Breakingviews

Euro bank recap battle line limits solidarity

By Hugo Dixon

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The latest battle lines over euro zone bank recapitalisation show the limits of solidarity. The German, Finnish and Dutch finance ministers have made clear there won’t be a free lunch for Spain, Ireland or other countries if they need euro zone cash to shore up their banks.

Following last June’s euro summit, some investors briefly convinced themselves that Madrid had found a way of offloading the cost of recapitalising its lenders to the euro zone bailout fund, the European Stability Mechanism. There was also hope that Dublin would be able to shift the cost of rescuing its banks to the ESM retroactively. After all, the summiteers had agreed that the ESM would be able to recapitalise banks directly once an effective banking supervisor for the zone has been established.

Such optimistic thinking always seemed naive. But the finance ministers of the zone’s AAA-rate countries have now decisively poured cold water on it.

They have said that legacy assets should be the responsibility of national authorities. That would seem to squish the idea that Spain or Ireland (or, indeed, Greece or Cyprus) could shift their banking problems to the wider euro zone. They have also said that recapitalisation should always occur using “estimated real economic values”. Given that Dublin and Madrid have paid far more for banking stakes than they are now worth, a transfer of the responsibility to the ESM – even if it could be engineered – would crystallise big losses.

Although the three northern European countries aren’t the only voices in the euro zone, they probably can dictate terms. Such a hard line may, in turn, complicate plans to negotiate a single banking supervisor. After all, if the carrot of bank recapitalisation now seems a distant and less attractive prospect, southern countries may be less keen to submit themselves to the stick of centralised discipline.

Nixing China’s oil bid may create Canada discount

By Christopher Swann

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Canada is at risk of slapping a national discount on its resources sector. Investors reckon there’s a roughly one-in-four chance that the country’s politicians will block a $15.1 billion offer by China’s CNOOC for local energy company Nexen. Takeovers by state-owned companies raise tricky questions. But hoisting the national flag over a company of little strategic importance risks further alienating outside investors.

When state-owned oil giant first unveiled its bid on July 23, investors expected little Canadian resistance. Since then, however, doubts have crept in. Nexen shares are now hovering about 10 percent below CNOOC’s cash offer of $27.50. Though that’s still well above the pre-bid level of $17.30 to which Nexen shares would probably return if the deal was blocked, the market is no longer taking approval for granted.

Part of the anxiety stems from Prime Minister Stephen Harper’s insistence that market access should run both ways. Canada’s Bank of Nova Scotia, for example, has been waiting a year for official go-ahead to purchase a minority stake in China’s Bank of Guangzhou. Cabinet members – and the country’s spying agency – have also expressed concerns about selling to state owned companies which might harbour sinister political motives. And Canada has form in spurning foreign buyers: two years ago, it blocked BHP Billiton’s $39 billion takeover of Potash Corp., the world’s largest fertilizer company.

But buying Nexen hardly gives the Middle Kingdom control of Canada’s energy output. The company is the nation’s 24th largest pumper of oil, according to Macquarie, and about three quarters of the Nexen’s resources are outside Canada. Blocking the takeover would also raise tricky policy questions: is Canada singling out Chinese buyers, or would it also object to the trio of Indian state companies that recently lodged a $5 billion bid for Canadian oil sands currently owned by ConocoPhillips?

Hoisting the flag over Nexen would be bad news for investors in other Canadian mid-sized drillers – including Talisman Energy and Celtic Exploration – that are seen as potential foreign targets. Canada has said it needs $640 billion over the coming decade to fully exploit its energy reserves. Rebuffing its most enthusiastic investor seems especially foolish.

Franco-German politics first hurdle for BAE/EADS

By Pierre Briançon

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

France and Germany must clear the air before the merger between BAE and EADS can proceed. Their uneasy alliance over the Airbus maker’s shareholding and governance cannot continue as is – its end is even a prerequisite for the merger. But Paris and Berlin remain obsessed by “parity”, the sacrosanct notion that their position in the company should be identical. Franco-German parity could be preserved in a larger group, as long as political passions are kept under control.

The two nation’s shareholdings in EADS have always been kept rigorously equal – currently at 22.5 percent for each side. The only asymmetry was that the French state has a 15 percent direct stake in the company, with media group Lagardère, formerly a defence contractor itself, owning 7.5 percent. On the German side, Daimler long represented the country’s interests. The auto group has been reducing its stake – 7.5 percent has gone to a consortium of government controlled regional banks and KfW, the state-owned lender was set to buy another 7.5 percent.

Ideally, the merger would serve as a golden opportunity to clear the air. Each of the three governments involved – the UK, France and Germany – would own a golden share with significant blocking powers. Furthermore, as important customers of the enlarged group, they would have considerable influence over its decisions.

The problem is that the French government seems to want to keep its stake in the group – which would be reduced to around 9 percent in the combined entity. It’s unclear whether this is a deal-breaker for Paris. The government’s preference may simply be motivated by the need to avoid a domestic backlash over “privatisation” – still a dirty word in some circles of the ruling left.

But if the French persist, the German government might be tempted to go ahead with the sale of the Daimler stake to KfW. Such a move back into the state’s orbit would reinforce UK worries about excessive politicisation, perhaps leading to a British nixing of the project.

Indian power sector bailout is a good first step

By Andy Mukherjee

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

India’s electricity distributors have become zombies. The industry’s $35 billion debt overhang, equivalent to 2 percent of the country’s GDP, means it has few resources to invest in transmission and distribution. The result is massive underinvestment that chokes off economic growth – 11 percent of power demand is unmet – and causes crippling grid failures like the ones that plunged most of the country into darkness in July.

That is why the federal government’s bailout of the sector is a good first step. Half the debt, most of which is owed to state-owned banks, will be shifted to state governments. That’s as it should be: officials have long curried favour with voters by directing distributors to supply power at uneconomic prices.

Banks will also have to restructure the remaining loans, triggering bad-debt charges that will hit their earnings this year. But bank shareholders can’t complain. The deal is the best they could have expected, especially as distributors are prohibited from raising tariffs to recoup past shortfalls.

Beyond the onetime cleanup, India needs a strategy to ensure that distributors don’t accumulate new bad debts. It will be hard to make state politicians improve their behavior: they are powerful figures in a fragmented political landscape. One possibility, however, is to tie their hands by linking distributors’ pricing to benchmarks based on the cost of producing, transmitting and generating energy.

If states want to subsidise electricity prices, these should be explicitly a part of annual budgets. A 2003 fiscal management law, currently in tatters, should be revived to place a limit on the states’ – as well as the federal government’s – spending.

Percentage-mania builds confidence in 50-50 world

By Rob Cox and Edward Hadas The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

The latest is 14.1. But Mitt Romney’s tax rate is only one of many touchstone percentages doing the rounds. The U.S. presidential hopeful has also contributed 47, the percentage of Americans he says are dependent on government handouts. Both those numbers have irritated a lot of people. The challenger would prefer that the focus shift to a number which embarrasses President Barack Obama. A good candidate is 8.1 – the percentage of the labor force which is unemployed.

Percentages frame many current debates. The Occupy Wall Street movement contributed the 1 percent of excessively rich Americans and economists Carmen Reinhart and Kenneth Rogoff offered the 90 percent ratio of government debt to GDP as a borderline of fiscal ill-health. Investors have decided that euro zone sovereign bond yields below 7 percent, or depending on the day 5 percent, mark the end of the crisis. In China, the GDP growth rate is the magic number – 7.5 percent is the current talisman.

This percentage-mania is basically a good thing. To start, it is more sophisticated than a round number fixation – oil at $100 a barrel, the U.S. national debt at $16 trillion or the S&P 500 at 1500. Percentages are ratios, so they provide at least twice the information as a single number. More sophisticated mathematical measures might be even more helpful – second derivatives and standard deviations, anyone? But most investors, let alone voters, will struggle to understand why.

More importantly, these percentages provide helpful markers in a more complicated world. Sure, it’s arbitrary to say that 14.1 is low, while 25 or 40 is a reasonable percentage tax rate, and it’s silly to reduce the development of China’s to a single number. But the magic ratios make it harder to ignore problems and deny failures.

Still, accountants are justly criticized for choosing to be precisely wrong rather than roughly right. Any numerical obsession in the inevitably murky world can easily degenerate into sloppy thinking. The effort to meet a clear percentage target can encourage statistical legerdemain, warp judgments or distort policies. Do the math: There is a 100 percent need not to rely too much on the numbers.

India in depth: Twin deficits joined at the hip

By Andy Mukherjee

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

India’s yawning trade deficit is not a separate problem from the government’s budget shortfall. They are two sides of the same coin. The connection between them becomes evident when one looks at the current account gap not as the excess of imports over exports, but as the difference between the country’s investment and savings.

The twin problems started in February 2008, when New Delhi undermined a six-year process of reducing deficits by announcing a $15 billion farm-debt waiver. That blunder, compounded by several other acts of fiscal irresponsibility, had a pernicious effect on the nation’s savings-investment dynamic.

Fiscal profligacy encouraged households to seek cover in imported gold as an inflation hedge. A quintupling of household investment in “valuables” between the 2008 and 2012 financial years shrank the pool of financial savings available to the domestic corporate sector, which was unable to maintain the breakneck pace at which it had been issuing equity and debt securities.

That, in turn, made Indian companies increasingly reliant on foreigners’ money to finish projects already underway. The current account deficit shot up to 4.2 percent of GDP in the last financial year. In the last two years, India’s stock of foreign debt has shot up by 32 percent even as the monetary authority’s foreign-currency reserves have fallen.

Unless the current account gap returns to a more sustainable level, a repeat of the 1991 currency crisis cannot be ruled out. In India’s case, a more sustainable current account may mean reducing the deficit to between 2.4 percent and 2.8 percent of GDP, according to a Reserve Bank of India research paper.

China’s “third strike” in 2013 is the one to watch

By Wei Gu

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

China’s leadership change might be a big event, but it is another occasion that matters most for the Communist Party. A new set of leaders will be ushered in during the 18th Party Congress, expected to happen in October. To hear what they stand for, the world may have to wait until the “third plenary”, which brings together around 370 of the Party’s top figures, a year from now.

Chinese history shows the third meetings matter most. That figures: the first one is usually about selecting leaders, and the second about personnel changes in the government. By the time of the third plenary session, which has tended to happen a year after the first, the top politicians would have secured their power and formed a consensus on how to move forward.

The most significant was in 1978. At that year’s third plenary session, a second-generation of Chinese leaders, led by Deng Xiaoping, turned against the doctrine that that whatever Chairman Mao said must be obeyed. Deng instead pushed the idea of finding truth from experiments, and China’s focus shifted from internal debates and revolutions to development and opening up.

A third plenary in 1984 saw the concept of the planned economy abandoned. That year, China began to allow companies to issue stocks. Flash forward to 1993, and Deng put forward his views on the socialist market economy, prompted by a high-profile tour to Southern China, spanning adjustments to state-owned companies and rural reforms. It was at another third plenary in 2003 that Hu Jintao’s now famous concept of “scientific development” began to emerge. While official proclamations didn’t yet use that phrase, state media and other politicians soon started to.

China’s ten-year political cycles suggest that the next third plenary session will be another key event. Reform and development are always on the agenda, but income inequality and economic imbalances are creating new pressures on the incomers to come up with new ideas. While the “big reveal” is approaching fast, it’s that vital third pow-wow that could really set the tone.

Obama may find an exceptional friend in Facebook

By Robert Cyran The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

U.S. President Barack Obama might find an exceptional friend in Facebook. The social network’s second-in-command, Sheryl Sandberg, should be on the short list for a top economic job if he wins a second term in office. Yet she’d potentially give up some $130 million in unvested equity to take the job. Her boss Mark Zuckerberg could bridge the gap. But it may cost Facebook shareholders dearly.

Sandberg certainly is qualified to assist the Obama administration. She worked at the Treasury from 1996 to 2001, serving as chief of staff. Since then her star has soared, first with success as a Google executive, and for the past four years as the adult in the room at fast-growing Facebook. The growing importance of technology in the U.S. economy could easily make her look like an inspired choice for an administration that has been criticized for not understanding the private sector.

Whether Sandberg is interested in uprooting is a good question. While she’s shown a proclivity for public service, participating in the white heat of technological revolution is intellectually and personally rewarding. And this year she built a 9,200-square-foot mansion in Menlo Park. Happily for Sandberg, high levels of government are also full of bright people. While negotiating budget deals can be painful, serving the country offers rewards for the soul.

The financial benefits of Washington obviously don’t compare. But serving at Facebook has left her rich. Sandberg received 38.1 million units of Facebook restricted stock units (RSUs) in 2008. By the inauguration of the next president in January, more than 95 percent will have vested. At the current share price, the total value of the RSUs that have vested would be about $800 million. RSUs are taxed as normal income when they vest and employees receive shares.

If Sandberg accepted an invitation to Washington, Facebook might take the bigger financial hit. The company is struggling to generate revenue from its users’ shift from computers to mobile devices. So Sandberg’s premature departure would be viewed badly, since Wall Street sees her as the social network’s chaperone. What’s more, more than 1 billion shares held by insiders may be on the block in the next half year. Any sales by Sandberg could add to the downward pressure on the stock, which has fallen from $38 at its May IPO to around $22 today.

When Hank Paulson left Goldman Sachs to lead the Treasury in 2006, the bank accelerated the vesting of his equity. There’s no precedent at Facebook for a similar move, but the stakes are higher. Sandberg holds 3.5 million options with a strike price of $10.39 and 1.2 million in the money at $15. The total value of these options using a Black-Scholes model, plus unvested RSUs granted in 2008 and 1.2 million in 2011 using Facebook’s current stock price, would be about $130 million.

Consumer boycotts won’t decide Sino-Japan fight

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Are consumers China’s secret weapon? Not when it comes to winning its ongoing spat with Japan. Even if some Chinese shoppers are giving Uniqlo and Toyota a miss, history shows that consumer boycotts have at best a short-lived effect. Economic warfare looks reassuringly hard to wage.

Calls for Chinese consumers to stop buying Japanese sound troubling.

But there’s little evidence they work. In 2003, many U.S. consumers boycotted French wines over that country’s refusal to condone the Iraq invasion. Despite stories of sharp drops in sales, U.S. trade data shows imports increased sharply year on year during the campaign. In 2006, some Muslim countries ditched Danish goods after supposedly blasphemous cartoons, causing alarm at Lego and dairy maker Arla. Even so, a Danske Bank assessment at the time suggested only 2 percent of Danish exports were exposed.

One problem is the “free rider” effect – consumers support boycotts in principle, but don’t want to stop buying products they like. Cars may be an exception, since they’re highly visible and easy to vandalise, so Toyota and Nissan have reason to worry. For other products, however, online retail makes it easy to cheat. It was still easy enough to find Nikon and Sony products on Chinese ecommerce sites on Sept. 19.

Attacks on production and investment can be more effective. The oft-touted example is the “divestment” campaign against South Africa during the Apartheid years, when U.S. students forced college endowment funds to sell shares in companies with South African links.

Leap off fiscal cliff is bad option, but not worst

By Richard Beales The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Leaping off the so-called fiscal cliff is a bad option for the United States. But it might not be the worst. If U.S. politicians can’t wrangle a deal first, January will bring tax increases and spending cuts. The economic shock could bring another recession. But it could also improve the political chances of a real fix.

The Congressional Budget Office predicts output could shrink by 0.5 percent in 2013 if current law isn’t changed. Tax reductions enacted under George W. Bush would finally expire and mandatory spending cuts in last year’s Budget Control Act would kick in.

The big risk would be triggering a downward economic spiral. On the other hand, the CBO reckons another consequence is that the U.S. deficit would sharply reduce in 2013, to about $640 billion from $1.1 trillion this year. Over a decade, federal debt would fall to just under 60 percent of GDP from over 70 percent this year. If deficit-reducing measures were instead postponed indefinitely, the CBO reckons that America’s debt-to-GDP ratio would swell to an alarming 90 percent a decade hence.

Moody’s Investors Service even indicated on Sept. 11 that America would be more likely to retain its Aaa rating with a budget trajectory that looks like the fiscal cliff rather than if Congress were just to extend the status quo. Delaying the mandatory spending cuts – which lawmakers imposed on themselves explicitly to force action if no larger plan was agreed – would badly dent U.S. credibility.

In any event, either potential occupant of the White House in 2013 would reshape the post-cliff budget within months. For Republicans, it is too heavy on tax revenue rather than cost cuts – though the Budget Control Act would lop $55 billion a year off both defense and non-defense spending. But the starting point would be closer to a sustainable path. The more cost-cut-weighted proposals of Obama’s 2010 fiscal commission – rejected by both the president and Romney’s running-mate Paul Ryan, a commission member – might even find new support.

As for taxes, the expiry of the Bush rate reductions would push the top marginal federal income tax rate up to 39.6 percent next year from 35 percent currently. Some Republicans might not be swayed from a belief in a maximum rate of, say, 25 percent. But those GOPers simply determined to reduce taxes would suddenly have room to negotiate. Democrats, too, would be happier cutting government revenue from a higher base.