May 2020 – eDubki

DIGITAL YUAN-CHALLENGING DOLLAR’S HEGEMONY?

China’s Central Bank has recently launched an homegrown digital currency as part of its effort to boost up electronic payments system. This also means that China has become the first major superpower to boast of its own digital currency.

According to People’s Bank of China, the intention of digital currency is to limit the cash in circulation with an aim to reign in money laundering and promote digital payments.The trials of digital currency have been introduced as part of pilot project across four cities-Shenzhen, Suzhou, Chengdu and Xiong’an.

The digital currency will have features similar to a “mined” cryptocurrency that uses blockchain technology with distributed ledger . But as the regular blockchain uses decentralized system with anonymity, the digital yuan will be circulated through legal banking channels. The details regarding users privacy remain unclear.

With its research in the area for more than five years and subsequent launch, the digital currency may serve as a key element in establishing what we can term as ‘Chinese might’. A dominant force in global politics and economy, China’s emergence as a leader in global crytpocurrency was but inevitable. The digital currency can be seen as a concerted measure to shore up its efforts to promote Chinese Renminbi(RMB) as an alternative especially to the US Dollar. This can be understood from the following: Firstly, introduction of Chinese Renminbi under IMF’s Special Drawing Rights(SDR) in 2016 alongside US Dollar, Euro,British Pound and Yen. Secondly, use of global financial centres like Taiwan, Hong Kong and Singapore in internationalisation of RMB. As a result of which more and more global indices like MSCI,FTSE have begun to include Chinese bonds and equities. Thirdly, introduction of CIPS(cross border interbank payments system) as an alternative to SWIFT in offering RMB based clearing and settlement services. And finally, the introduction of sovereign digital currency called digital yuan.

As the global economy reels with Covid-19 and a recession as its aftermath, the digital currency move by China can also be seen as a masterstroke in promoting technology as the major enabler in the global financial system. Where does that leave the West and the US? Is it the beginning of an end of USD hegemony? How will the US respond to the challenge?Will there be a Bretton Woods moment in the digital financial system?

As the world stares into uncertainty ,China with the first mover advantage is clearly far ahead than any of its global peers. The Dragon is surely breathing fire.

Recession’20- Is recovery in sight amidst Covid19 ?

The spread of COVID-19 has been unabating so far having accounted for nearly 300K deaths and infecting several millions . If the data sources are to be believed , no other nation with a notable exception of China,Japan and South Korea is able to “fend off” the virus,yet. With no vaccine or cure readily available, the policy makers across the globe are actively looking to lift the lockdowns and encourage “economic activities” with “great degree of uncertainty and fear”.

The new motto: Learn to live with the virus- serves as a perfect prelude to kickstart the economy. The world is facing its worst recession since the Great Depression of 1930s and the governments and policy makers are reeling under pressure to restore the economic normalcy.

Will the recession last for several years or be a quick turnaround? Can the world expect more shocks ? Is there a ‘new normal’ in place? What could be the mode of recovery? Will it be a V shaped or “Swoosh” shaped recovery? As the economies reopen, the answer to these questions would be more clear. Though the early signs of recovery from China pose a little encouraging if not an optimistic picture.

Let’s try to find out the “best possible” recovery method that can be attributed to the global economy amidst COVID19:

V Shaped Recovery: V-Shaped recovery involves a sharp decline in metrics followed by a sharp rebound to the pre-recession levels. With mostly every industry being battered, a V-shaped recovery can be ruled out in the short term.

2. U- Shaped Recovery: U-shaped is defined by a longer trough. This can last several quarters before the green shoots emerge. The recovery is rather undefined than compared to sharp rebound in V shaped recovery.

3. W-Shaped Recovery: W-shaped recovery is characterized by a period of extreme volatility. It can be best summarized as recession-recovery-recession.

4. L Shaped Recovery: The slow rate of growth and persistent unemployment are the hallmarks of a L-shaped recovery. The economy may never be restored to its pre-recession level.

5. Swoosh Shaped Recovery: The recovery best resembles the Nike logo and is characterized by longer duration of economic growth. It’s longer than the V-shaped recovery and slower than a U shaped one.

The massive impact of Covid-19 on sectors like hospitality,airlines and real estate and its cascading effect on many others severely dims the prospect of a V-shaped recovery. As the virus lingers on and the new social distancing norms take effect, the economic recovery might be a painful one atleast in the short to medium run. In these uncertain times one cannot rule out a U or a Swoosh shaped recovery. Or a new lexicon be added to the economic dictionary?BEHOLD!

HACIENDA HEDGE

DEFINITION:

Hacienda Hedge is the world’s largest sovereign oil hedge. Deriving name from its Finance Ministry, Mexico places options bet on the future direction of oil prices. As a private placement(OTC), the deal doesn’t divulge on potentially market disrupting details such as numbers of barrels hedged, the cost of arranging the private options to sell at a fixed future price, and the months in which the future sales are price guaranteed. The only known is the “Price”.

HISTORICAL BACKGROUND:

Despite falling oil production,Mexico’s oil hedge has real economic significance. Its oil revenues still generate over 1/10th of its export earnings. Mexico first hedged oil in 1990, after Iraq’s invasion of Kuwait . The then prices soared from a low of $15.06 to $41.15 in a matter of months. The Mexicans greatly benefited. But the experience from the Asian Crisis of late 1990s caught Mexico unaware and bought Hacienda Hedge into a formal yet ‘secretive’ strategy. As per the reports, the strategy has formally come into force in 2005 and has been a regular feature ever since. The oil hedge on an average covered between 200 million and 300 million barrels.

PRESENT DAY:

While the oil crash in April’20 riled global markets and resulted in setback for many oil economies, Hacienda Hedge proved to be a great boon for Mexico’s finances. The put option of $1 billion with a strike price of $49 a barrel has significantly propelled the nation’s finances and the estimated figure is not too difficult to guess.

BAGEHOT’S DICTUM

DEFINITION:

Coined after the financial essayist Walter Bagehot,Bagehot Dictum states that in times of financial crisis, the central banks should lend early and ‘without limits’ to solvent firms at a ‘higher interest rate’ with ‘good collateral’.

CONTEXT:

The economic havoc created by Covid-19 in the world is increasingly putting more pressure on the global central banks to adopt uncoventional policies to combat the financial crisis. Specifically, lending only to the solvent firms against the collateral and charging a penalty rate not only promotes the efficient allocation of resources but also limits the moral hazard arising out distortionary market practices. The Bagehot’s Dictum, in principle, certainly serve the central banks to limit the adverse effects on economic activities and promote employment.

PAYCHECK PROTECTION PROGRAM:

The Paycheck Protection Program offers a modern version of Bagehot’s Dictum. Under, the CARES Act(2020) passed by the US Congress, Paycheck Protection Program for Small Business Administration intends to provide upto eight weeks of payroll and other costs for the businesses to remain viable.

CONCLUSION:

Even after being in existence for nearly 150 years, the relevance of Bagehot’s Dictum couldn’t have been more pronounced. It continues to guide the modern central banking to this day and more so under exceptional circumstances.