Archive for the ‘ Finance ’ Category

Mario Draghi’s Silent Bazooka

Photo Credit: Spears Magazine

Last week, the President of the European Central Bank (ECB) – Mario Draghi, literally lifted global financial markets by unveiling a new ‘unlimited’ bond-buying programme designed to purchase European sovereign bonds in the secondary market. This decision is sequel to Draghi’s earlier pledge to do ‘whatever it takes to preserve the Euro’; this time around, the ECBs plans were well received by financial markets.

A direct result of this plan is that European banks holding sovereign bonds now have a safety net even if these European countries default on their debts. The markets were quick to understand this and within 24 hours, the share price of Spain’s Bankinter SA was up 6%; France’s Societe Generale – 8%; Italy’s UniCredit – 8%; Britain’s Barclays – 6% and even Germany’s Deutsche Bank was up by 7%. While stocks rallied, Spanish 10-year bonds fell to a 3month low of about 5.82%, indicating increased confidence in the strength of the country’s economy. The Euro also closed higher in currency pairings.

If today’s stock prices reflect the present value of future earnings and cashflows, then the above figures are good for the Eurozone and the global economy as well. The ECBs actions should place a downward pressure on interest rates thereby encouraging demand for credit by both retail and industrial clients. This will boost economic activity. Should this plan be successful, the ECB would have shortened the recession and recalibrated Europe for growth. After all, how are countries in the Eurozone expected to meet their debt obligations if they cannot produce?

According to the ECB, the buying of bonds will be sterilized; implying that every Euro spent will be offset by mopping up equal amounts of cash elsewhere within the financial system. In theory, there is no additional liquidity created and the fears of inflationary pressure in the short term seem to be have been allayed. However, there are a few areas of concern. Sterilization in this case means creating new bank reserves i.e requiring European banks to maintain a higher cash reserve balance with the ECB and paying these banks an interest for these ‘unloaned’ funds. Invariably, banks will be quick to deposit more cash with the ECB at the expense of lending to the real sector – the real engine of growth.

Secondly, the ECB plans to buy only bonds with a maturity period of less than 10 years. This reveals the ECBs plan as a short term tactic rather than the long term strategy needed to solve the economic problems in the Eurozone. Also, the fact that banks are allowed to use the funds tied down with the ECB as collateral when making other risky bets and investments (which could go awry) is worrisome.

That said, Mario Draghi’s silent Bazooka was loud enough to cause ripples as far away as America, where there has been an increased clamour for Fed Chairman – Ben Bernanke to unleash a third round of quantitative easing. Although, the ECB’s plan is not a remedy to Europe’s widespread economic problems, it might just be the strong painkiller that will help restore competitiveness of economies in Southern Europe.

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World Bank Presidency: Who the Cap Fits

This week, the three candidates nominated for the position of President of the World Bank Group (WBG) will be interviewed for the job. Since its establishment 67 years ago, the WBG has been headed by 11 Americans, chosen by the President of the United States (U.S). But for the first time, the ‘selection’ process which was hitherto closed is being challenged.

Going by tradition, Washington has a strong monopoly of appointing the WBG President and is clearly not ready to relinquish its implicit privilege in such matters. However, as developing countries are beginning to play a larger role in the global economy, they are demanding a greater participation at a decision-making level in the WBG. The nominees for the top job are Jim Yong Kim, Jose Antonio Ocampo and Ngozi Okonjo-Iweala.

Jim Yong Kim

Dr. Kim is the man to beat. A South Korean born American, backed by President Barack Obama, Kim seems to have the right balance of qualities. He is the current President of Dartmouth College and a former Director of the HIV/AIDS department at the World Health Organisation (WHO). He co-founded Partners In Health – a non-profit healthcare organization dedicated to providing universal access to primary health care. He has spent a lot of his time engaging the poor directly and was even listed as one of the “100 Most Influential People in the World” by Time Magazine in 2006. He has been described as a very practical man who is at the vanguard of championing social and health justice. Being an outsider who has been willing to critique the WBG in the past, he is likely to infuse some new thinking which perhaps would create a new vision for the future of the Bank.

However, his expertise and experience is narrowly skewed to public health and this has raised prudent concerns in development circles. Also, some of the views expressed in his book – Dying for Growth, appear to be more or less unorthodox. In that book, he criticized corporate led economic growth, arguing that such policies in many cases make the poor in developing countries even poorer. This position has not been well received by Economists as the empirical evidence shows that economic growth has lifted millions of people out of poverty and is in fact strongly correlated with reductions in infant mortality and illiteracy. The WBG certainly doesn’t want a President who is ‘anti-growth’ and this is probably a perspective Kim would have to negotiate with.

Jose Antonio Ocampo

Dr. Ocampo is an even stronger contender. A respected Colombian Economist who has the backing of Brazil, he has served as a United Nations Under-Secretary-General for Economic and Social Affairs and is currently a Professor and member of the Committee on Global Thought at Columbia University. He is best known for reforming the UN Economic Commission for Latin America & the Caribbean as Executive Secretary. Within the Colombian government, Ocampo has held important positions such as Finance Minister, Minister of National Planning, Minister of Agriculture and Rural Development and Chair of the Central Bank board. His policies as finance minister were crucial in helping Colombia to withstand the effects of the Asian and Latin American financial crisis. He is highly respected in academic circles and is a winner of the Leontief Prize for Advancing the Frontiers of Economic Thought.

Ocampo’s experience is incredibly vast and his reputation as a reformer is an enviable one. He has a global perspective and his experience is a perfect blend of economics, government/policy formulation, and finance both in academia and in the real world. The need for reforms in the WBG has been reiterated in development circles and Ocampo is the best candidate for such a tough task.

Ngozi Okonjo-Iweala

Ngozi appears to be the overwhelming favourite. A former Managing Director at the World Bank, she seems to be the ideal candidate who has been groomed for the job. Like Ocampo, Ngozi trained as an economist in top U.S schools, but she went a step further by specialising in regional economic development. She has held multiple positions within the Nigerian government as Minister of Finance, Foreign Affairs Minister and Coordinating Minister for the Economy.

She is best known for negotiating an $18 billion write-off of Nigeria’s debt with the Paris Club of Creditors. As Finance Minister and Head of Nigeria’s Economic Team, she helped instil transparency in the polity and facilitated Nigeria’s receipt of its first ever credit rating. If Ngozi gets the top job, she is expected to broaden the WBG’s development agenda and ‘hit the ground running’ immediately. Moreover, she will command the respect of equally brilliant economists at the WBG.

Ngozi possesses the edge of being well acquainted with the internal workings of the World Bank right from the Young Professionals level to that of Managing Director. Although, being an insider, she might be constrained in carrying out far-reaching reforms within the WBG. She is also viewed as a conventional economist and her tacit support for the removal of fuel subsides in Nigeria without adequate palliative measures is an episode which is still fresh in the minds of her countrymen.

Within the BRICS Nations, she has the backing of South Africa and has even been endorsed by 35 former senior World Bank officials, as well as The Economist and The Financial Times.

The Selection Process Needs Reforms

The voting arithmetic clearly favours Jim Yong Kim if the decision comes to a vote by the WBG’s Board of Governors – thanks to the weighted voting system employed by the Bank. Simply put, voting power is determined by ownership shares and in turn capital contribution. This easily gives the U.S.A a hefty share of 16.45% as a percentage of total votes (see table and link below). Europe, with a collective voting weight of about 30% is likely to support Washington’s candidate in order to maintain the gentlemen’s agreement under which a European gets to run the International Monetary Fund (IMF) while an American heads the World Bank Group. Effectively, both the U.S and Europe wield over 45% of votes. Add Japan (which has 7.89% of the votes and is likely to support the American candidate) to the equation and America has its majority.

World Bank Group: Constituencies, Executive Directors and Voting Status

Country

Vote as % of total vote

United States

16.45

Japan

7.89

Germany

4.51

France

4.32

United Kingdom

4.32

Source: S. Griffith-Jones (2001) 

Evidently, the voting system is flawed and needs as much reforming as the institution itself. The relatively small voting share of low and middle income countries is a sharp contrast to the fact that they represent over 80% of the world’s population and bank membership. This needs to change. Prior to now, there has been a strong rationale for the U.S (being the largest shareholder) to protect its interests by appointing the President of the WBG, but such a monopoly seems trite today, as the global rebalancing of the economic pie is increasingly apparent. The glass ceiling over the leadership of the WBG has to be removed and replaced with a selection process that involves competition, transparency and merit.

Kim’s nomination is actually a smart move by President Obama and suggests a compromise from Washington.  The Obama administration seems to believe that the clamour by developing countries (and largely the East) for greater representation at the top hierarchy of the WBG is manageable, and that it can tack between the demands of the East, the development practitioners and the Republican Party. However, with over $43bn lent out by the WBG in 2011 alone, a critical understanding of the specific problems of development finance is essential for the individual who heads the World Bank. The President of the WBG should command the respect of the major shareholders, be capable of demonstrating leadership which staff support and possess proven credibility on the development front. That person is Ngozi Okonjo-Iweala.

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