Currency unions in action around the world

The US dollar is used by three neighbouring sovereign states, Panama, El Salvador and Equador. In Panama, the local currency, the Balboa, has, since its creation in 1904, been tied to the US dollar.

Panama has no central bank. The US dollar is the paper currency while Panama issues coins equivalent to cents. It was followed by Equador in 2000, and then by El Salvador in 2001, both choosing to adopt the dollar as their de facto currency. A downside of this link is that the three countries have no influence over money supply. A spokesman for the US Federal Reserve confirmed: “Dollarised countries do not have a role of any kind in the Federal Reserve’s formulation of US monetary policy.”

The Swiss National Bank is the independent central bank of Switzerland, with the Swiss government taking no part in the setting of monetary policy. Neighbouring Liechtenstein had used the Swiss franc since the 1920s and then formally joined in currency union in 1980. That agreement allows for the government in Liechtenstein to inform and consult the Swiss National Bank “if needs be”. But a spokesman for the Swiss National Bank said: “Liechtenstein does not have any formal role in setting the monetary policy.”

The Australian dollar is used by three other independent nations, the tiny islands of Kiribati, Nauru and Tuvalu. The islands issue their own coins alongside Australian denominations which are treated as equivalent to the Australian dollar. In Kiribati, prior to independence, Australian currency was widely used. After independence in 1979, coins were issued in order to show its new political status. Tuvalu began a similar arrangement in 1976. Nauru has relied heavily on Australia since independence in 1968. In all three cases, the central bank is the Reserve Bank of Australia. A spokesman said the three countries had to abide by its decisions on interest rates and monetary policy.

In 1986, a Common Monetary Area for Southern Africa was signed covering South Africa, Lesotho and Swaziland. Namibia subsequently joined. This formalised a de facto currency union which has been in place since the 1920s. Under the 1986 deal, the three smaller countries were given the right to issue their own national currencies, pegged to the South African Rand. There is no common central bank, but – as the biggest player – the South African Reserve Bank holds sway. The countries’ bank governors meet three times a year but “the smaller CMA partner countries do not sit on the South African monetary policy committee and have to accept the monetary policy decisions taken by the SARB as given”, a spokesman for the SA treasury says.

Participatory notes investors pull out Rs 1 Trillion from India

Rich overseas entities, investing in Indian markets through 'Participatory Notes', are estimated to have pulled out over Rs 1 lakh crore (about USD 20 billion) in less than three months on fears of getting caught in the government's taxation net and its black money trail.

As a result, the quantum of money invested through these P-Notes has hit its rock-bottom levels of just about 10 per cent of total FII (foreign institutional investment) holdings -- which used to be more than 50 per cent a few years ago.

The Participatory Notes (P-Notes) allow foreign HNIs (High Networth Individuals) and other rich investors to invest in India through already-registered FIIs, while saving on time and costs associated with direct registrations.

The flight of P-Note investments began late in March after the government in its union budget proposed new taxation regime of General Anti-Avoidance Rule (GAAR) and certain retrospective amendments for taxing offshore transactions.

Sources said that P-Note investors have already pulled out close to Rs 1 lakh crore (about USD 20 billion) from Indian equity and debt markets, while they might have decided against putting in fresh investments worth at least Rs 50,000 crore ever since the new tax policy was proposed.

While GAAR has been deferred by a year, the tax proposals for offshore transactions could apply to FIIs as well.

It is feared that the new taxes could lead to heavy tax burden for the foreign investors investing through tax-friendly jurisdictions like Mauritius. Most of the overseas entities route their investments into India through such places to take benefit of their tax-friendly regimes.

There are apprehensions that FIIs could be forced to pass on their tax liabilities to their P-note clients, thus adversely impacting their overall returns on investment.

Many hedge funds and ultra-rich investors from abroad prefer P-Notes, which are sold by India-registered FIIs, as it allows them maximise the returns through savings on costs and rigmarole of various regulatory processes.

As per the latest data available with market regulator Sebi, the total value of PNs in Indian markets stood at about Rs 1,30,012 crore (about USD 25 billion) at the end of April 2012, down from Rs 1,83,151 crore at the end of February and Rs 1,65,832 crore as on March 31, 2012.

This figure was on a sharp uptrend this year till middle of March, but started declining sharply after tax proposals came to be known. While the mid-month figures are not shared by Sebi, the industry sources said that the total value of PNs are estimated to have reached near Rs two trillion (about USD 40 billion), before it started sliding in late March.

Sources said that the total value of PNs is estimated to have fallen further to near Rs one lakh crore level (about USD 15 billion) currently, marking a fall of nearly same amount from its late-March peak. The share of PNs in total FII holding stood at 16.4 per cent in February, but fell to 11.4 per cent by April. It has now further fallen to near 10 per cent level, sources said, while adding that most of the FII outflow currently taking place is in the P-Note accounts.

The PNs have been accounting for mostly 15-20 per cent of total FII holdings in India since 2009, while it used to much higher in the range of 25-40 per cent in 2008. However, it was as high as over 50 per cent at the peak of Indian stock market bull run during a few months in 2007.

In addition to the new taxation proposals, the government's recent White Paper on Black Money has added to the flight of P-Note investments from India, sources said. The White Paper, tabled by the Parliament on May 21, said that Pnotes were being used by Indian citizens to re-invest the black money in the country.

"Investment in the Indian Stock Market through PNs is another way in which the black money generated by Indians is re-invested in India," it said.

Participatory Note is a derivative instrument issued in foreign jurisdictions, by a Foreign Institutional Investor or its sub-accounts against underlying Indian securities.

"... through the instrument of PNs, investment can be made in the Indian securities market by those investors who do not wish to be regulated by Indian regulators due to a variety of reasons," the White Paper noted.

The reasons could include the desire of investors to keep their identity anonymous, which is possible also for the reason that PNs/ODIs can be freely traded and easily transferred without disclosing the identity of the actual beneficiaries, it added.

As per the White Paper, since PNs are issued from Offshore Financial Centres (OFCs) such as the Cayman Islands, British Virgin Islands, Switzerland, and Luxembourg, it is possible to hide the identity of the ultimate beneficiaries through multiple layers. Amid rising concerns that some of the money coming through PNs could be unaccounted wealth under the of FII investment, market regulator Sebi has already taken various measures to ensure that these instruments are not used for black money laundering. It was due to the steps taken by Sebi that the PNs' share in total FII holding had previously fallen from over 50 per cent to 15-20 per cent.

The Pacific gulf

Next year marks the 500th anniversary of the European discovery of the Pacific after Vasco Núñez de Balboa was lured by an Indian cacique’s promise of “another ocean, where there is plenty of gold.” Last week, four of Latin America’s fastest-growing economies renewed this quest for Pacific gold when they signed a “deep integration” pact. Mexico, Colombia, Peru and Chile, with combined economic output of $2tn, say the alliance will help them expand trade with Asia. It is another sign of how the world’s economic centre is shifting from the Atlantic.

The pact was signed, symbolically, at one of the earth’s most powerful deep space telescopes, in Chile’s Atacama Desert. That the observatory lies 2,600m above sea level also lent the ceremony a certain breathlessness. After all, there has been a lot of talk about regional integration over the past two decades, but far less action. The Mercosur trade bloc, forged in the 1990s by Brazil and Argentina, is foundering as both countries respond to economic problems by withdrawing behind trade barriers. The Andean Community has meanwhile been part dismembered by socialist Venezuela. The Pacific Alliance, with its talk of the free movement of goods, capital and labour, is a return to the liberal spirit of the past: a group of countries that believe the best route to development is open markets, foreign investment and free trade. Potentially, it also establishes a regional counterweight to Brazil.

In many ways, politicians are merely catching up with business. Chilean retailers operate in Colombia and Peru; Colombian utilities in Peru; Mexican companies in Colombia; and LAN, the Chilean airline, everywhere. The new pact faces formidable obstacles, though. Relations between Chile and Peru are dogged by memories of bitter 19th century border disputes. The pact’s countries meanwhile run for 7,000 miles from top to toe. MILA, an alliance between the Bogotá, Lima and Santiago stock markets, provides a cautionary warning: trade volumes have been sluggish since it was founded a year ago.

Still, at least its members have gone about negotiations in a businesslike way. Early talks, for example, were conducted via video conferencing, rather than the usual grandstanding summitry. Although there is a risk of over-categorisation, the contrast is striking between the pact’s liberalising attitudes and that of the more protectionist and sluggish Brazilian and Argentine economies on the Atlantic seaboard. They should take note; others have. A EU-style free trade area without the countless petty regulations and requirements imposed by Brussels would position South America as a powerful economic competitor to its neighbors north of the Rio Grande.

Offshore yuan market may evolve like Eurodollar market

The emerging offshore yuan--or reniminbi--market could be mostly used in the future to channel renminbi-denominated funds between borrowers and lenders not resident in mainland China, the Bank for International Settlements said in its quarterly review published Sunday.

Drawing on the experience of the market for Eurodollars, which are U.S. dollars deposited in banks outside the U.S, the BIS said it expects the offshore renminbi market to evolve much like other types of offshore markets and to behave over time as an intermediary between non-resident borrowers and lenders of renminbi.

Currently, the offshore renminbi market mainly serves as a conduit for funds from the rest of the world to mainland China. Its use as an intermediary between non-mainland borrowers and lenders or for mainland residents investing in offshore renminbi assets has been limited, the Basel-based BIS said.

The report, authored by Dong He of the Hong Kong Monetary Authority and Robert McCauley of the BIS, found that in the long run the Eurodollar market has primarily delivered pure offshore intermediation among non-residents. That is, it has permitted dollar-denominated transactions between non-U.S. residents outside of the U.S. and beyond U.S. jurisdiction.

"If the renminbi offshore market were to follow the Eurodollar market, this pure offshore intermediation would rise," they said.

The report added that the renminbi of late hasn't been appreciating consistently against the dollar. That might encourage non-resident borrowing in the currency, which in turn would also help the development of the market.

In the offshore yuan market in Hong Kong, where the Chinese currency floats freely, the dollar was at CNY6.3670 late Friday. The central parity rate for the onshore yuan was fixed by the People's Bank of China at CNY6.3308 Friday; the yuan can be traded in a band that is 1% above and below that level.