This Gold is a must-have for India

Jul 24, 2010

In this issue:
» Are govt. subsidies on their way down
» Not much 2G spectrum left
» Monetary policy has to be tightened further
» The key to solving US' unemployment problem
» ...and more!!

A lot of focus in recent times has been on that precious yellow metal called gold. After all, in an environment where paper money is being printed at the drop of a hat, gold is being looked upon as a solid wealth preserver. Not only investors, but banks and governments are also stocking up their gold reserves.

But there is another precious resource, call it 'black gold' if you will, that India acutely needs. Especially if it wants its economy to grow at that magic double digit rate. A resource that the country is woefully short of. Yes, we are talking of coal. India's coal shortfall is predicted to double to around 242 million tonnes (MT) in the five years to 2017. In response to this, a top government advisory body has proposed that the government should allow private firms to mine coal to plug supply shortages. This will help India boost power generation which is the key to propelling its economy to double-digit growth rates.

At present, India does not permit commercial mining of coal by private firms. However, it allows power producers to access 'captive blocks' for their fuel needs. The country has 267 bn tonnes of coal reserves. 40% of these have been proven. But social and environmental issues have slowed down the pace of production. As a result, coal shortages have compelled many power producers in India to scout for international coal assets.

Meanwhile, India's power infrastructure remains woefully inadequate. In the five years to 2012, the likely capacity addition that will take place is 62,000 megawatts (MW). This is way below the 78,000 MW target that had been set. And this current pace of addition is barely sufficient to achieve a growth rate of 8%. The government has repeatedly tripped on its investment targets in the past. Will this time be any different? Sadly, we are not so sure.

 Chart of the day
The Indian government's fiscal deficit does not paint a rosy picture right now. And realizing this, it laid a roadmap for bringing this deficit down in the Union Budget 2010. Stimulus measures aside, the main culprits have been subsidies and interest payments. However, today's chart of the day shows, after increasing steadily since FY03, govt. subsidies could see a drop in FY11. This seems like an encouraging sign. The government's recent move to free up petrol prices and raise prices of other fuels was with the aim of bringing oil subsidies down. Therefore, the intention is right. But will we see more such subsidy reductions in the years ahead? Only time will tell.

Data Source: CMIE

Economics is a social science. And here, what the participants think and do has a very important bearing on the end result. Consider the European Union for example. The Greece episode dented investor confidence in the region's banks in a big way. And this line of thinking had started having an effect on the region's economy. Thus, restoring investor confidence in Europe's banking system became a top most priority for administrators. In a view to achieve this, a stress test of the region's 91 banks was initiated about two months back.

The test involved trying to find out whether banks could end up with sufficient capital if another slowdown were to happen. After making all the banks on the list go through the test, the results were finally published yesterday. And it looks like there is no major reason to worry. The results showed that only seven of the 91 banks failed to meet capital standards and a cumulative capital shortfall of 3.5 bn Euros has been identified at these banks. Incidentally, five of the seven banks were Spanish whereas Germany and Greece had one bank each. While this is indeed good news as things are not as bad as anticipated, there are many who are not convinced. They believe that the stress test parameters were not tough enough. Well, we may have to wait a bit to know whether the confidence has been really restored. Or the EU continues to go down the path of disintegration.

If you had any doubts over the US going the Japan way, rest assured. Your doubts will soon be confirmed. The interest rates in the US have been near zero for more than six quarters now. And if Ben Bernanke is to be believed, lowering the rates further is the key to solving US' unemployment problem. With unemployment staying high at over 9%, the Fed chief has little recourse but to address this issue on a priority basis. But his solution seems to be paving the way for the US dollar's demise.

Heightened fears of a double-dip recession has forced Bernanke to take further steps to allay the economic concerns. But not with much success. His strategy to lower rates may spell distress for the US and emerging economies as well. The former may get drawn into a deflationary cycle. The emerging markets may see huge influx of hot money. Also, the perilous state of the reserve currency is not something that global economy will benefit from.

"Call dropped." "Network busy." Common responses when we make calls from our mobiles. The problem - inadequate spectrum and its natural outcome, network congestion. In India, spectrum is controlled by the Government. The government auctions a part of this spectrum to the telecom operators who in turn use this to carry the volume of calls made by us.

So why doesn't the government just allocate more spectrum to the operators who will improve their networks? The answer is, the government doesn't have much 2G spectrum left. Then what would happen to the new operators who have paid through their noses for getting this spectrum but haven't received any till now? How will they launch their services? And what would happen to the congested networks of the incumbent operators? This just adds on to the woes of the telecom sector which is already facing tough times with increasing competition.

India has been labeled as one of the least economically free countries in the world. According to the Index of Economic Freedom released by The Heritage Foundation and The Wall Street Journal, India is ranked at number 124. The main reasons for the same are quite obvious. Rampant corruption, poor investment norms and soaring inflation are all part of the unfavourable mix. However, even its BRIC counterparts are not doing too well. Brazil ranks slightly higher at 113, but Russia and China are lower at 143 and 140 respectively.

Inflation concerns have been persisting in India for quite some time now. And the Prime Minister's Economic Advisory Council (EAC) opines that monetary policy has to be tightened further to deal with it. The EAC Chairman Mr. Rangarajan has stated that inflation is almost twice their comfort level. The EAC has projected a wholesale price inflation rate of 6.5% at the end of the current fiscal. This is much higher than the RBI's estimate of 5.5% and the Finance Minister's estimate of 5-6%. According to the EAC, the food inflation of last year has pushed up inflationary expectations. This, in turn, has translated into higher wages. This in turn has been the main driver of inflation in manufactured products. Monsoons, hopefully, should ease some pressure on prices in the near term. But in the longer term, the government will seriously need to address the pressing concern of food security for the country.

The past week was a good one for the global markets as the key indices ended the week on a positive note. While interest in Asian stocks increased on the back of higher commodity prices, the US markets also moved up as companies raised profit forecasts. India's benchmark index, the BSE-Sensex ended the week higher by 1% on the back of positive global sentiments coupled with good set of June quarter numbers from select heavyweights.

Ending higher by 6%, Brazil led the pack of gainers this week. It was followed by China and US which ended higher by 6% and 3% respectively. France, UK and Hong Kong followed suit with gains of about 3% each. Japan (up 0.2%) and Singapore (up 0.5%) were amongst the lowest gainers this week.

Data Source: Kitco, Yahoo Finance

 Weekend investing mantra
"When purchasing depressed stock in troubled companies, seek out the ones with the superior financial positions and avoid the ones with loads of bank debt." - Peter Lynch

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4 Responses to "This Gold is a must-have for India"


Jul 25, 2010

Madhur Kotharay's comment can be the cover story for tomorrow's 5 Minutes. It is an incisive analysis of what is going on in Europe. From a different point of view, a weakening Euro brings new M&A opportunities to the world. Cash rich and underleveraged Indian corporate houses with global vision may perhaps spot opportunities in EU. Risk aversion may not mean same decisions every time, while risks of FII pull out are always there. While USD may gain from a weakening Euro, sustainability of investment flows into USA is not yet established, as various data are not bringing comfort. There is a limit to Government driven revival. Economies which are firing from all cylinders may not get decoupled from the global developments but may either continue to keep a longer curve with equities than other markets. If they do not, they may offer a fresh round of opportunities for those who are ready for cash. Not a time to leave the market - to survive or to thrive.


Sanjay Negi

Jul 25, 2010

How can spectrum be more scarce or plentiful in India compared to other it because we talk more(no evidence, on the contrary, we use much less talk time minutes per user) or is it that our powerful, corrupt government and its agencies hoard large parts of the God given(equal to all countries to the best of my knowledge) spectrum...


Adi Daruwalla

Jul 25, 2010

I am a bit disappointed that inspite of the 3 top tech companies of India, having declared thier results, EqMaster has no comments of Q1 results of Indian corporates in the 5 min wrap up. Howver everybody is gaga about certain results with dividends being paid etc, some centenary bonuses too. But the deeper part of the statement of accounts is being missed by everybody. Any takes for improving the nation's development and contributing to the governments ex chequer or coffers? None, well there are at leats 1400 comanies listed at the trading bourses, of which there will be atleast 50 who owe a large sum of money to the government over the last 5 - 7 years. These are in the form of customs and excise duties that are pending to be paid. Reason; dispute whether these should be paid or not, and arbitrations. Isn't it in the interest of the government to fast track these cases and bring them to conclusion, whereby they will receive the necessary funds for nation development. e.g. Wipro has cases pending since 2005 to the sum of Rs. 3200 million approximatley. Bombay Dyeing is another company with amounts that are smaller. If you take 50 companies and multiply the above figures you would know what the government is missing out on. Also take into account the black money lying in the Swiss banks, according to Ram Jethmalani if the moeny is brought in then every Indian will have 2.5 lac rupees and all defecits can be wiped out. So who is going to be the Pied Piper of New Delhi in this case, to bring out the rats and their dosh (mullah). I think in India the commoner with the barrage of diffculties metted out on her/him has become para normal, and that is why we survive and are resilient. It is not going to last long tough! Think about it.


Madhur Kotharay

Jul 24, 2010

European Bank Stress Tests

With the bank stress tests turning out to be a non-event, the markets are supposed to go up. But I have my reservations on the bank stress results. They calculated the effect of the stress on Mark-to-Market securities held by banks. But they did not count it for Hold-to-Maturity securities.

A bit of a primer on this: Banks buy a lot of government bonds on which they earn interest. This is similar to your FDs, except that the FD is yours and yours only. If you need money, you break the FD. However, in global finance, you cannot break the FD - you just sell it. So such FDs (bonds, actually) keep changing in price, while the bank FDs that you take are fixed in value (1 lakh rupee FD, for example, will always be 1 lakh rupee FD, which is the amount you will get on maturity or completion of its tenure). If the bond is generating 10% interest and is originally worth Rs 1 crore, its value may not stay the same as the interest rates change. Because of recession, if the regular interest rates drop to 5%, suddenly the bond that you own that generates 10% interest on 1 crore starts generating as much interest as a new 2 crore bond since the new bond will be only at 5% interest. So the 1 crore 10% interest bond that you own is worth a 2 crore 5% interest bond. Thus, you can actually sell that 1 crore 10% interest bond in the market at 2 crores. Remember, that when the bond matures, say 20 years from now, you would get only 1 crore back, not 2 crores but since 20 years is a long time, the bonds can be sold at higher price of 2 crores currently.

Since you can sell a 1 crore bond at 2 crore, it is like a share and hence the banks can show profits when their values increase (which happens in a falling interest rate regime) and show losses when their values drop in rising interest rate scenario. That makes banks' incomes very volatile in a business cycle. Remember, banks are legally required to hold a good part of their holdings in government bonds. So they are not allowed to sell all of their bonds in a low interest regime. Then, why have this volatility? Thus, the legal framework allows banks to segregate their bond holdings as either Not-To-Be-Sold-Till-Maturity or Could-Be-Sold-Anytime. The former is called Hold-To-Maturity or HTM bonds and the latter is called Mark-To-Market or MTM bonds. The differentiation is the discretion of the bank but they typically do not do much change in the HTM bonds of theirs (as there is a legal minimum requirement). They are allowed to change the value of their MTM bonds based on the interest rate scenario and required to keep the value of their HTM bonds unchanged.

Now that you are an expert on HTM and MTM bonds, note that the European stress test checked the losses the banks would incur in their MTM bonds. If Greece comes near default, it might ask its debtors (or bond-holders) to take a haircut and write-down the value of its bonds. The test assumed that Greece at worst will ask the banks to take a 25% drop, i.e. the banks will say "Ok, ok, don't default. We are willing to take a 25% reduction in the bond value. Those 10 billion euro bonds are worth 7.5 billion now and you can pay only 75% interest than that you were supposed to pay us". This might even happen in case of a default. Greece might say, "we are bankrupt. So we cannot repay your loans. However, we want to do business with you in future. So kindly accept only 75% value for your bonds and we will honour the interest commitments if you allow us to pay only 75% interest." Alternatively, the banks would go to other banks and say that Greece will return only 75% of the money (75% is a hypothetical number though it was the number used by the stress testing people for Greece this time). So do you want these bonds at 75% of the prices? etc. etc.

Thus, the stress tests checked the survival of the banks by adjusting down MTM bonds. However, if Greece defaults, the value of their HTM bonds, though payable only after 10-20-30 years, would be permanently marked down as Greece is not going to say after 20 years that we are wealthy now and we will honour those old bonds at full price, once they have been marked down 25% after default. Thus, the stress test should have reduced the HTM bonds also for banks for the stress test. Note that in case of close-to-default situation, HTM bonds need not be adjusted as they mature only after 20 or 30 years by when all things will be normal again. However, in case of default, HTM bonds need to be adjusted. Thus, in my opinion, the stress tests were overly optimistic and a big danger remains in case of Greece, Ireland, Portugal, Italy or Spain defauling. Spain is especially dangerous as it is very very large compared to the other 3 countries. Spain GDP is $1.46 trillion compared to India's $1.24 trillion!! Of course, Italy is a $2.12 trillion GDP Gorilla, too.

End Game

The governments around Europe are undergoing a huge austerity program. That is going to plunge that zone into deep recession. There is no question about it. In that case, the tax revenues fall and since the government has no way to prop up the economy, the Euro zone future is also very very dicey. I believe we are going to face at least one or two sovereign defaults in the next 2-3 years as that is the only way out for a country that cannot service its interest burden due to a steep fall in its tax revenues. Ergo, the European banking sector is going to stay vulnerable for a long time to come. I just do not see how this is going to sort out peacefully.

I also believe that if things are somewhat bad in the world, India wlll benefit as it becomes one of the few economies doing well and so a lot of investments will shift from USA, Europe, Japan to India. That would help our markets. However, if things get really bad, people do not switch countries, they switch assets. They would get into Gold or US bonds or cash and even pull out money from India, as the risk aversion sets in. That can pull down Indian market severely. This is exactly what happened from Sept 2007 to Jan 2008. Since the world was somewhat bad, the global investors kept pulling money out of the world and putting into India and commodities. So India kept going up while the USA was tanking. We thought it was 'decoupling'. Then, in January 2008, things became 'really bad', people started pulling money from India first and then from commodities. Soon, hash-sha, Hush-sha, all fell down. :-)

I believe currently we are in 'somewhat bad' scenario. So as the world indices are dropping, we are going up. If the world were drop down to 'really bad' scenario, India will tank badly.

While you might a lot of positive talk with good monsoon, good results, reduced fiscal deficit, and even good numbers in the USA and the UK, keep a saner head. Keep some cash in hand, I think 15-20% is fair but don't get out of the markets as you cannot time the explosion of this problem bomb and could miss a significant rally if it were to happen.

Global headwinds and local tailwinds! It has never been so nerve-wrecking for me. But then, to quote Andy Grove of Intel, in stockmarket, "Only the Paranoid survive".

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