A threat bigger than Euro crisis for RBI - The 5 Minute WrapUp by Equitymaster
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A threat bigger than Euro crisis for RBI

Jun 16, 2010

In this issue:
» Debt mutual funds are running for cover
» SEBI's tax proposals favour MFs over ULIPs
» Bankers' bonuses will be capped at 50% of pay
» Hedge funds now are increasingly risk averse
» ...and more!

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00:00
 
India never had to face the kind of subprime woes that the US faced. And yet when the fury of the global financial crisis unleashed, India was not spared. While Indian capital markets took a severe beating, the economy also felt the impact of a slowdown. Little wonder then that the ongoing debt crisis in Europe is also raising concerns in India. But the RBI is unperturbed. It maintains that for the central bank inflation in India is a much bigger concern than the debt crisis in Europe.

And this is hardly surprising. The central bank has been trying to ward off high inflation for quite a while now. May's inflation rate stood at 10.16% and was the seventh straight month reading over 5%. This has made the case for RBI strengthening interest rates all the more stronger. Infact, the central bank has not ruled out an interest rate hike before its scheduled policy review in July. RBI's immediate plan of action is to ensure that inflation comes within its comfort limits of 5% by the end of March 2011. The way the scenario is unfolding, that seems a tad bit unlikely. But the monsoon season has just begun and a good spell of rainfall will certainly go a long way in easing the woes of high prices.

01:07
 Chart of the day
 
They may be different in a lot of ways. But there is not much to differentiate between 3 of the 4 BRIC countries (China, India and Brazil) atleast as far as industrial production is concerned. As today's chart of the day shows, April 2010 saw Asia doing very well in terms of industrial production. Japan's production grew by leaps and bounds. China, India and Brazil grew over 17% apiece. US lagged way behind but a recovery in the country could gradually be very well underway.

Data Source: The Economist

01:46
 
Now, this surely is the debt market equivalent of FIIs doing mass selling of Indian equities. Around Rs 600 bn has been pulled out of debt mutual funds over the last 10 days, reports a leading daily. This has no doubt triggered a "major but manageable" liquidity crunch in the fund industry. And here too, the institutional investors are to blame. Of course, not the foreign kind but of the desi variety.

Apparently, it is the outflow towards the telecom spectrum auction and the advance tax payments that is leading to the crunch. Banks are calling on debt funds for redemption as their own cash is drying up on account of the reasons just outlined. What more, this is also leading to debt funds incurring losses as not all assets are being sold at profits. Although the problem is significant, we do not think it will spiral out of control. It is just one part of the monetary system that is being affected as liquidity changes hands.

However, such incidences, like they do in equity markets, do provide opportunity for debt investors who have cash at hand. For it gives them the chance to scoop up debt instruments at attractive yields. As mentioned in the article, rates on one year CDs have gone up a good 1% to 6.25% as against the earlier 5.25%. Cash is indeed the king here as well.

02:34
 
It seems that the government's discontent with ULIPs (unit linked insurance plans) is far from over. The insurance based investment plan has attracted plenty of unwanted attention in the recent past. Especially with the SEBI attacking the mis-selling of this product and its governance. The insurance regulator, however, chose to oppose this move.

But it seems that the government is now siding with the mutual fund regulator SEBI. It has proposed tax implications that clearly favour equity mutual funds over ULIPs. The proposed Direct Tax Code seeks to tax ULIPs as per current income tax slabs. On the other hand, it proposes a tax after capital gains deduction on mutual funds. This means that the effective tax rate on mutual funds will be lower. This can channelize plenty of funds from ULIPs to funds. Also this can bring back the much needed liquidity that has deserted mutual funds in recent times.

03:11
 
Bankers both in the US and Europe have faced increasing ire for the role that they played in accelerating the world's worst financial crisis. The fact that they pocketed fat bonuses only deepened their unpopularity. Since then, there have been more calls for tighter regulations on banks. And in a recent development, European lawmakers have proposed that bankers' bonuses should be capped at 50% of their pay. Directors at banks that received public funds would also have their salaries capped at US$ 615,000, and at least 40% of any bonus would be deferred for five years. These measures have been approved by the Economic and Monetary Affairs Committee in France. This is what the committee has said, "If bankers and traders want to leave and go to other jurisdictions, it just shows that they do not have confidence in their own performance. To those that would leave, good riddance." Hmm, some serious words indeed.

03:46
 
There was a time when China was seriously considering reducing its holdings in US Treasuries. After all, US was hit hard by the financial crisis, the government was printing massive doses of money and big stimulus packages only widened its deficit. The status of the dollar then was questioned. The way things stand now, not much has changed in the US. But China boosted its holdings of US Treasury debt in April for the second straight month. These holdings increased by US$ 5 bn to around US$ 900 bn in April. Why? Because of fears that Greece and other European governments could default on their debt. Worry of possible defaults has sparked a flight to safety and that has benefited US Treasuries. Indeed, till the time that the crisis continues to rage in Europe, we won't be seeing too much of dollar bashing.

04:18
 
Hedge funds used to be the ultimate tool for the ultra-rich to double or even triple their multi-million dollar investments. These funds were privy to lax rules and little government oversight. Investors didn't care about the risks, or where the money was invested. All they wanted were high returns.

Now, investors face the threat of their annual returns halving to a mere 10% due to increased risk aversion by hedge fund managers. May 2010 was officially the worst month for hedge funds post the fall of Lehman Brothers. The average hedge fund lost 2.3% due to euro-zone uncertainty before the Greek bailout was announced. But, the crisis is still far from being over. Hedge fund managers will most likely lose their 20% performance fee this year. This is typically paid on profits the funds generate. But given the way hedge funds burnt their fingers badly in the financial crisis, not taking too many risks is not such a bad strategy after all!

04:45
 
In the meanwhile, the Indian markets were trading in the green at the time of writing. However, this was amidst some volatility. Stocks forming part of the auto, IT and metals sectors were amongst the top gainers, while those from the FMCG and healthcare were amongst the top losers. The market sentiments in other Asian regions were also positive with Japan, Singapore and China trading higher by about 1.8%, 1% and 0.3% respectively.

04:56
 Today's investing mantra
"In security analysis the prime stress is laid upon protection against untoward events. We obtain this protection by insisting upon margins of safety, or values well in excess of the price paid." - Benjamin Graham

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5 Responses to "A threat bigger than Euro crisis for RBI"

Sekar Narayanaswamy

Jun 16, 2010

Dear All,

Predictions are more accurate, practical and understanding he world market scenario. The way mutual funds liquidating assets and booking profit is good example for your statemet.

Yes, one have to be more calculative in risk averse.

Thanks to "Equitymaster" for the timely advice.

Like 

Hitesh

Jun 16, 2010

very good report. it is giving details in short and effective way. Keep it up 5MWU.

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Pralhad Sarpotdar

Jun 16, 2010

This is regarding New Draft Tax Code.
Will you please enlighten readers on the implications of Capital Gains for retail, small investors?? Some say that shoert term capital gain period is extended from 1 year to 2 years and that the income earned will be added to income from other sources AND the amount will be taxed as per rate applicable to this slab.
Is it correct???

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surendra jain

Jun 16, 2010

Very good and thought provoking write up. In spite of the market going up, I am unable to get rid of the feeling that things are not OK and a major correction may come sooner than later.

The RBI wii be forced to increase the interest rates as the worth and purchasing power of the retired persons is crashing due to totally unabated CPI rise. People don't know how to protect their money. Govt gets higher taxes and continues to find new ways to gather more and more funds to either repay/service it's internal and external debt, debt waivers and consumption expenditure. Asset creation is now only by private sector or Govt. and private sector partnership. In these ventures the private sector licensees are allowed to make unreasonable profits.

Those who took loans to book houses and commercial properties don't get possession even after 3 years of the due date. They pay higher EMIs as well as higher rent while disposable income keeps shrinking due to the living cost rise month after month.

I don't know how some people feel our economy is in a great shape!!

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t n v swamy

Jun 16, 2010

Good report and it is interesting to read.

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