Damaging distortion

The simple truth is that governments are playing a far greater role in the global financial system than ever before. The sorry part is that they are acting badly by distorting markets and information. In short, they are acting just like governments

Economists and financial analysts use tools derived from studies of markets and market economies in the developed world to help predict the future direction of the world economies, but there has been a tectonic change. The rise of Asia, emerging economies and the financial crisis has changed the rules. The simple truth is that governments are playing a far greater role in the global financial system than ever before. The sad part is that they are acting badly by distorting markets and information. In short, they are acting just like governments.

For the past two decades, the Japanese government was the largest purchaser of US government bonds. Although in the long bond bull market the value of the bonds did go up, they did not go up in terms of yen as the dollar weakened. So either the Japanese government was among one of the worst investors on the planet or they were not trying to make a profit.

They were buying US Treasuries in an attempt to keep the yen low. A cheap yen acts as a subsidy to Japanese export industries. So the Japanese government happily lost money, taxpayers' money, in order to subsidise its export industry. The fact that it did not work never fazed the government, because in their eyes it worked perfectly. The Liberal Democratic Party stayed in power for almost 54 years.

Now China is the main buyer of US Treasuries for basically the same reason. They are trying to sterilise the renminbi in order to keep their export industries competitive. The losers in this process are the Chinese people who would benefit by a stronger currency. But they don't matter very much. The ruling Communist Party feels that its policies have been very effective in keeping them in power for over 60 years. So why change?

But it is not just Asian countries making political decisions to protect their export industries that are distorting markets. Now the American Federal Reserve is in on the act. The Fed is now the third largest buyer of US Treasury bills. Like the Asian countries, they are not acting like other market participants by trying to make a profit. In theory they are trying to fulfill their government mandate by trying to increase employment.

Not to be outdone, the European Union created the European financial stability facility to buy bonds of European countries like Ireland, Portugal and Greece. The Japanese and Chinese governments are exacerbating the issue by supporting the Euro to insure its survival as an alternative to the dollar, regardless of the cost. This is the problem.

All of these governments are not motivated by profit, so they could care less about price. Their massive buying power helps to distort the price signals from the bond market by artificially depressing yields. The yields are especially important because they are a direct indication of risk.
But it is not just currency manipulation or bailouts. Governments all over the world are interfering in markets as never before. Sovereign wealth funds are managing ever larger amounts of money, often not very wisely. Their political masters imagine that they have the abilities of George Soros, but often end up like the clients of Bernie Madoff. In the mean time, their decisions send capital where it ought not to be, overvaluing assets and confusing the reality of risk.

Market phobia also extends to state-owned companies. The collapse of Communism and the retreat of socialism were supposed to put an end to these taxpayer subsidised monoliths. They are not only alive and well, but they are growing. All of the world's largest oil firms are firmly in state hands. Large state-owned companies make up four of the top five companies and 32% of the top 50 companies.

China is supposed to have privatised great swaths of its economy to become a land of one billion capitalists, but the reverse is true. Over the past several years, a programme of renationalisation has been going on in China. This process has been exacerbated by the recession, when the capital available to private enterprises dried up. It is estimated that over 20% went under. Meanwhile, state-owned companies were flooded with capital as the state-owned banks opened their vaults to distribute 16.5 trillion renminbi ($2.5 trillion) in loans.

In the past, there were socialist countries like China, and the former Soviet Union, India and Africa, but their effect on the global economy was tiny. Things have changed. The impact and distortions inflicted on the world's markets will continue. They will often be dramatic, because the political motives of governments are far less predictable than the profit motives of business.  Worse, since governments are the law, there are no legal disincentives requiring any degree of transparency for their actions. So the rise of emerging markets will certainly change global markets, but most likely in ways that the markets and those who analyse them do not expect.    

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected])   


Q3FY11 analysis: Maruti Suzuki, Bank of Baroda

Maruti gets hit by higher raw material & staff costs; BoB’s asset quality continues to improve


  •     Net profits and sales were at the lower end of expectations.
  •    The company was hit by higher raw material costs and staff costs. The Rs1,000 per vehicle discounts due to the festive season also had an impact. Staff costs are likely to remain at current levels to sales, the management indicated.
  •    The company also saw adverse currency impact-the yen appreciated sharply against the rupee.
  •    Maruti's capacity has increased to 1.4 million units from April 2011 (from 1.3 million units)-this could help reduce the waiting periods for its 'Swift' and 'Dzire' models, going forward.
  •     In its conference call, it said that it has hedged its euro exposure for the first half of FY12 but kept its dollar exposure un-hedged-and 70% of its current exports are dollar denominated. It has also not taken any price increases on exports.
  •    It has no plans to launch diesel models below the Swift's price point (aroundRs6,00,000) as yet, while competition has already launched diesel models.
  •    Upcoming small car launches by Toyota (March 2011) and Honda (October 2011) could limit Maruti's ability to take price hikes and this could pressure margins.
  •  Maruti's CNG models seem to be doing well. CNG models account for 20% of sales in the cities where they have been launched and an expansion of CNG infrastructure should boost volumes.
  •    What is great about this quarter is that Maruti has been able to defend its market share quite well. Market share was up at 54.3% in Q3 from 51% in Q2 and 50% in Q1. Defending it further may not be so easy and its biggest competitors are likely to be Honda, Hyundai, Toyota, and Volkswagen.

Maruti Suzuki Q3

FY11 Result Highlights

(Rs million)

Dec 09

Sept 10

Dec 10

Net sales








Profit after tax




Excise duty to gross sales (%)




Raw material to net sales (%)




Staff costs to net sales (%)




EBITDA margin





Maruti's share price has underperformed the Sensex quite sharply in the last three months.


  •     Both NII and net profit came in higher than expectations.
  •    NII growth was led by 33% y-o-y and 7% q-o-q growth in loans.
  •   Deposits grew at 31% and 4% y-o-y and q-o-q.
  •    Credit/deposit ratio at 71% is amongst the best in the industry.
  •    Non-interest income moderated a bit mainly due to a huge fall in treasury income. However, forex income was up sharply.
  •    Provisions were up y-o-y but NPL provisions were down 15%.
  •     Net profit growth at 28% is one of the best among PSU banks.
  •    Restructured loans were Rs56 billion, almost the same as in Q2. Overall restructured assets are 2.9% (facility-wise) of loan book.
  •    The bank has confirmed that its total provision will be Rs20.60 billion for pension (annual charge of Rs4.10 billion to be amortized over five years) and Rs900 million for gratuity. A total of 22,400 of its employees participated in the second pension option.


Bank of Baroda

Q3 FY11 Result Highlights

(Rs million)

Dec 09

Sept 10

Dec 10

Net interest income
















Net profit




NIM (%)




Cost/income (%)








Gross NPA

(% of loans)




 Bank of Baroda's shares fell quite sharply over a three-month period and have underperformed the Sensex by quite a margin. However, the shares have started picking up after the results.


The Egyptian aftermath

Money-market rates in developing nations are increasing at the fastest pace since 2008 on concerns that the unrest in Egypt may destabilise the Middle East.

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