A Curious Case of Net Neutrality

These days’ Indian youth more concerned about Net Neutrality than anything else. Though, most internet users do not have any idea, what exactly net neutrality means, but they are ready to change their Facebook status and send an email to TRAI. Interestingly, the All India Bakchod, who is known for great entertainment not for their knowledge in the field of economics or laws, has released two videos explaining why one should support net neutrality. Talented AIB has been successful to make fun of important issues, while pushing ill-informed users to send email to TRAI.

There are two key issues over net neutrality- one Should companies like Whatsapp and Skype share their revenue with Telecom companies or Not? To answer this tricky question, let’s understand this – In a hypothetical world, there are 5 villages and these villages are not connected with each other. Now Assume a company A (Telecom) has built connecting roads between these villages, by paying millions of dollars in government and investing another million in building infrastructure. Soon after building the road company at (Telecom) starts bus services and it charges Bus fare (Voice and SMS) and road toll (Internet) separately. So basically, the company A has divided its revenue between the Bus fare and Road toll. Now, after a few months, Company B (Whats~app) is launching a new bus service while offering free bus rides to all. Hence, most of customer shifted from company A’s bus service to Company B.

Now please answer Should Company A charge anything from company B? or Should Company start charging more for Road toll (Internet Pack)? While answering the same one should not forget that company B has not invested a single penny in constructing the road neither it has paid anything to the government!

Second, Should Companies like Flipkart or Snapdeal pay to Airtel on behalf of their customers? I think it is not a question of net neutrality, but a question of marketing strategies? To answer this part, let’s consider this scenario, assuming the two companies P & Q have their stores in a village 5 and sells Mobile Phones. The customer has to pay for bus service to R (Telecom). R charges a fixed amount charge of INR X. One fine day, to attract more customers company P announces that it will start paying the travelling costs to or on behalf of its customer!

What do you think, is it illegal on the P’s part to provide free travelling service?

What will happen long run ~ Will Q be out business, if it does not pay on behalf of customer? Most likely No!, Since from the customer’s perspective, it is overall cost that matters, if the mobile price of Q including traveling cost is less than mobile price of P then any rationale customer will buy from Q only. Additionally, since travelling costs will be very low in comparison of mobile cost, it does not make any difference.

One more point, there is not much of difference in a toll-free number and company refunding the internet charges on behalf of the customer. So, when toll-free number does not affect your freedom to call anyone, how come free-website affects your freedom?

This Article (Click Here) gives a heavy dose of economics while explaining why or why not Telecom should be paid by E-commerce and other companies, while this article (Click here) raised the concerned misplaced use of net neutrality. I would also recommend reading Airtel side of the story (Click Here)

At-last, let me clarify, this is a very imperfect analogy. It helps one understand what is going on, but only in the sketchiest fashion. It leaves out very many things that should, under ideal circumstances, have been included. 

Why Euro Pop Up ?

Global financial markets are witnessing classical risk-off sentiments as emerging markets are witnessing broad sell-off in their currencies, which was ignited by Yuan devaluation (Read More). China has devalued Yuan after an alarming decline in its exports, sending ripples to financial markets. Major equity markets witnessed heavy sell off lead by Chinese equity markets(Read More), which fell more 25% since Yuan devaluation.

Historically, the US dollar tends to appreciate against the major currency pairs during such turbulent times. Interestingly, US dollar has failed to live up-to this notion during current crisis. Though, the US dollar has raised sharply against emerging market currencies, but it fell nearly 4% against the major currencies. On the other hand, Gold, Japanese Yen, Swiss Franc and US treasuries surged on safe haven demand. So why US dollar failed to live up-to the expectations? It is because recent volatility and pace of market decline, which do raise major concerns of weak global growth, has definitely created a doubt in US FED member regarding interest rate hike.

Though the movement in the US dollar is unusual, but current piece caters to sharp gains in Euro, especially against emerging market currencies. Ever-since Yuan devaluation Euro has surged nearly 7% against the US dollar and more than 11% against Indian rupee. The recovery in Euro is so strong that it gives a false sense of reversal story in EUR/USD pair, which is still in bearish trend. 

	Before Crisis	24th Aug	Change
US dollar index	97.91	92.62	-5.4%
EUR/USD	1.09	1.17	7.3%
GBP/USD	1.5597	1.5818	1.4%
USD/JPY	125.27	115.89	-7.5%
USD/CHF	0.9751	0.9255	-5.1%
Gold	1090	1159	6.3%
EUR/INR	69.76	77.66	11.3%

Short Background

The Euro has been in a primary downtrend from last one year as it has lost nearly 20% against the US dollar during this period. This fall EUR/USD pair is strongly supported by diverging monetary policy stance between the two major economies. On one hand, the US FED is on the path of raising interest rates, first times after six years. On the other hand, the ECB has kept interest near zero levels and been on a bond buying spree to fuel the growth in the European economy, which has been struggling with weak demand and low inflation.

Case in Point

As ECB pledged to keep interest rate near zero levels, Euro became prime borrowing currency. The market participants started to enjoy positive carry trade by borrowing money in Euro terms and started to invest in high interest paying emerging markets and risky equity investments. At same time, investor remained reckless by keeping currency risk unhedged on expectation of further decline in Euro. Soon after Yuan devaluation, when emerging market currencies started to witness sharp depreciation this carry trade turned negative (Owing the losses on EUR/EMCs pairs). The market participants, who have borrowed in Euro terms, were forced to hedge the currency creating huge but temporary demand for Euros. Hence, the current rally in EUR/USD pair has been majorly due to carry trade unwinding and risk aversion.

Are current levels of EUR/USD pair sustainable?

First, let us understand why major central banks, including ECB, are running ultra-eased monetary policy? The prime target of running ultra-eased monetary policy is to revive domestic economic growth and inflation and secondary favorable outcome is weak currency. A weak currency leads to recovery in exports revenue, which in turn revive the domestic economic activity. The current gains Euro will put further pressure on European economy, which is already surviving on borrowed oxygen. Secondly, the recent economic numbers from US and Europe clearly paints striking difference in economic recovery. US second quarter GDP grew by healthy 3.2%, while German GDP still struggling at 0.4% growth rate.

Finally, the current Chinese crisis has enough fire power to push US rate hike (Read More) on back burner, but the current diverging monetary policy stance will remain intact. Hence in all likely hood, the EUR/USD pair will soon start its southward journey toward 1.10 levels before aiming for target of parity. 

Source : Bloomberg

Chinese Mayhem

On 2^nd bi-monthly monetary policy, RBI governor Mr. Raghuram Rajan has reiterated his stance on currency – The RBI will continue to monitor currency markets to keep the rupee volatility in check. Back then, a currency analyst might have thought that how much more calm markets does he want? The Indian rupee had been trading in a broad range of 63.30 to 64.30 from last four month. Indian rupee had showed remarkable strength among its peers as major emerging currency markets witnessed sharp depreciation. The key reason for the same was substantially improved macro-economic indicators, mainly improved current account deficit and sustained decline in headline inflation and strong FII and FDI flows Then this dream run of Indian rupee ran-into Chinese Mayhem and rest is history.

Short Background:

Since 2005, China has been following a closely managed foreign exchange regime, where in it sets central parity foreign exchange rate every session and the rate is not allowed to move more than 2% either side. The China being a net exporting country could afford the gradual appreciation of Chinese Yuan against the US dollar. With USD/CNY pair falling from levels of 8.27 in July 2005 to 6.06 in July 2014. 

Case in Point:

After July 2014, global markets witnessed key developments which forced Chinese authorities to devalue Yuan. The commodity markets literally collapsed with major commodities falling nearly 50% due to supply glut and weak global demand.  The sharp decline in commodity prices, led by crude oil, resulted in the lower realization of exports. The Chinese exports declined both value and volume as weak global demand continued to put downward pressure on exports volume.

Second major development was substantial gains of US dollar against major currencies. In times, when major central banks were adopting the ultra-eased monetary policy to support their economies; the US FED started to prepare the markets for US interest rate hike. This diverging monetary policy stance resulted in strengthening of US dollar index, which gained nearly 20% from pre July 2014 levels. Since the Chinese Yuan was more or less pegged with US dollar, it also gained substantially against its trading partners. As Chinese Yuan started losing its competitive advantage the export demand started to shift to competitive economies.

Pulling the Trigger:

The Chinese economy, which has been facing structural slow-down amid the lack of domestic demand, came under further pressure amid the consistent decline in export earnings. The Chinese authorities have been highly proactive on both fiscal and monetary front to fuel the growth. The People Bank of China has cut the benchmark interest rate multiple time and lowering margin requirement to increase the investment activity. On the other hand, the government pledging billions of dollar to stem the free-fall Equity markets.

The Chinese authority finally pulled the trigger after the release of July’s export earnings data, which declined more than 8% on Y-o-Y basis. On 11^th August, People Bank of China announced that it will allow market forces to drive the value of Chinese Yuan. As per the new policy the Chinese intervention will be substantially reduce but intra-day movement will remain in a range of 2% from central rate. Interestingly authorities retained the right to set central parity foreign exchange rate, though it will consider the market forces before deciding the central parity exchange rate.

The Major Asian currencies including rupee, witnessed sharp depreciation in line with Chinese Yuan. The offshore Chinese Yuan (CNH), which does not regulated by China, fell more 6% in just three days; sending ripples in major financial markets. During same period, The USD/INR pair also joined the party and gained nearly 2% to its 23 month high levels of 65.23 levels. Though, there is a little doubt that rupee will continue to take cues from movement in Yuan but one must not forget the state of India’s macro-economic conditions. “Right now the street’s running around with its hair on fire, but the storm always passes and Rupee will stand strong on other side”

Can We Trust China?

The current change in foreign exchange policy is win-win situation for China as it will serve two key purposes. One fall in Chinese Yuan would boost the exports and second, Chinese authority maintained that its new foreign exchange policy regime is a move towards free-float currency, which would lead to inclusion of Yuan among the IMF’s reserve currency.

When a cricket team captain dictate bowler on every single delivery, do you trust him when he says “he allows bowlers to set fielding”. Same is case with China – The China has micro-managed its equity markets it would be pre-mature to trust China, when it says it will allow market forces to drive in currency.

Food for thought - In January, Switzerland National Bank had suddenly removed the EUR/CHF floor rate creating ripples in currency markets, which lead to major defaults across the world. But in hind sight, the SNB took the right decision as ECB announced monetary easing program me, hence it would very difficult to protect the floor prices of EUR/CHF pair.  Similarly, the move by Chinese central bank can also be seen as preparation for US interest rate hike.

Source : Bloomberg, People Bank of China

When should FED hike the rate in 2015?

Anyone remotely close to Forex market would know that the timing of US interest rate hike is the most analyzed event in last one year. The US dollar has been the best performing currency ever-since financial markets started to factor in US interest rate hike. To put things into perspective the US dollar index, which measures strength of US dollar against major currency pairs, has gained more than 21% in last 13 months. The US economic recovery has been modest, while other major economies continued to struggle against weak demand and low inflation. The labor market activity has been picking up steam with US unemployment claims falling to 42 year low levels and inflation has been showing modest recovery despite weak crude oil prices. These strong economic numbers allow the US Fed to ponder over interest rate hike, while Europe and Japan are yet to conclude their quantitative easing program me.

Ever Since October’2014 Fed meeting, where in FED finally concluded its bond buying program-me, market participants have been closely following FED meeting statements, meeting minutes and public speech of FOMC members for cues regarding the rate hike. The US Fed, who has bench-marked economic data as the main driver for rate hike, has evolved its stance on rate hike from ‘Considerable Time’ to ‘Patient’ and finally to ‘anytime lift off’.  Along the journey US dollar bulls have cheered every positive economic data pushing US dollar index above 100 levels. (The US Dollar index started in March 1973 at 100 level, soon after the dismantling of the Bretton Woods system)

This dream run of the US dollar was finally halted by so called transitory factors, which pushed US economy into temporary recession. Transitory factor such as unfavorable weather conditions, weak crude oil prices pushed the retail sales and core durable goods order into negative territory. Accordingly, the US FED revised the economic projection downward, but maintained that it will remain on a path of rate hike. The clouds over US interest rate hike deepened amid ongoing Chinese and Greece economic crisis. The US FED had acknowledged that it will remain mindful of the global economic condition before hiking the rates. From last few weeks the tide has again turned in favor of US dollar bulls as US economic recovery seems to have turned a corner. The US economy showed signs of strong recovery with core-durable goods order printing 0.8% growth and unemployment rate falling to its seven year low of 5.3% levels.  The US home sales data has also been beating estimates by sufficient margins, which raises the concerns of asset bubble.

Though, Central Bankers have a habit of backtracking of its own forward guidance (Interesting Read) but they tend to have a strong underlying reason for the same. The US FED Chairperson, Ms. Janet Yellen has acknowledged the economic recovery and prepared the markets regarding a possible interest rate hike later this year. So now the real question is – when should FED hike the rate in 2015? When is right time to apply the brakes; when you are going with the current or against the current? If you can answer this correctly, you would realize that if at all US FED wants to hike interest rate this year than September or October would be an ideal time for raising the interest rates, as US economic growth tends to peak in third quarter.Hence, the economy would be resilient to sustain the interest rate hike without losing much of momentum. Moreover, The US economy growth has shown seasonality trend as it tends struggle in first quarter, which rules out interest rate hike in December 

Source: http://www.federalreserve.gov/, www.BloombergView.com

Chinese Market Crashed – Why you should care!

First Published on 14th July 2015

I’ve never been on Wall Street but I care about Wall Street for one reason and one reason only because what happen on Wall Street matters to Main Street – Ben Bernanke

The Greece crisis has lost its charm to Chinese equity market crash, the financial experts are now more worried about Chinese economic stability than Greece debt crisis. Chinese equity markets just lost nearly 33% in last one month, yet the Shanghai index is up by 23% year till date. So how much does Chinese equity markets lost last month? Any guesses…!! It was just 150% of India’s gross domestic product, yes nearly $3,000 Bn has been evaporated.

The Chinese equity markets started to gain momentum mid of last year with the expectation of monetary easing by the People Bank of China (PBoC). The Chinese economy has been slowing down from last few quarters with PMI numbers remained close of 50, at times below 50, which indicates the contraction in the economic activity. That said, markets seem to neglect what was happening on ground levels and started to gain on expectation of extra-ordinary steps by Government and Central bank to fuel the economy. The Shanghai index rose nearly 150% in just one year period. This astonishing rally came under light of 4 times interest rate cut by PBoC to 4.85% level and increasing participation by the retail investors. The margin trading remained the first choice of the retail investors, who did not think twice to pledge their real estate to invest in equity.

The Chinese equity markets showed the classical quality of bubble, investors keep on buying irrespective of the underlying values of asset. The prices continue to raise despite the significant downward correction in earnings. Apart from announcing market friendly steps government has been involved in cheer leading the stock markets. Hence the government has a major hand in the bubble formation, which is exactly the reason why government has put its weight behind the market. The Chinese government has delayed the IPOs, allow companies to halt trading in their stocks, allowed pension funds to invest in equity markets, the forced brokers on a buying spree, increase the restriction on short-selling.

In these difficult times, everybody wants to ask a very important question. How fire sale in Chinese equity markets will affect the Chinese economy?  To answer the question lets assess the depth of participation of retail investors. Only 7% of the Chinese population is involved in stock market trading, fairly lower than US and Europe. Most of the retail investors have less $15000, exposure to the stock markets. Hence the current level of retail participation should not be a source of worry. The Chinese financial markets are still much closely managed by the government, which gives it enough fire power to stabilize the market in the medium term.

At last, the current situation in China has enough fire-power to push the world economy towards another great depression, but one should not forget how US FED stabilize the markets after the stock market crash in 1987. 

Source : Bloomberg, CNBC

Will Greece Default ?

First Published on 24th June 2015

The China Republic, world’s second largest economy, has been outperformed by Greece, a country on the verge of default. Recent Google search data showed that in the month of June market participants have searched Greece crisis significantly more than a brewing Chinese crisis. The Greece crisis has been at center stage ever since the victory of Alexis Tsipras, who had won the Greek election on the promise of reducing austerity. Mr. Alexis Tsipras believes the EU and IMF must ease the terms of the loan and leave Greece independent when it comes to fiscal policy. On the other hand, the EU and IMF leaders have little faith in the Greece policies and want to implement strict norms to achieve a fiscal surplus.

The Greece has to make a payment of € 1.6 Bn, which it does not has, by Tuesday to IMF to avoid the default. Hence the Greece has continued on its hitherto followed path of negotiating with its lenders to issue a new loan to repay the previous one. First things first- will Greece default this month, or say, this year? From a game theory perspective the answer is ‘A Big No’. From the perspective of Greece, ‘An event of default’ would be a disaster and it would take at-least a decade if not more to regain the confidence of investors. From the perspective of lenders, EU and IMF, ‘An event of default’ might lead to a chain of defaults in Europe, pushing back European economic recovery, which is already breathing on borrowed oxygen. On the other hand, a deal will be a more of a balance sheet transaction than cash Flow. The funds sanctioned by lenders will be used to repay the loan to the same lender. Hence, both the participants have a lot of incentive to avoid default in near term.  

What will happen in the long term? Frankly speaking, Mr. Tsipras has made electoral promises (high pension, high wages and high public spending) which he just can’t not afford. From the political perspective, this case has few things in common with the situation of Aam Aadmi Party in Delhi, where in Mr. Kejariwal had made unrealistic and anti-growth promises just to gain short term popularity. Just like Mr. Arvind Kejariwal has to hike the electricity bills Greece will succumb under EU pressure. Greece political class must understand that it can no longer afford recurring negotiation with lenders and it should start putting growth above the public friendly policies.

For European Union and IMF, it is more of problem of principle than funds as ECB is already printing nearly € 2 bn per day, more than Greece’s current payment. The European Union wants to set an example that an indebted country must practice policies of fiscal discipline, which will result in fiscal surplus. Unlike Greece, other troubled European countries like Spain has running a plunging primary budget deficit, strong growth, rapidly rising productivity, and a burgeoning trade surplus.    

At last, the biggest risk for the financial markets is the reckless behavior of Greece leaders, who believe that EU and IMF just can’t afford a Greece default. A similar state of mind was shared by Dick Fuld, CEO of Lehman Brothers ultimately leading to the demise of the bank.

Source: Google Trend Bloomberg

Whose benefit anyway?

Indian railway budget has been long used for fulfilling political promises, every year government announces new trains and new tracks without considering the financial feasibility. After ages Naredra Modi government announced a railway budget, which actually addresses the operational challenges of railways. The theme of FY 2015-16 budget was centered on improving the operational efficiency, passenger experience and increasing private-public investments.

The government has announced that the passengers can now book tickets 120 days before the date of Journey. The announcement has been a good news for few, who plans their travel in advance and it is irrelevant for someone like me, who plans journey hours before the departure. There is only one clear winner – ‘Indian Railway’. The Advance booking facility has been long used as working capital financing by Airline industry, which is ready to offer hefty discounts for the same. On the other side, the Indian railway does not provide any discounts owing to the fact that it does not have any close competitor.

Indian railway’s top line stood near INR 160,000 Cr for FY 2014-15, the passenger segment contributed just 27% and Goods earnings fetch remaining 73%. Reserved passenger segment fetches nearly INR 12,800 Cr, nearly 8% of the topline. Now to ‘Guesstimate’ advance amount collected by Railway, one needs to estimate the average advance booking. The demand of railway tickets on peak dates can be understood from the fact that confirmed tickets for 29^th August (Rakhi-Celebration) is not available since 10^th May 2015. To understand the advance booking status for a normal day, I have considered journey from Mumbai to Gwalior. In Mangala Lakshadweep Express no confirmed tickets are available for next 80 days (more than two and half month) for 81-120 seats are on an average 50% booked.

If we extrapolate this observation to whole reserved segment even by conservative estimates seats are fully booked for 60 days and for 61-120 day period the seats are on an average 40% booked. As per these estimates railway would have collected nearly advance of INR 2986 Cr (12800*60/120 + 12800*60*0.4/120)/3 Hence at any given day, railway has advance ticket deposit of 2986 Cr. The Railway would have been earning nearly 8% return on this fund, which lead to an earning of nearly INR 66 Lac per day.

Interestingly the Railway would be earning far more than INR 66 Lac per day via advance booking system. As railway issue nearly 30% more ticket than actual capacity under waiting system. Though railway refunds the amount in case of ticket does not get confirmed, but it surely earns interest on the same!

Source: Official Railway Budget  & IRCTC 

Little Respite for Bowlers

Just like any other game governing bodies the International Cricket Council (ICC) has been proactive to increase the viewership of cricket, which is yet to have double digit test playing nations. The game of cricket has evolved all the way from 5 days game to One Day Internationals to 4 hour T20s. The first phase of transmission from Test format to ODI has been effective. The ODIs demand far more viewership than Test cricket. The experts of field believe that T20s would replace ODIs from its number one position.

One of the reasons of popularity of shorter period formats is the spike in the run rates. People seem to enjoy high scoring run chases than low scoring thrillers. Hence a game, which was played equally b/w bowlers, has shifted a lot in favor of batsmen. Watching Sachin thrashing the fast blowers is far more engaging than watching Batsmen struggling against Dale Styen. For a fact, batsmen command far more advertising than bowler across the countries.

Unfortunately, the ICC has made this market trend (that viewers like high scoring matches) as base for its adjustment in the rules. Over past few years ICC has tweaked many rules in favor of batsmen. Only four players outside the circle, a free hit for every no ball (Over-stepping), Playing with two new balls (which reduces the effectiveness of reverse swing and spins). The ICC is not only enemy of bowlers here- even the respective cricket boards of countries have joined the party. The boards regularly favor batting friendly wickets resulting in high scoring matches, which in turn result in higher viewership.

The new rules and favorable playing conditions has shifted the battle between a bat and a ball to a battle b/w the batsmen of two teams. The economy rate (number of runs per 6 bowls) has been on an uptrend in the last five years. To put things into perspective the average economy rate for the period July 2014 – June 2015 has been 5.50, almost 11% higher than the average economy rate of 4.92 for period July 2011- June 2012. Bowling average (runs per wicket) figures have also increased by 13% from 28.92 to 32.89 during the same observation periods. A similar trend can be observed in the last two world cups.  The economy rate of bowlers surged by 12% from 5.03 per over in World Cup 2011 to 5.65 per over in World Cup 2015 despite the fact that World Cup 15 was played in Australia, historically known for lower bowling economy rates. Bowling average in WC 2015 has spiked to just below 33 from a touch above 29 in WC 2011.

Though everybody loved it when AB de Villiers struck a phenomenal 162 off just 66 against West Indies at a strike rate of 245, the ICC has realized that an ever rising run rate can be fatal for cricket. The ICC has now scraped the batting power plays and allowed five fielders in outfield in the last ten overs.  These new rules would be a major relief for the bowling units, which, hitherto, were just playing to get thrashed.