ECB Cuts Interest Rates-VRK100-10Nov2011

ECB Cuts Interest Rates

Rama Krishna Vadlamudi, HYDERABAD   10 November 2011
www.ramakrishnavadlamudi.blogspot.com

On 3 November 2011, the European Central Bank, headquartered in Frankfurt, decreased the key interest rate in the eurozone to 1.25 per cent from 1.50 per cent effective 9 November 2011. This is the key rate through which ECB provides the bulk of the liquidity to the banking system in the eurozone.

This is the first policy action taken by Mr Mario Draghi immediately after taking over as ECB president. He had taken over the duties as president of the ECB on 1 November 2011. He replaces Jean-Claude Trichet who served from 1 November 2003 till 31 October 2011.

Update on Eurozone Debt Crisis:

Italian Government’s cost of borrowing has gone up to more than seven per cent as investors are afraid that Italy will be next victim of the eurozone debt crisis. The yield on 10-year Italian government bond has gone up to seven per cent, this is the highest since the formation of eurozone in 1999.

The economic and financial crisis in the eurozone is fast turning into a political crisis with the Greek government in trouble and the Italy’s prime minister, Silvio Berlusconi, saying he would resign after the financial reforms are passed. Talks are going on in Greece to form the next government as the current prime minister George Papandreou is set to resign.

This brief write-up discusses the key policy interest rates of European Central Bank (ECB). The eurozone is now facing a debt crisis after the global financial crisis of 2008 with several EU nations, like, Greece, Ireland, Portugal and Spain facing economic chaos due to enormous public debt, banking crisis and possible economic recession. Some defaults are expected in the eurozone.

Key interest rates of the ECB:

There are three important rates set by the ECB. The most important of them is the refinancing rate of the Main Refinancing Operations.

1. Refinancing Rate: This refinancing rate is considered as the key policy rate of the ECB. Main Refinancing Operation is a regular open market operation conducted by the national central banks (NCBs). Under the MRO, the NCBs provide the majority of the liquidity to the banking system in the euro area (or eurozone). MRO is conducted on a weekly basis and normally has a maturity of one week. The refinancing rate of 1.00%, effective from May 13, 2009 till April 12, 2011, was the lowest in the ECB’s 10-year history. The present rate is 1.25 per cent effective from 9 November 2011.

MAIN REFINANCING OPERATIONS (MRO)
w.e.f.	Refinancing Rate (key ECB policy rate)	Action
9-Nov-11	1.25% fixed	down by 25 bp
13-Jul-11	1.50% fixed	up by 25 bp
13-Apr-11	1.25% fixed	up by 25 bp
13-May-09	1.00% fixed	down by 25 bp
8-Apr-09	1.25% fixed	down by 25 bp
11-Mar-09	1.50% fixed	down by 50 bp
21-Jan-09	2.00% fixed	down by 50 bp
10-Dec-08	2.50% fixed	down by 75 bp
12-Nov-08	3.25% fixed	down by 50 bp
15-Oct-08	3.75% fixed	down by 50 bp
9-Jul-08	4.25% variable	up by 25 bp

2. Deposit Facility: It enables commercial banks in the euro area to park their surplus funds with their respective national central banks (NCBs) at this rate. It is an overnight facility. The present rate is 0.50% from 9 November 2011. (It is similar to Reserve Bank of India’s Reverse Repo rate under its Liquidity Adjustment Facility.)

3. Marginal Lending Facility: It is an overnight facility by which liquidity is offered to the financial sector from the eurosystem. It is a standing facility through which counterparties receive credit from a national central bank at a pre-specified interest rate against eligible assets/securities.  The  present  rate  is 2.00 per cent,  effective  from 9 November 2011. (It is similar to RBI’s Repo rate under LAF.)

Rate Corridor: The interest rates on marginal lending facility and deposit facility normally provide a ceiling and a floor for the overnight market interest rates. Overnight market rates are expected to move within this corridor.

OVERNIGHT FACILITIES
Deposit Facility			Marginal Lending Facility
w.e.f	Rate	Action	w.e.f	Rate	Action
9-Nov-11	0.50%	down by 25 bp	9-Nov-11	2.00%	down by 25 bp
13-Jul-11	0.75%	up by 25 bp	13-Jul-11	2.25%	up by 25 bp
13-Apr-11	0.50%	up by 25 bp	13-Apr-11	2.00%	up by 25 bp
			13-May-09	1.75%	down by 50 bp
8-Apr-09	0.25%	down by 25 bp	8-Apr-09	2.25%	down by 25 bp
11-Mar-09	0.50%	down by 50 bp	11-Mar-09	2.50%	down by 50 bp
21-Jan-09	1.00%	down by 100 bp	21-Jan-09	3.00%	down by 75 bp
10-Dec-08	2.00%	down by 75 bp
12-Nov-08	2.75%	down by 50 bp	12-Nov-08	3.75%	down by 50 bp
9-Oct-08	3.25%	up by 50 bp	9-Oct-08	4.25%	down by 50 bp
			8-Oct-08	4.75%	down by 50 bp
			9-Jul-08	5.25%	up by 25 bp

   Data is as on 9 November 2011                             Data Source:  ECB

Definitions:

European Central Bank (ECB):

The ECB sets the interest rates and is responsible for the single monetary policy of the euro area. It is headquartered in Frankfurt, Germany.

Euro area (or eurozone):

Those EU member states that have adopted the ‘euro’ as their single currency are part of the euro area. There are now 17 European countries which are members of the eurozone, with a common currency, the euro.

Eurosystem:

Eurosystem is the central banking system of the euro area. The ECB and the national central banks of the European Union (EU) member states that have adopted the ‘euro’ as their common currency are part of the eurosystem.

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Note on author: Author is an investment analyst and writer. The views are personal and this is written only for information purpose. The author has a vested interest in the stock markets. Readers are advised to consult their certified financial adviser before taking any investment decisions.

Author’s articles on financial articles can be accessed at:

www.ramakrishnavadlamudi.blogspot.com

Foreign Exchange Losses-India Inc-VRK100-6Oct2011

The Chicken and Master Story*

A chicken is fed every day by its master. At precise times of the day, the master’s wife comes and feeds the chicken. Relishing its daily food smugly, the chicken in its mind establishes a link between the approach of the master’s wife and feed being put into its bowl. The chicken forms an impression that whenever the master’s wife comes, she brings fodder.

Like every story, there’s a twist in the tale.

Finally, the chicken’s run of good luck comes to an end. You may have thought the chicken doesn’t get its food one day. No, on one fateful morning the farmer’s wife comes over and wrings the chicken’s neck.

Yuck, this is really loathsome! Well, that’s how some stories end. In the real world too.

(* This is a favourite story of Bertrand Russell, British philosopher and mathematician of great repute. Source: Sophie’s World by Jostein Gaarder.)

Foreign Exchange Losses

As in the above story, Indian corporate managers have often been fooled by the movement of dollar-rupee currency exchange rate. They made equity investors shaken once again.

The Indian rupee moved between 44.50 and 50.00 during the second quarter of this fiscal year. Prior to this period, the rupee’s exchange rate was stable for about 18 months. So, the finance managers believed that the rupee would remain stable against major currencies, like, dollar, sterling, euro and yen. They formed a general link between the past stability and future movement of dollar-rupee rate.

  

Rama Krishna Vadlamudi, HYDERABAD       6 November 2011
www.ramakrishnavadlamudi.blogspot.com

They were proved utterly wrong when the US dollar appreciated against the euro, etc.; and the rupee lost about 10 per cent versus the dollar.  They could have saved the blushes for stakeholders had they taken appropriate hedging strategies. The finance managers smugly assumed that the rupee would remain in a small range and failed to hedge their forex positions, which cost the companies heavily.

The amount of losses Indian companies are suffering on their foreign exchange exposure makes us wonder what kind of risk management practices they are following to minimize their foreign exchange losses.

There is no doubt whatsoever that India Inc’s understanding of foreign exchange risk is rather primitive. In 2007 and 2008, Indian companies made heavy losses due to unexpected appreciation of rupee against the dollar. At that time, companies assumed that the Reserve Bank of India would never allow the rupee to appreciate against the dollar. The total loss was estimated to be about Rs 20,000 crore at that time for India Inc.

Time and again, Indian companies are unable to measure the exchange rate risk and take appropriate steps to reduce the risk. Maybe, they are playing with stakeholders’ funds in an overconfident way in the foreign exchange market.

Forex losses are on account of exchange rate fluctuations and derivatives transactions involving imports, exports, expenses and foreign currency borrowings.

List of a few companies

Greenply Industries: The company made a forex loss of Rs 11.2 croe and a net profit of Rs 11.9 crore during the quarter ended September 2011. As can be seen from the table below, the company would have doubled its profit but for the forex loss. Interestingly, the company made forex losses in June 2011 and September 2010 quarters also amounting to Rs 4.68 crore and Rs 6.48 crore respectively.

Not only small companies, but big companies too are making forex losses.

Bharti Airtel: During July-September 2011 quarter, forex loss was Rs 239 crore versus forex gain of Rs 249 crore during July-September 2010 quarter.

Sterlite Industries: The company suffered a total forex loss of Rs 466 crore during the second quarter on account of mark-to-market forex losses arising out of foreign borrowings, consumption of raw materials and other expenditure.

Interestingly, these companies have revealed (on their websites and on the stock exchanges’ websites) very sketchy details about the nature of these forex losses. 

Below is a random list of companies which suffered losses on account of rupee’s 10-per cent fall against the US dollar during the July-September 2011 quarter:

Company	Foreign Exchange loss	Net Profit
	Rs crore	Rs crore
Exide Industries	15.0	51.0
Srei Infrastructure	39.0	25.0
Bajaj Auto	95.0	726.0
Bharti Airtel	239.0	1,027.0
Dish TV	30.0	(49.0)
JSW Steel	513.0	127.0
Blue Star Ltd	19.5	(20.8)
Essar Oil	407.0	(166.0)
Greenply Industries	11.2	10.1
Sterlite Industries	466.0	1,744.0

                                Figures is brackets are net losses

 Pattern-seeking animals

Jawaharlal Nehru, independent India’s first prime minister, believed that the Chinese were very friendly and rubbed shoulders with Zhou Enlai; and ultimately we paid a very heavy price when China invaded us in 1962 and delivered us a swift and humiliating defeat.

Likewise, we thought stock prices of real estate companies would go up forever as real estate prices had been rising for long. Real estate companies have been suffering in the last three/four years even as real estate prices have remained stagnant or slightly gone up.

We are pattern-seeking animals. Ancient men observed that the Sun rises in the East and sets in the West. The observation made them to assume that the Sun was going round the Earth until Copernicus discovered that it was the Earth that was going round the Sun.

We are often fooled by patterns in nature and society. We assume what we observed in the past will continue in future also. In the real world, it does not happen. Mostly, historical patterns have a way of not repeating themselves in future.

The financial managers of companies need to have a proper understanding of financial history. They have to expect the unexpected and devise some hedging strategies to protect shareholders’ wealth. Otherwise, we will continue to suffer due to the excesses of these people.

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For author’s latest articles on dollar-rupee movements, just click:

Indian Rupee Falls

Stocks, Bonds, Rupee and Inflation

Note on author: Author is an investment analyst and writer. The views are personal and this is written only for information purpose. The author has a vested interest in the stock markets. Readers are advised to consult their certified financial adviser before taking any investment decisions.

Author’s articles on financial articles can be accessed at:

www.ramakrishnavadlamudi.blogspot.com