Euro Debt Crises - a discussion

This post is in continuation to my previous post "The euro area's debt crisis", below you can find a series of discussion I had with Karthick and Yeshwant.  I thought it is worth posting it for two reason, one, I could register our discussion so that it doesn't get lost, two, I felt the discussion would immensely benefit fellow readers too.  Happy reading :) as always, your comments, thoughts, questions are most welcome.

You didn't talk about the rise of Euro crisis. A Little of history of why Euro? could help. Why some countries opted out/were opted out ? I would like to know was Germany/France hesitant against Euro and if so why ?

The purpose of the write up (Euro Debt Crises) was essentially to highlight the mounting public debt by countries in the Euro zone and gross fiscal irresponsibility by the ECB.  We have discussed enough about the birth of the crises, it all started off with mortgage defaults which ultimately lead to failure of the banking system in the west, and that had a  contagion effect.  Still if you are interested, we can work on a detailed cover story analyzing the birth of the crises, well, “why Euro” is a topic in itself :), could not have done justice with just a para on it.

Well, Germany isn't opposing the Euro publicly, but somewhere the insiders want to dump the Euro as they feel it is an unnecessary financial burden, the fundamental question raised is, why the average German taxpayer should pay for making up the losses of Greece, Spain, Portugal?  which could otherwise be used to fuel their own economic growth.  Some even argue that the weak Euro is the reason behind Germany's recovery :-) (Very political and controversial).

The countries in the Euro zone wanted to leverage the financial strength of stronger Euro nations like that of the Germany and France to raise money from the international markets to fund their budget deficits (which is used for large scale bank bailouts), otherwise it is virtually impossible for Greece or Portugal to raise money at tolerable / sustainable rates of interest, given their fiscal position.

Restructuring a insolvent country's debt. What does this mean ?
 
Sovereign Insolvency is when a country is unable to service its debt obligations.  Restructuring is nothing but revisiting the rate of interest and bond tenure in order to make the debt repayable which would otherwise become a bad debt.

We cannot see this only in the light of Sovereign debts/Fiscal deficits. I guess UK, Italy too run huge deficits. The problem is unequal distribution of wealth and supply [goods, Man power]

Not just the UK, even the US runs mammoth deficits, but the US and UK have their respective dollar and pound to fall back upon.  Since the dollar is considered a global reserve currency, the global trade is dominated by the dollar and pound, hence it is easier for the US to raise money from the international markets to fund its deficits or even print money (though this would result in hyperinflation).  And the Euro was proposed to challenge the virtual monopoly of the dollar and rest is history.

This brings us to the fundamental question, how was the value for Euro as a currency determined ?  How is exchange rate determined for the first time? I understand later, it is the open market operations that determine. Still, How is china able to control it's remnibi internally ? Isn't it a violation to set currency exchanges if they were part of WTO ?

Well, there are primarily two ways by which value of a currency could be determined (This calls for a separate, more serious discussion in itself), one, exchange or market determined which is referred to as free float two, a fixed exchange rate regime also known as Pegged system.  A lot depends on capital account and current account convertibility as well.  Please be informed that interest rates, bond yields have a very important role to play in determining the value of a currency.

If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand (which is what is sustainable in my opinion).  A movable or adjustable peg system is a system of fixed exchange rates, but with a provision to devalue the currency.  For example, between 1994 and 2005, the Chinese renminbi was pegged to the United States dollar at renminbi 8.2768 to $1.  China was not the only country to do this, from the end of World War II until 1967, Western European countries all maintained fixed exchange rates with the US dollar based on the Bretton Woods system.

The China is able to control remnibi internally through open market operations, i.e the Govt would buy dollar from the currency market if it wants devalue remnibi and sell the dollar if it wants the remnibi to appreciate.  This is an internal issue and the WTO has no direct control over open market operations to my knowledge. 

Even India resorts to buying and selling of dollar through the RBI in order to avoid the Rupee from appreciating.  This is much politically motivated, we can have a separate thread to discuss its wide implications.

As in how can they value and devalue their currency just by buying/selling dollars. I am sure there is lot more factors into it like Balance of Payments, etc

Indeed, a country can very much manipulate the value of its currency by buying and selling dollars in the open market, but it is not as easy as said, this is just a stop gap arrangement.  In the long term, the value of a currency is purely dependent on the demand and supply mechanism which in turn is largely dependent on the Balance of Payments.  For example, if a country has strong export growth year on year, the aggregate demand for that country's currency grows in the international market, as a result the currency appreciates and if the vice versa happens, currency depreciates.

Because if that is the case, why does India and other 3rd world countries not go for a pegged system..?

I have clearly said that a pegged system is indeed not sustainable at all, unless and until the economy happens to be export driven like that of China, or if the currency is backed by a cartel of nations like that of the Euro.

A pegged currency makes the system more vulnerable to a Currency Crises, it's consequences are disastrous and unexplainable.  Such crises may result in hyperinflation or extreme deflation.  Therefore, for a domestic demand driven economy like that of India or any 3rd world country for that matter, implementing a pegged system is without a doubt "Suicidal".

China on the other hand has a very strong hold on exports, Chinese products have become household for the West, with such strong export growth and BOP, Current account & Capital account surplus, China is able to afford a pegged system.

Chanakya's Chant by Ashwin Sanghi

Chanakya's Chant is possibly India’s answer to Dan Brown.. :-) Ashwin Sanghi’s “Chanakya's Chant” is as engaging and intriguing as Kalki’s “Ponniyin Selvan”, I am drawing a comparison only for the reason that both being novels with historic reference.  The author’s uncanny ability to make every line exciting as well as enlightening, make us contemplate if authors like Chetan Bhagat are much overrated!! 

The book runs two stories in parallel, one in 340 BC where Chanakya, Chandragupta and how the two of them due to their efforts managed to unify most of India under one king.  Two, story from modern Indian politics that of Pandit Gangasagar Mishra and his protege Chandini Gupta.  The narrative keeps alternating between Chanakya’s efforts to make Chandragupta the emperor of India and Pandit Mishra’s efforts to make Chandini the Prime Minister of India..  The author switches between the past and the present with ease and fluidity, both the stories mesh together effortlessly.

Well, I am not quite sure how much liberty the author has taken with respect to history, on the face of it looks like history has not been mangled with, barring quite a few sub-plots and sub-stories that are too farfetched to be true.  Nonetheless the book makes an excellent screenplay for an action paced thriller, came to know that UTV had already acquired the movie rights for this book.

Chankya's Chant is an eminently readable novel.  Happy reading..

Bottom line – War is Politics with Blood, Politics is war without blood..  Power has always come at a price and the price as Chanakya points out is not just one’s emotions but one’s conscience as well. 

Investments in Purti Power & Sugar legitimate indeed..!!

 

I was baffled by the media reports that alleged 14 shell companies with fake addresses and directors having invested crores of rupees in Purti Power & Sugar ltd in which Nitin Gadkari used to be the chairman besides holding a minority stake (he resigned as the chairman after becoming BJP president).  He was accused of channelizing black money through ‘shell’ companies which amounts to money laundering.  Being a keen observer of politics and corporate scams, I decided to spend some time to understand the money laundering allegation against Nitin Gadkari and investments in the Purti group.  Ultimately I found that media has been misquoting facts and blowing issues out of proportion.  The allegations were NOT based on researched facts or investigation.  The media seems more interested in sensationalizing which only demonstrates their desperation to stay relevant in today’s 24*7 media.  Read on..

The first and the foremost allegation against Nitin Gadkari is the controversial investment of 47.34 cr in the Purti group by 14 ‘shell’ companies that have fake addresses, directors and are ownerless.  A closer look at the Balance Sheet of Purti Power and Sugar Ltd will reveal that the investment of 47.34 cr was made in 2002 and not recently as claimed by the media.  The 47.34 cr which is a little over 85% of the total share capital in Purti which is 55 cr, was made between 2002 and 2006 by a well known Nagpur based business group (The Mehta Group that manages an asset base of over 2000 cr) through 12 of its legitimate companies with real operations and NOT ‘shell’ companies as claimed.  It is worth mentioning that the IT department had conducted a probe in Purti way back in 2006 and has accepted that the 47.34 cr investment made by the Mehtas to be legitimate.            

If the 55 cr investment in Purti is lawful at the time the investment between 2002 and 2006, how come it is claimed to be illegitimate after 2010? 

A comprehensive look into the issue reveals that Mehta group, the genuine investors of Purti have transferred their shares from the 12 companies that made the original investment to 14 of its own ‘shell companies’ in the year 2010.  Please note that the Mehta group has taken ownership of these 14 shell companies and these are NOT ownerless companies as claimed.  Had only the media gone back in time to track the original source of the 47.34 cr in Purti, it would have realized that the investment is indeed genuine and not bogus.  This very fact demolishes the media’s pitch that investment in Gadkari associated Purti are made by ownerless and fake entities.  If the Mehta group decides to transfer 85% of shares in Purti to 14 of its own shell companies, the original investment of 47.34 cr made until 2006 DOES NOT become illicit overnight..!! 

Coming to the 14 shell companies, it is to be noted that these 14 shell companies were not created overnight to transfer the shares, as a matter of fact these 14 companies were owned by the Mehtas ever since 2003-04 and have even been pledged as collateral with nationalized banks as a substitute to Mr. Manish Mehta of the Mehta group.  That being the case, I do not understand on what grounds the media claims that these 14 companies are bogus and ownerless. 

Next question, why did the Mehtas transfer their shareholding in Purti to shell companies?  Read on.. 

Purti has been primarily operating in the backward areas an, as a result it had accumulated losses to the tune of 64 cr by the end of 2009.  Following which the loans sanctioned to Purti were categorized as NPA as per banking norms.  The RBI guidelines stipulate that if one loan becomes bad, all the loans given to the promoter group companies have to be categorized as NPA.  The Mehtas who manage business worth 2000 cr did not want their reputation to go for a toss just because Purti has become “sick”, therefore Manish Mehta effected a pretentious separation of his group from Purti by transferring his share holding to the ‘shell’ companies and pledged the shell companies with the banks as security for further loan.  Now this is a secretarial issue and cannot be considered as illegal or even immoral.  Though the above said restructuring in Purti might bind the Mehtas “morally”, Nitin Gadkari has absolutely nothing to be blamed of, neither moral nor legal.

Three facts are incontestable.  One, the investment of 47.34 crore by the Mehtas through 12 of their functioning companies have been accepted by the IT department as legitimate after thorough investigation.  Two, only the legitimate investment was transferred from 12 functioning companies to 14 shell companies (it is as simple as transfer of money from one pocket to another).  Three, the Mehtas are the true owners of the 14 shell companies which have been accepted by the Banks as collateral on behalf of Manish Mehta, which disproves the allegation that the shell companies are fake and ownerless.

Based on facts, any right minded individual will arrive to the logical conclusion that Nitin Gadkari is neither criminally nor morally culpable for investments in Purti.  Had only our media been a little more diligent and investigated the matter with patience, truth would not have been fabricated as it has been; nonetheless enough damage has already been done to malign the BJP and its national president which will ultimately help the Congress to counterattack the BJP when the issue of corruption is raised.  It is worth to point out that the total shareholding of Nitin Gadkari in Purti is less than a ‘lakh of rupees’.       

Let me confess, I am not a fan of Nitin Gadkari or his style of functioning, in my opinion he has a long way to go to even come close to tall leaders like Atal ji / Advani ji who have dedicated their lives in growing the party from day one and has been successful in making the BJP a viable alternative for the Congress.  However Gadkari‘s hands are clean with respect to investments in the Purti group, therefore there is no need for him to resign as the national president of the BJP just because certain sections of the media have made mindless contentions.  

Note: All the facts mentioned above are based on findings by Shri. Gurumurthy that is available in the public domain.  

Jai Hind