'These evils will outlast us all'

May 19, 2010

In this issue:
» The impact of Euro crisis on China
» A big relief for SMEs
» Real estate players face the debt heat again
» US$ 50 bn of road projects in the pipeline
» ...and more!

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First came the subprime crisis in the US. Then came the sovereign debt crisis in Europe. The common thread between the two was the poor assessment of risk. As a result, credit ratings agencies invited as much widespread criticism for their role in the financial crisis as no other business ever did. Expert after expert hauled the rating agencies for not being able to assess default risks properly. But the latest comment by Bill Gross of Pimco, the world's largest bond fund manager, seems to be the last nail in the coffin.

As per Economist, Gross has sarcastically compared rating agencies to 'vampires in the dead of the night'! He says that the agencies that fuelled the debt crisis by overrating trillions of dollars of poor debt have had a relatively easy time. This is when money managers and central bankers in the developed world have had to answer embarrassing questions. But by virtue of their oligopolistic business, the rating agencies have escaped unhurt. Calpers, a globally renowned pension fund, has recently initiated court proceedings against the big three agencies with a fraud suit. But Gross believes that despite their wildly inaccurate ratings, the credit rating agencies will outlast us all. This he assumes is due to the lack of evidence available to nail them down. Gross also alleges that a dozen other suits have already been dismissed against S&P alone.

Known for his erudite comments on the financial crisis in the West, Gross seems to pointing fingers at the right people. But unless the regulatory bodies take the case of rating agencies more seriously, yet another crisis may not be too far.

Do you think that the rating agencies will get punished for their role in the financial crisis? Please share your views with us.

 Chart of the day

Data source: Equitymaster

Indian companies rounded off FY10 with reasonably good set of numbers. These were particularly from the stable of metal, automobile and pharmaceutical companies. With lower input costs and higher pricing power these sectors emerged as the top gainers in terms of profit margins. Crisis situation in the developed economies did little to temper their prosperity. As today's chart shows, the profits in the fourth quarter of FY10, showed steady sign of up move despite the crises in developed economies. Most of this was supported by the fact that India's consumption demand remains largely isolated from the fate of the global economy. Going forward, however, investors would do well to keep their eye on long term trends rather than bet on quarterly estimates.

It's all so linked. Definitely so in the world of finance. An event happening in a distant place has curious effects half way across the world. Take for instance the recent sovereign debt crisis in Europe. The Greek debacle has weakened the Euro. That makes China less competitive in Europe, their largest market. Why? You see, China's export juggernaut is based on their artificially weak currency, the Yuan. It takes two currencies to set an exchange rate. With the Euro weakening, Chinese exports have become costlier than before (in Euro terms).

Ironically, it endangers any move by the Chinese to revalue the Yuan upwards vis-a-vis the US Dollar. It may be noted that the US has been putting pressure to relook the currency peg. A demand US makes to increase the competitiveness of its own goods. Another impact of the European crisis is that Chinese exporters are finding it hard to obtain trade finance from European banks. This puts enormous pressure on Chinese companies to finance their working capital needs. Clearly, the European malaise could easily reach China or the US. Through routes not yet fully factored in by observers. The world economy is deeply linked indeed!

Small and medium enterprises (SMEs) can now breathe a little easier. The SEBI has relaxed share-listing norms for these companies. This is by allowing them to disclose their results every 6 months. This is in contrast to the 3 months timeline for bigger companies. Having said that, these SMEs will have to maintain a public shareholding of atleast 25% of the total number of shares issued at all times. SEBI has also issued guidelines with respect to the procedure that these SMEs have to follow if they want to list themselves on the main exchange. Relaxation of the norms by SEBI means that these SMEs can now focus more on their business goals rather than face the pressures of meeting quarterly expectations. A smart move we think!

It is a known fact that the real estate developers stretched their arms beyond their means during the real estate boom. In the greed to acquire land bank majority of the developers leveraged their balance sheet as if there was no tomorrow. But now when the debt repayments are due, all real estate players are facing the heat. Developers believed that the best way to get out of the debt trap was to raise equity. And some of them did manage to raise equity to pay off debt in the recent past. But now even this is going to be uphill task as the investor's appetite for real estate companies has waned. Otherwise what could explain the fact that despite receiving in principal approval from SEBI, majority of the developers having lined for IPOs are yet to launch their offers?

Even the listed entities that were planning for QIPs to repay debt have to cut their issue sizes due to lack of investor interest. We believe that this time around the developers won't be able to fox the retail investor who has already burnt his finger once. The best possible solution to get out of this vicious debt circle is to clear the inventory at a discount. However, will the developers resort to undercutting when the prices across cities have remained buoyant? Only time can tell that. However, we believe undercutting is the best possible solution to deleverage at this juncture.

If road transport minister Mr. Kamal Nath is to be believed, the government is slated to award a huge US$ 50 bn of road projects during FY11. Additionally, he expects private investors to fund as much as 70% of the amount. Private equity players are expected to put in about US$ 18 bn in the sector this fiscal. This comes on the back of a few policy changes that India has seen recently. These are meant to facilitate greater foreign and private equity participation in project SPVs and toll projects. As per Mr. Nath, there is little risk for foreign investors investing in these road projects as traffic is almost assured in India. Further, he is known to have said that that foreign investors can expect a return of 16% to 18% on their investments. With the level of red tapism and land acquisition problems that these projects typically face, we wonder if such a statement can indeed be made with any conviction.

Indian textile companies have had a rough phase over the past two to three years. The demand for their products (majorly exports) was hampered by the economic slowdown. Plus, there was a significant amount of stress on their financials on the back of high interest costs. Companies had taken upon a good amount of debt on their books to finance their expansion plans during this period. These included expansion through the organic and inorganic routes.

Having barely seen some signs of improving demand, the textile companies seem to be at it again. Due to the slowdown, many plants have shut shop across the world. As such, assets are available at throw away prices. Trying to take advantage of this situation, Indian textile companies are again believed to be scouting for acquisition targets in and outside the country. We believe that this may be a worrisome sign as it could add more pressure to the balance sheet of textile companies, most of which already have a high debt ratio. Instead of cleaning up their balance sheets, they will need to borrow more to fund these acquisitions. Plus, with the interest rates expected to rise, there could be additional pressure on their cash flows.

Indian indices like their peers in Asia had a sombre outing today as investors chose to book profits in stocks across the board. Indian stock market are in fact the biggest losers in Asia today, following Indonesia and Singapore. The BSE Sensex was trading nearly 355 points (2%) lower at the time of writing. Stocks and commodities around the world fell today as the Euro traded near a four-year low after Germany banned speculators from some bets against government bonds and banks. The new regulations raised concerns about investors being able to hedge their European holdings or sell assets as the region's debt crisis worsens. Stocks from the banking, auto and commodity sectors were the biggest losers. European markets have also opened lower.

 Today's investing mantra
"You ought to be able to explain why you're taking the job you're taking, why you're making the investment you're making, or whatever it may be. And if it can't stand applying pencil to paper, you'd better think it through some more. And if you can't write an intelligent answer to those questions, don't do it." - Warren Buffett

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28 Responses to "'These evils will outlast us all'"


May 20, 2010

They are like Indian politicians they will servive after all the scams


Amitabh Kumar Sinha

May 20, 2010

By no means. They know how to cover their flanks very well. The world over the legal system is such that these kind of people escape unpunished easily.



May 20, 2010

Your quarter 4 profit analysis good, but isn't revenue comparison also fruitful along with profit? There are high chances that profit is based on cost cut, price increase etc.; whereas revenue growth will actually bring out the real uptick in demand

Also, on your point of rating agencies, its high time they get regulated by SEBI - I recently noticed one of the housing finance arms of leading pvt. sector bank in India getting a rating for their fixed deposit on the basis of a so-called 'letter of comfort' from parent company - & this was specifically mentioned by the concerned rating agency...What's the intrinsic value of a letter of comfort!! Its nothing more than a piece of paper and the rating decision can not be guided by such a piece of paper, for sure!!!



May 20, 2010

Not a chance! If there is enough of govt and media pressure, then this would spiral into a blame game. Thats all!


ullaspriya shah

May 20, 2010

if not then whom you punish for these type of disaster in financial market..ist subprime and then this debt of piigs.now what USA or UK or else .this is a chain and in chain if one ring broaken other will certainly break may be litle late but it will broke.except India and china consumption base growth is not seen then how they will repay their debt or say how will they earn for debt payment..this cycle will be continuous and this things if known earlier from rating agencies then precaution shall be taken now nothing to save the financial market unless and until asset like gold or platinum is on sale.


Rohinton Kadva

May 20, 2010

All rating agencies appear to follow specific methodologies. However, none of them is transparent enough to make public disclosures of its methodologies. There is a pressing need to rationalize such disclosures accross the board. This will enable consumers to make more informed decisions based on such ratings.


Anand Tripathi

May 20, 2010

It is true that Rating agencies are the root cause of the sub-prime crisis & Other subsequent crisis triggered by that( along with credit policy of FED) but the business model of rating agencies is more responsible. They take commission from the company which they rate hence there is a clash of interest. SEBI has taken a Extreemly welcome step in this regard in asking for performance evaluation of the debt rated in the past. This will put some control over frivolous rating atleast in India. Americans & Europeans should learn this from SEBI.



May 20, 2010




May 20, 2010

It is highly unlikely that the rating agencies will be taken to task for their deficiencies. It is in fact very surprising that when the global economy was in turmoil and several leading international banks collapsed like a pack of cards, only the bank managements were getting the blame for lack of proper control & regulation, but the rating agencies who rated them did not invite any criticism from eminent economists and the media. Banks relied heavily on the report furnished by these agencies and paid the price.



May 20, 2010

the rating agencies want business and hence they tend to protect the businesses they rate rather than whom they cater to.this phenomenon can be seen in ISO ratings as well as similar other ratings.the only way is to have a national fund which will engage these agencies so that they are unbiased. but alas even this is not foolproof .the only final solution is people with integrity.but where do you find them as you cannot buy them ?

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