Saturday, 1 October 2011

Global Ponzi - IMF, EURO & US Prescription for Debt Woes

What is a ponzi scheme? Wikipedia terms as " fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from any actual profit earned by the individual or organization running the operation."

In simple words " Its like robbing paul to pay peter". This scheme works till you get enough money from new contributions to pay old contributions. The day that is exhausted, its bust.

Now lets look at current debt crisis.

  1. European Banks have lent enormous funds to countries like Greece, Italy, Portugal & Spain. (but then that is normal practice. All governments do that)
  2. If government runs surplus budgets, they reduce debts. (but then someone raises questions, doesn't government have efficient use of resources(read surplus) other than paying back debt?). So governments runs deficits. (blame J M Keynes to a certain level for this)
  3. To cover the deficits, governments borrow more money.
  4. Now this works fine till we have primary surplus that is interest is less than borrowings. If that is breached, then you borrow to pay interest. (In corporate lingo, you need to have Debt Service Coverage Ratio of 1 or more)
Many of the European nations, particularly PIGS have been having huge deficits and their interest costs soaring very high, which do not seem to be bridged by additional borrowing( means unable to service debt).

I have seen such kind of situation in small mircofinance entities, particularly called as co-operative credit societies. In such institution, you will always find that their loan recovery rate is almost 100%. The truth is nowhere near it. These institutions have their books window dressed to appear clean.
The mechanism works like this:

  1. A microfinance institution, MFIN issues loan of 10,000 to Pawan. The interest rate is 2% per month, which translates to 240 in a year. the tenure of loan is one year
  2. At the close of year, Pawan says, he is unable to pay. Now, the MFIN does not want to show any NPA (Non-Performing Asset).
  3. So they work out scheme saying, Pawan paid 10,240 along with interest on last day of financial year.
  4. MFIN issues new loan to 10,240 on the first day of new financial year or last day of current financial year.
  5. Now this happens only in books, there is no actual money changes hands.
  6. The books represent 100% recovery. Balance Sheet is good.
What happened?

  • Income(I) which should have been reduced by non-recoverable 10,000 would reflect (I-10,000) now actually represents no losses and income of 240 i.e (I+240).
  • What is the amount of mis-apprpriation - [(I+240)-(I-10,000)] = -10,240.
  • What happens, if the is revealed or caught? criminal proceedings for fraud, misappropriation.
Now lets look at Debt Crisis:
1) PIGS is running deficit of mammoth proportions.
2) ECB, IMF suggest we should have EFSF (European Financial Stability Fund). The corpus was recently raised to 440 Billion Euro.
3) How are they gonna use it? Leverage the fund to generate the resources of 1.7 Trillion Euro and lend to nations with debt crisis to help repay debt.
4) So the banks, which will get repaid will be eager to subscribe these new bonds issued by EFSF, so that their existing loans get repaid and no losses are booked.

Does that not sound like the Microfinance institution explained above? Yes, only that was at a scale of 10,000 this is magnified by ratio to 1000 times.
So the misappropriation of profits, funds, mis-representation is of huge mammoth scale. and what happens because of this action? Markets rebound, feel confident of overcoming the crisis. reward the parliamentarians who perpetrated this fraud?

The crisis in the first place was because the Governments leveraged their future earnings by having fiscal deficit (deficit financing as called by Keynes). Keynes said, We are dead in long term. so look for short term solutions. So he said, if the economy is not growing, borrow money and spend it in the economy, which due to money multiplier effect grow the economy in multiples of spend and eventually recover that cost incurred from future tax income.
This is nothing but leveraging your future income(cash flow) with current borrowing with expectation that this will be cancelled out.

This theory was fine. Many countries implemented too. Deficits were norm of the day. Only people forgot was this was solution for short term. When that short term ended and long term started nobody cared. Everybody turned the keynes on his head... to cover one deficit another big borrowing program created. to cover that borrowing, still larger borrowing program created...

This works only till you are able to generate future income to compensate for the losses of current borrowings. What happens after that? Then everything crashes..

Are we in this mode now? or there is still steam left to leverage more? and how long will we able to keep on leveraging our assets?

Is somebody asking these questions?

Tuesday, 16 August 2011

Debt Worries, Unusual Problems- Unusual Solutions..

Since 2008, when the economic ills were being treated with generous does of liquidity, the core crisis of debt management was postponed for some time. Now those ghosts of the pasts have come back to haunt those economies.

Visit to any of the European countries, you will realise, how clean the roads are, how well built the infr
astructure is, how well maintained the entire country is. The question that I used to ask everytime is, where do they get such money from? how do they fund these projects? why there are so less people and so many facilities? Tell an European to work overtime (after work hours) & you will find a person scowling. Ask him to pay for his medi-aid and he will scream cruelty.

What they did not realise is that, while creating such benefits for the public, governments used debt route to finance it. These measure did help in increasing the government expenditure, which in turn multiplied the effect on the economy. At the same time, it also created huge liabilities for the governments.

These debts now have become the cornerstone of the current crisis. The governments do not have sufficient monies even to service those debts. They have been over-leveraged.

As the solution for it and they will discuss, how fiscal deficits have ruined the economy. what is not realised is that these deficits were financed to create assets (huge infrastructure), which have no or neglible returns. That was a terrible waste of money. How have they solved it? By pumping more money in the economy, which is again raised by debt.

Now everybody wants to reduce deficits, that too not by raising incomes rather by cutting down the expenditure.... Whatta logic?

You reduce expenditure and that leads to reduction in income (as private investment/expenditure is already in doldrums), this will in turn lead to reduced tax revenues of the government. The government responds by reducing more expenditure. (that's cascading)

After long time, really good move was seen in the markets, i.e. reduction of deficit by combination of reducing expenditure and increasing of revenues. This was done by Italy on August 14, 2011.

Raising revenue is a good option. This was further reiterated by calls from Warren Buffett to increase tax revenues from super rich.

Lets hope, such sense spreads to other European and US economists too. One has to know that you cannot get rich by reducing expenses but by increasing revenues.

Reducing expenses will have multiplier effect on economy. Increased revenues will provide room to governments for maneuvering. Mindless austerity measures will not lead us anywhere, it will just shrink the economy. governments not only need to service their debts, they also need to have planned expenditure.

Saturday, 7 May 2011

Mandatory Cost Audit - A Necessary Devil?

So here comes the NEWS. The government has changed the applicability of the Cost Audit from industry/company-specific to generic.

On one had it marks a good attempt to fill the loopholes in existing policy of applicability of cost audit to various sectors and companies but on other, it calls for raising a basic question - "Is cost audit necessary"?

Of course, (nandatory) cost audit is, still, supposed to be one of the vital bases for formulating regulatory/legal framework relating to price control (like pharma, fertilizers), excise and other levies (like cement,agrochem) and other direct or indirect taxation.

But, as a matter of fact, most of the companies coming under applicability of cost audit, take it just as yet-another-compliance statement (it may be noted that the author is a qualified cost accountant having spent three years at cost audits of various industries). No company would like to dilute the information on the productwise cost component split, willingly. I am neither saying that they are correct nor that they have fullest right not to disclose this kind of information. However, I feel that companies will comply with the requirements of section 233B [cost audit], 201 (1) (d) [cost accounting records] of companies act happily only and only if they feel, it is a "value-adding" activity for the company itself (well, the ICWAI has been stressing that it IS a value additive activity, but in fact, it is nowhere visible from the format and ingredients of the Cost Audit Report.

The cost audit, by its nature itself, is quite different from other forms of financial audits like statutory / internal / concurrent / tax. Financial audits have a well defined rules and framework (like Accounting Standards). However, in case of cost accounting records the methodology and parameters for cost measurement or assessment or allocation or apportionment differ from industry to industry (it even differs in companies of different size, operational area within same industry). The existing set of CAS (cost accounting standards are definitely not sufficient to cover them all. Moreover, the industry-specific Cost Accounting Record Rules need a detailed review and serious make-over with the changing situations.

There are very few countries in the world which have this kind of mandatory cost audit (and the countries where it is not mandatory or it is not at all existing comprise of all sorts like capitalist, socialist and communist). In India, it was made mandatory in line with socialist principles set by our Government in early days with a view to "general good". It had vital importance in the days of pre-deregulations. The Institute made a good attempts of revising the format of cost audit report in last decade. It needs to cover whole gamut of cost optimisation with respect to ensuring optimum pricing and utilisation of countries resources. For example, when the provision covers Cement industry, it is understood that cement is a basic factor of countries infrastructure. But then, the Realty sector also needs to be covered to ensure that the planned benefit of policy which may be based on the cost audit reports of cement companies, are delivered to the society, the ultimate user and owner of the national resources. Likewise, covering consumer electronics seems beyond reason based on the ideas behind the applicability of cost audit.

The point is not to prove the cost audit redundant or useless. It is an endeavour to make it more comprehensive and useful for the nation as well as the corporates (and ultimately the consumer). I think, let's hope that the current move by the Government is the initial step towards the same.....

What do you think?

Saturday, 26 March 2011

RUPAY-- Alternative to VISA & MaterCard

National Payments Corporation will launch India's very own payment card "RUPAY".

Some data on it:

Name: RUPAY (earlier "IndiaPay")

Conceptualized by: Indian Banks Association (IBA) on instance by Reserve Bank of India (RBI)

Designed By : Ernst & Young

Logo By: Ernst & Young

Number of participating Banks: Ten (10)
All done through: NPCI National Payments Corporation of India

NPCI setup in : 2009
All 6 Public sector Banks, 2 Private Banks & 2 Foreign banks own stakes in this.

Amount paid to international cards in 2010 : INR 5 Billion (500 Crore)
Percentage of domestic transactions : 90%

Debit card transactions in January 2011: INR 37.12 Billion (3712 Crore)
Credit card transactions in January 2011: INR 69.35 Billion (6935 Crore)

Leverage : National Financial Switch