Insolvency in Cyprus and China and reassessment of risk

Governments are happy to shift bad debts onto taxpayers, or even better to some other country’s taxpayers. Investors have felt safe that there is no down side, no risk. But two insolvencies in recent weeks may change these expectations and changed expectations are contagious

Since the beginning of the financial crises five years ago, governments all over the world have used every means possible to stimulate their economies. The methods include infrastructure projects, forced loans, lower interest rates, and bank bailouts. They also include promises to “do whatever it takes” in Europe to recent promises to kill deflation in Japan. Perhaps the most famous is the eccentric monetary policies of the United States Federal Reserve—known as quantitative easing or QE. If the measure is global equity markets, the avalanche of free money has been very effective. But if we look at the global economic picture, we might feel differently. The policies have fallen far short of expectations.


Government policy both fiscal and monetary has been effective for equity and bond markets for probably one reason—trust. Markets assume that anytime there is even a hint of a downturn, central bankers and occasionally governments will appear like super heroes and make everything right. Governments or banks can print trillions of dollars. Regardless of the cost, they are happy to shift bad debts onto taxpayers, or even better some other country’s taxpayers. Investors have felt safe that there is no down side, no risk. But two insolvencies in recent weeks may change these expectations and changed expectations are contagious.


The first and most obvious insolvency was Cyprus. At first glance Cyprus looks like an isolated case. Cyprus is a small country. Its economy makes up less that 0.2% of the Eurozone. Its population is about 1,100,000, slightly more than Rhode Island, my home state, the smallest state by land area in the US. Cyprus also looks different because it was running a tax haven for Russian flight capital. The financial sector was seven times its GDP. But this is not unusual. Both Malta and Ireland have similar financial assets to GDP ratios. In Luxembourg the bank assets are a massive 22 times GDP.


Cyprus’s size did not help. Bailing out Russian depositors did not sit well with German and other northern European taxpayers who would be stuck with the bill. Letting a small country’s financial system and economy go down the drain is not a major political liability. Quite the contrary, with many voters it will no doubt be a plus. So a deal was worked out under which Cyprus’s two main banks, Laiki and the Bank of Cyprus, were restructured. Laiki was wound up. Its bad loans were placed in a bad bank while its insured deposits were transferred to the Bank of Cyprus. Laiki’s 4.2 billion euros of uninsured deposits, bondholders, senior as well as junior, will most likely be wiped out. The Bank of Cyprus will be recapitalized, but partially at the expense of uninsured depositors who may take a 60% loss on 10 billion euros worth of assets.


So Cyprus’s problem is solved, except for one thing—risk. Cyprus is not the only country in the European Union (EU) with shaky banks. As part of an earlier deal to stop the ongoing financial crisis, the EU countries agreed to negotiate a Eurozone wide bank banking union. This would have included supervision, resolution and deposit insurance which some consider a minimally sufficient condition to make a divergent monetary system work. But for now this is off the table. So investors in any of Europe’s problem banks both in little countries like Slovenia or larger countries like Spain or Italy might be reassessing their risk.


It also brings into question the European Central Bank President Mario Draghi’s famous promise. Banks will not be saved by whatever it takes. If banks can’t or won’t be saved at all costs, as investors expect, then countries may not be either. This is a massive change. Investors and depositors in unsteady banks may feel the need to flee to safety the next time markets begin to question their solvency. It also won’t be so easy to convince them that everything is alright. All they need to do will be to look at the investors in Cypriot banks to guess their possible fate.


The other insolvency was a bit more obscure but not any less important. For the markets the bankruptcy of Suntech Power Holdings (STP) did come as a great surprise. The cut back on government subsidies coupled the massive Chinese oversupply has crippled the solar industry. The situation got really out of hand thanks market distortions of government support in China, US and other countries, whose politicians were all eager to encourage a nascent technology. The bankruptcy of Suntech was just considered a sequel to the bankruptcy of the US company, Solyndra, which defaulted on a $535 million government loans in 2011.


But the bankruptcy of Suntech was different. This was not some local Chinese company. This was a company whose stock was listed on the New York Stock Exchange. It had issued not only internationally-listed equity, but $541 million in bonds. It was also different because it was the first company from mainland China to go bankrupt and default on its bonds since the bankruptcy of Guangdong International Trust and Investment Corp (GITIC) in 1999. There have been other defaults notably that of FerroChina in 2008 and Asia Aluminum in 2009, but these never resulted in a mainland bankruptcy, probably because of what happened to GITIC.


GITIC was basically the investment arm of the province of Guangdong. Investors assumed that as a government agency its bonds were backed by not only the provincial government, but also the government in Beijing. They weren’t. As I wrote in my book Investing in China, (2002) GITIC was declared bankrupt in a summary hearing by a lower court in Guangzhou. The Chinese assumed that international investors would just take their lumps and that would be that. They didn’t. Money invested in China froze up overnight.


It took months of assurances by the government to restore trust. In the process they bailed out several other investment trust companies which were in the same situation as GITIC. But it was too late for GITIC’s investors. Although it is very hard to actually know, my guess is that they received about 2% on the dollar. Since then China hasn’t repeated the mistake.


Instead the authorities have gone to great lengths to avoid any hint of bankruptcy as I outlined in my recent piece Turning Japanese: Avoiding insolvency. Like their European counterparts the Chinese have bent over backwards to insure investors that there was little or no risk in investing in Chinese companies.


It is not like the Chinese did not try to save Suntech in the usual way.  Most companies seek bailouts from local banks and governments. Suntech was no exception. Last September it received a $32 million loan from the government of Wuxi. It also received loans from the China Development Bank, like other solar companies in trouble.


Before the bankruptcy commentators assumed that the company would receive a $1 billion bailout. Even highly placed and connected Chinese made this assumption. Shi Dinghuan, president of the Chinese Renewable Energy Society and an adviser to the State Council, said “The government won’t let this well-known company enter catastrophe easily.” But like the Cypriot banks, the government did let Suntech go under. They didn’t do whatever it took. The financial cavalry never arrived. The Chinese authorities apparently feel that either international investors will shrug it off or China doesn’t need them anymore. Whatever the reason, the assumptions about risk and the safety of Chinese bonds are basically wrong.


There may be trouble if and when investors wake up to this fact. But it is not just China. The size of the trouble has been exacerbated precisely by the actions of the government agencies like the Federal Reserve which have been doing their utmost to assure investors. By flooding the world with money investors have gone on a hunt for yield. This has resulted in the demand for bonds from some very exotic places. Since 2010, the governments of Mongolia, Belarus, Zambia, Georgia, Bolivia, Tanzania, Paraguay, Angola, Nigeria, Albania, Montenegro, Jordan and most recently Honduras have all been able to issue bonds on global markets for the first time.


The reason why these countries have been barred from credit markets is simple. They weren’t worthy. But now thanks to the Fed, money is pouring in, but where it goes no one knows. It doesn’t always stimulate growth. Problems are already evident in Thailand, Malaysia, Hong Kong, South Korea, Brazil as well as China. While emerging market bonds have been booming, emerging markets have been slowing. While the S&P reached new highs, emerging stock markets suffered their worst drop since 2008. Most Chinese companies are known for steady profits. But now even huge Chinese companies like ZTE, Aluminum Corporation of China and COSCO, China’s largest shipping company, are suffering losses.


Markets suffer their greatest corrections when they realize that their most cherished assumptions about risk are simply wrong. This occurred in 2008 when investors belatedly discovered that sub-prime CDOs weren’t safe after all. As the economic cycle grows increasingly old, it appears that the credit issues are repeating themselves. It is difficult to determine when and what provokes investors to reassess their assumptions, but once the contagion starts it can move very quickly. Investors always feel that they will be able to get out before the storm hits. But these are not stocks that can be sold in an instant. These are bonds which are famously illiquid and at some point it will all end in tears.


(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)


Novartis loses patent battle in SC over its cancer drug Glivec

While a one-month dose of Glivec costs around Rs1.2 lakh generic drugs, manufactured by Indian companies, for the same period are priced at Rs8,000

Swiss pharma major Novartis AG today lost a seven-year long legal battle for getting its blood cancer drug Glivec patented in India and to restrain Indian companies from manufacturing generic drugs, with the Supreme Court rejecting the multinational company’s plea.


A bench of justices Aftab Alam and Ranjana Prakash Desai dismissed the claim of the Swiss firm for getting exclusive rights for manufacturing the cancer drug on the ground that a new substance has been used in the medicine.


The judgement, which was keenly watched by pharma companies across the world, will clear hurdles coming in the way for the manufacture of generic drugs in India for cancer patients.


While a one-month dose of Glivec costs around Rs1.2 lakh generic drugs, manufactured by Indian companies, for the same period are priced at Rs8,000.


Advocate Pratibha Singh, appearing for Indian drug firms Ranbaxy and Cipla which had opposed Novartis’ plea, said that the judgement is a victory for Indian companies as they can now manufacture cheaper drugs so long as there is no patent over a medicine.

“Patents will now be granted only for genuine inventions and not on repetitive inventions. The Supreme Court said there was no new invention in the Novartis' drug,” she said.


She also said there should be no fear that foreign firms would be affected with the verdict since as long as they have genuine inventions, patents will be given to them.


In its judgement, the apex court also held that “imatinib mesylate” used in Glivec is a known substance and Novartis can’t claim patent over the drug for using this chemical.


Novartis had approached the Supreme Court in 2009 against the order of Chennai-based Intellectual Property Appellate Board (IPAB), which had rejected its claim for patent.


The multinational company (MNC) had applied for patent in 2006.


Novartis' claim was opposed by Indian pharma companies, which are manufacturing generic drugs, as well as by health aid activists in the apex court.


They had claimed that the MNC is not entitled for patent and it is indulging in “ever-greening” of patent by simply changing the composition of the ingredients of the drug.


Ever-greening of patent right is a strategy allegedly adopted by the innovators having patent rights over products to renew them by bringing in some minor changes such as adding new mixtures or formulations. It is done when their patent is about to expire.


A patent on the new form would have given Novartis a 20-year monopoly on the drug.


Earlier, the Comptroller General of Patent and Design had denied patent to Glivec on several grounds including its alleged failure to meet stipulations under Sections 3(d) and 3(b) of the Indian Patent Law.


Section 3(d) restricts patents for already known drugs unless the new claims are superior in terms of efficacy while Section 3(b) bars patents for products that are against public interest and do not demonstrate enhanced efficacy over existing products.


During the arguments earlier, Novartis had tried to dispel the impression that its drug would be beyond reach of poor cancer patients due to its high cost.


“The purpose is not to make money from the poor. This is not the purpose, but am I not entitled for patent for our drug? We are fighting the case on principle,” senior advocate Gopal Subramanium, appearing for Novartis, had said.


He had submitted that there should be no cause of concern that the poor would not get treatment and had claimed that 85% of such patients are treated free under its scheme.


India’s manufacturing output growth falls to 16-month low in March

Constant power cuts weighed on the manufacturing sector. Moreover, the volume of incoming new work increased at the slowest pace in 16 months and export orders expanded at the slowest pace in seven months

The country’s manufacturing sector witnessed the slowest rate of expansion in 16 months in March as power outages hampered production activity and decline in new business orders, according to observations made by an HSBC survey.


The HSBC India Manufacturing Purchasing Managers’ Index (PMI)—a measure of factory production—stood at 52 in March down from 54.2 in February.


Constant power cuts weighed on the manufacturing sector. Moreover, the volume of incoming new work increased at the slowest pace in 16 months and export orders expanded at the slowest pace in seven months, HSBC said.


Though the index has remained above the 50 mark, below which it indicates contraction, for more than three years now.


The PMI reading for March showed that manufacturing operating conditions in the country has improved at slowest rate since November 2011.


“Manufacturing activity lost momentum in March, with output growth slowing notably on the back of a deceleration in new orders and power outages,” HSBC chief economist for India & ASEAN Leif Eskesen said.


India’s current account deficit hit a record 6.7% of GDP in December quarter to $32 billion on account of surge in oil and gold imports, besides weak exports, according to data released last week.


Eskesen further noted that output could get a lift in coming months as inventories are replenished. Inventories of finished goods were depleted to meet demand, partly due to the output disruptions caused by power cuts.


Meanwhile, HSBC said even as input as well as output prices increased at a moderate pace during March, the scope for further monetary policy easing remains ‘limited’.


“Encouragingly, input and output price inflation eased.


“Even so, the scope for further monetary policy easing remains limited,” Eskesen said.


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