Category: CONCEPTS

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.

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.

HEADLINE:

• The Reserve Bank of India in its Third Bi-monthly Monetary Policy Statement for 2019-20 on Aug 07, 2019 announced a rate cut of 35 basis points(0.35%).

• Federal Reserve on Jul 31,2019 lowered interest rates by 25 basis points(0.25%)

DISSECTION:

The two headlines above indicate that there has been a rate cut by the respective central banks of India and US. So, what is a rate cut? What role does it play in a country’s economy? The rates- policy rate or interest rate is a monetary policy tool mostly under the authority of a country’s central bank either through legal backing or mandate. A policy rate determines the availability and cost of money and credit in the financial system. The various forms of policy rate include Repo (repurchase) rate, Reverse Repo, Marginal Standing Facility Rate and Reserve Ratios(Cash Reserve and Statutory Liquidity). These policy rates assist in a country’s economy to contract or expand. For instance, a cut in the interest rate boosts economic activity through fostering credit expansion. While a rise in interest rate is commonly aimed at curbing inflation, currency depreciation and excessive credit growth.Finally, the central banks may choose to maintain the status quo by keeping the rates unchanged(hold).

NOTABLE PHRASES:

A monetary policymaker can be perceived as Hawk or Dove depending on the policy rate. A hawkish policy primarily favors high interest rate to arrest inflation while a dovish policy involves low interest rates to boost economic growth.