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A MACRO VIEW OF GLOBAL FINANCE

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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A MACRO VIEW OF GLOBAL FINANCE

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  1. A MACRO VIEW OF GLOBAL FINANCE INDRANIL DEB JANUARY 2013

  2. 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

  3. 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.,

  4. 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.

  5. 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

  6. 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.

  7. 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

  8. 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

  9. 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

  10. 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

  11. IMPACT ON GLOBAL CURRENCY MARKETS SOURCE: THE MINT(THE WALL STREET JOURNAL), OCTOBER 14,2008

  12. 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

  13. 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

  14. 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

  15. 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)

  16. 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)

  17. 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

  18. 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

  19. 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

  20. WORLD GDP GROWTH 2007-2012

  21. 2013

  22. POLITICAL ORIENTATION OF RULING PARTIES(COALITIONS) Role of Government

  23. KEY ECONOMIC STATS OF THE MAJOR ECONOMIES

  24. LIKE TO GET A SENSE OF USD 2 BN DOLLARS? Trailer 53’ Pallet- 48” x 40” CAN YOU DRIVE A 53’ LONG TRAILER-TRUCK?

  25. THE BIG NATIONS ARE CARRYING HIGH-LEVELS OF DEBT

  26. HOW GOVERNMENTS PILE UP DEBT

  27. US DEBT GRAPH FROM 1940 ONWARDS

  28. DEBT OF THE G7 AND THE US AND NOW… LET’S GET A SENSE OF THE SIZE OF THE DEBT PILE…

  29. THE UNITED STATES OF AMERICA The US Capitol Building, Washington D.C. Length(North-South): 751.33 feet; Width: 350 feet; Height:288 feet

  30. CHINA The Oriental Pearl Tower, Shanghai – 1,535 feet

  31. JAPAN Dai-Ichi Power Plant, Fukushima – 860 acres

  32. GERMANY Brandenberg Gate, BerlinLength: 213 feet; Height: 85 feet

  33. FRANCE The Eiffel Tower, Paris Height: 1069 feet; Base: 328’ x 328‘

  34. 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

  35. RUSSIA St. Basil’s Cathedral, Moscow Area: ( sq. ft.); Principal façade length: feet; Height(Tower): 187 feet

  36. INDIA TajMahal, Agra Sides of the Octagon: 180 feet(4 long sides); Height(Dome): 115 feet Height(Minarets): 130 feet

  37. KEY ECONOMIC STATS OF THE MAJOR EUROPEAN COUNTRIES

  38. 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)

  39. 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

  40. 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.

  41. 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

  42. FORECAST(AN EDUCATED GUESS) FOR 2013

  43. 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

  44. 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

  45. 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)

  46. Thank you

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