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Analytical Monthly Review, published in Kharagpur, West Bengal, India, is a sister edition of Monthly Review. Its December 2007 issue features the following editorial. — Ed.
In April, eight months ago, we drew your attention to the “Innovative Financing for Infrastructure” scheme set out in Chidambaram’s budget speech. He announced aUS$5 billion “infrastructure financing initiative”formed by U.S. financial giants Citigroup and Blackstone, together with Infrastructure Development Finance Corporation (IDFC), a private sector enterprise with public investors, andstate owned India Infrastructure Finance Company Limited (IIFCL). The aim was stated to use the foreign currency reserves of the Reserve Bank of India (RBI) to fund infrastructure development without creating domestic inflationary pressure. The intention was declared, among other things, to set up an overseas entity “to borrow funds from the RBI, invest such funds in highly rated collateral securities, and provide ‘credit wrap’ insurance to infrastructure projects in India for raising resources in international markets.” We criticised the proposal as a scheme for private speculation with public funds, and warned that “at the end of the day there will be the inevitable bankruptcies and defaults followed by the assumption by the Government of India of debt equal to the looted forex reserves.”
Today things look a bit different from last April. The “end of the day” came before this particular “innovative” scheme could get itself launched into the gathering disaster, despite the best efforts of Chidambaram & Co. As we write in the first week of December we read that leading exporters are being denied dollar loans by their banks, themselves reportedly denied access to their existing lines of credit with major London and U.S. banks. A truly global credit crisis following on the collapse of “innovative financing” appears to be underway.
A brief summary of the situation as it looks at the moment may be useful. In August a panic broke out in U.S. securities markets set off by the recognition that the sharp increase in defaults by U.S. homeowners on their mortgage payments threw into question the worth of an unascertainable amount of debt securities. “Innovative” securities that were based in part on such mortgages were omnipresent, but no-one could readily establish precisely which securities were so affected nor to what extent. Naturally, trading in all securities that might reasonably be thought to be so affected ceased. Short term debts (“commercial paper”) that in the normal course were renewed without question were, it developed, in many cases based upon longer term “innovative” securities that were no longer marketable. If such short term debts were not renewed, a freeze seemed likely that would reach to the “money market” bank or brokerage accounts of U.S. savers. On the verge of a general seizure, the U.S. Federal Reserve intervened to make vast funds available and cut the stated rates for borrowing from the central bank by financial institutions. The panic came to an end, and in a more orderly fashion the process began of determining which debt securities were affected, to what extent, and on whom the still growing losses had fallen.
At the start of December, despite massive provision of funds by U.S., British and European central banks and further cuts in interest rates by the central banks of the United States and Canada, the stringency of ready funds is again as great or greater than it was in August. Further, any illusion that the credit problem would be limited to the U.S., based on the absurd thesis that the rest of the world had “decoupled” from the U.S. centre of imperial capital, has now disappeared. The difference between the rates at which major money market banks lend to each other (“Libor”) and the rate government bonds pay is at levels not seen in recent times. That is to say, banks now regard each other with a growing absence of trust. Citibank and leading British banks are reported to be requesting their customers not to borrow in order to preserve their liquidity, and thus Indian banks are suddenly denied funds on credit lines they had every reason to believe they were entitled to draw upon. The process of recognising the financial losses outstanding has only begun, with to date some $50 billion of losses admitted and at a minimum many hundreds of billions of dollars of losses not yet publicly acknowledged. In short, it is likely that some major U.S. and British financial institutions, were their holdings of securitised mortgages and other “innovative” financial products to be valued at what they could be sold for today, are at least technically insolvent. And it seems safe to say that December of 2007 shall later be seen as closer to the start of this process than to its end.
Let us then return to the Chidambaram budget speech proposal to borrow foreign exchange reserve “funds from the RBI, invest such funds in highly rated collateral securities, and provide ‘credit wrap’ insurance to infrastructure projects in India for raising resources in international markets.” Each of the elements in this “innovative financing” has been shown to be central to the now global financial crisis, as also the two U.S. financial powers at the heart of the scheme, Citigroup and Blackstone.
The first “innovative” element was to obtain higher returns from the RBI funds now invested in low yielding but safe foreign government bonds by instead investing those funds in “highly rated collateral securities.” It now appears that much of the toxic waste U.S. mortgage debt served as collateral for securities rated (by the three dominant U.S. rating agencies, Moody’s, Standard and Poors, and Fitch) with the highest possible AAA rating, equivalent to the bonds of the United States government itself. Citigroup played a central role in packaging and selling such “highly rated” collateralised debt obligations, often to gullible government entities around the world. One case that has reached international attention in the last several days is the purchase of “innovative” Citigroup products by municipal governments in Norway. The city of Narvik in Norway sold a half interest in its municipal power plant to buy these “highly rated collateral securities” issued by Citigroup. It now appears that these local governments shall lose as much as 80% of their invested funds, and the city of Narvik may have to sell the remaining half of its power plant just in order to meet the payroll of the municipal corporation. The Financial Supervisory Authority of Norway in a letter of November 27 said that Citigroup’s information used to sell these “innovative” products had been insufficient and misleading.
The other part of the Chidambaram proposal, the use of the credit of the proposed semi-public corporation to provide “credit wrap” for the debt of Indian corporations seeking external funding for supposed infrastructure investment, also corresponds to a mechanism central to the emerging credit crisis. One way that debt securities could obtain ratings higher than their quality deserved was to be insured (“wrapped”) by an insurer with the highest rating; the security then obtains the rating of the insurer. In late November as doubts spread about the worth of insurers who had “wrapped” mortgage related debt (and thus given it AAA ratings), the European inter-bank market for such “covered” debt shut down. Groupe Banque Populaire and Groupe Caisse d’Epargne had to rescue their indirectly owned credit insurer CIFG, and doubled the company’s capital with a $1.5 billion investment. The condition of the much larger U.S. credit insurer Financial Guaranty Insurance Co. (FGIC), the insurer for US$315 billion of bonds, was immediately of great concern. It remains to be seen whether its owners, notably Blackstone group, will be willing and able similarly to rescue FGIC. Were the AAA ratings of the leading credit insurers to be downgraded, the result would be an automatic downgrade of the estimated US$2.4 trillion insured bonds and a corresponding decrease in their value. For example, a 10% decrease in the market value of covered bonds would add more than US$200 billion to the losses that have already occurred.
Had the foreign exchange reserves of the RBI been used as set out in this “innovative” proposal in Chidambaram’s budget speech, the losses to the Government of India today would have been at minimum the equivalent of many thousand crore rupees. Credit for avoiding this outcome must be given to the leadership of the RBI that has so far resisted intense pressure from Chidambaram and from the office of the Prime Minister on every element of the “innovative” scheme.
The necessity of investment in infrastructure is still incessantly employed as a cover to steal public property for private profit, the true meaning of “PPP” (supposedly “public private partnerships”). We cannot say it better than Congress-man Jairam Ramesh, Union minister of state for commerce, whose shameless remarks at a business get-together were quoted in the Economic Times of December 3rd: “I don’t believe in the PPP model which has become the mantra for infrastructure projects in India. PPP to the business community at large means private funding of public projects. But it should ideally be public funding of private projects. . . .” It is most depressing to note that also present was West Bengal chief minister. In his remarks he is quoted by the Economic Times as once again celebrating the illusion of foreign direct investment (FDI) for infrastructure development, which even Jairam Ramesh rejects! We urge those whose voices may still be heard to point out that the moment of the apparently irresistible power of such as Citigroup and Blackstone is over, and that following their advice has moved from being unwise to being irrational. Perhaps we should invite the treasurer of the municipal corporation of Narvik, Norway, to Kolkata to explain.