Sovereign dollar bonds

Many of you might have noticed that the Indian government announced a plan to borrow in dollars in international capital markets. It will be India’s first foreign currency sovereign borrowing from capital markets.

In one short sentence, it is ill-advised. If you thought that the issue of ‘Masala’ bonds (rupee bonds issued for foreigners to subscribe) were safer, that is wrong too. Happy to elucidate. Have done so here.

I wrote about it in my column on the budget published the day after the budget was presented:

One headline that grabbed attention pertains to the government announcing its intention of issuing sovereign debt in foreign currencies. Apparently, India thought of it in 2013 but did not go ahead as the macro fundamentals were deemed dodgy then. But, probably the best time to borrow would be when the domestic currency is undervalued. The Indian rupee in the second half of 2013 was close to being undervalued. Right now, India’s macro fundamentals are not weak, although big question marks remain over the economy’s growth rate, its sustainability and vulnerability to a global stock market correction. In other words, the risk is tilted towards further weakness of the Indian rupee. In 2013, it was tilted towards its strengthening after a hefty correction.

On the other hand, the timing is opportune in another sense because global central banks are back to considering further crazy monetary easing moves. To that extent, raising foreign currency borrowing now is a case of good timing. Another upside is that the government would not be crowding out domestic savings, which have declined in recent years and show no signs of reviving. That is a good thing. [Link]

The above two paragraphs only focused on the micro issue of timing the bond issuance in foreign currency. But, the argument in favour of issuing foreign currency denominated bonds in terms of it not crowding out domestic borrowers is not entirely correct, I admit, because Dr. Y.V. Reddy had pointed out lucidly as to why it is no help to domestic non-sovereign (private sector borrowers).

The argument is this: if India’s safe current account deficit is 2% of GDP and if Government of India borrows from foreigners (it is part financing of the CAD), then the amount available for other domestic borrowers in foreign currency is going to be reduced by that amount. The ‘ceiling’ is unofficially set by the ‘safe’ current account deficit for the country.

Then, on July 9, I wrote more extensively for MINT on the dangers of the Indian government borrowing in foreign currency. [Link]. It might open the door, together with other measures announced in the budget, for greater financialisation of the economy at a time, when its macro-economic health and performance are brittle.

Besides Dr. Y.V. Reddy’s piece, one of the best comments on this subject came from Sanjaya Baru. It is well worth a read.

In this piece, Shankkar Aiyar suggests alternatives to raising dollar resources through sale of sovereign bonds:

Yes, India must raise additional resources and in dollars to finance the aspiration for high growth. Why not raise dollar resources by listing LIC? Why not aggregate surplus land with government into a land bank and call for bids? Why not transfer government ownership of public sector banks and enterprises into an exchange-traded sovereign fund?

The broken world of finance or Does Capitalism need enemies?

I was startled to read these two stories and contrast them with the picture below.

This image file came via courtesy of this website.

This article in Bloomberg gamely tries but fails to make sense of the craze for negative yielding bonds.

Wework floated a debt before filing for IPO! It has been losing money ever since it was founded and it is valued at USD47.0bn!

In contrast,

Regus owner IWG , founded in 1989, has a similar business. It booked revenue nearly twice as high as WeWork did last year yet it has an enterprise value a bit above $4 billion. [Link]

Wework co-founder has reportedly cashed out US$700 million from the company through stock sale and borrowings against shares of Wework. JP Morgan advised him on his sales and it is also advising the company on its debt offering. His shares hold 10 times the voting rights of standard shares. He has properties that are leased back to Wework and he collects millions in rent from Wework! Source: Link

Evidently, he could cash out so much because the company had the chutzpah to issue USD4.0 billion of debt

What a model of ethical capitalism!

It is into this loss-making company with co-founder cashing out such a large sum before IPO that Softbank decided to invest USD 16.0 billion including USD 6.0 billion of new money! The amount was eventually scaled back after partners opposed it.

Blame central banks and their policies for money losing its value and investors losing their heads and eventually, their shirts and trousers.

The real economy does not need rate cuts

The Federal Reserve will announce its interest rate decision tomorrow (Wednesday). Financial markets expect a rate cut of 25 basis points or even 50 basis points. But, William Dunkelberg, Chief Economist at the National Federation of Independent Businesses, beautifully and in very simple language establishes that the real economy does not need interest rate cuts. If anything, credit availability, cost of loans, unmet credit needs are all at near five-decade lows. Read the whole thing here. It is worth it.

It is clear that the Federal Reserve under Jay Powell has really flattered to deceive in respect of decoupling monetary policy from asset prices. Now, it is fully captured, it appears. One still entertains a faint hope that the Federal Reserve Open Market Committee will surprise us pleasantly with some spine.

In a sense, William Dunkelberg’s article really is a succinct capture of all that is wrong with ‘The Rise of Finance’ that Gulzar Natarajan and I had documented.

Who makes recessions in America?

I stumbled upon the website of CMG and Mr. Steve Blumenthal’s weekly missive called ‘On my radar’. He had penned one of his recent letters based on David Rosenberg’s presentation at the John Mauldin’s Strategic Investment Conference. Must attend one of them soon. At least, an impressive array of speakers.

One thing one has to like, admire and envy about David Rosenberg is that in 2011 or so, he switched to being an equity market bull and rode the wave all the way up to 2018. He has again turned bearish now. Full credit to him for such intellectual openness. It requires a lot of discipline and intellectual integrity to be able to switch.

This is a clear case of seeing things as they are likely to be rather than as what one likes them to be. Not easy at all.

The presentation and the slides are, as usual, very informative and perceptive. I have a minor/major quibble about the causality attributed to Federal Reserve tightening for economic recessions in America. That is a false framework, in my view.

Recessions happen not because the Fed hikes interest rates. The Federal Reserve tightening merely confirms that the cycle had run its course. The Fed’s mistake is not that it overtightens but that it does not tighten enough and early. Indeed, what it does is to tighten too late and even then it does too little only. But, that is enough to topple the apple cart of the economy because, by then, it had accumulated so many excesses that it does not need too many excuses to topple over.

So, who makes recessions in America? It is the Federal Reserve and financial institutions that pay little heed to accumulating risk and passing them on to the rest of the society. The Federal Reserve is still the villain but not with its ‘restrictive’ or ‘normalisation’ stance but with its ‘low and easy for long’ stance.

‘Blaming the Fed’ for recessions plays into the hands of politicians and the financial market types who would prefer a perpetual flow of funds at cheap rates. They can earn the returns and pass on the risks to the broader society and taxpayers.

In response to the criticisms that the Fed tightenened and precipitated a recession, the Federal Reserve eases aggressively and keeps rates too low for too long in the next cyle. That is what the Federal Reserve did in 2001-07. The result was 2008. Again, the Federal Reserve has repeated 2001-07 between 2009 and 2017 and the result is likely far worse.

Did the Fed overtighten?

Rosie focused on the Fed overshooting the neutral rate, actually tightening as we go into recession with a combination of balance sheet reduction and interest rate increases (something I’ve also been ranting about).  [Link]

That was from the John Mauldin weekly missive, ‘Thoughts from the Frontline’ published on May 17, 2019 (‘Takeaways from the SIC’). Rosie is David Rosenberg of Gluksin Sheff, formerly North America Investment Strategist (or, Chief Economist?) of Bank of America – Merrill Lynch. That was quite a while ago. He has been with Gluskin Sheff for quite a while.

Look at the very chat (below) that David Rosenberg has presented at the Strategic Investment Conference (SIC) that John Mauldin conducts annually in May:

Financial Engineering and Fed Rates


On this basis, how can one say that the Fed overtightened? In fact, it is fairer to say that it left rates too low for too long. So, despite acknowledging that the crisis of 2008 revealed the flaws of a monetary policy framework that ignored the financial sector, how can one pass judgement on Fed monetary policy under Powell, again ignoring the financial sector?!! Beats me.

In fact, the U-turn that Powell made in December 2018 has once again made the financial sector riskier, more unstable and hence, more vulnerable to a downturn.

The two theorems of Lacy Hunt

First, federal debt acceleration leads to lower, not higher interest rates. This is because the economic stimulus effectiveness ends quickly, but the debt overhang causes weaker business conditions that reduce loan demand.

Similarly, monetary easing eventually leads to lower, not higher interest rates. Debt productivity falls, making the velocity of money decline so monetary policy becomes asymmetric and inefficient. [Link]

He has charts to show that. Notice that they are all ‘hard currency’ countries. Therein lies the clue to the relevance and applicability of his theorems:

Federal Debt and interest rates


Between economic pessimism and market optimism

Through Andrew Batson’s blog (yes, I caught up with quite a bunch of his posts today), I chanced upon this Greg Ip article written in January 2019 at the time of the meeting of the World Economic Forum. Greg Ip concludes that central bankers have to acknowledge that the world economy was not strong enough to withstand the return to a normal level of real interest rates and therefore, must do the following:

Nonetheless, central banks need to proceed carefully: in a low-growth world, a little bit of monetary tightening can go a long, and painful, way. [Link]

Yesterday, while searching for something on the net, I stumbled upon the ‘Weekly Global Economic Update’ put out by Deloitte. The latest edition (14th May 2019) is here. It highlights an important financial stability risk that raises questions over Ip’s preferred monetary policy:

The US Federal Reserve has warned about the risks to the financial system from the sharp increase in corporate debt.15 In the Fed’s periodic report on financial stability, it noted that “borrowing by businesses is historically high relative to [GDP], with the most rapid increases in debt concentrated among the riskiest firms amid signs of deteriorating credit standards.” It drew attention to the fact that, although the volume of corporate debt increased 4.9 percent in 2018, leveraged loans increased by 20.1 percent, thereby boosting the risk profile of the corporate sector. It also said that asset values are relatively elevated and that investors continue to exhibit a high appetite for risk.  ….. It said a downturn could hurt the financial system because of “the rapid growth of less-regulated private credit and a weakening of underwriting standards for leveraged loans.” [Link]

They have quoted from the ‘Financial Stability’ Report of the Federal Reserve Board.

This is the all-important question that monetary policymakers have avoided confronting. If one keeps policy loose for the sake of real economy vulnerabilities, how does one prevent that from feeding through to irrational financial market optimism that does not really square with the real economy weakness or stagnation?

Financial markets do not worry about the numerator (cashflows). They are happy if the denominator (discount factors) is low. In other words, it will worry about the numerator if stock markets are discounting mechanisms. They are not. In casinos, fundamentals do not matter. Only luck and liquidity matter.

With their ostensible purpose of supporting the real economy – for which there is very little long-term evidence – central banks end up lowering risk premiums in financial markets. That, in turn, boosts asset prices, turn them into bubbles, stoke wealth and income inequality (one way to boost short-run stock prices is to cut wages to pay interest on debt taken to finance share buybacks!) and makes the economy even more vulnerable. Then, commentators again call for low interest rates while all that it has done is to boost the financial economy while doing zilch to the real economy.

When will this farce end? It is inconceivable that either commentators or policymakers are unaware of the reality. Are they captured or what else is the reason?