IMF Fiscal Monitor – Progress on Deficit Reduction

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

According to a recent IMF report, governments are making progress in addressing fiscal policy issues, but downside risks remain elevated as 2011 growth prospects are reduced.  The rising public debt levels in advanced countries are projected to top 100 percent of GDP in 2011.  A large portion of the increase came since 2007 from a drop in GDP, lower revenues and elevated spending damaging government balance sheets.

Overall, fiscal adjustment in advanced countries has declined by over 2% of GDP since 2010.  The improvement in most cases was at or better than expectations.  Progress in fiscal adjustment is better than expected. 

For Europe, the challenge is to sustain fiscal consolidation while minimizing the growth fallout.  Europe needs to focus on crisis resolution mechanisms to help resolve the solvency issues and limit contagion.  Overall, the deficits in the euro area are expected to decline by 2% of GDP this year and 1% next year.  The speed and severity of the spread of financial pressures in the euro should serve as a lesson for the United States and Japan. 

In the United States, a focus is needed on entitlement and tax reforms as well as measures needed to raise revenues and broaden the tax base.  The U.S. deficit is projected to decline by 1% of GDP to 9.6% for 2011.  For Japan, disaster relief and reconstruction are short-term objectives, but more detailed medium-term planning is needed to focus on reducing the debt and budget deficit ratio and raising tax revenues through reforms. 

Emerging markets emerged from the crisis in relatively good shape, with continued progress expected on deficit reduction.  A few countries could be vulnerable to shift in capital inflows.  Low-income countries survived based on buffers built-up in good times, but need to address social spending and their vulnerability to rising food and commodity prices.

However, despite the IMF’s relative slightly optimistic view markets remain concerned about growth prospects.  The IMF noted two risks in the outlook: that public sector insolvency and/or that excessive fiscal tightening are not sources of instability.  The optimal policy is to reduce the deficit in a timely manner without severely impacting growth.

For more on this click on the link to the IMF site:  www.imf.org/external/pubs/ft/fm/2011/02/fmindex.htm

QE2 sets sail in the UK. The emerging markets say “Thank you”.

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The Bank of England decided today that because of the Euro-crisis and a sluggish home economy the financial system in the UK needed more quantitative easing: a flood of cash to build some forward economic momentum.  Over the near future the Bank will purchase £75 billion (about 115 billion USD) of bonds with freshly printed money in the hope (?) that the financial crisis hitting Europe will, at worse, only have a minor impact on the UK economy.   Will this new flood of cash help the UK avoid the effects of the contagion now pulsing through Europe?  That is the question that has economist offering as many answers as there are economist plus one.  Regardless of the effect on the UK, there is a more generally accepted feeling that the more powerful benefits will be to the emerging markets.  To quote Sir Terry Leahy (ex boss of Tesco):  “QE created an awful lot of liquidity intended for the real economy but found a home in markets and speculators looking for quick returns."

 

We witnessed from the Great Recession the power of quantitative easing’s effects on the economies of the emerging markets.  The positive effects included creating new wealth and a near unprecedented increase in their middle classes.  This benefit came back to haunt the easing nations in the form of a high commodity prices which have arguably contributed to a sluggish economic recovery and increased talks of a second dip recession.

 

What does this mean for risk departments?  Keep an eye on the horizon and watch for signs of other countries joining the QE parade.  It may be time to revisit those hedging strategies you put off due to the current pullback in commodity prices – it’s days may be short lived. 

Cash everywhere, but what to do with it!

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

Many companies are hoarding cash at present.  Apple is a prime example with over $80 billion of cash.  This indicates that businesses are reluctant to go on buying sprees of targets that might seem cheap at the moment but might become cheaper in coming months.  It also indicates that they are keeping reserves in place in case the global economic situation continues to deteriorate.  These factors also make them more reluctant to return cash to shareholders in the form of dividends or share buy backs.  Normally it is considered inefficient for companies to hold large cash balances as they reduce returns to shareholders.  However, the foregoing illustrates that there are good reasons at present for companies to hoard at least a certain prudent amount of cash.

 

Of course, U.S. companies also have the problem of “stranded cash” (or “trapped cash”); that is cash held in foreign subsidiaries, which is very tax-inefficient to repatriate.

 

High cash balances in a company should beg certain questions, especially in the current climate.  In what is it invested?  What currencies is it invested in?  How liquid is it?  Is it earning the best return possible?  Even investments that were recently considered very low risk need to be focused on right now.  Is your company investing enough additional time and expertise in managing cash?  Does your Board of Directors take an interest? 

 

The risks are huge and we have certainly seen companies with growing and substantial cash balances that are not beefing up their investment strategies, risk management, controls and oversight accordingly.  Some can manage to these issues internally.  Others could use outside help for a very modest expenditure in relation to the risks and possible downsides they face.  Doing nothing more than has been done before seems particularly unwise.

We seek it here, we seek it there. Is risk everywhere?

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Seeking risk in everything can sometimes be as debilitating as not seeking or understand risk at all.  One of my favourite blog discussion points is those dealing with individuals and organizations that spend great human and financial capital to minimize downside risk.  It can be argued that everything entails some degree of risk (which should not be equated with opportunity costs) but at times, the likelihood of occurrence of the actual cost when the risk is realized is rather trivial. 

 

 

The word of advice here is understand the risks you or your organization face and identify those with true cost (financial and in human capital) to the firm for addressing the others may set your firm back on innumerable levels.

 

Note:  A thank you to "funny times" (http://www.funnytimes.com/cartoons_tag_result.php?tag=risk) for today's risk cartoon.