The Connectere brings forward the mind’s eye and panoramic view of the young writing enthusiasts on various topics

Category: Economics Page 1 of 12

Paris Agreement

Where is India in Paris?

Built on the foundations of the United Nations Framework Convention on Climate Change (UNFCCC) and the Copenhagen and Cancun Agreements, the Paris agreement requires all countries irrespective of being developed or developing—to make significant commitments to address climate change. Adopted on December 12, 2015, it is seen as a great inflexion point since, at present, every nation on this Earth have adopted the Paris agreement to keep the global average temperature rise well below 2 degrees Celsius. This clearly brings to light the necessity of addressing climate change, especially now when there is this eternal race of blindfolded development and growth that we are turning away our eyes from the quintessential resources that support and sustain our life. 

The Mexican Crisis of 1994

The Mexican peso crisis, also known as the tequila crisis, is a slang term used for financial fallout resulting from the Mexican economy. It was one of the first major currency crises in the South American continent. The value of the Mexican peso almost collapsed as a result of this crisis. The number of foreign reserves the country had, rapidly decreased to extremely low levels and in the end, the Mexican government had no other option left so they required a bailout to save the country from this crisis. Foreign investors that had invested in Mexican bonds ended up losing 15% of the value of their investments in a single day and over 40% of the value in the long term. These rates look disastrous considering that bonds are fixed-income investments and losing money on bonds is considered to be a very rare possibility. So, what led the nation to this nightmarish disaster? Let’s delve into it. 

Currency Mismatch

The Mexican government witnessed a significant currency mismatch on its balance sheet. This meant that even though the Mexican government earned all their income in peso, they had taken a major section of their debt in US dollars. Mexico had a fixed exchange rate system, meaning that the country had fixed the value of its currency with respect to the US Dollar. This meant that the Mexican Central Bank would carry Forex operations to keep the value of their debt stable as compared to the United States. Hence, they needed dollar reserves to conduct these operations and therefore did not have the dollars to pay off their debt.

Maturity Mismatch

Along with the currency mismatch, the Mexican government also had a serious maturity mismatch on its debt. This indicated that a huge amount of debt was due and could not be paid because the government did not have sufficient reserves. Hence, in 1994, the government owed $35 billion including interest and principal payments, despite only having $6 billion in reserves which frightened the Mexican officials. Further, the Mexican government had already taken so much debt that it could hardly finance any more deficits by borrowing further money.

Current Account Deficit 

Mexico also had a huge current account deficit which meant that the level of importing of goods and services was greater than the exports. This deficit was largely funded by portfolio investments in the Mexican stock market. In the short run, it seemed to be safe. However, portfolio investment can leave countries within a matter of minutes. So, it was not at all a safe option to finance something as crucial as current account deficits. The Mexican government paid the price of this blunder later as it saw a huge exit of capital and had no resources to finance its deficits.

Political instability

The political condition in Mexico was not at all good as there were a lot of high-profile kidnappings going on at that time which made the investors feel very scared. Along with that the assassination of a Presidential candidate sparked fears amongst the investors. This made investors think that the law and order situation within the country had broken down. The media started making theories about the intensity of the situation and investors in the foreign exchange market started exiting the peso market as quickly as they could.

Increase in the US interest rates

During the late 1990s, the US had raised their interest rates. As the US was considered the most powerful economy in the world, so the investors who had kept their money in other parts of the world including Mexico thought it would be a better and safe option if they will move their money to the US as they were getting a better return there and they did not have to experience the risks that the Mexican economy brought along. Therefore, they took their money from Mexico and put it in the US and this further triggered the crisis.

Tabular representation of the crisis

Impact of the crisis

The Mexican financial crisis of 1994 was one of the most serious setbacks the country faced in its history. With the devaluation of the Mexican peso, the country witnessed a severe recession. Till 1995 the country’s GDP declined by 6.2%. The economic hardship caused by the catastrophe was tremendous as the income levels and imports dropped, economic growth stagnated, unemployment rose to high levels, inflation reduced the buying power of the middle classes, poverty increased substantially and even the social fabric of the society was stretched thin. In addition to this, the investment that might have been used to solve social issues and poverty was instead being used to pay back the debt.

Response to financial crisis

With the assistance of the United States government, Mexico was rescued from this situation and the circumstances began to recover in 1996. This is because Mexico imported American goods in a large proportion. Mexico also shared a long borderline with the United States, and political disturbances there could sooner or later enter America. Therefore, the American government by some means managed a $51 billion bailout so that the severity of the crisis in Mexico reduces. In return, Mexico had to keep their oil reserves as collateral. Moreover Mexico had to face several restrictions which were imposed by investors, such as following strict monetary and credit growth policies till the whole of their debt was paid off.

Conclusion

The Mexican Tequila Crisis was triggered by a combination of various factors which include poorly carried out reforms, a fixed exchange rate system, current account deficits, an increase in interest rates in the US and social unrest, which finally led to both a currency and banking crisis. The intensity of the crisis was reduced and further destruction was prevented with the help of the US and the IMF. If they did not intervene then the situation could have gotten worse as the banking sector, which was already in a bad shape, would have collapsed. The Mexican debt crisis is therefore a perfect case study of what can go wrong when countries try to keep false high-level Forex rates with the help of open market operations of their Central Banks.

https://economics.rabobank.com/publications/2013/september/the-tequila-crisis-in-1994/

https://www.managementstudyguide.com/mexican-currency-crisis-tequila-crisis-of-1994.htm

This article has been written by Divyansh Kaul, studying Bcom. hons. at Shri Ram College of Commerce, Delhi University.

NPAs

Lakshmi Vilas Bank and NPAs

The economic fallout of the coronavirus pandemic is expected to push up non-performing assets of the banking sector. To support the statement, I‘d like to point out that recently Reserve Bank of India (RBI) has stated that the estimated ratio of gross NPAs may rise to 12.5% by March, 2021, which might happen according to a baseline scenario. To explain is better, NPAs are non- performing assets which are a sort of loan or advance for which the principal or the interest on the same, is not paid and remains overdue for a period of 90 days. Usually, banks are required to classify NPAs further into substandard, doubtful and loss assets.

It’s known for a fact that India’s NPA ratio is one of the highest among comparable countries. After failure stories of IL&FS, Punjab & Maharashtra Cooperative Bank and DHFL, and the bailout of Yes Bank, the Reserve Bank of India has announced a decision to impose a 30-day moratorium on Lakshmi Vilas Bank Ltd. commonly known as LVB. Thus, the curious case of Lakshmi Vilas Bank is very important to look at. It is an Indian private sector bank established a century ago in Tamil Nadu. As of November 2020, the bank has 566 branches across 19 states and 1 union territory. 

The RBI that LVB’s branches and deposits of Rs 20,973 crore, has undergone a steady decline with perennial losses over the last three years, ending up only eroding the bank’s net-worth. Almost 1/4th of the bank’s advances have turned out to be bad assets. It posted a net loss of Rs 397 crore in the September quarter of FY21, as against a loss of Rs 112 crore in the June quarter. Its gross non-performing assets stood 25.4% of its advances as of June 2020 (a year ago it was 17.3%). It had low levels of liquidity and with continuous withdrawal of deposits; the bank has not been able to raise adequate capital to address these issues. Serious governance issues in recent years have led to “deterioration in its performance”, as of a statement by RBI. Eventually a draft amalgamation scheme of Lakshmi Vilas Bank with DBS Bank India was passed by RBI. This merger would result in write-off of paid-up share capital and lastly delisting of Lakshmi Vilas Bank from all stock exchanges.

So what went wrong? Let’s have a flashback. 

2016

The problem initiated when all its focus shifted from SMEs to large businesses. One of the loans soon turned out to be a bad loan given to former promoters of pharma major Ranbaxy and Fortis Healthcare, of Rs. 720 crores.

2018

A Delhi branch of LVB was sued to recover fixed deposits worth about Rs 800 crores that the bank invoked to recover loans to the Singh brothers. 

2019

RBI put LVB under Prompt Corrective Action (PCA) due to which it was not able to issue fresh loans or open a new branch anywhere. Soon the board members of Lakshmi Vilas Bank approved a merger of the bank with the country’s 2nd largest housing finance company i.e. the Indiabulls Housing Finance Ltd. The latter’s shareholders were to receive a 90.5% stake in the consolidated entity, which were to be called Indiabulls Lakshmi Vilas Bank, but all went in vain as the RBI objected to the merger proposal.   

The dream catcher of every small depositor is the DICGC aka Deposit Insurance and Credit Guarantee Corporation, an RBI subsidiary. It gives insurance cover on up to Rs 5 lakh deposits in banks. This assures that the financial system is safe and sound but time and again the failures have wavered the confidence of depositors. However, are NPAs in the banking sector expected to accelerate? This is exactly where we started. The pandemic has affected the cash flows of people and of the companies. Absolutely, NPA’s will differ sector-wise with IT and pharma to lose less than tourism, aviation etc.  

Together with a moratorium placed on Lakshmi Vilas Bank and maximum permissible limit for withdrawals at 25,000 per depositor, the bank is facing a 55% dip in share prices as of last week of November. 

coffee economics

The coffee economics

Your daily cup of coffee definitely has a whole lot more going for it than providing that early morning pick me up. World’s third most popular beverage, after tea and water (yay for our tea lovers!), and second most traded commodity after crude oil, coffee is a significant and pervasive economic driver. Surprisingly only a few know how much this crop wields. Should you lose sleep wondering if your favorite beans are going to disappear in the future? Not yet. Although, we do need you to grab a cup of your favorite brew while we explain just how important the coffee industry is to the world’s economy.

The last decade witnessed the value of the global coffee industry rocket. It almost doubled to a whopping $90 billion [3]. A recent study showed that more than 2 billion cups of coffee are consumed everyday worldwide [4] and the coffee market is expected to grow at an average rate of 5.32% between 2020 and 2024 [5]. The demand for coffee today is mostly driven by the younger generations who are more than willing to spend a few extra bucks on unique and premium coffee experiences. With the global demand for coffee increasing at a rapid pace as more and more consumers show a thirst for coffee craftsmanship, you must be of the opinion that it would be an ideal time for the coffee farmers. But it’s not! The entire communities around the world with their rich histories are very much struggling. 

The coffee crisis

Coffee may be the constant of some of our lives, but its industry as a whole is often deeply in troubled waters. As much as 20 million small farmers across the tropics, from Mexico and South America to Africa, India, and Vietnam, heavily rely on their coffee harvest to survive. They’ve known crises for 30 long years and still scientists believe a global coffee crisis is imminent. Forces are combining to create a crisis that even higher prices alone won’t fix. 

The year 2019 was declared another economic coffee crisis. World’s number 1 coffee producer, Brazil over supplied coffee to such an extent that market prices went below the minimum prices that a farmer needs to break even. According to BBC [1], by May 2019, coffee prices reached their lowest in over a decade at $0.88 per pound.  While our fancy lattes and cappuccinos cost us a good few bucks, farmers on the other hand suffer a great deal due to the market fluctuations.  As much as 60% of coffee farmers in Guatemala, Nicaragua, El Salvador and Mexico reported food insecurity during the harvest cycle in the previous decade, according to a paper published by the Specialty Coffee Association of America.[2]

Owing to decades of instability and economic shocks, the production of coffee fell from 15000 tons in the late 1980s to just 500 in 2017 in Zimbabwe.[7] In addition to the collapse of the country’s national economy, they also  witnessed knock-on effect of low yields of high quality coffee, leading to limited economic returns for farmers.

On top of the ups and downs that the market forces cause, climate change is threatening the existence of the very plant where our all-important daily brew begins. Coffee, a very high-maintenance plant, thrives in a very narrow temperature window- too cold and the berries will freeze, if it’s too hot, the berries don’t grow properly. Farms in Indonesia and other coffee-producing countries tend to sit at a particular elevation where the ideal temperature range can be sustained. But the temperatures are changing around the globe rapidly. Temperatures in Colombia’s coffee region have risen more than 2 degrees Fahrenheit since 1980. Climate change has also made rainfall patterns less predictable and caused favorable conditions for coffee rust, a fungus that can devastate an entire crop. To top it all, experts predict climate change could cut the land suitable for Arabica coffee production in half by 2050 [6], eradicating both coffee and livelihoods and causing havoc down there.

Trade and economy

With the boom in demand for coffee in the last decade, it has surely become one of the most volatile investment tools to trade. While some use coffee futures and options to hedge their portfolio, others speculate. As the global consumption of the bean continues to grow steadily, many artisanal coffee shops are rapidly cementing their place in modern society’s retail business. As an important dietary staple, this agricultural commodity has spawned a large economy of its own. One of the largest importers of coffee, the United States of America alone is economically impacted by coffee by more than $225 billion, which is approximately 1.6% of the country’s GDP. The coffee industry in America alone employs more than 1.7 million people. And that’s just one country! Imagine the numbers for other larger importers of coffee like the European Union, Japan, South Korea and Canada amongst others. By now even you would agree, coffee commodity prices play a very important role in our economies. 

When choosing to trade this commodity, it is important for investors to decide on the coffee bean type. The two popular varieties are Arabica and Robusta. Arabica coffee accounts for more than 70% of the coffee in our markets and is typically the more expensive to purchase, out of the two. While these beans are of higher quality having a smooth and lighter taste, Robusta beans are stronger bitter due to their higher caffeine content. Due to its high caffeine composition, Robusta beans are more in demand and usually trade at higher prices. Both these coffee beans are traded as options and futures contracts on New York, Singapore and London stock exchanges amongst others.  

One of the easiest ways to trade coffee is with CFDs. A contract for difference is a contract between a trader and broker in order to try and profit from the price from the price difference between opening and closing trade prices. The buyers are liquid when they purchase CFDs as they are not tied to any asset. They have just purchased the underlying contract. It saves the investors from the inconvenience of buying and owning the commodity physically. In addition, CFDs give the opportunity to trade coffee in both directions. Regardless of having a positive or negative view of the coffee market forecasts and predictions, investors can try to profit from both upward and downward future price movement.

So is coffee a good investment? For starters, just like any other asset, trading coffee gives no guarantee of higher returns. Nevertheless, for years, this agricultural commodity has attracted attention from international investors and traders who wish to add substantial growth and diversification to their portfolios. Coffee as an investment allows investors to diversify their portfolios. In an equity only portfolio, investors are able to lower the volatility due to the absence of correlation between this commodity and other asset classes. It also serves as a safe haven in times when markets are turbulent, thereby providing protection against inflation and declining currencies.  

The way forward

Not every investor is comfortable with commodities markets, but there’s no denying that coffee futures are here to stay. We believe it holds potential in great abundance. But we need to spare a thought about those who grow the bean which we trade and make profits. While major changes to infrastructure or more than a decade long-established practices are never easy or straightforward, investment to revive coffee industries can help struggling regions to not only face today’s challenges, but also be prepared for the future and grow. Collectively, we can and should help vulnerable communities to unlock the enormous potential of coffee – restoring local economies and sustainable livelihoods, while preserving the future of some of the world’s rarest blends

 

References-

[1]  https://www.bbc.com/news/world-us-canada-48631129

[2] https://scaa.org/PDF/SCAA-whitepaper-blueprint-end-hunger-coffeelands.pdf

[3] https://www.ft.com/content/5009be96-7569-11e9-be7d-6d846537acab

[4] https://www.britishcoffeeassociation.org/coffee-in-the-uk/coffee-facts

[5] https://www.britishcoffeeassociation.org/coffee-in-the-uk/coffee-facts

[6] https://www.independent.co.uk/life-style/food-and-drink/coffee-rare-luxury-peruvian-farmers-climate-change-fairtrade-leaf-rust-disease-a9127266.html

[7] https://www.telegraph.co.uk/business/2019/05/08/coffee-key-perking-zimbabwes-battered-economy/

Read other articles in this series:

  1. The Hidden Economics In Fashion
  2. The Economics of Food Technology

 

 

Food tech

The Economics of Food Technology

“Are you hungry, just order online”- has become a trendy catch line in today’s time. Technology has made our lives simpler and this holds true when it comes to food. The delivery of meals on a tap just reflects how technology is changing our lives. Technology has revolutionized nearly every industry on this planet. Food industry doesn’t remain unaffected by the technological revolution. The industry has the largest consumer base in the world. Despite the economic changes, the food industry won’t lose its consumer base, which makes it an attractive proposition for tech enthusiasts. Technology can revolutionize this industry as well. Digitalisation can help in production of food at a larger scale, improve accessibility and ensure sustenance of edibility. Food technology has already impacted in many ways- food tech startups like Zomato and Swiggy have become excessively popular.

Fashion

The Hidden Economics In Fashion

It is aptly said, “Fashion is a way to say who you are without having to speak.” But when it comes to the industry blooming under the name of fashion, it is loud enough to be a glorious global affair worth $2.7 trillion, with a lot of hidden economic undertones.


The ripple effects fabricated by technology, globalization, creative business models, demographics and social media have resulted in almost double the fashion production process in the past 10 years, greater credits to the flourishing middle-class shoppers across the globe, thereby increasing the per capita sales and claiming a huge segment of the economy. The pace of change, the occurrence of short-lived replaceable trends and the evident mutation of styles thus highlight the essential economic undercurrents involved.

Prison

Prison Economy

Law and justice is one of the pillars of any democracy, with increasing crime rate, drug trafficking and immigration, human storage is one of the challenges for any government. Prisons have evolved from detention centers for criminals to a vibrant place involving sports, learning centre, etc. Today’s prison is no less than a small economy. There can be a check on the conflict between objectives and reality, but in this article we will explore the functioning of private prisons. 

tax havens

Economics of Tax Havens

You have been successfully running a business in the United States, since a few years now, and earning hundreds of thousands in profits. Yet, every time the company closes its accounts, you feel blue as you see a big chunk (21 percent) of the profits being taken away in the form of corporate tax! It’s not hard to understand why you feel the way you feel. No one likes to see their hard-earned money being given away to the government, while you’re left with a mere fraction of you thought you were working for. But, what can you do, right? You can’t get away with not paying taxes; that’s tax evasion, it’s illegal. However, you come across a news article stating that Apple, a trillion dollar company, pays less than 1 percent in effective tax rate! And your only question is, “How?” Well, it is through the (legal way of) economics of Tax Havens.

Page 1 of 12

Powered by WordPress & Theme by Anders Norén

Get all updates from The Connectere. Sign up below

The Connectere publishes new content daily. It ranges from articles to podcasts and news analysis. To not miss out on these updates, sign up for our email newsletter. We promise we don't ever spam. (Once you put in your email, you will need to go and confirm the subscription from your inbox once)

Subscribe!