakhstan will save at least 1 percent of the total amount of transactions (tens of millions of dollars) avoiding payments in dollars and euro. (56)
Russian President Dmitry Medvedev criticized delaying the creation of a new international financial system, and announced that the French President and himself were going to take the initiative as long as “Bretton Woods Agreements do not reflect current economic situation anymore.” (57) “Both President Sarkozy and I worry about the new international financial architecture, it is not just far away from the perfection, we have not taken serious steps on this issue,” Medvedev said. (58)
5. Other countries
In April 2009 the Latin American leaders signed into effect a new South American currency, to be called the ‘sucre’. ALBA leaders (representing Venezuela, Cuba, Bolivia, Honduras, Nicaragua, and Dominica) say the sucre is necessary to help defray the regional effects of the world economic crisis by substituting their trade in dollars with a new alternative currency. The ALBA countries and their allies plan to use the virtual sucre by early 2010. (59)
In the second quarter ending in June 2009, central banks around the world invested 63 percent of their new cash reserves into euro and yen, and put only 37 percent into dollars. (60)
Kuwait, Saudi Arabia, Qatar and Bahrain signed in June 2009 an accord to create a joint monetary union council, a prelude to establishing a Gulf central bank and launching a monetary union and single currency. The remaining two members of the Gulf Cooperation Council (GCC), the UAE and Oman, did not sign after deciding to withdraw from the project. The GCC states have set 2010 as the target to launch the monetary union and single currency, but many experts believe that target is too ambitious and unrealistic. (61)
Turkey announced in the end of October 2009 that it was switching to national currencies in trade with Iran and China, ending dependence on the dollar and the euro for about 20% of its commodity turnover. (62)
The International Monetary Fund sold 2 metric tons of gold to the Bank of Mauritius on the basis of market prices prevailing on Nov. 11, 2009. (63)
Shortly thereafter the IMF sold 10 metric tons of gold to the central bank of Sri Lanka for about $375 million. The purchase is part of Sri Lanka’s plan to diversify its reserves and it has been gradually accumulating the metal in the past nine months. “Gold is a good anchor and hedge to have in these volatile circumstances,” said Nivard Cabraal, the bank’s governor. “We think it’s a good time to buy.” (64)
In the beginning of January 2010 Canada announced that it might sell about 1 billion euros of 10-year bonds, its first issue of debt in the European currency in more than a decade. This strategy will help attracting new investors, while debt denominated in U.S. dollars is becoming less popular among the creditors given the declining value of the U.S. currency. (65)
It is obvious that the trend of the diversification out of the dollar persisted through the whole year of 2009 and is continuing in 2010.
Part IV
WAY OUT
Peterson-Pew Commission on Budget Reform suggests that “the United States must show its creditors that it is serious about stabilizing the federal debt over a reasonable timeframe. Both spending cuts and tax increases will be necessary.”
Most of the economists would suggest that the U.S. anti-inflation strategy should include:
* suppression of inflation expectations and stimulation of savings;
* reaching balance between budget receipts and expenditures;
* increasing the mass of commodities; and
* strengthening national currency by establishing an unconditional priority of inflation targeting over other government programs (such as military expenses, unemployment rate regulation, influencing the national currency market, etc.).
Will the U.S. assume such a pain by reducing spending and fighting the deficits? Probably not, taking into consideration the words of Sir John Templeton, the John Templeton Foundation, who said in 2005: “The psychology all over the world is that people will not re-elect leaders who want them to be thrifty. The voters will elect the government that spends more money.” (66)
Many analysts are pretty sure that the weak dollar policy is beneficial to the U.S. Therefore, whatever the authorities say, there will be no resistance to dollar depreciation on their part.
Most experts already doubt that the solution of the problem depends much on the U.S. and call for global measures. “We must reform the international monetary system,” Yu Yongding, a former Chinese central bank adviser, stated in mid-November 2009. “A good monetary system should make us confident. But we don’t have confidence in the U.S. dollar now,” he added. (67)
George Soros is convinced that we “need a new currency system and actually the Special Drawing Rights do give you the makings of a system,” he told the Financial Times.
THE FUTURE OF THE DOLLAR
The future of the dollar is in jeopardy now as it is evident from the article.
This subject is the primary focus of futureofdollar.com. We follow latest developments in this area and provide our readers information from reliable sources.
This analysis was prepared by http://www.futureofdollar.com ©
March 11, 2010
Notes:
(1) Paul Krugman, Currency Crises, 1997;
(2) Reuters, December 17, 2009;
(3) David Justin Ross, The Future of the Dollar and China: The Threat of Collapse and the Move Towards a New Reserve Currency, October 27, 2009, Radiant Asset Management, LLC;
(4) Ibid.
(5) Ibid.
(6) budgetreform.org, December 14, 2009;
(7) U.S. Department of Labor, March 5, 2010;
(8) Reuters, February 8, 2010;
(9) U.S. Department of Labor, March 5, 2010;
(10) Gallup, February 23, 2010;
(11) The Beige Book, March 3, 2010;
(12) IMF, January 31, 2010;
(13) The Department of the Treasury;
(14) CNNMoney.com, March 10, 2010;
(15) Bloomberg, February 1, 2010;
(16) Bloomberg, January 26, 2010;
(17) Bloomberg, January 8, 2010;
(18) Paul Krugman, Currency Crises, 1997;
(19) Bloomberg, February 4, 2010;
(20) FOX Business Network, June 24, 2009;
(21) The Economic Times, November 13, 2009;
(22) Reuters, October 26, 2009;
(23) Bloomberg, October 28, 2009;
(24) The Korea Times, October 28, 2009;
(25) The Three Trillion Dollar War: The Real Cost of the Iraq Conflict, book discussion, April 8, 2008;
(26) Reuters, December, 2009;
(27) RB.ru Russian Business, September 1, 2009;
(28) Bloomberg, March 24, 2009;
(29) Bloomberg, November 17, 2009;
(30) USA Today, March 25, 2009;
(31) Maurice Obstfeld and Kenneth Rogoff, Global Imbalances and the Financial Crisis: Products of Common Causes, November 2009;
(32) People’s Daily Online, September 28, 2009;
(33) The Associated Press, September 3, 2009;
(34) The New York Times, September 4, 2009;
(35) CommodityOnline.com, September 21, 2009;
(36) RosBusinessConsulting, November 6, 2009;
(37) NEWSru.com, October 28, 2009;
(38) Vedomosti, 28 September, 2009;
(39) Bloomberg, 25 November, 2009;
(40) ChinaPro.ru / Vedomosti, 25 November 2009;
(41) The Globe and Mail, February 8, 2010;
(42) Ibid.;
(43) Ibid.;
(44) Xinhua, March 1, 2010;
(45) Bloomberg, July 4, 2009;
(46) Bloomberg, November 3, 2009;
(47) Merco Press, October 29, 2009;
(48) Ibid.;
(49) Bloomberg, October 4, 2009;
(50) RIA Novosti, June 5, 2009;
(51) Bloomberg, October 24, 2009;
(52) Reuters, November 25, 2009;
(53) Ibid.;
(54) Reuters, November 2009;
(55) Rossiiskaya Gazeta, March 9, 2010;
(56) RBC TV, March 10, 2010;
(57) RIA Novosti, March 1, 2010;
(58) Ibid.
(59) Venezuelanalysis.com, April 17, 2009;
(60) CNBC, October 14, 2009;
(61) ArabianBusiness.com, October 11, 2009;
(62) RIA Novosti, October 28, 2009;
(63) IMF Press Release, November 16, 2009;
(64) Bloomberg, November 25, 2009;
(65) Bloomberg, January 5, 2010;
(66) NewsMas;
(67) Bloomberg, November 17, 2009.
About the Author
Futureofdollar.com is a group of people who, just like billions of other people around the World, will have to live with the future consequences of the current global crisis provoked by short-sighted politicians. We wish as many people as possible were aware of such consequences.