The ghost of Dabhol - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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The ghost of Dabhol 

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In this issue:
» Problems continue at Dabhol
» Oil bonds will have to wait
» Cheaper commodities: good or bad?
» McDonald's on fighting inflation
» ...and more!

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 00:00    The ghost of Dabhol refuses to go away...
Originally conceptualised in 1992 as a show case project for India, the Dabhol power project has had more than its share of bad luck. It has been hit by charges of corruption, high costs and payments issues at various times in its troubled history. Of late, there has been much finger pointing due to frequent breakdown of turbines.

And now the power plant has been forced to cut down electricity generation after a technical snag at Petronet LNG's Dahej terminal cut gas supplies to the unit in Maharashtra. Ratnagiri Gas and Power, the new owner of the 2,150 MW (megawatt) power plant, needs 5.4 million standard cubic metres per day (mmscmd) of gas for two of its operational units, but the supplies have been restricted to only 2.2 mmscmd. The shortage of gas supply would curtail power generation to just 300 MW. The power problems for companies and businesses operating in the state of Maharashtra are thus far from being over and will only require them to source power at higher costs from external sources.

 00:34    Oil bonds will have to wait
There was a proposal from the petroleum ministry that the public sector oil marketing companies (PSU OMCs) be given oil bonds now to subsidise the underrecoveries likely to be incurred by them in 2QFY09 and 3QFY09. The PSU OMCs- IOCL, BPCL, HPCL- incurred underrecoveries to the tune of Rs 520 bn in 1QFY09 and are facing a severe cash crunch on the back of losses at the operating level.

However, the finance ministry is opposed to the proposal, as it believes that the credit markets in India cannot smoothly absorb the release of such a large amount of bonds. In fact, the finance ministry allows the OMCs to offload only 25% of total amount of bonds that they hold at any point in time. It may be noted that banks are generally not keen to buy oil bonds, as they don't enjoy statutory liquidity ratio (SLR) status. Only entities like the LIC end up buying the bonds.

Besides selling the bonds to others, OMCs also encash them in US dollars from the RBI through the mechanism of a special window. Interestingly, the RBI is not in favour of extending the window further as it hampers the growth of financial markets.

What we find strange in the entire episode is how the government treats PSU OMCs like internal arms, forcing them to sell at below-market prices. But when it comes to compensating them for bare survival, it treats them as independent corporates who should follow principles of free-markets. It is one thing to practice the hypocrisy, quite another to involve investors money in the exercise by getting these companies listed.

Gross underrecoveries incurred by PSU OMCs
Rs bn FY05 FY06 FY07 FY08 FY09E
Petrol 2 27 20 73 NA
Diesel 22 126 188 352 NA
PDS Kerosene 95 144 179 191 NA
Domestic LPG 84 102 107 155 NA
Total 201 400 494 771 2,453
Source: PPAC, Press information bureau, GOI

  • Also read - Oil & gas: Fates continue to differ

     01:24    RBI takes cues from rain gods
    India's strategy to combat inflation this year hinges largely on expectations of a bumper harvest of crop, which still depends on the generosity of the rain gods. Predicting inflation is therefore very tricky. According to the meteorological department, the cumulative rainfall during the first half of this year's monsoon season, which runs from June through September, has been 2% less than the average between 1941 and 1990. This observation, however, is not very conclusive given the vagaries of the rainfall pattern.

    The RBI's monetary policy statement last week made six references to the monsoon compared with just one for the troubled US subprime mortgage market. That is an indication of the importance policymakers attach to seasonal rainfall. Although one should not be surprised given that we live in a country where little of the arable farmland has access to man-made irrigation facilities. According to the International Water Management Institute, even after 200 years of canal building, less than 15% of Indian farmlands benefit from canal irrigation. The share of farming in India's GDP in FY08 was less than 18%, compared with 28% in 1998.

    Without an improvement in yields, agriculture in India will become more unprofitable, even as the nation's large and increasingly affluent population demands more and better food. In the absence of a credible, long-term strategy to boost agricultural production, the Indian government has resorted to draconian measures to tackle inflation. Locally traded futures contracts have been banned in rice, wheat, potatoes and chickpeas. At the same time, the government has allowed imports of many key commodities at zero or reduced tariffs to satisfy local demand. None of this impels the domestic farmer to boost production. Probably policy makers have more tasks on their hand than looking heavenwards.

     02:19    Are lower commodity prices a good thing?
    Prices of all kinds of commodities have declined in the past few weeks. Zinc, tin, nickel, and platinum prices have slipped and have been joined by copper, aluminum, corn, soybeans and of course, crude oil. The price of crude oil hit its record high of US$ 145 in early July and has since declined by almost 20%. Given how participants in the equity markets have been pointing towards oil for their worries, this should be a cause for celebration.

    On the face of it, yes. But when we consider that the decline in commodities is most likely due to a demand pullback on the back of a worldwide economic slowdown, good news doesn't sound all that good. The only section that might still be cheerful would be the environmentalists. They would be hoping that there is 'demand destruction', i.e., users permanently switch to greener alternatives just like the power utilities that gave up on oil after crude prices spiked in late 1970s.

  • Also read - Capital goods: Do rising material costs hurt?

     02:50    UN stresses on public health
    China and India have more in common besides being the two most populated countries, with 1.3 bn and 1.1 bn people respectively. The former's GDP expanded in excess of 10% per annum in FY08 while the Indian economy grew by 8.8% in FY08. However, the countries growing at the fastest pace in the world do not seem to be spending enough to conserve their human capital.

    As per the UN health statistics, China reduced the under-five child mortality rate by 80% between 1970 and 2006, to 24 per 1,000 live births from 118. In India, the rate dropped by 60%, to 76 per 1,000 live births in 2006 from 236 in 1960. Nonetheless, the Ministry of Health and Family Welfare's estimate that the Indian government's spending on health of about 0.9% of GDP is petty. At the end of 2003, the per capita health expenditure was US$ 82 in India and US$ 278 in China (on PPP basis) as against US$ 5,711 in the US and US$ 2,389 in the UK. This disparity does not seem to have reduced much. Thus besides working on other engines of growth, the fastest growing nations must pay heed to the UN's call for health security. The same may require some policy measures in making drugs more accessible and affordable and require Indian pharma companies to accordingly align their strategies.

  • Also read - Identifying pharma stocks

     03:33    Two wheeler sales deprived of finance...
    After global major Citibank, India's largest private sector bank, ICICI, is also moving away from providing finance at the two-wheeler showrooms. However, the bank continues to provide finance from its own branches. This development is being taken as a shift by the bank away from the two-wheeler financing business where it incurs significant default rates. This has led to an accumulation of non-performing assets as per RBI guidelines. Moreover, RBI has also tied the bank's hands in employing recovery agents to seize vehicles from defaulters.

    However, the bank maintains that the move is aimed at reducing operating costs by leveraging its banking network. Interestingly, the bank will continue to disburse auto loans from the showrooms when it comes to financing four wheelers.

    Whatever be the cause, this development is likely to cause much heartburn for the two-wheeler pack, i.e. Hero Honda, Bajaj, and TVS who now have to look for local arrangements like cooperative banks for finance, especially in the rural markets.

  • Also read - Hero Honda: Heroic indeed!

     04:04    After-effects of US govt.'s squandering...
    "Falling government revenues amid a slowing economy, coupled with increased federal spending, will result in a US budget deficit this year of around US$ 400 bn," writes Reuters. Pimco's chief, Bill Gross recently warned that if the US government does not mend its ways..."I'm forecasting three years from now we'll see our first trillion-dollar deficit." Well, that's a lot of money to lose. A trillion dollars is the size of India's entire economy currently!

  • Also read - A trillion dollar meltdown

     04:19    McDonald's on fighting inflation
    Your 'neighbourhood' burger might soon get expensive! After recording record profits during the latest completed quarter, the world's largest restaurant chain is said to be planning to offset mounting commodity pressures by way of raising prices of its products. "I don't think customers care that much if the price moves slightly away from a dollar," said the company's CEO Jim Skinner recently. "It will always be the best value around," he said. Now, that's what we call the benefits of having a 'competitive moat'.

  • Also read - 'Competitive moat' and more lessons from Warren Buffett

     04:35    In the meanwhile
    After opening on a weak note today, the Indian benchmark indices forayed into the positive territory in the subsequent hours of trade. However, the indices could not hold on to their gains and edged towards the dotted line post noon. They traded within a narrow range thereafter. In the final hour of trade, participants choose to book profits at higher levels that led the indices to pare substantial gains. The close was nevertheless just above the dotted line. As regards global markets, while the US indices ended on a firm note yesterday, the Asian indices have closed a mixed bag today, and the European indices are trading higher currently. Crude prices closed marginally weak, with US light sweet crude ending lower by half a dollar.

     04:53    Today's investing mantra
    "If the new thing you are considering purchasing is not better than what you already know is available then it hasn't met your threshold. This screens out 99 percent of what you see." - Charlie Munger.
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