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Showing posts with label UBS. Show all posts
Showing posts with label UBS. Show all posts

Saturday 25 August 2012

The Libor fuss!

The story behind the Libor scandal


Logos of 16 Banks Involved in Libor Scandal - YouTube


SINCE the outbreak of the Libor scandal, readers' reaction has ranged from the very basic: What's this Libor? to the more mundane: How does it affect me?

Some friends have raised more critical questions: Barclays appears to have manipulated Libor to lower it; isn't that good? The problem first arose in early 2008; why isn't it resolved by now? By popular demand to demystify this very everydayness at which banks fix this far-reaching key rate, today's column will be devoted to going behind the scandal starting from the very basics about the mechanics of fixing the rate, to what really happened (why Barclays paid the huge fines in settlement), to its impact and how to fix the problem.

What's Libor

The London Inter-Bank Offered Rate (Libor) was first conceived in the 1980s as a trusty yardstick to measure the cost (interest rate) of short-term funds which highly-rated banks borrow from one another. Each day at 11am in London, the setting process at the British Bankers' Association (BBA) gets moving, recording submissions by a select group of global banks (including three large US banks) estimates of the perceived rates they would pay to borrow unsecured in “reasonable market size” for various currencies and for different maturities.

Libor is then calculated using a “trimmed” average, excluding the highest and lowest 25% of the submissions. Within minutes, the benchmark rates flash on to thousands and thousands of traders' screens around the world, and ripple onto the prices of loans, derivatives contracts and other financial instruments worth many, many times the global GDP. Indeed, it has been estimated that the Libor-based financial market is worth US$800 trillion, affecting the prices that you and me and corporations around the world pay for loans or receive for their savings.

A file photo showing a pedestrian passing a Barclays bank branch in London. Barclays has been fined £290mil (US$450mil) by UK and US regulators for manipulating Libor. — EPA

Indeed, anyone with a credit card, mortgage or car loan, or fixed deposit should care about their rate being manipulated by the banks that set them. In the end, it is used as a benchmark to determine payments on the global flow of financial instruments. Unfortunately, it turns out to have been flawed, bearing in mind Libor is not an interest rate controlled or even regulated directly by the central bank. It is an average set by BBA, a private trade body.

In practice, for working purposes, Libor rates are set essentially for 10 currencies and for 15 maturities. The most important of these relates to the 3-month US dollar, i.e. what a bank would pay to borrow US dollar for 3 months from other banks. It is set by a panel of 18 banks with the top 4 and bottom 4 estimates being discarded. Libor is the simple average (arithmetic mean) of what is left. All submissions are disclosed, along with the day's Libor fix. Its European counterpart, Euro Interbank Offered Rate (Euribor), is similarly fixed in Brussels. However, Euribor banks are not asked (as in Libor) to provide estimates of what they think they could have to pay to borrow; merely estimates of what the borrowing rate between two “prime” banks should be. In practice, “prime” now refers to German banks. This simply means there is in the market a disconnect between the actual borrowing costs by banks across Europe and the benchmark. Today, Euribor is less than 1%, but Italian banks (say) have to pay 350-40 basis points above it. Around the world, there would similarly be Tibor (Tokyo Inter-Bank Offered Rate); Sibor and its related SOR (Swap-Offered Rate) in Singapore; Klibor in Kuala Lumpur; etc.

What's wrong with Libor?

Theoretically, if banks played by the rules, Libor will reflect what it's supposed to a reliable yardstick to measure what it cost banks to borrow from one another. The flaw is that, in practice, the system can be rigged. First, it is based on estimates, not actual prices at which banks have lent to or borrowed from one another. They are not transactions based, an omission that widens the scope for manipulation. Second, the bank's estimate is supposed to be ring-fenced from other parts of the bank. But unfortunately walls have “holes” often incentivised by vested-interest in profit making by the interest-rate derivatives trading arm of the business. The total market in such derivatives has been estimated at US$554 trillion in 2011. So, even small changes can imply big profits. Indeed, it has been reported that each basis point (0.01%) movement in Libor could reap a net profit of “a couple of million US dollar.”

The lack of transparency in the Libor setting mechanism has tended to exacerbate this urge to cheat. Since the scandal, damning evidence has emerged from probes by regulators in the UK and US, including whistle blowing by employees in a number of banks covering a past period of at least five years. More are likely to emerge from investigations in other nations, including Canada, Japan, EU and Switzerland. The probes cover some of the largest banks, including reportedly Citigroup, JP Morgan Chase, UBS, HSBC and Deutsche Bank.

Why Barclays?

Based on what was since disclosed, the Libor scandal has set the stage for lawsuits and demands for more effective regulation the world over. It has led to renewed banker bashing and dented the reputation of the city of London. Barclays, a 300-year old British bank, is in the spotlight simply because it is the first bank to co-operate fully with regulators. It's just the beginning a matter of time before others will be put on the dock. The disclosures and evidence appear damaging. They reveal unacceptable behaviour at Barclays. Two sorts of motivation are discernible.

First, there is manipulation of Libor to trap higher profits in trading. Its traders very brazenly pushed its own money market dealers to manipulate their submissions for fixing Libor, including colluding with counter-parties at other banks. Evidence point to cartel-like association with others to fiddle Libor, with the view to profiteering (or reduce losses) on their derivative exposures. The upshot is that the bank profited from this bad behaviour. Even Bob Diamond, the outgoing Barclays CEO, admitted this doctoring of Libor in favour of the bank's trading positions was “reprehensible.”

Second, there is the rigging of Libor by submitting “lowered” rates at the onset of the credit crunch in 2007 when the authorities were perceived to be keen to bolster confidence in banks (to avoid bailouts) and keep credit flowing; while “higher” (but more realistic) rates submission would be regarded as a sign of its own financial weakness. It would appear in this context as some have argued that a “public good” of sorts was involved. In times of systemic banking crisis, regulators do have a clear motive for wanting a lower Libor. The rationale behind this approach was categorically invalidated by the Bank of England. Like it or not, Barclays has since been fined £290mil (US$450mil) by UK and US regulators for manipulating Libor (£60mil fine by the UK Financial Services Authority is the highest ever imposed even after a 30% discount because it co-operated).

Efforts at reform

Be that as it may, Libor is something of an anachronism, a throwback to a time long past when trust was more important than contract. Concern over Libor goes way back to the early 2008 when reform of the way it is determined was first mooted. BBA's system is akin to an auction. After all, auctions are commonly used to find prices where none exist. It has many variants: from the “English” auction used to sell rare paintings to the on-line auction (as in e-Bay). In the end, every action aims to elicit committed price data from bidders.

As I see it, a more credible Libor fixing system would need four key changes: (i) use of actual lending rates; (ii) outlaw (penalise) false bidding bidders need to be committed to their price; (iii) encourage non-banks also to join in the process to avoid collusion and cartelisation; and (iv) intrusively monitor the process by an outside regulator to ensure tougher oversight.

However, there are many practical challenges to the realisation of a new and improved Libor. Millions of contracts that are Libor-linked may have to be rewritten. This will be difficult and a herculean exercise in the face of lawsuits and ongoing investigations. Critical to well-intentioned reform is the will to change. But with lawsuits and prosecutions gathering pace, the BBA and banking fraternity have little choice but to rework Libor now. As I understand it, because gathering real data can often pose real problems especially at times of financial stress, the most likely solution could be a hybrid. Here, banks would continue to submit estimated cost, but would be required to back them with as many actuals as feasible. To be transparent, they might need to be audited ex-post. Such blending could offer a practical way out.

Like it or not, the global banking industry possibly faces what the Economist has since dubbed as its “tobacco moment,” referring to litigation and settlement that cost the US tobacco industry more than US$200bil in 1988. Sure, actions representing a wide-range of plaintiffs have been launched. But, the legal machinery will grind slowly. Among the claimants are savers in bonds and other instruments linked to Libor (or its equivalent), especially those dealing directly with banks involved in setting the rate. The legal process will prove complicated, where proof of “harm” can get very involved. For the banks face asymmetric risk because they act most of the time as intermediaries those who have “lost” will sue, but banks will be unable to claim from others who “gained.” Much also depends on whether the regulator “press” them to pay compensation; or in the event legal settlements get so large as to require new bailouts (for those too big to fail), to protect them. What a mess.

What, then, are we to do?

Eighty years ago banker JP Morgan jr was reported to have remarked in the midst of the Great Depression: “Since we have not more power of knowing the future than any other men, we have made many mistakes (who has not during the past five years?), but our mistakes have been errors of judgement and not of principle.” Indeed, bankers have since gone overboard and made some serious mistakes, from crimes against time honoured principles to downright fraud. Manipulating Libor is unacceptable. So much so bankers have since lost the public trust. It's about time to rebuild a robust but gentlemanly culture, based on the very best time-tested traditions of banking. They need to start right now.

WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN

Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who speaks, writes and consults on economic and financial issues. Feedback is most welcome; email: starbizweek@thestar.com.my.

Friday 22 June 2012

Moody's downgrades 15 major banks: Citigroup, HSBC ...

Citigroup and HSBC were among the banks downgraded


The credit ratings agency Moody's has downgraded 15 banks and financial institutions.

UK banks downgraded include Royal Bank of Scotland, Barclays and HSBC.

In the US, Bank of America, Citigroup, Goldman Sachs and JP Morgan are among those marked down.

BBC business editor Robert Peston reported on Tuesday that the downgrades were coming and said that banks were concerned as it may make it harder for them to borrow money commercially.

"All of the banks affected by today's actions have significant exposure to the volatility and risk of outsized losses inherent to capital markets activities," Moody's global banking managing director Greg Bauer said in the agency's statement.

The other institutions that have been downgraded are Credit Suisse, UBS, BNP Paribas, Credit Agricole, Societe Generale, Deutsche Bank, Royal Bank of Canada and Morgan Stanley.

Moody's said it recognised, "the clear intent of governments around the world to reduce support for creditors", but added that they had not yet put the frameworks in place that would allow them to let banks fail.

Some of the banks were put on negative outlook, which is a warning that they could be downgraded again later, on the basis that governments may eventually manage to withdraw their support.

“Start Quote

The most interesting thing about the Moody's analysis is that it, in effect, creates three new categories of global banks, the banking equivalent of the Premier League, the Championship and League One”
In a statement, RBS responded to its downgrade saying: "The group disagrees with Moody's ratings change which the group feels is backward-looking and does not give adequate credit for the substantial improvements the group has made to its balance sheet, funding and risk profile."

The BBC's Scotland business editor Douglas Fraser tweeted: "Cost of RBS downgrade by Moody's: having to post an estimated extra £9bn in collateral for its debts."

Of the banks downgraded, four were cut by one notch on Moody's ranking scale, 10 by two notches and one, Credit Suisse, by three notches.

"The biggest surprise is the three-notch downgrade of Credit Suisse, which no one was looking for," said Mark Grant, managing director of Southwest Securities.

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Related:

FDIC: Failed Bank List

Friday 7 October 2011

Why 'Occupy Wall Street'? Job growth fails to dent US unemployment rate!


Steve Denning

Why 'Occupy Wall Street'?

Steve Denning, Contributor
RADICAL MANAGEMENT: Rethinking leadership and innovation

Esperanza Casco (C) who's home in Long Beach w...Image by AFP/Getty Images via @daylife

For people wondering why the ‘Occupy Wall Street’ movement is spreading across the country, an article earlier this year in  Bloomberg by Danielle Kucera and Christine Harper sheds some light. It discusses the continuing disconnect between the amount of pay in finance and the value generated to society:

Wall Street traders still earn much more than brain surgeons. An oil trader with 10 years in the business is likely to earn at least $1 million this year, while a neurosurgeon with similar time on the job makes less than $600,000, recruiters estimated.

After a decade of deal-making, merger bankers take home about $2 million, more than 10 times what a similarly seasoned cancer researcher gets.

“I don’t think it’s healthy for the economy to be this skewed,” said Stephen Rose, a professor at Georgetown University’s Center on Education and the Workforce. “I believe there’s some sort of connection between value added to the economy and pay. Everyone is losing sight of any fundamentals.”

Yet many bankers think they’re not paid enough


For those in middle class finding it difficult to make ends meet or for recent college graduates struggling to find a decent job, the pay numbers are truly eye-popping.

In the first three quarters of 2010, eight of Wall Street’s largest banks set aside about $130 billion for compensation and benefits, enough to pay each worker more than $121,000 for nine months of work. That’s up from the same period four years earlier — before the crisis — when the lenders set aside a total of $113 billion, or enough to pay an average $114,400 to each worker.

Calculated in dollars, average pay per employee has risen at Bank of America Corp. [BAC] Citigroup Inc. [C], Credit Suisse Group AG [CSGN] and UBS AG [UBS]and declined at Deutsche Bank AG [DBK], Goldman Sachs Group Inc. [GS], JPMorgan Chase [JPM] and Morgan Stanley [MS] since the same period in 2006.

“The bottom line is all the people in investment  banking understand that they work harder and are under more stress,” said Jeanne Branthover, a managing director at Wall Street recruitment firm Boyden Global Executive Search. “Many don’t think they’re paid enough.”



What is the basis for these financial rewards?


John Cassidy, writing in The New Yorker in an article entitled What Good Is Wall Street? asked a banker how he and his co-workers felt about making loads of money when much of the country was struggling.

“A lot of people don’t care about it or think about it,” he replied. “They say, it’s a market, it’s still open, and I’ll sell my labor for as much as I can until nobody wants to buy it.” But you, I asked, what do you think? “I tend to think we do create value,” he said. “It’s not a productive value in a very visible sense, like finding a cure for cancer. We’re middlemen. We bring together two sides of a deal. That’s not a very elevated thing, but I can’t think of any elevated economy that doesn’t need middlemen.”

The [banker] is right: Wall Street bankers create some economic value. But do they create enough of it to justify the rewards they reap? In the first nine months of 2010, the big six banks cleared more than thirty-five billion dollars in profits.

It wasn’t always this way


It hasn’t always been this way. Cassidy notes that from around 1940 to 1980 things were different.

Economic historians refer to [this as] a period of “financial repression,” during which regulators and policymakers, reflecting public suspicion of Wall Street, restrained the growth of the banking sector. They placed limits on interest rates, prohibited deposit-taking institutions from issuing securities, and, by preventing financial institutions from merging with one another, kept most of them relatively small. During this period, major financial crises were conspicuously absent, while capital investment, productivity, and wages grew at rates that lifted tens of millions of working Americans into the middle class.

Banking of course wasn’t the only factor. This was a period when oligopolies were in charge of the marketplace and could charge pretty much what they wanted, even for products that weren’t particularly good. So they could afford to offer life-time employment with good salaries.

Since the early nineteen-eighties, by contrast, financial blowups have proliferated and living standards have stagnated. Is this coincidence?

For a long time, economists and policymakers have accepted the financial industry’s appraisal of its own worth, ignoring the market failures and other pathologies that plague it. Even after all that has happened, there is a tendency in Congress and the White House to defer to Wall Street because what happens there, befuddling as it may be to outsiders, is essential to the country’s prosperity. Finally, dissidents are questioning this narrative. “There was a presumption that financial innovation is socially valuable,” [a critic] said to me. “The first thing I discovered was that it wasn’t backed by any empirical evidence. There’s almost none.”

True, but banking wasn’t the only factor. This was also a period in which the big companies that used to be in charge of the marketplace, found themselves struggling to cope with global competition and the new power of the customer and could no longer offer life-time employment at high salaries.

One might have hoped that the banks would have provided an element of stability in a turbulent period. As it turned out, the net effect of the financial sector has been to aggravate the instability.

Slum lords in pin-striped suits


The case for bankers, if any, rests on the argument that their activities grow the economic pie. However, most of the income comes from extracting rents in a zero-sum game. Cassidy quotes Gerald Epstein, an economist at the University of Massachusetts:

These types of things don’t add to the pie. They redistribute it—often from taxpayers to banks and other financial institutions.

Cassidy’s overall take? He cites with approval Lord Adair Turner, the chairman of Britain’s top financial watchdog, the Financial Services Authority, who has described much of what happens on Wall Street and in other financial centers as “socially useless activity”:

Many people in the City and on Wall Street are the financial equivalent of slumlords or toll collectors in pin-striped suits. If they retired to their beach houses en masse, the rest of the economy would be fine, or perhaps even healthier.
_________________
Steve Denning’s most recent book is: The Leader’s Guide to Radical Management (Jossey-Bass, 2010).

Follow Steve Denning on Twitter @stevedenning

And join the Jossey-Bass online conference webinar”: Sep 22-Oct 20, 2011. My session is on Thursday October 13 at noon ET. To register, go here and use discount code 

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Job growth fails to dent US unemployment rate

Economy created 103,000 new jobs in September, but unemployment remained high at 9.1 per cent.
Al Jazeera and agencies
Frustrated with the ailing economy, protesters have staged #Occupy rallies in over 500 American cities [Getty]

The US economy created 103,000 jobs in September, the labour department has reported, a much stronger figure than expected but not enough to lower the unemployment rate.

Economists had expected Friday's report to say that the economy only replaced 60,000 jobs in September.
The private sector accounted for all of the the gains, which were boosted in part by the return of 45,000 telecommunications workers who had been on strike in August.

"Job gains occurred in professional and business services, health care, and construction. Government employment continued to trend down," the labour department said.

Meanwhile, the unemployment rate was still stagnant at 9.1 per cent for the third straight month in September.

For African-Americans, the unemployment rate is 16.7 per cent - the highest it has been in 27 years and double the rate of unemployed whites.

Al Jazeera's Patty Culhane, reporting from Washington, explained that the number of unemployed and under-employed Americans is in the millions.

"There are still 14 million Americans who aren't working today, even though they'd love to have a job," she said.

"Beyond that, there are something like six million that have been unemployed for more than six months. That is a unique feature of this recession - how long people are staying out of work."

She said there are another nine million Americans "who are working part-time jobs because, quite frankly, that's the only job they can find".

Growing frustration

With the underlying data still dire, Friday's news is unlikely to dampen President Barack Obama's calls for congress to pass a $447bn jobs bill- which he says could create 1.9mn new jobs.

In depth coverage of US financial crisis protests
He said on Thursday said that America's growing #Occupy protest movement reflected people's frustration with the American financial system and the country's declining economy.

"I think people are frustrated, and the protesters are giving voice to a more broad-based frustration about how our financial system works," he said at the White House.

Republicans, who oppose Obama's jobs bill, said the latest jobs figures were another indication of Obama's mismanagement of the economy.

"There were far too few jobs created this month, which shows the need to spend less time making campaign style speeches and more time trying to work together to identify policies that we both can agree will create an environment for job creation," Eric Cantor, the House of Representatives majority, leader said.

Al Jazeera's Culhane said that Obama is playing "campaign politics" by "going all around the country saying blame the republicans".

But, she points out, "no US president in recent history has ever won a second term with unemployment anything close to this high".

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Wednesday 3 August 2011

Barclays, HSBC, BoA among big European, US Banks Job Cuts, Hard Hit !






Barclays job cuts take Europe’s tally to 40,000

Swiss firms hit by impact of soaring franc

LONDON (MarketWatch) — A running tally of planned job cuts by European banks reached around 40,000 Tuesday, little more than halfway though earnings season, as firms that failed to control costs or were over-optimistic about growth make the deepest cuts.

Barclays PLC UK:BARC -0.12%   BCS -0.84%  was the latest to confirm job losses Tuesday, saying it’s already cut 1,400 jobs and indicating the figure could rise to around 3,000 by the end of the year.

Citibank Executive on U.S. debt deal

In an interview with The Wall Street Journal, Michael Zink, Citibank's country officer in Singapore, discusses the implications of the U.S. debt-ceiling deal for global markets and the dollar.

The announcement came as the bank reported a 38% drop in net profit to 1.5 billion pounds ($2.45 billion), partly due to compensation it’s paying to customers who were sold inappropriate insurance.

The Barclays cuts take the total announced by banks reporting in the last week to 35,000. On top of that, UBS AG CH:UBSN -7.70%   UBS -4.68%  also confirmed it would slash jobs, with media reports in Switzerland pegging the number of losses at around 5,000.

The total doesn’t include a further 15,000 job cuts announced by Lloyds Banking Group PLC UK:LLOY -3.02%   LYG -4.46%  at the end of June.

Strong franc hurting Swiss banks

UBS and Credit Suisse CH:CSGN -7.77%   CS -4.16% , which is cutting around 2,000 jobs, are facing an uphill battle against the soaring Swiss franc because they have such a big cost base in Switzerland, but receive a lot of their revenue in dollars and euros.



On top of that UBS CEO Oswald Gruebel made a significant effort to rebuild the firm’s fixed-income trading business in the wake of the crisis, but is now cutting back in areas where it’s not making money, said Christopher Wheeler, an analyst at Mediobanca.

“Ozzie is a trader and he’s taking a trader's view by cutting his positions,” said Wheeler.

HSBC Holdings PLC UK:HSBA +0.43%   HBC -0.20%  will cut around 30,000 positions by 2013, reflecting the fact that the bank “massively over-expanded in retail banking,” Wheeler added.

Soaring costs at HSBC have been a significant worry for investors for some time, leading the bank to announce in May that it will withdraw from markets where it can’t achieve the right scale. Read more on HSBC's cost-cutting plans. 
 
Societe Generale analyst James Invine said in a note to clients that costs are still “a mountain to climb” for HSBC and that much of the growth is due to wage inflation in its faster-growing markets.

“That is a cost about which it can do very little, particularly given Asia’s strategic importance for the group,” Invine said.

The Barclays cuts are a mix of trimming a bloated looking corporate banking arm and slimming down European retail banking, as well as trimming its Barclays Capital investment banking arm after some pretty aggressive expansion, said Wheeler.

Barclays was the bank that snapped up the U.S. operations of Lehman Brothers Holdings, including around 10,000 staff, after the U.S. firm collapsed in 2008.

“In bull markets, you can hide a lot,” he said.

“But when you get into these sort of markets you have to address it, because, it sticks out like a sore thumb.”

Simon Kennedy is the City correspondent for MarketWatch in London.

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HSBC Plc is reportedly close to announcing that it will cut thousands of jobs as it embarks on a cost-cutting drive. — Reuters

HSBC may cut 10,000 jobs

HONG KONG: HSBC Plc may cut more than 10,000 jobs as it embarks on a cost-cutting drive, Sky News reported, citing people close to Europe's biggest bank.

The bank's plans had not yet been finalised, Sky News added, citing an insider at the bank

A HSBC spokeswoman in Hong Kong declined to comment.

HSBC's move would be the latest in a wave of cuts announced by the global financial industry, which has been hit by market volatility and lacklustre profits.

Just yesterday, Swiss bank Credit Suisse announced it would cut about 2,000 jobs after a second quarter hit by weak trading activity and the strong Swiss franc.

 
Switzerland's second biggest bank saw net profit fell 52% to 768 million Swiss francs (US$958.9mil), it said on Thursday.

Standard Chartered, Lloyds, Goldman Sachs and UBS are among banks that have announced job cuts in recent months, hit by rising costs and weak revenue growth.

State Street Corp, one of the world's biggest institutional investors, said earlier this month it would eliminate as many 850 jobs from its technology unit as it tried to curb costs.

HSBC has about 330,000 employees worldwide.

The Sky report came after it said in May it was looking for sustainable cost savings of US$2.5bil to US$3.5bil in order to reach a cost efficiency ratio target of 48%-52% by 2013.

It also said it would be conducting a strategic review of its cards business in the United States, and would limit its retail banking operations to markets where it could achieve profitable scale.

It already cut 700 jobs in its UK retail banking arm in June this year out of its staff of 55,000 in the country, one of many banks that have said they will cull jobs to save costs as lenders fight off a limp economic recovery.

HSBC shares in Hong Kong were down 1.1% by noon yesterday, in line with the broader market's 1% decline. - Reuters

Big Banks Hit Hard In Market Sell-Off

DAVOS/SWITZERLAND - Brian T. Moynihan, Preside...Image via Wikipedia
Big U.S. and European banks were hit hard in Thursday’s stock sell-off, highlighting investor concerns about some of the more prominent financial institutions.

In the U.S., Bank of America’s stock fell by 7.44% and has now tumbled by 33% this year. Bank of America’s chief executive, Brian Moynihan, will now really have his work cut out for him next week when he plans to take questions on a public call hosted by Bruce Berkowitz, the rock star hedge fund manager who has taken a big and controversial position in the nation’s biggest bank.

The KBW Bank Index fell by 5.3%, but some of the biggest banks in the U.S. fell more, like Citigroup, which fell by 6.6%. Big banks like Citigroup are struggling to deal with surging litigation costs stemming from the credit crisis while also dealing with more stringent capital standards.

The situation in Europe is worse, where investors are starting to wonder more and more about the Italian government securities being held by the large European banks, not to mention IOUs from the other countries like Spain. Italy is really getting more mired in the euro crisis and UniCredit shares tumbled by more than 9% on Thursday. Lloyds Banking Group has now seen its shares lose nearly half their value in 2011.

The decline in bank stocks could add momentum to the job cuts already being implemented on Wall Street and the banking sector. HSBC recently said it would slice 30,000 jobs. It will also potentially weigh on the economic recovery. But at least some banks are making the best of an ominous situation. Bank of New York Mellon said on Thursday it will start to charge clients fleeing to safety a fee for extraordinarily high deposits.

Sunday 3 July 2011

Inflation in Malaysia: Myths and perceptions!





By PRISCILLA LIM 

The general view on the street is that Malaysia suffers from rising inflation. Do the statistics back the claim?

RECENT headlines in the Malaysian media have highlighted the issue of the unholy alliance of rising inflation, stagnant wages and subsidies rationalisation.

It is an “unholy” alliance simply because subsidies rationalisation and imported inflation result in rapidly rising price levels. Coupled with the problem of slow rising wages, it implies that our buying power as consumers is decreasing.

Certain quarters would have us believe that Malaysia is a ship headed for an iceberg and a Titanic-style tragedy could happen any time now. To add salt to the wound, they argue that those at the helm, like the captain on the Titanic, are sleeping and that like the passengers on the Titanic, we will not survive this tragedy. But is this gospel truth or an urban myth?


Is our purchasing power shrinking?

In a recent article, it was claimed that Malaysians have been suffocated in recent months by rising prices of food and necessities as well as a wage rate that is as difficult to move as a buffalo on a padi field.

It was implied that Malaysians are incapable and not resilient enough to cope with the price hikes as their purchasing power is relatively lower than in many countries.

A quick check with the industry standards on price levels and wage data, the Swiss bank, UBS, Price and Earnings Report, indicates that residents in Kuala Lumpur have similar purchasing power with their counterparts in Singapore. Their purchasing power also tops that of Shanghai, Beijing and nearby Bangkok and Jakarta. We are also not far behind Taipei and Seoul in terms of purchasing power (see Chart 1).

Absence of subsidies in these countries has led to rapidly increasing price levels. As a result, employers have had to compensate workers with a higher wage which then increases the costs of production. This increase is passed on to consumers, causing prices to increase again and thus begins the vicious cycle economists call wage-push inflation.

To put it simply, wages have risen in tandem with the rapidly rising costs of living in those countries.

Is inflation on the rise?


The general perception on the street is that Malaysia suffers from rising inflation, at a level much higher than what the common Malaysian can cope with. Anecdotal evidence suggests that price levels have been rising at a much faster pace than what is officially reported. Many recount stories of how our much favoured teh tarik cost only 80 sen five years ago but today, it is between RM1.50 and RM1.80.

In pure MythBusters ingenuity, The Economist has created a rough method to test whether the statisticians have been toying with the inflation figures. It makes use of its famous Big Mac Index, which attempts to roughly measure inflation by tracking the increase in price of a McDonald's Big Mac over the years.

To achieve an accurate measure of inflation, one requires a basket of goods that is identical and commonly available across many countries. The McDonald's Big Mac was chosen because it is produced to a common specification in 120 countries around the world.

In order to determine the reliability of official inflation figures, The Economist compared the difference in the 10-year average of the Big Mac Index and the official reported inflation. A positive figure would indicate that the government has been under-reporting inflation and a negative figure implies otherwise, i.e. the government has been over-reporting inflation.


The Economist (The McFlation Index, Jan 27, 2011), in reporting its findings, accepted an error margin of +/- 2%. It expects the Big Mac inflation to exceed overall inflation as food prices have escalated much faster in recent years. Furthermore, the Big Mac basket of goods (food, materials, wages and rent) differs only slightly from the common basket of goods for overall inflation (food, fuel, rent, healthcare and transport, among other things). To compare how Malaysia fares against other countries, see Chart 2.

Malaysia scored a “positive” 2% point difference between the Big Mac Index and the official inflation rate. While the “positive” 2% may mean that Malaysia's reported official inflation rate is under reported, the inflation rate of the US and Japan is also marginally under reported, where the quantum is similar to Malaysia.

Thus, compared with other countries, Malaysia can be considered as faring rather well. We are on par with China and the US while just slightly above Japan and the European region. Considering that we are just under the +2% threshold with an error margin of +/- 2%, we can definitely conclude that our inflation figures are rather reliable.

Why then is the price of teh tarik increasing faster than the reported inflation? The main culprits of such inflation are unscrupulous traders who take advantage of the situation to earn a hefty profit. Tales have been told of how the price of a cup of coffee at the kopitiam increased by 20 sen when the price of 1kg of sugar was increased by 20 sen. Such price increases often go unreported, hence resulting in the disparity between the popular anecdotes and the official inflation rate.


Is the captain steering this ship sleeping?

The reported inflation rate in May 2011 increased 3.3% from May last year. The biggest increase came from the alcohol and tobacco group (6.3%), followed by transportation and hotels and restaurants (6%). Food and non-alcoholic beverages is third at 4.5%.

Economists, and politicians on both sides of the divide, concur that inflation has been rapidly increasing in recent months, sparked by the wave of subsidy rationalisations.

The argument for cutting subsidies is a logical and rational one. Malaysians have been enjoying artificially low food and fuel prices compared with regional peers so much so that we have grown reliant on these subsidies to maintain the lifestyle that we now enjoy.

Our reliance on these low food and fuel prices has rendered Malaysia's economy vulnerable to price shocks happening internationally. World prices of essential items such as sugar, fuel, cooking oil and flour have been increasing rapidly due to shortages in world supply.

How so? Prices are signals given by the economy-at-large regarding the supply and demand of the products we want. An artificially low price will cause us to consume more than what is available, thus leading to a misallocation of scarce resources.

In order to mitigate the effects of subsidy rationalisations, the government increased the price of petrol systematically so as to cushion the impact of the price hike on consumers. RON95 was introduced in December 2009 at the price of RM1.75 per litre as an alternative to RON97 after the government announced plans to fully remove the subsidy from RON97. All subsidies for RON97 were removed from July 2010.

The increase in food prices has also been limited to sugar, cooking oil and flour. The government has explained that this is due to the escalating prices of these products in the world market. The price increases, however, have been gradual rather than immediate.

Subsidies for other produce such as rice and fish, which are locally produced, remain. The subsidies for these sectors also remain as those that will be most affected should these subsidies be removed are the hardcore poor and low-income families. Table 1 and Table 2 outline the various subsidies provided and the amounts allocated by the government to fund these subsidies.

For the hardcore poor, the Agriculture and Agro-based Ministry has the Rice Subsidy Programme for the People (Subur) programme. It issues coupons to the hardcore poor and other targeted low-income groups three times a month to purchase 10kg of ST15% grade rice at a discounted price of RM14 rather than the retail price of RM24.

Stagnating wages?

Much to the disappointment of economists around the world, the Democratic Capitalist view that market forces alone are efficient enough to determine fair wages is no longer valid. Employers today no longer play the passive role of adopting the market wage rate. They are instead active participants and key players in the wage determination.

Researchers at the Federal Reserve of Cleveland found that standard factors such as type of occupation, human capital, demographics and industry characteristics only accounted for half of the wage variation between employees. The other half has been attributed to employer characteristics.

This implies that the bargaining power of workers today has declined not only in Malaysia but across the world as well. The imbalance of power and control at the bargaining table has caused the Malaysian labour market to become uncompetitive and inefficient, resulting in stagnating wage levels.



Here, I would like to suggest two reasons why wage levels in Malaysia have been stagnating over the years.

1. Over-supply of labour 

According to basic economics, employers will not have the incentive to offer higher wages should there be a large number of employees who are first able and then willing to work at the offered wage.

The logic is similar to the goods market where oversupply of a product causes prices to drop since the demand for the product can be easily fulfilled. This scenario is relevant to two large groups of Malaysians the low-skilled workers and fresh graduates or junior executives.

Low-skilled workers are often in jobs labelled as 3D dirty, dangerous and demeaning. We have foreign workers who are eager to perform these jobs at wages that are lower than what Malaysians would accept. This undermines the job opportunities for many of the “low-income to hardcore poor” Malaysians who do not mind taking on these jobs as it may be their only opportunity to earn a living.

Included in this category of workers are domestic maids, cleaners, construction workers, odd-job labourers, and coffee shop waiters.

As such, it is highly relevant that the government has taken its first step to a minimum wage for workers with the passing of the National Wages Consultative Council Bill in the Dewan Rakyat last week.

A mandatory minimum wage for low-skilled workers will ensure that they are not exploited by unethical employers and will not be vulnerable to the tides of change that are common in today's globalised economy.

With most of these jobs being performed by foreign workers, millions if not billions of ringgit are transferred out of Malaysia in remittances, and the country loses out in foreign exchange. When the Minimum Wage regulations kick in, there should be no wage differential for the same job, eliminating the advantages of having foreign workers instead of local Malaysians.

More low income Malaysians would have more job opportunities.

In the case of fresh graduates/junior executives, a simple survey of Salary Guides available in the market showed that their wages have not increased by much. Salaries for non-executives, however, showed the largest increase of between 6% and 12% across the industries in the last five years.

Industry experts suggest that there is an oversupply of graduates with similar skill levels. Employers often lament the inability to hire good quality graduates that are not just head-smart but have the initiative and relevant soft skills to bring value to the company.

A study done by the National Higher Education Research Institute (IPPTN) revealed that most Malaysian graduates are not aware of the realities of the working environment as well as employer expectations. Most are caught up in their own world and have an apathetic attitude towards the world around them.

2. Price levels of commodities/basket of goods and services

Wage increases are motivated by increasing price levels. The employment of labour in economics is described as a derived demand.

This suggests that increases in the demand, hence price, of goods and services generate employment and increase in wages.

Domestic price adjustments in Malaysia to world prices have been slow due to the many subsidies that are provided by the government. As such, many private sector employers do not find the need to increase basic wages in order to keep their employees. Instead, they provide other forms of compensation such as better healthcare coverage, share options, higher EPF contributions, etc. While some doomsday soothsayers only compare the wage and purchasing powers, how does Malaysia's rate of EPF contributions compare with those in other countries?

Wage adjustments have also been known to lag behind inflation as wages are more difficult to change compared with the price of a cup of teh tarik at your favourite coffee shop. Employment contracts and company budget allocations come only once a year compared with the menu that can be reprinted overnight. With the subsidy rationalisations, it would be a matter of time before the pressure mounts on employers to increase wages.

Gospel truth or urban myth?

Gone is the era where unity among Malaysians is not just about racial harmony and living peacefully together but also encouraging one another in the spirit of muhibbah to be resilient and brave the troubled times that challenge our path as a young nation. Fifty-four years down the thorny road, a much expressed opinion is that the younger generation today is either apathetic to nation building or unpatriotic.

As a member of this young “Y” Generation, I would like to believe that we are not unpatriotic. Instead, I believe we lack the understanding of what it means to build a nation together as one community with “blood, toil and tears”.

Building a nation is not just about building its economy. It's also about building its people. We are the heartbeat of the Malaysian economy. It is not the government nor the Opposition that is steering this ship and selecting the course that this ship takes. It is people like you and me, the Malaysian rakyat.

> The writer is a Gen-Y Malaysian who is currently pursuing her PhD with the University of Nottingham (Malaysian campus) in Economics. She graduated with a First Class Honours in Economics from the same university and hopes to become a person in high demand without the prescribed side effects of permanent head damage.