Economy is like a bathtub...

Sep 25, 2008

In this issue:
» Japanese undoing the Pearl Harbour
» India to import 90% of crude requirement by 2030
» Benign interest rates ahead?
» Security threat thanks to economic boom
» ...and more!

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Japanese undoing the Pearl Harbour
Almost 63 years and a month ago, the US dropped two atomic bombs on the Japanese following the latter's attack on the former's territory of Pearl Harbour. Now in 2008, bankers from the 'land of the rising sun' are heading towards Uncle Sam...not with bombs but with capital that can diffuse many financial bombs waiting to erupt in the remnants of Wall Street.

Japan's biggest bank Mitsubishi UFJ is buying up to 20% of Morgan Stanley. Also, the country's largest brokerage Nomura Holdings is snapping up bankrupt Lehman Brothers' operations in Asia, Europe and the Middle East. And Sumitomo Mitsui (Japan's third largest bank) is expected to invest 'several hundred billion yen' in Goldman Sachs.

However, as reported in the business daily Mint, "The difficult thing will be the execution. Japanese companies have had a tendency to overpay for overseas acquisitions. Cultural issues will also be a factor. Japanese organisations are run in a very different way from Western banks. Quite how both sides learn to live with each other will be interesting."

Interestingly, the number of casualties on Wall Street (those that have lost their jobs) stands at nearly 200,000, which is about the same as the number of casualties in the 1945 nuclear bombings on Hiroshima and Nagasaki!

Where is the oil?
As if the rising crude prices were not enough, India's dependence on crude oil imports for meeting its energy requirements is expected to increase from 78% currently to 90% by 2030. Stagnation in production is expected to be the reason for the same. Fathom this - as per reports in a leading business daily, India had estimated reserves of 725 m metric tonnes (MMT) of oil at the beginning of FY08, as compared to 739 MMT in FY91 and 703 MMT in FY01.

This amply demonstrates the fact that no progress has been made. Further, domestic crude production has been stagnant at around 33 MMT per annum for the last 10 years. India's appetite for crude in the meanwhile has been rising steadily and highly subsidised prices at the retail level have further worsened the situation (as it has led to inefficient utilisation of this precious resource). As a matter of fact, the demand for petroleum products is expected to grow at 3% per annum in the next 25 year to 270 MMT in FY31 (129 MMT in FY08).

However, there is light at the end of the tunnel. Natural gas production is not likely to meet with a similar fate as crude production. In fact, production of natural gas is on the rise and output is expected to double from 32.4 bn cubic metres in the last fiscal year. More importantly, the differentiating factor between crude and natural gas production will be new discoveries in case of the latter especially from FY09 onwards. But all is not hunky dory and the disconcerting fact is that India started becoming an importer of natural gas from FY05, before which it never had to go in for gas imports. All this could only mean that India's trade balance, which is already into a deficit is not likely to get any respite soon. A depreciating rupee will only worsen matters further.

Benign interest rates ahead?
The newly elected governor of the Reserve Bank of India, Dr. Subbarao will be putting forth the half-yearly review of monetary policy on the 24th of next month. While much has been written and said about the new governor's cautious stance on inflation-reigning measures there are conflicting views about the central bank's longer term casting of interest rates. Goldman Sachs believes that interest rates in India are set to cool off with inflation levels nearing single digits in the coming months. However, one of the largest private sector banks in the country, HDFC Bank sees long term interest rates rising even further.

While the world makes a mockery of the US that is struggling with debt levels estimated to cross US$ 11 trillion, we are ignoring the fact that back home the government borrowing levels are not looking too pleasant either. The RBI has been regularly making funds available to banks in the past two weeks to boost the availability of funds. However, as capital flows to emerging markets shrink amid a global credit crunch, the same is expected to unwind.

In the meanwhile...
While most of the key Asian indices closed in the red today, the Chinese Shanghai Composite (up nearly 4%) was amongst the few gainers in the pack. The Indian benchmark BSE-30 index closed lower by 1%. The Indian markets in fact languished in the red throughout today's session as the rupee continued to lose ground against the US dollar.

The rupee fell to its lowest (46.3 to a dollar) in a week today as month-end dollar demand from importers and oil companies weighed on it. The US markets are expected to continue witnessing the jitters over the fate of the government's US$ 700 bn financial sector bailout plan. The European markets are trading in the positive currently.

Realty strikes hard
Nearly 112 m square feet of retail space is expected to be delivered in the next 2 to 3 years signaling sufficient supply of real estate space. But are there enough takers? As per a report from a leading business daily, the total vacancy rate in Mumbai malls stood at 13.1% in August 2008, the highest since 2005. In fact, the vacancy was as high as 30% to 50% in some suburban malls. Vacancy at Delhi's prime and suburban markets also rose to 16.2% and 10.8% respectively in the first quarter of FY09.

Real estate companies are waking up to deal with the slowdown. Hit by falling fund-raising avenues and demand from customers, construction companies are in the process of increasing the variable pay packages for a large chunk of their employees, as a measure to counter a prolonged slowdown. This is expected to help them keep their fixed costs under control. While most companies of this genre are yet shying away from downsizing their employee base, they are certainly wary of controlling the employee costs.

Sreedharan's comments sting Congress
A septuagenarian credited with achieving the impossible, Mr. E Sreedharan has many achievements to his credit. The latest one being the building of the Delhi Metro project. Known as the engineer who took up the challenge of building the Konkan Railway that reduced the Mumbai-Kochi distance by one-third he has been selected as one of the most outstanding Asians by Time magazine.

However, the former Delhi Metro Rail Corporation (DMRC) managing director's comments on the Hyderabad Metro Rail project has not gone well with the Planning Commission. Stung by Sreedharan's charges in a letter to Planning Commission Deputy Chairman Montek Singh Ahluwalia, the Congress government has sought an unconditional apology failing which it has threatened to sue him. Sreedharan's letter, in which he expressed reservations over the way the government awarded the Hyderabad Metro contract to Maytas-led consortium, is likely to provide ammunition to the opposition's attack on the government as they gear up for next year's elections.

Sreedharan, who served as a consultant for Hyderabad Metro project has remarked that making available 296 acres of prime land to a BOT (build, operate and transfer) developer for commercial exploitation could lead to a political scandal. He believes that the BOT operator has a hidden agenda to extend the metro network to a large tract of its private land holdings so as to reap a windfall profit of four to five times the land price.

Another blow to China's exports
Although known as an export-driven economy, the recall of Chinese toys and now diary products from the US and Europe and their ban in several nations in the West indicates loose quality controls and raises questions about quality administration in the country. The dairy scandal has revived concerns about China's food-safety controls after previous scares over seafood, dumplings and pet food.

Following the US and Europe, many Asian countries have also pulled down China's dairy products amid escalating international concern about chemical contamination that has killed four infants and sickened 53,000 in the dragon nation. Over 20 countries and markets in Asia, Africa and Europe have either banned or recalled dairy products or goods made using milk from China, the latest in the leagues being South Korea and France. While it would certainly be harder for China to continue exporting to the West as the lawmakers call for tougher controls, the same may result in cascading effect with many other countries putting a ban on Chinese products.

Buffett's all for the bail out
Today morning, a leading business news TV channel pulled off a big broadcasting coup in the current troubled times in the US financial markets. In a lengthy interview, it picked up Warren Buffett's brains on topics ranging from his most recent investment in Goldman Sachs to his views on the US$ 700 bn government sponsored bailout of financial firms.

Buffett was his usual self, wit and simplicity personified. He commented that the economy is like a bathtub in which hot and cold water cannot be separated, and had the bailout not been planned, Wall Street would have immersed in that bathtub very quickly. When prodded on his Goldman investment going against his well-publicised hatred of Wall Street firms and why this was a right deal at the right time, he replied, "I don't try to time things, but I do try to price things. And I've got a formula that says bet on brains, and bet on them when it's the right type of deal. And in this case, there's no better firm on Wall Street. We've done business with them for years, with Goldman, and the price was right, the terms were right, the people were right. I decided to write a check."

The master also heaped a lot of praise on the treasury secretary Henry Paulson and warned that if his proposal of the US$ 700 bn does not get a go-ahead from the Congress then what happened in the last week in the financial markets would look like a 'Nirvana' in front of what will eventually unfold. He was further of the opinion that the US economy, like in all previous crises, would also pass through the current one and would eventually do well in the long run. Comforting words indeed from someone who has lived through many a recessions himself.

Security threat thanks to economic boom
If Pakistan is to wage a war on India today, we would probably have to run for cover or try and align a couple of rifles on our own shoulders. This is because we do not have enough defence officers guarding our borders. One downside of the economic boom over the past three to four years has been the fact that more youngsters have been lured by lucrative financial and IT sector jobs over weathering the extreme climate on the borders.

Despite being the world's fourth largest military force, India's armed forces are facing a severe manpower shortage being unable to compete with private sector jobs offering salaries as much as 5 times higher. The army has 11,371 fewer officers than it needs. The navy has 1,461 unfilled slots. The air force has enough planes for 300 more pilots than it has. To counter the lure of private business, the military is carrying out a publicity campaign to entice young people. It is also planning to increase the defense spending by as much as 10% this fiscal. To retain officers, the army this year has also proposed paying Rs 1 m for completing 10 years of service and an extra Rs 0.2 m a year after that.

Today's investing mantra
"Wall Street people learn nothing and forget everything." - Benjamin Graham

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