Why you must read the fine print of 'cheap money'?

Jun 4, 2011

In this issue:
» Will China export inflation to the world?
» A new dimension to the Euro crisis
» Growth in India's most promising sector at 20 month low
» Is nuclear power inevitable for India?
» ...and more!
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You may have often read that there are no free lunches in finance. But it is important to reckon that what is 'nearly free' or rather 'very cheap' also needs to be studied very carefully. If you are not too convinced probably a look at the state of affairs of Indian real estate companies will help. These entities have offered the best lessons on how to leverage balance sheets and create notional assets. The concept of land banks that offered these entities steep valuations during market boom has now lost its sheen. And the companies themselves see no alternative other than selling the land banks to get rid of the expensive debt. Investors who got carried away with the realty theme did not read the fine print of land banks. That these assets may not get developed and sold soon enough to repay debt while it is cheap never occurred to them.

Another case of such ignorance about cheap money was the case where borrowers with limited resources got lured by banks for accepting dirt cheap home and car loans. The loans appeared irresistible for a temporary period. But neither the banks nor the borrowers realized the problem until the loans got re-priced and turned into NPAs.

On a global scale, the US Fed has made a mockery of the fine print of cheap money. By choosing to print money as and when it felt like, the world's largest economy not just worsened its own debt position. It also ensured that inflationary trends and asset bubbles are here to stay in the global economy. Again those who believed that the QEs would thwart the risk of global economic meltdown chose to avoid reading the fine print of cheap money.

Our advice to investors therefore would be to remain careful while borrowing too cheap or investing in companies while they are borrowing too cheap. It is necessary to remember what is 'nearly free' could get very expensive when the times are tough.

Do you think studying a company's debt liability very carefully could minimize investment risks? Let us know your views or post them on facebook page.

 Chart of the day
Concern over rise in food prices has assumed catastrophic proportions as supplies get choked and demand continues to multiply. Poor harvest, erratic weather conditions and natural calamities have affected food supplies more adversely in the last 12 months than it has in a long time. As per Economist, America's stocks of coarse grains are the lowest for 15 years. In India, logistics and storage problems offer no relief to consumers despite good acreage of some crops. As seen in today's chart, the rise in global prices of food items has ranged from 10% to over 100% YoY in the past year. In such a scenario, it is pertinent that government across the world take some immediate steps to sort out this issue.

Data source: Economist

There is novel way of looking at the European debt crisis. Think of Germany and Greece as a troubled couple at the brink of divorce. The reason for the turmoil, like most things in life, is money.

If you rewind back to the 19th century you would find a young Germany mesmerised by the charm of Greece. In fact, there are quite a many cultural institutions linking the two countries. The love affair went well for a while. Then World War II happened and the world turned 180 degrees. After the war, West Germany was overhauled and it went on to become Europe's economic powerhouse. However, Greece remained plagued by political turmoil and that, in turn, took a toll on its economy.

What's the scene as of today? Both the economies are at loggerheads. While Germany is the most robust Euro zone economy, Greece is faltering and gearing towards a potential default. And German banks would lose billions of euros in Greek sovereign debt in the event of a default. Like we started the story about this troubled marriage, the only reason they're trying to work things out is for the sake of kids, meaning the other economies in an increasingly interdependent world economy. We are not at all optimistic about this troubled family finding its way to a happy ending.

If there is one advantage that China has kept intact over the years, it is that of providing low cost labour. This has certainly made imports cheaper for the US. But it has also made its exports and that of a lot of other nations expensive vis-a-vis the dragon nation. But perhaps not anymore. Analysts at Societe Generale, one of the world's leading investment banks are now warning China will soon start exporting inflation to other nations. Infact, it may have even begun doing the same. The biggest proof of the same is the rising domestic inflation in China. In March, inflation hit a 32-month high of 5.4% YoY. And as per the analysts, the policymakers remain well behind the curve. Furthermore, this process now looks irreversible as any effort to rein in the same could also end up hurting economic growth.

Thus, it is only a matter of time before consumers in US, one of the largest importers of Chinese goods starts feeling the pricing pinch. Of course, it can well be argued that US shift to other countries. However, this may not be an easy task given how much they have come to depend on China. All in all, higher inflation looks like an almost certainty for the US now.

This is something well expected. Balancing inflation and growth has never been an easy task. The recent interest rate hikes are finally pinching the sentiments in the economy. And the one at the receiving end this time is the services sector. Overtime, it has grown to be a major pillar of the Indian economy lending 55% to Indian GDP. However, the service sector growth slid to 20 month low in May as high prices and interest costs dragged down the new business growth. While we are still in expansion phase, the pace with which we will grow and for how long is a matter of concern. The data is accompanied by a decline in the GDP growth for the quarter, giving an outline of the picture that could emerge at the end of FY12.

The current situation is a real test for policy makers to check how well they tame inflation without sacrificing growth. We expect further hike in interest rates by RBI to ease inflationary pressures. Unfortunately, this may come along with a fall in investments and hence the economic growth. With rising oil prices and the country bracing for a hike in diesel and cooking fuels, the job only gets tougher.

The devastating earthquake in Japan created a nuclear power crisis in the country. Following this crisis, countries all over the globe have started debating about the disadvantages of electricity from nuclear power. Countries like Germany have decided to shut down all the nuclear power plants by 2020. The outcome seems logical after looking at the result of the nuclear crisis in Japan. But in India, the government seems to have taken a different stand. The environment ministry recently gave clearance for the Jaitapur nuclear power project. In further support to the nuclear power, we saw Jairam Ramesh, the environmental minister saying that India cannot meet its power requirement without nuclear power and cited examples of countries using it. True that France still gets 70% of its electricity from nuclear power but this cannot be the premise for approving projects in India. We believe that nuclear power can be really advantageous in terms of building power capacities throughout India. But, having said that, the government should not jump to conclusions. Instead, it should initiate a detailed examination of the Japanese nuclear mishap in order to understand the possible risks that could arise out of this in future.

It was a mixed week for world markets with more red marks than green ones. China was the biggest gainer of the week (up 0.7%) on bargain picking ahead of another possible rate hike by the central bank. The US was the biggest loser down 2.3% on disappointing jobs data. Increasing employment rate has led investors to believe that that the economic recovery in US is stalling.

In Asia, Japan closed the week down 0.3% while Hong Kong closed the week down 0.7%. Indian stock markets featured amongst the top gainers in Asian closing marginally higher by 0.6%. This was on the back of inflow of foreign funds. The onset of monsoons on time coupled with the predicted that it would be normal has given some comfort to the market reeling under high inflation and rising interest rates. Singapore closed the week up 0.3%. Brazil ended the week with a marginal gain of 0.1%.

Data source: Yahoo Fianance, Kitco

 Weekend investing mantra
If you feel you can dance in and out of securities in a way that defeats the inflation tax, I would like to be your broker"; but not your partner." - Warren Buffett

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3 Responses to "Why you must read the fine print of 'cheap money'?"


Jun 6, 2011

You have rightly identified the problem of false valuations of the Real Estate companies discovered by projecting a development of the projects on the land banks and then discounting the valuation at the current value. Assuming that the project will be approved, funded, built and sold as projected. Well when that did not happen as planned the land had to be valued at the market value which was way below the projected value.
WHAT IS THE CURE? HOW DO THE REAL ESTATE COMPANIES GET BACK ON THEIR FEET? ONE WAY OUT IS TO NATIONALISE THE DEFAULTING DEVELOPERS AND AFTER A COOLING PERID OF 3 YEARS ACTION THE COMPANY TO A NEW BREED OF DEVELOPERS. Put the fear of God and the law into the minds of the developers that they stand to loose everything if they continue to fool around/ renege on their promises.



Jun 4, 2011

Thanks Sirs, actually I enter new in this field. I am not have adequate knowledge to comments on the ibid subject. However, I understand the views of the author and sure my grateful thanks to whole team. When I visit next time, I will place my comments in profitable manner. I will read such articles in coming days without fail.Once again, MY HEARTIEST THANKS TO THE TEAM FOR PRESENTING SUCH A VALUABLE INFORMATION. PLEASE ACCEPT MY SALUTE.



Jun 4, 2011

Real Estate, Construction and Metal companies are heavily dependent on debt funding. Unfortunately, these sectors are also experience highest demand swings. some of teh projects get stretched to far. Its extremely important to study their debt equity ratio and revenue realization cycle. We have seen the real state and construction companies, once very much sought after, are at their near bottom, which is 5 to 10 times lower from the peak.

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