»5 Minute Wrap Up by Equitymaster

On This Day - 15 JUNE 2012
Should Subbarao now build warehouses?

In this issue:
» In which direction is Dr Copper headed?
» India steps up oil imports from Saudi Arabia
» No loan restructuring for mismanaged companies
» Why hotels are implementing austerity measures...
» ...and more!

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He joined at a time when not just Indian but global financial system was at crossroads. The subprime crisis had just reared its ugly head. It threatened to sink even the most resilient financial systems. Since September 2008, Dr Subbarao has donned many hats. As chief of India's central bank, he has had to be a savior, facilitator and negotiator, all at the same time. First he was supposed to de-risk the domestic economy from subprime crisis. Then he was supposed to rein spiraling inflation. After that he was expected to support India's fledgling growth rate. And now it seems he could be expected to do the unthinkable! If the government has its way, the RBI governor may also need to find a solution for rotting grain produce. The same produce for which the government has fixed very high minimum support prices (MSP) to appease farmers. And in the bargain, once again stoked inflationary pressure.

Every time the government goes wrong with its policy measures, it looks for quick fix solutions. More often than not the RBI is expected to use its monetary tools to set things right. Inflation, oil prices, rupee depreciation. The RBI is supposed to have solutions for each of these. Despite Dr Subbarao hardly mincing words with regard to the government's ineptness in handling inflation, his views have found no takers. Other governors with the Reserve Bank of India (RBI) have also cited marginal room for interest rate cuts. Quite understandably since the government's wasteful spending has gone to gargantuan proportions. But once again, all eyes are fixed on the upcoming policy review that could ease liquidity further. That would ease growth pressures, albeit temporarily.

But we will not be surprised if this time a prudent Dr Subbarao should propose building the warehouses too! After all, our government does not seem to realize that the best solution to tackle inflation is ensuring better storage of food grains. On one hand the government is allowing surplus produce to rot in the open during monsoons. There is also a proposal to offer wheat at dirt cheap prices to industries. On the other hand, high MSPs (Minimum Support Prices) are being doled out to appease farmers. All of this if tackled with better warehouses and logistics could solve the inflation problem for good. And that would leave the RBI with more time to look into crucial matters, rather than quarter on quarter inflation control. Well, if the government remains tongue tied and paralyzed, it would eventually be pertinent for the more hands-on regulators to take some radical steps.

Do you think the RBI should once again yield to the government's demand and reduce interest rates to curb inflation? Let us know your comments and post them on our Facebook page / Google+ page.

 Chart of the day
As the government's reform measures fail to make any headway, investors have increasingly lost interest in economy and infrastructure related stocks. Instead the consumption story has once again taken centre stage. As seen in today's chart, the performance of the benchmark indices on the BSE over the past year, shows that commodity and infrastructure stocks have failed to evince investor interest. On the other hand more resilient and defensive sectors like FMCG and Healthcare have found more takers. Auto and banking sector have seen some volatility depending on the RBI's interest rate stance. But the negativity towards IT stocks is largely to do with the rupee's uncertain future with respect to the US dollar.

Data source: Yahoo Finance

Fundamental analysis is not a good place to be in these days. The simple reason being that policymakers are hell bent on not letting free markets run their course. Every time a bad news comes along, central banks seem ready with money in hand. No wonder, asset prices are displaying extreme volatility. Take Copper for example. Just as it was appearing that the industrial metal would continue its losing streak, it did a U-turn yesterday and posted its first weekly rise in seven weeks. All of it on the back of reports that central banks are poised to inject liquidity in the case of a crisis in the financial markets. Fundamentals though continue to remain weak. The USA, as well as China, is facing pressures on the economic front thus clouding demand prospects for copper. But as long as central banks stand ready to throw money at the system, it would be a risk to bet on the direction of copper prices. Our heart goes out to not just analysts but businesses that have to manage their costs in the midst of such uncertainty in commodity prices.

That oil forms the largest share of India's import bill is not news. India is in fact the fourth largest oil importer in the world. Interestingly the country appears to be stepping up its oil imports as it has sought another 100,000 barrels per day (bpd) from Saudi Arabia. This is in addition to the 640,000 bpd that it received in 2011-2012. This increase may suggest an increase in demand for oil from India. That could be one big reason. But another and equally important underlying reason is quite different. India needs to cut down its imports from Iran. Due to the sanctions by US against Iran, India too was finding it increasingly difficult to meet its oil import needs. Therefore, it has sought more oil from OPEC (Organisation of the Petroleum Exporting Countries). But not from Iran.

As the Indian economy has slowed down, the hotel industry has not been spared either. The debt crisis in the developed world has not eased. As a result, foreign tourist arrivals have seen a drop. This has led to lower occupancies in hotels. Rising airfares have only added to the industry's woes. Companies have also undertaken austerity measures. This means that business hotels, especially five-star ones, have not benefited much from conferences and meetings. Despite this, the hotel industry claims to be better prepared than what they were in 2008 when the global financial crisis struck. In response to the slowdown, hotels have begun to implement austerity measures themselves. These include cutting down marketing expenditure, staff-to-room ratios and energy consumption. Whether these moves will bolster the sagging bottomline of hotels remains to be seen. But given many near term concerns for the economy, these could be steps in the right direction.

The last two quarters of FY12 saw a massive wave of corporate debt restructuring (CDR). Air India and various power discoms saw their loan rescheduled. However, the Reserve Bank of India (RBI) may now make it harder for corporate loans to be restructured. That is unless there are valid external reasons for the same, which are beyond the control of managements. For example: sharp fall in cotton yarn prices and poor global demand have sorely affected textile mills. The textile industry is now demanding a Rs 1 trillion recast of loans. As of now, the outstanding standard restructured assets of the banking system are estimated at between Rs 2.1-2.3 trillion. Restructuring of the tenor or interest rates can help the borrower better service the loan versus defaulting on the same. However, the RBI wants to make sure that mismanaged companies are not given a longer leash. Thus, it makes sense for the central bank to streamline its guidelines for this matter.

China's export competitiveness is subject to multiple factors. Artificially pegged currency and economies of scale are a few of them. And when it comes to export of power plant equipments China enjoys a clear sustainable competitive advantage. This has placed the Indian equipment manufacturers at a disadvantage. Now, considering the way the Chinese are making inroads into the Indian market. It seems difficult that this competitive gap would ever narrow in the future.

We have been hearing a constant rant that the Chinese profligacy is attributed to currency advantage. But this ignores the other benefits that come along with China. Cost advantage is one of them. A Chinese manufacturer can provide power equipment at almost half a price than an Indian manufacturer. This is after accounting for the cost of transportation and import tariffs! It can also deliver that equipment in much shorter span of time. Access to cheaper loans from Chinese banks provides another advantage. Thus, if India has to overcome the China threat it will have to take multiple steps. Method to reduce marginal cost of production is one of them. A sound reform agenda with free market pricing is another.

Taking cues from their peers across Asia, the indices in Indian stock markets made a firm up move into the positive territory backed by investor interest in heavyweights in auto, cement and banking sectors. The positive sentiments seem to be primarily based on hopes of rate cut by the RBI. At the time of writing, the BSE Sensex was trading 192 points above the dotted line. The indices in most other Asian markets closed higher in today's trade. Those in Europe have, however, opened in the positive.

 Today's investing mantra
"A disproportionate number of the great business fortunes built up during the inflationary years arose from ownership of operations that combined intangibles of lasting value with relatively minor requirements for tangible assets" - Warren Buffett

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