»5 Minute Wrap Up by Equitymaster

On This Day - 30 AUGUST 2011
Is RBI's latest move positive for India Inc.?

In this issue:
» Pimco's Gross rues his mistake
» Ajit Dayal's view on the Sensex
» No one wants to acquire brokerage houses
» No dent seen in IT firms' hiring plans
» ...and more!
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Banking is no easy business. And there are many risks inherent while running banks. This was amply evident during the global financial crisis when the global banking industry was at the root of the crisis. While major US and European banks had to go with a begging bowl to their respective governments to bail them out, the Indian banking industry emerged relatively unscathed. All because of the prudence of the Reserve Bank of India (RBI) and its strict regulations for the way banks operate in India.

Yet, despite the regulations, India Inc. has shown growing interest in entering the banking sector. The likes of Tatas, Birlas and other big corporate houses have expressed interest in the past for setting up banks. The RBI for its part has been cautious so far with respect to the same. And very rightly so! In recent developments, the central bank has decided to open the doors to let corporate houses enter but not without meeting various criteria first. Some of the major conditions that will have to be fulfilled before the RBI grants a license include sound credentials and integrity, a 10-year record of successfully running their businesses, a minimum paid-up capital of Rs 5 bn, 25% of their branches to be set up in rural unbanked regions, listing within two years.

In addition to this, such banks must be owned by a separate holding company that cannot borrow money to float the bank. Further, total foreign holding in the bank cannot cross 49% while the operating company must lower its stake to 20% by 10 years. Not just that, meeting all these criteria does not automatically result in banking licenses being granted. This is because the RBI intends to be very selective and will have the last word when it comes to granting permission to set up banks.

The positive is that more banks will help boost financial inclusion in the country. Thus, while India Inc. will herald this move, a lot will depend on how serious they are in setting up and running a bank. The RBI, understandably, is a bit paranoid given that banking lies at the heart of a country's economic health. Thus, as long as the central bank keeps a vigilant eye on the way corporate houses are running banks, the chances of mismanagement and unhealthy practices should be minimal.

Do you think that RBI's move to allow corporate houses to run banks is a good one? Share with us or post your comments on our Facebook page.

 Chart of the day
Ideally speaking, rise in labour productivity should be matched by a more or less equal rise in wages. But that does not always happen. Today's chart of the day shows that in the period 2000-10, India's wages have not grown faster than labour productivity when compared to its Asian counterparts. This means that there is scope for wage hikes in India going forward. In contrast, China's wages have grown a quick rate and have outpaced the growth in productivity.

Data Source: The Economist

If there should be a competition to find out the Warren Buffett equivalent of the bond markets, the crown would most likely fit the best on the head of a certain Mr Bill Gross. And just as the Oracle of Omaha's mistakes are analysed and dissected more than perhaps his success stories, experts also tore into the latest error committed by Gross. In fact, as per Gross' own admission, it was a mistake to bet so heavily against the price of US Government debt. And he has had to pay a heavy price for it. PIMCO, the iconic bond firm helmed by Gross, had its flagship fund ranked a dismal 501st out of 589 bond funds in the category as on yesterday. The word has it that Gross' bet that the US bond yields would start inching up in view of the coming inflation in the US seems to have misfired in a big way.

Thus, rather than going up, the yields went down as investors took safety in bonds following the turmoil in equity markets. But Gross hasn't given up on the idea just yet. He still believes that US Treasuries will go down in price in the future as devaluing the same seems to be the only way out for an economy knee deep in debt. It will be interesting to see whether Gross is proved right in the long term. But the man's track record and our own understanding of the situation do tell us not to bet against him.

To buy or to sell stocks when Sensex is at historical lows is a question that most investors have on their minds these days. The fundamentals of Indian companies may have not changed dramatically in the past few months. But the global macro-economic and the domestic political scenario certainly has. As the US Fed commits itself to another round of QE or the UPA government fails to check corrupt practices, markets may get hammered even more from the current levels. So should investors stay on the edge and be mere spectators while markets remain volatile? We had Ajit Dayal, the founder of Equitymaster, with us to address these concerns of our subscribers at a recently hosted webinar.

The impact of FIIs selling Indian stocks due to external concerns is something that has irked Ajit for long. In fact he showed some very interesting slides on why it is neither Indian politics nor economics that has been impacting the benchmark indices. The earnings of Sensex companies too have had a secular upward move. But it is the erratic buying and selling by foreign investors that has brought the Indian markets to ransom on several occasions. Simply because of the sheer volume of FII trades as against Indian investors'. With fears about debt contagion and sovereign crisis lingering in the markets, the bottom may be far from here. However, Ajit also reiterated his views on the Sensex moving closer to 30,000 levels by the end of 2012. In fact, according to him, going by the market estimates of 2012 earnings of Sensex companies and giving it a multiple of 17.5 (average over the past 5 years), the index can comfortably cross 24,500 levels. But that is provided the FII money does not retreat on fears of global meltdown. Ajit's final comments on being a buyer of stocks for long term financial needs and buyer of gold as an insurance against market volatility were amongst the most important takeaways for the participants of the webinar.

Click on the video below to view Ajit speak at the Webinar.

The volatility in the Indian stock markets has led to lower margins for the Indian brokerage firms. This combined with higher costs has led to cheap valuations for most of them. This makes many of them an attractive acquisition target. However, not many want to acquire them. Why? The rules are just not conducive. The biggest incentive for acquiring a brokerage firm would be the access to its huge customer base. An existing firm or a new firm can easily acquire the customers of another firm rather than building the entire network from scratch. But the rules require that the new firm will have to fill out the KYC (Know Your Customer) formalities for the entire customer base if it acquires a brokerage. This in itself is a painstaking and costly process.

Besides, it can lead to some customers leaving the network entirely. In addition to this, the acquiring firm would also have to renegotiate with all the sub-brokers. It is a known fact that in India, it is the sub-broker who has a better relationship with the customer. And if the sub-broker leaves, then its goodbye to his share of customers. And last but not the least is the history of acquisitions made in India. Most of the brokerage businesses acquired by other brokerage firms or banks have been complete failures. This has made the firms stay away from further acquisitions. Therefore, despite cheap valuations, there are not many takers for the sector.

The rising uncertainties in the global economic environment due to the recent debt crisis in the US and some of the European countries seem to have not had any effect on the confidence levels of Indian software firms. The reiteration of maintaining their earlier chalked out aggressive recruitment plans at least says so. Information Technology (IT) majors have already started visiting campuses to hire entry-level employees.

There is a chance that clients of these software firms delay their project starts. There is also a possibility of the IT budget cuts. But these companies are looking at the long term growth prospects in the sector. Therefore, they are building capacities in anticipation. Though it may be a good move from a long term point of view, it can adversely impact the margins of these companies in the short term if demand environment continues to remain bleak.

Indian stock markets have been trading in the positive territory after opening trade on a strong note. At the time of writing, the benchmark BSE Sensex was up by 264 points (1.6%). All sectoral indices were trading in the green except FMCG and Capital Goods. Barring China and Indonesia, Asian markets too were trading firm. Europe opened trade on a positive note.

 Today's investing mantra
"High prices inside of a year will typically be 100% of the low price. Businesses don't change in value that much. That is simply crazy. There are extreme degrees of fluctuation, and Mr. Market will call out the prices. Wait until he is nutty in one direction or the other." - Warren Buffett

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