Can crisis bring out the best in businesses?

Sep 7, 2011

In this issue:
» Is private sector subsidizing govt's interest cost?
» The next commodity that will be on fire
» Indian capital markets to welcome hedge funds
» Industrial use of this precious resource to triple!
» ...and more!

"The Chinese use two brush strokes to write the word 'crisis'. One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger - but recognise the opportunity"- John F. Kennedy. We were tempted to quote these words of the famed US President to highlight the upsides of surviving an economic crisis. It seems that even the sectors that have been written off by investors are doing a decent job of crisis management. Wonder whether it can bring out the best in them to create long term value!

Take the Indian real estate sector. There is little that the sector can bank upon to improve the prospects of revenue growth and profitability. Although much of the woes are of their own making, builders are stuck with large inventories and no buyers. Critical resources like land, labour and capital have become increasingly inaccessible to the sector. In such tough times, the players have had no option but to realign their business strategies to deal with the crisis.

Using one builder's land and another's development and marketing skills have come handy in times of execution crisis. These have solved the problem of non-availability of huge tracts of prime land and avert the shooting land prices. With demand touching historical lows, real estate inventory is lying unsold for as long as 40 months in a few cases in Mumbai. Due to this, builders have also had to share capital with their peers. But all said and done, timely execution and realistic pricing could go a long way in solving the sector's woes. As far as demand is concerned it is only a matter of time before the interest rates reverse and buyer appetite improves. Also given the scope of urbanisation in the smaller towns and cities, we believe that real estate is a business that is here to stay. Provided done with efficiency, ethics and stakeholder friendliness.

In fact not just realty but several sectors like IT, auto and textiles that have witnessed investor apathy in recent times are likely to come back with a bang. Cost efficiency, sustainability and innovation are some of the techniques that are likely to bring out the best in them. It is for investors to spot the most promising players while the tide is against them.

How do you think businesses can bring out the best in themselves during times of crisis? Let us know your views or post them on our Facebook page.

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 Chart of the day
As if the government's tardy reforms and failure of disinvestment targets creating havoc with fiscal planning was not enough, the oil prices are making a joke out of India's fiscal budgeting. As today's chart shows, both revenue and fiscal deficit levels in India have nearly tripled as a percentage of GDP in the past 12 months. Spiraling oil prices and economic slowdown have contributed to the fiscal woes.

Data source: Livemint

'Statutory' is a word that one usually associates with a warning on the face of a cigarette pack. If something is statutory it means that it has to be followed compulsorily by all the concerned parties. In other words, it is a permanent rule. It should be noted that the word statutory also finds a place in the banking industry. The industry has something called as the Statutory Liquidity Ratio (SLR). What this means is that the SLR is a mandatory requirement for all banks to invest a fixed percentage of their deposits in government securities. Thus, even if there is a shortage of funds for the private sector, precious little can be done as the funds cannot be diverted from government securities and lent to the corporates. This is certainly helpful during times of crisis as banks are forced to keep the credit machinery going on account of their investments in government bonds. However, the SLR can create problems when the liquidity in the system is low. It leads to the Government enjoying subsidised rates of interest at the expense of the private sector. This reality has not been lost on the RBI Governor.

Speaking on the sidelines of an event recently, the RBI Governor opined that SLR must be brought down so that credit flow to the private sector is eased. However, he stopped short of mentioning the exact ratio. Like all the central bank policy actions in recent times, we support even this one. The cut in the SLR though should not be too much as it will then divert funds for development towards payment of interest by the Government.

The move for gradually rationalizing prices in the energy sector might take a key turn. This time, the commodity that may weigh heavy on the consumer's budget will be coal. It is important to note that while coal prices are decontrolled on paper, they are adjusted only in consultation with the coal ministry. No wonder, the domestic coal prices are 30%-50% lower than the imported coal. Just one day back, the pooling of natural gas prices was ruled out by the high level government committee as it believed that the natural gas users could not be asked to subsidise costlier imported liquefied natural gas (LNG). However, the planning commission has different plans as far as coal is concerned. It believes that pooling costlier imported coal prices with cheaper domestic coal in the short term make this shift easy.

We doubt that the pooling concept will have many takers. The move may benefit private producers, however, companies like NTPC will be at the losing end since around 85-90 % of its consumption is met through domestic coal. While we do need to be realistic about pricing coal, it can't be a single pronged price centric strategy. The sector needs to get rid of distortions like partial decontrolling of prices. The Government needs to set a regulator and work on supply side dynamics as well. We believe it should rather focus on policy reforms like easing entry barriers of private sector and a reform in the mining bill to begin with.

Indians do not hear much about hedge funds simply because so far, they have not been permitted by the market regulator. However, there is a good likelihood that domestic companies would soon be allowed to float hedge funds. Let us first tell you what exactly a hedge fund means. Contrary to what the names suggest, hedge funds are very aggressively managed high-risk high-return portfolio of investments involving complex financial products such as equity derivatives, structured products and so on. You could say they are a more sophisticated form of mutual funds meant for the super rich. But unlike mutual funds, they involve relatively fewer investors but require big ticket investments.

With the number of high net worth individuals rising at a scorching pace in India, the appetite for hedge funds is immense. Experts suggest that the Indian capital markets would receive at least US$ 2 bn in funds once the hedge fund option is made available to wealthy investors. Though these funds may seem attractive, they may bring in little merit to our economy, not to mention the extreme volatility caused by big speculative hedge funds.

This is one precious resource that has not been given its due while the limelight is always on its more illustrious peer notably oil. And yet, the availability of this resource cannot be taken for granted. We are talking about water. Indeed, water has a crucial role to play in India's economic development. Although only 8% of the country's total freshwater withdrawal is used for industrial purposes, the demand will grow significantly in the coming years. The water requirement for industrial use is likely to quadruple from the current 30 bn cubic metres (bcm) to 120 bcm by 2025, according to the World Bank. This means that companies will have to focus on water management and how to do more with less water. Suitable investments need to be made in water conservation, water recycling and waste water treatment techniques. Big companies have the resources to invest in these projects. But it is not so for small and medium scale enterprises which are often ignored in discussions even when their contribution to overall economic development cannot be undermined. Indeed, industries have to come out with suitable guidelines which address the problems of water pollution and how to treat it. Otherwise, industrial growth could get thwarted if not in the immediate future, certainly in the longer term.

China, the world's largest steelmaker and iron ore consumer, is diversifying its iron-ore imports. Its iron ore imports from countries other than traditional partners (Australia, Brazil, India and South Africa), has increased by 4% in the first half of this year. Particularly, the imports from India fell by 14.9%. This is primarily due to higher cost of iron-ore imports from India.

In a bid to curb exports, Indian government had raised export taxes and freight rates on iron-ore. As a result, the average cost for Indian iron ore increased to US$100 per tonne, more than double the production cost in Australia and Brazil. Moreover, there is a ban on shipments from Karnataka, which account for one-fourth of India's annual exports, due to illegal mining swindle. The higher export cost led to a decline in margins of iron-ore producers. The government's steps to prevent iron-ore exports came in line with its plans to boost the domestic steel industry. India aims to increase its steel production capacity to 120 m tonnes by 2012 from 67 m tonnes in 2010. The decline in exports will enhance the supply of iron-ore in domestic market. This will lower the raw material costs for the domestic steel companies, in turn boosting their margins.

After a positive start today the Indian indices gathered momentum and made further inroads into the positive territory backed by buying interest in banks, FMCG and auto heavyweights. The Indian stock market was amongst the top gainers in Asia today. At the time of writing, the BSE Sensex was trading higher by 253 points. Most other Asian markets also closed higher. Europe has also opened on a positive note.

 Today's investing mantra
"Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down." - Warren Buffett

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2 Responses to "Can crisis bring out the best in businesses?"


Sep 8, 2011

Nice article! but blog that real estate sector is entering in secular bear market. What is your opinion ?



Sep 7, 2011

Three points on your Wrapup:
RE: SLR reduction. While it has been amply proved that the RBI Governors of India are best in the world and it is due to their foresight we did not face any problem since 2008, hte even slightest relaxation in SLR would not be a good step. One the amount of SLR kept by a Bnak in GOI securities is hardly 5.25% of it deposits, reducing this would not lead to a very high amount of money which the Banks can lend to private enterprises. We should continue with the present policy only.
Re: Starting of hedge funds - Be prepared for more volatility - "satta". Traders will have to be more alert.
Re: Water shortage in future: We at Rotary Clus have Roof water harvesting as a thrust project of every District through out India. Every Club carries out these projects, wherein the rain water is diverted thru pipelines leading the water underground thereby recharging the parched earth. Just compare the rainfall in Israel and India. GODs have been very merciful on us and we get tremendous amount of rains. If we plan properly, we can never ever have shortage of water. Moreover massive tree palntations is of utmost importance.

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