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A MACRO VIEW OF GLOBAL FINANCE. INDRANIL DEB JANUARY 2013. INDEX. THE ACTORS IN THE ECOSYSTEM. THE GLOBAL FINANCIAL ECOSYSTEM/ INDIA. THE US SUB-PRIME CRISIS(2008)- HOW, WHAT?. THE “IMPOSSIBLE TRINITY(TRILEMNA)” OF GLOBAL FINANCE. THE FISCAL-MONETARY-TRADE TRIANGLE. ECONOMIC CYCLES.

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slide1

A MACRO VIEW

OF GLOBAL FINANCE

INDRANIL DEB

JANUARY 2013

slide2

INDEX

THE ACTORS IN THE ECOSYSTEM

THE GLOBAL FINANCIAL ECOSYSTEM/ INDIA

THE US SUB-PRIME CRISIS(2008)- HOW, WHAT?

THE “IMPOSSIBLE TRINITY(TRILEMNA)” OF GLOBAL FINANCE

THE FISCAL-MONETARY-TRADE TRIANGLE

ECONOMIC CYCLES

A GLIMPSE OF THE LARGEST ECONOMIES

THE MAGNITUDE OF THEIR DEBT BURDENS, EURO-ZONE

BUSINESS ENITITIES – HOW THEY WORK, IMPACT THE SYSTEM

A FORECAST FOR 2013

slide3

THE ACTORS IN THE ECOSYSTEM

  • Money is the common denominator for all economic activity in modern society
  • In all discussions on the subjects of the economy, finance and banking

the basic postulate is that money is the medium of exchange

Financial System:

The basic element of a financial system is 1 the individual(economic man).

An individual adult, typically, engages in economic activity of some kind, in order to earn her or his living. In the world that we live in, at the lowest level of an economic system, we typically have agriculturists or farmers, individuals who either work on their own plots of land or work in a farm as a hired hand. In the first case, poor of countries of the world normally have a large number of subsistence farming activity, that is, farms where the crop is sufficient to feed only the farmer and his immediate family members, leaving no surplus for the market. As the output from these farms are not exchanged for money, the value of their output, normally does not enter the computations of the financial system.

A large proportion of the population of the world also consists of labourers, both skilled as well as unskilled.

As the skill and education levels of individuals increase, they are paid better and higher wages and are engaged in higher-skill jobs, such as those of teachers, doctors, engineers, scientists, researchers, authors, musicians, etc. Whatever be their vocation, this composite group, comprising of men and women who form the basic element of the financial system, are known as “individuals”.

At the next level, there are 2“businesses”. These are non-personal entities and may be constituted either firms, companies, associations or bodies, depending on the laws of each individual country in which they operate.,

slide4

THE ACTORS IN THE ECOSYSTEM

The third group is known as 3 “governments” and this could either be the local municipalities, the government of a state or province and a federal, national, union or central government of a country.

These three groups, broadly, are the eventual suppliers and users of money within a financial system.

The surpluses that these entities generate, namely, savings, profits and budget surpluses, respectively, in the case of individuals, businesses and governments is supplied into the financial system.

  • The savings/surpluses that these entities generate flows into the financial markets, which can be broadly segmented into the “Capital Markets” and the “Money Markets” through
  • 4financial intermediaries such as banks, insurance companies, mutual funds, provident funds, hedge funds, private equity funds, currency reserves and sovereign wealth funds. The money is transferred from the savers/surplus-generators to these intermediaries against issue of securities. The intermediaries, on the other hand, invest these moneys in various instruments floated by issuers in the capital and money markets, depending on their respective mandates.

The Capital Markets are markets where suppliers and users of “equity” or “risk” capital transact. On the other hand, the “Money Markets” are markets for “debt” instruments or fixed-income instruments, that is, instruments that carry lower levels of risk, are normally secured against collateral and offer a fixed, low rate of return to the investor or lender.

At the apex of the monetary system of an economy is the 5 Central Bank of the country.

slide5

THE GLOBAL FINANCIAL ECOSYSTEM

THE WORLD BANK &

IMF

THE EUROPEAN

CENTRAL BANK

SDR

LOANS

AID

GRANTS

THE ASIAN

DEVELOPMENT BANK

THE CENTRAL BANK

COUNTRY A

THE CENTRAL BANK

COUNTRY B

THE RESERVE BANK

OF INDIA

THE CENTRAL BANK

COUNTRY X

TAXES

DIRECT/ INDIRECT

LOANS

AID

GRANTS

PSU DIVIDENDS

GOVERNMENT

LOCAL

STATE

UNION

SPENDING

RAW MATERIALS

WAGES

RENT

EXPENSES-SERVICES

BANKS

LOANS

TAXES

PE FUNDS

SPENDING

INTEREST

DIVIDEND

TAXES

SAVINGS(INVESTMENTS)

CURRENCY

BANK FIXED DEPOSITS

SHARES AND DEBENTURES

UNITS OF UNIT TRUSTS

PSU BONDS

MUTUAL FUND UNITS

PROVIDENT, PENSION FUNDS

HEDGE FUNDS

MUTUAL FUNDS

INSURANCE

BUSINESS

ENTITIES

OTHERS

EARNINGS/ INCOME

WAGES, PENSION

RENT/ CAPITAL GAINS

INTEREST/ DIVIDENDS

PROFIT

SPENDING/CONSUMPTION

PRICE FOR GOODS & SERVICES

HOUSEHOLDS

1

2

3

4

5

INDIVIDUALS

slide6

GLOBAL FINANCIAL ASSETS - 2010

The stock of all debt and equity across the globe increased by 5% in 2010 to $212 trillion,

Half of the growth came from rising stockmarkets, which account for a quarter of all financial assets.

Global debt increased by 3% to $158 trillion, reaching 266% of GDP.

On-balance-sheet lending in China added $1.2 trillion to the debt stock, and its share of non-securitised loans now exceeds America's or Japan's.

China also led the way in initial public offerings, with 45% of the total.

Further fiscal deterioration in the rich world meant that global government debt increased to $41 trillion, equivalent to 69% of GDP among the 79 countries covered in the report.

slide7

THE INDIAN FINANCIAL SYSTEM-AN OVERVIEW

MINISTRY OF FINANCE

FINMIN DIRECT SUPERVISION

RESERVE BANK OF INDIA

SECURITIES AND EXCHANGE BOARD OF INDIA

FISCAL POLICY

MONETARY POLICY, EXCHANGE RATE MANAGEMENT

CAPITAL MARKETS SUPERVISION

VENTURE CAPITAL FUNDS

MUTUAL

FUNDS

CAPITAL MARKETS

PRIMARY DEALERS

NBFCs

FINANCIAL INSTITUTIONS

COMMER-CIAL BANKS

STOCK EXCHANGES

MERCHANT BANKS

UNDERWRITERS

STOCK BROKERS AND SUB-BROKERS

CUTODIANS

DEPOSITORIES & PARTICIPANTS

FIIs

INVESTORS

FOREX MARKET

MONEY MARKET

DERVTV MARKET

HOUSEHOLDS

INDIVIDUALS

slide8

THE US SUBPRIME CRISIS(2008)-HOW, WHAT?

MONETARY EASING

LOW INTEREST REGIME

RATING AGENCIES

INVESTMENT BANKS

COMMERCIAL BANKS

INSURANCE COMPANIES

REGULATORS

FEDERAL RESERVE

GOVERNMENT

EXCESSIVE HOUSING ASSETS

HUGE CREDIT EXPANSION

LOSS IN 2008

USD 500 BN+

LEHMAN BROS. USD 210 BN

BEAR STERNS USD 90 BN

MERRILL LYNCH USD 52 BN

AIG USD 41 BN

WAMU USD 15 BN

HUGE ASSET BUBBLE

COLLAPSE

2000

2008

slide9

HOW CDOS WORK

The underlying assumptions for pricing the securities did not factor in a 20% fall in house prices

MORTGAGE 1

MORTGAGE 2

MORTGAGE 3

MORTGAGE 4

M

M

M

M

M

MORTGAGE 5

MORTGAGE 6

AAA

M

M

M

M

M

M

AA+

M

M

M

M

M

M

M

M

M

M

M

M

M

M

M

M

M

M

B

M

M

M

M

M

M

C

M

M

AAA

AA+

B

C

BORROWER 1

BORROWER 2

BORROWER 3

BORROWER 4

BORROWER 5

BORROWER 6

M

M

M

M

ALT A LOANS

M

M

M

M

ABS

FICO(Fair Isaac Corporation) Score Of less than 680

slide10

WHAT REALLY WENT WRONG

THE LEVERAGE MULTIPLIER-HOW IT WORKS

$10 bn

By borrowing $15 for

every $1 of capital-or

leveraging up 15 times-

an investment bank

could turn $10 billion into a portfolio of $150 billion

1

2% drop

$ 3 bn loss

30% capital erosion

0

$150 bn

But leverage also

amplifies losses. When

the value of the bank’s

portfolio drops by 2%,

or $3 billion, 30% of the bank’s networth effectively gets wiped out; reducing the original capital of $10 billion to $7 billion

2

Those losses have

ramifications that go

beyond the bank. If its

leverage ratio

remains the same, the bank may have to cut back its lending-in this case by $45 billion(3 billion x 15). That sudden tightening hurts the economy.

3

0

$ 45 bn cutback in loans

30% on gross portfolio

Sudden tightening/ squeeze hurts the economy

slide11

IMPACT ON GLOBAL CURRENCY MARKETS

SOURCE: THE MINT(THE WALL STREET JOURNAL), OCTOBER 14,2008

slide12

THE “IMPOSSIBLE TRINITY”(TRILEMNA)

FREE CAPITAL

FLOW

FIXED

EXCHANGE

RATE

SOVEREIGN

MONETARY

POLICY

The modeling of real exchange rate and of the current account determination has been, and

remains, one of the most enduring and challenging topics of research in open-economy macroeconomics.

However, until quite recently, the study of the two variables has proceeded on largely

separate tracks. For instance, the typical examination of the real exchange rate relies upon eitherinterest rate and purchasing power parity conditions

slide13

THE “IMPOSSIBLE TRINITY”(TRILEMNA) - POSTULATES

  • FISCAL POLICIES USED TO SUSTAIN EFFECTS OF NOMINAL DEVALUATION OF
  • REAL EXCHANGE RATE
  • MAGNITUDE OF CHANGE IN REAL EXCHANGE RATE DEPENDS ON THE SIZE OF
  • DEVALUATION, THE DEGREE OF FISCAL ADJUSTMENT AND THE MEANS BY
  • WHICH FISCAL DEFICIT IS MANAGED(REDUCED)
  • CHANGE IN NOMINAL EXCHANGE RATE NEEDED TO MAINTAIN THE
  • DEPRECIATION OF THE REAL EXCHANGE RATE WILL DEPEND ON WHETHER
  • FISCAL DEFICIT IS ELIMINATED BY INCREASING TAXES ON TRADED AND NON-
  • TRADED GOODS OR BY EDUCING GOVERNMENT EXPENDITURES
  • REQUIRED DEPRECIATION HIGHER IF THE FISCAL DEFICIT IS REDUCED BY
  • INCREASING TAXES THAN IT WILL BE IF THE DEFICIT IS CUT BY LOWERING
  • GOVERNMENT EXPENDITURE – LOWER IF EXPENDITURE FELL ON TRADED
  • RATED THAN NON-TRADED GOODS
  • IMPLIES THAT AUTHORTIES MUST ENSURE CONSISTENCY BETWEEN EXCHANGE
  • RATE ACTIONS AND POLICIES TO REDUCE FISCAL IMBALANCES IN ORDER TO
  • ACHIEVE A DESIRED-LEVEL OF THE REAL EXCHANGE RATE NECESSARY TO
  • ATTAIN BALANCE OF EQUILIBRIUM
slide14

THE FISCAL-MONETARY-TRADE TRIANGLE

THE GOVERNMENT

FISCAL

POSITION

  • INFLATION
  • INTEREST RATES
  • MONEY SUPPLY
  • GOVERNMENT
  • BORROWINGS
  • INVESTMENT GAP
  • EXTERNAL
  • CAPITAL REQUIRED
  • SURPLUS/ DEFICIT
  • BUDGET
  • INVESTMENT
  • POLICY
  • TRADE POLICY
  • INVESTMENT GAP
  • EXTERNAL
  • CAPITAL REQUIRED
  • REAL RATE OF
  • RETURN
  • EXCHANGE RATE
  • CONVERTIBILITY

THE CENTRAL BANK

  • INVESTMENT
  • POLICY
  • TRADE POLICY
  • INVESTMENT GAP
  • EXTERNAL
  • CAPITAL REQUIRED
  • REAL RATE OF
  • RETURN
  • EXCHANGE RATE
  • CONVERTIBILITY

THE GOVERNMENT

MONETARY

POSITION

TRADE/

INVESTMENT

slide15

FISCAL

  • GDP SIZE
  • GDP GROWTH RATE
  • POPULATION
  • EMPLOYMENT/ UNEMPLOYMENT RATE
  • JOB-CREATION vs. POPULATION GROWTH
  • PCI
  • NET POPULATION GROWTH RATE
  • DEMOGRAPHY
  • SIZE OF BUDGET
  • SURPLUS/ DEFICIT
  • DEFICIT FINANCING
  • NATIONAL DEBT(FISCAL DEFICIT)
  • DOMESTIC
  • EXTERNAL
  • LIMIT ON EXTERNAL BORROWINGS(GOVERNMENT & PRIVATE)
slide16

TRADE

  • EXPORTS
  • PRINCIPAL EXPORTS
  • IMPORTS
  • CRITICAL IMPORTS (FOOD, CRUDE OIL, )
  • NET EXPORTS/ IMPORTS
  • CURRENT ACCOUNT SURPLUS/ DEFICIT
  • FOREGN EXCHANGE RESERVES
  • (BALANCE NEEDED TO MEET CRITICAL IMPORTS)
slide17

MONETARY

  • GDP
  • MONEY SUPPLY
  • OUTSTANDING BANK CREDIT
  • GOVERNMENT INTERNAL DEBT
  • INFLATION MANAGEMENT
  • SECTORS TO BE PROMOTED
  • SECTORS TO BE CHECKED
  • COST OF DEBT CAPITAL
  • LIMIT ON EXTERNAL BORROWINGS
  • EXCHANGE RATE MANAGEMENT(CENTRAL BANK INTERVENTION)
  • CENTRAL BANK SUPERVISION OF FDI AND FII INFLOWS/
  • OUTFLOWS(CONVERTIBILITY
slide18

ECONOMIC CYCLES – IMPACT ON INTEREST RATES, ASSET PRICES

OUTPUT

2017/18/19…?

Peak

2014/15…?

Peak

2000

SLUMP

Contraction

Expansion

2008

Interest

Rates

Rising

BOOM

Interest

Rates

Falling

RECOVERY

RECESSION

Bond

Prices

Rising

Bond

Prices

Falling

Stock

Prices

Falling

Stock

Prices

Rising

TIME

slide19

ECONOMIC CYCLES & VALUATIONS

Error of optimism

PE expansion, Credit too easy, Long term investing, Ends in a sudden shock

Leading sectors fail, credit tightens. General profit environment okay, but PE falls

Boom spreads, widespread prosperity. Markets rise due to earnings

One sector takes off and then entire market follows. Sentiment improves as EPS rises

Money really tight. Fear demand and EPS starts falling

Easy credit, slack earnings

Easy credit to try and kick-start profits

Greed

Buying

Apathy

Panic

Hope

Apathy

Scattered

Buying

Envy

Buying

Fear- Revulsion

BEAR MARKET

BULL MARKET

BUBBLE MARKET

BEAR MARKET

GARP/ Trading

Market

Trading Market

in Bear Rallies

Value

Momentum

Value

•Dividend Yield

•Price/BV

•Replacement Cost

•Reflexivity

• PE/G

• Option Value

•Dividend Yield

•Price/BV

•Replacement Cost

•Payback

•P/E

•EV/EBIDTA

•DCF

•Technical Charts

slide24

LIKE TO GET A SENSE OF USD 2 BN DOLLARS?

Trailer 53’

Pallet- 48” x 40”

CAN YOU DRIVE A 53’ LONG TRAILER-TRUCK?

slide28

DEBT OF THE G7 AND THE US

AND NOW… LET’S GET A SENSE OF THE SIZE OF THE DEBT PILE…

slide29

THE UNITED STATES OF AMERICA

The US Capitol Building, Washington D.C.

Length(North-South): 751.33 feet; Width: 350 feet; Height:288 feet

slide30

CHINA

The Oriental Pearl Tower, Shanghai – 1,535 feet

slide31

JAPAN

Dai-Ichi Power Plant, Fukushima – 860 acres

slide32

GERMANY

Brandenberg Gate, BerlinLength: 213 feet; Height: 85 feet

slide33

FRANCE

The Eiffel Tower, Paris

Height: 1069 feet; Base: 328’ x 328‘

slide34

UNITED KINGDOM

The Houses of Parliament, London

Area: 3.24 hectares(3,48,750 sq. ft.); Principal façade length: 873 feet;

Height(Victoria Tower): 323 feet

slide35

RUSSIA

St. Basil’s Cathedral, Moscow

Area: ( sq. ft.); Principal façade length: feet;

Height(Tower): 187 feet

slide36

INDIA

TajMahal, Agra

Sides of the Octagon: 180 feet(4 long sides);

Height(Dome): 115 feet Height(Minarets): 130 feet

slide38

BUSINESS ENTITIES-THE SEVEN BASIC “TYPES” OF BUSINESSES

Raw Materials

Extract or grow base materials Eg, mining, farming

Infrastructure

Manufacturing

Converting raw-materials to finished goods

Eg, food, electronics, cars

Ports, Airports, Railway Stations, Hotels, Convention Centres, Hospitals

Creating a sustainable superior ROI

Trading

Insurance

Buying and selling products

Eg, Wholesalers, Retailers, Exports, Importers

Pool premia receipts from many to meet claims from a few(accident-event, death, retirement)

Services

Banking

Selling People’s time – Lawyers, Accountants, Doctors, Software Engineers, Telecom, Internet

Accept deposits from savers, lend money to borrowers (business and personal)

slide39

BUSINESS ENTITIES-THE TYPICAL ECO-SYSTEM IN WHICH THEYOPERATE

GOVERNMENT

REGULATORS

STRATEGIC PARTNERS

Capital

Sales

INVESTORS

RATING AGENCIES

Role of Business

SUPPLIERS

Asset use

Cash

Equity Investors

BUSINESS

VENTURE

Products and

Services

COMMERCIAL BANKS

Banks

Return

Costs

EMPLOYEES

CUSTOMERS

INVESTMENT BANKS

COMPETITION

CENTRAL BANK

INSURANCE COMPANIES

slide40

THE FUNDAMENTAL BUSINESS MODEL

Capital

Sales

Asset use

Cash

Equity Investors

Operating

Assets

Products and

Services

Banks

Return

Costs

Globally, a fiercely competitive business environment has prevailed where companies, not wishing to be left out of the race to grow bigger within the shortest possible time, raised both equity and debt capital heavily to fund ambitious expansions, acquisitions and diversifications. It was all about maximising growth opportunities, and financing this was not an issue.

A sudden change in business environment have left equity investors with stuck investments, increase in debt and inventories of companies leading to tight liquidity.

slide41

THE CURRENT ENVIRONMENT

GLOBAL FINANCIAL CRISIS(2008 and after)

■ Massive destruction of capital pool

■ Lack of confidence

■ Poor liquidity in banking system

GLOBAL ECONOMIC CRISIS

■ Recession in major economies

■ Lower growth in others

■ Lower consumption and demand

Capital

Sales

Asset use

Equity Investors

Cash

Operating

Assets

Products and

Services

Banks

Return

Costs

RESULT:

■ Lower Sales and Profits

■ Reduced cash flows

■ Lower Return on Capital Employed

■ Reduced Market Capitalisation

■ Lower Enterprise Valuation

slide43

2013- BEGINNING OF A MAJOR DELEVERAGING CYCLE

STAGES

1) Debt Reduction

2) Austerity

3) Transferring wealth from haves to have-nots

4) Debt monetization

U.S.

Spain

Monetary policy less effective. Where effective, such policy becomes preferred policy

Fall in economic activity and financial asset prices

Transfer of household debt to sovereign debt by monetary and fiscal stimulus- that leads to a recovery

U.K.

France

Nominal interest rates brought down and currency devalued. Exports an important growth driver

Greece

Bubble

Burst

De-leveraging

Leverage Cycle

No

Bubble

Japan

Ireland

Italy

Debt growth accelerates. Private sector savings go down

Typical debt/ income ratios decline as economic activity and financial asset prices improve.

Hong Kong, Singapore

South Korea & Taiwan

China &

India

Canada/ Australia/ New Zealand

Brazil & Latin America

Printing of money/ monetization

slide44

THE GLOBAL ECONOMY IN 2013 – MAJOR TRENDS

  • US Economic Recovery Continues
  • Chinese Infrastructural Expansion

3. The future of the EU

4. Global Currency Volatility

5. Commodities Prices Begin to Escalate

slide45

THE WEB OF GLOBAL CAPITAL FLOWS(EXPECTED)

CHINA WILL CONTINUE TO RECEIVE HIGH FDIs

INFLOWS INTO INDIA COULD SLOW-DOWN UNTIL GENERAL ELECTIONS

THE US COULD WITNESS

LARGE FDI INFLOWS – STRONG REVIVAL OF ECONOMY

0%-1%

1.5%-2%

2.8%-3.3%

Euro Area

Russia, E Europe

JAPAN COULD INVEST HEAVILY IN MENA & USA

U.S.

UK

Emerging

Asia

5.5%8%

Japan

M & P – NEW MAGNETS

Middle East & North Africa

Singapore, Hong

Kong

Philippines

4%-6%

2%-4%

4%-6%

Malaysia

Latin

America

3%-4%

FDI INFLOWS INTO S.A. LIKELY TO BE RELATIVELY QUIET

FDI INFLOWS INTO MENA LIKELY TO INCREASE-MORE FOR RE-CHANELLING

3.5%-5%

Australia & New Zealand

GDP growth

(projected)