The vicious debt cycle - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The vicious debt cycle 

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In this issue:
» India's infrastructure story has not fizzled out
» China no more financing US deficits
» Satyam may add to its banks' bad debts
» FMCG companies find acquisitions irresistible
» ...and more!!

Global corporations, more so in the US, are already having their hands full tackling the recession menace. Their cup of woes has just gotten bigger. Companies that are lining up to refinance their debt will be forced to pay millions of dollars more in interest on account of steep borrowing costs. This would mean further pain at the net profits level in an environment when the bottomline is already not looking good. High degree of risk aversion as well as competition from government backed bonds has caused this steep increase in borrowing costs.

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As per estimates, US government alone will tap the market with US$ 2 trillion worth of bonds. In a world where there are only limited lenders, corporations will really have to entice them with significantly higher yields if they wish to raise funds. And we aren't even talking about companies down the hierarchy, whose plight is only going to worsen.

If more such companies go belly up because they are not in a position to raise funds at attractive rates, it would hurt the economic recovery efforts further. It is indeed a vicious circle that the US government has gotten itself into. First, it sells bonds to raise money for infrastructure spending. Then, these very bonds do not let smaller corporations access markets thus putting their very existence at risk. This is a classic case of getting caught between the devil and the deep sea.

Economic slowdown and fiscal deficit are making it unfeasible to meet the infrastructure targets set by the Indian Planning Commission. Our meeting with the country's largest private sector infrastructure financer IDFC highlighted the fact that India's infrastructure story has slowed down but not fizzled out. The demand for funds remains robust but fresh sanctions are being looked upon with heightened scrutiny. Poor liquidity in the global markets have also accentuated the demand for funds in the domestic market and kept the borrowing costs firm. Government's policy initiatives are also giving out mixed signals. While there are talks of pre-poning the Sasan ultra mega power project to the current five year plan, the allocation of 3G (third generation) spectrums may be pushed forward to the next one. IDFC sees adequate liquidity and good asset quality as the key challenges for the infrastructure funding business going forward.

The Chinese may have financed the massive deficits of the US running into more than a trillion dollars, but the American paper lures them no more. Given that the global economic slowdown has started to weigh heavy on China's economy, it is increasingly looking to divert its resources home. And the state of the deficit position in the US is not likely to change anytime soon. This is because Barack Obama has stated that Americans should get used to the prospect of "trillion-dollar deficits for years to come" as he seeks to finance an US$ 800 bn economic stimulus package.

With China also looking to pay for its own US$ 600 bn stimulus package, American bonds may not find as many Chinese takers as they had in the past. Despite that there still seems to be no shortage of buyers for these bonds and other debt instruments. China is further constrained by fewer dollars pouring into the country as a result of which its government has fewer dollars to buy American bonds. So, is the China-US equation set to change? Only time will tell.

Restaurants are said to be recession proof businesses. However, the recession in the US seems to have dampened the 'appetite' of Americans. This is evident from the data released by the National Restaurant Association. Its Restaurant Performance Index (RPI) - a monthly composite index that tracks the health of and outlook for the US restaurant industry - stood at 96.7 in November, down 0.4% from October and its 13th consecutive month below 100.

Not surprisingly, the economic downturn is the biggest challenge that these restaurant owners are facing. Also, not many of them are expecting improvement any time soon. Restaurant operators reported negative same-store sales for the sixth consecutive month in November with customer traffic levels also remaining negative.

Besides this, capex activity was subdued. Unless and until there is light at the end of the tunnel, the environment for restaurant operators will remain uncertain as has also been the case for other industries in the US. Till then they will have to just bat it out.

The Satyam fiasco will now make Indian banks stricter in their corporate governance norms and lending standards. Banks, which have an exposure to the beleaguered IT major are looking at options to stop sanctioning additional credit lines to the company and seek an auditor's explanation from it.

At the end of 1HFY09, the total secured debt of Satyam as per the company's balance sheet was about Rs 2.5 bn. However, given the overstatement in terms of cash balances, the borrowings are likely to become non-performing assets (NPAs) and weigh heavy on the books of its bankers, the likes of ICICI Bank, HDFC Bank and Bank of Baroda.

One company that might be the most relieved of Raju's confession must be Upaid, a leading mobile payment solutions provider and an erstwhile client of Satyam. Upaid recently filed a fraud and forgery case against Satyam in a US court, seeking damages of US$ 1 bn for infringement of its patent by the latter. The case is likely to come up for hearing in June 2009. In this context, Upaid had also filed a petition that Satyam chairman Ramalinga Raju was planning to strip the IT major's cash surplus (which was not really there) to avoid paying damages in the patent infringement case. With Raju's confession, Upaid's case against Satyam has only got stronger.

Indians may have the honour of inventing the zero and several other mathematical and astronomical concepts, but the country has now fallen behind many others in the pursuit of knowledge economy. In fact, going by the Global Innovation Index (GII), the country is not even as innovative as Slovakia, Slovenia, Estonia, or the Czech Republic. The index ranks India 41st among 130 countries in FY09 as against her being ranked 23rd in last year's index comprising 107 countries.

Ironically, this report has come at a time when India has launched several efforts to push the cause of scientific research and innovation. The government is set to table the National Innovation Bill in Parliament in its next session, which will make it easier for private investment to flow into research and development. The government has also planned to launch a US$ 183 m World Bank-funded programme to accelerate innovation.

Image Source: Mint

Indians have a lot more to complain about beyond corporate governance. The Indian government may offer too little governance but the bureaucrats do not shy away from making gargantuan promises. In a latest instance, a bureaucrat in the Prime Minister's offices has visualised about India producing 60,000 MW (megawatts) of nuclear power by 2030 i.e., in 21 years from now. This is when we are not able to see clearly where the country is heading in the next 5 years. Our current nuclear power capacity stands at just 4,120 MW, when we have the uranium capacity to generate 10,000 MW of power.

Crude oil remained unchanged after dropping the most in seven years yesterday as falling consumption led to reports of higher inventories of crude and gasoline. Amongst global markets, while the Indian markets were closed today on account of Moharram, other Asian markets ended the day in the red. The Nikkei and the Hang Seng (both down 4%) were the worst losers. The European markets have also opened on a sombre note.

'Make hay while the sun shines' goes the saying. Well the sun has definitely not been shining but some of our Indian FMCG companies are busy making hay nonetheless. With many companies facing credit squeeze, those with funds are finding irresistible to acquire other companies in these times which are offering very attractive valuations. Setting the pace for next year, 2008 saw four acquisitions in the last one year by three firms.

Emami acquired Zandu Pharmaceutical Works for over Rs 7,000 m, Dabur bought a 72% of Fem Care Pharma for Rs 2,040 m and Godrej Consumer Products (GCPL) expanded its presence in the South African market by acquiring Kinky hair brand which is its second acquisition in South Africa.

That apart, Marico Industries is still assimilating the acquisitions it made in Durban and Egypt last year, and like most others, is looking out for more in the domestic as well as international markets. We won't be surprised if their appetite extends into 2009 too.

04:55  Today's investing mantra
"The fact that people will be full of greed, fear or folly is predictable. The sequence is not predictable" - Warren Buffett
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