This word is a cancer for India's economic health!

Aug 22, 2012

In this issue:
» IRDA may allow insurers to risk investor money
» What Buffett's sale tells us about US municipal debt
» China rearing defunct companies
» Impact of economic slowdown on commodity prices
» ...and more!

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Most of India's state owned enterprises are currently on life support. Even by conservative estimates, these contribute at least 15% of the country's GDP. Hence there is little to explain on the critical state of India's economic health. The Indian government has left no stone unturned to ensure that the profitable PSUs bleed as much as unprofitable ones. As a result, not just the railways and state electricity boards, but also listed companies are piling up losses. Companies across sectors have not minced words about their dire state of affairs. Be it energy major Oil and Natural Gas Corporation Ltd. (ONGC), power major National Thermal Power Corporation (NTPC) or banking major State Bank of India (SBI). However, blinded by its political compulsions, the government sees little option than destroying public wealth.

But one quick fix solution that the government has adopted over the past few years has become the cancer for the economy's health. It answers to the name of debt 'restructuring'. Loans taken to fund agricultural losses, bleeding PSUs and loss making infrastructure projects have had this single remedy. The financers have been allowed to 'classify' the loans as standard as against writing them off as NPAs. Being just an accounting gimmick it allows the government to project all parties being financially sound. The loss making PSUs and the banks that have lent to them get away without taking the losses upfront. Moreover the PSUs get to borrow more despite their dire state of finances. If this was not allowed, several electricity boards, PSUs in oil, aviation and financial sectors would have declared bankruptcy by now.

But despite the risks of such a malpractice the government is set to put its seal on yet another 'restructuring' initiative. As per Bloomberg, a draft proposal by power ministry has sought to restructure US$ 35 bn (Rs 1.9 trillion) worth of loans. Held by power utilities, restructuring of these borrowings by banks will supposedly avert a power crisis in the country. Part of the loans will be transferred to state governments as well. Not that the financial condition of the state governments is any better. But with cash losses having widened 15 times over three years to Rs 288 bn, the state electricity boards are unlikely to find any lenders otherwise. The state governments are equally to blame for their stoic approach to raising power tariffs for years. As a result, the difference between the average cost of supplying electricity and the average tariff has almost doubled in last 11 years. Meanwhile transmission and distribution losses remained stagnant at 27%.

We believe that by offering an easy lifeline to such incompetent entities, the government is sealing the future of Indian PSUs. It is only a matter of time before the 'restructuring' bug devours what is left amongst India's so called 'navratnas'.

Do you think the government should stop restructuring debt of bleeding PSUs? Let us know your views or post them on our Facebook page / Google+ page.

 Chart of the day
The government has denied any plans to stall the operations of cash strapped avaition company Kingfisher Airlines. More concerning is the fact that it will alow the airline to be airborne, even if it means compromising the safety of passengers. Meanwhile the competitors of Kingfisher are looking to grab a share of its pie in the aviation space. As seen in today's chart, the likes of Indigo and Jet Airways that control 46% of Indian aviation space, can be key beneficiaries of some competition being grounded.

Data source: CAPA

The term 'credit default swap' first came into prominence during the US financial crisis of 2007-08. Virtually overnight, it turned many an investors into billionaires. And also bought many companies on the other side of the transaction on the brink of default. Insurance giant AIG being one of the names that met with the fate of the latter kind. If bought sensibly, a credit default swap can be a fantastic source of long term capital. This is because its cost of capital is virtually zero. And it is this property that has perhaps gravitated Warren Buffett, the world's most successful investor towards it.

However, there is one crucial difference between investment policies at AIG and those followed by the Oracle of Omaha. Buffett wastes no time in exiting the contract as soon as the risk reward ratio of buying a swap turns unfavourable. Like he did recently when he terminated, rather prematurely, credit default swaps insuring US$ 8.25 bn of municipal debt. The US municipal debt market is not in the best of health right now. Falling economic growth has led quite a few cities to file for bankruptcy protection. Thus, Buffett being Buffett, may have found the risk of staying with the investment on the higher side. And hence his decision to exit we believe.

The frequency of strikes and protests in India has picked up pace in the past few months. This time banks in the country are the ones protesting. This 2-day strike has started today to protest against proposed reforms that would ease mergers and allow more private capital, including foreign investment in the banking sector. Besides public sector banks, some private banks and foreign banks are also participating. Reforms were long overdue in the banking and financial sector but were always put on the backburner on fears that more foreign investors would exploit domestic interests. Not surprisingly, PSU banks appear to be protesting the most. Given that they are less nimble than some of their private and foreign peers, fears persist. The RBI so far has done a good job of ensuring the health of the banking sector. And there is no reason to believe that this will get compromised. Thus, certain reforms in terms of more consolidation in the sector could actually be welcomed. This would further strengthen the banking system and weed out the poorer ones.

A prudent way to control crime is to legalise it. As ridiculous as this theory sounds, this is exactly what the regulators in India seem to be doing. The reason why regulatory authorities were set up was to protect investors. They set rules that were to be followed by all, including the government, so that the investor interests remained secure. But off late, all regulators seem to be doing is to support the government and completely disregard the investors. Earlier to help the government with meeting its fiscal target, the SEBI changed the IPO rules to aid and speed up PSU disinvestment. It did not matter that the change in rules went against the investors. Now the insurance regulator, IRDA seems to be headed the same way. It proposes to increase shareholding limit for insurers in an individual company or bank.

The current limit stands at 10% and was established to ensure that insurers did not take undue risk by owning too much of another company. But off late, the government owned LIC has been called in to invest in nearly everything. Be it saving the almost failed offering of Oil and Natural Gas Corporation (ONGC). Or recapitalizing the public sector banks. LIC has been the knight in shining armor for all of the government's investment needs. But in the process, it could end up breaching the 10% rule. To prevent this, IRDA will simply raise the limits. Insane idea as it puts to risk the insurance company's corpus which is basically the investors' hard earned money. But who will stop them? After all they are the regulators. Looks like India now needs a regulator for the regulators.

What does it mean when NPAs (non-performing assets) in an economy's banking system begin to escalate? It is a clear indicator of tough economic conditions. But what if NPAs remain low despite a slowdown in the economy? And especially, when the country in question is China? For the second quarter of 2012, the ratio of Chinese banks' NPAs remained unchanged at 0.9%. These are the official numbers. They seem to be hinting that all is well in the Chinese economy. But dig a bit deeper and the inconvenient truth stares you in the face.

The truth is that the Chinese economy is indeed slowing. Several weak businesses are struggling to remain afloat. Ideally, what do you think should happen in such a case? They should be allowed to go bankrupt right. This would mean some short term pain for the banks. But this would certainly be in the long term interests of the economy. As per a Bank of America analyst, the Chinese government is not letting this happen. On the contrary, it is forcing banks to lend more to these failing businesses. Simple economic logic tells us that pouring money into financially unviable businesses is like putting money into the drain.

Such foolish steps may obscure the economic reality in the short run. But in the long term, this is set to disastrous for the Chinese economy. India is relatively lucky to have a sane central bank.

Amidst industrial slowdown, China is experiencing a huge pile up in commodities. Be it industrial or agricultural. For instance, steel and coal inventories in China are on a rise. While the coal inventories at one port are highest since 2008, the steel stockpiles though having fallen in the last 5 months are 19% higher this year. This is mainly due to significant industrial overcapacity that was accumulated over the years. Waning demand from the West is another factor. It may be noted that China is the world's largest consumer of base metals. It is also the second largest when it comes to crude consumption. Thus, a slowdown in China has a direct impact on the demand dynamics of metals and thus their prices.

Apart from industrial commodities, even the demand for agricultural commodities like cotton has started declining. The cotton consumption in China is expected to decline by 11% this year. It may be noted that China is the largest consumer of cotton accounting for almost 40% of the world's consumption. Thus, unless the growth prospects in China improve, the commodity prices will remain lukewarm.

The indices in Indian equity markets hovered around the dotted line for most part of today's session. The BSE Sensex was trading lower by around 6 points at the time of writing. Telecom, power and energy stocks were under the maximum selling pressure. Most other Asian indices closed lower today while Europe also opened on a negative note.

 Today's investing mantra
"According to our view, the high prices paid for 'the best common stocks' make these purchases essentially speculative, because they require future growth to justify them." - Benjamin Graham & David Dodd

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4 Responses to "This word is a cancer for India's economic health!"


Aug 22, 2012

Dear Sir.
I disagree with what you have written about so called reforms in Banking sector. By naming "Reforms" the strength of our Financial sector is targeted and attacked. You may try to closely scrutinise WHAT THEY ARE DOING in the name of REFORMS. Let Indian Govt take strong steps to weed out the menace of fake notes from the nation. Those in Ivory Towers are taking decisions and they set their own priorities which go against the common man. It is a typical case of "national pride" and not "reforms". And if Govt is in dire need of reforms to transform the country as a welfare nation it is high time that "REFORMS" begin in the judiciary and the legal system to start with. Those in powers forget that we are a REPUBLIC since 1950 !



Aug 22, 2012

The frankenstein released by myopic politicians for serving their narrow political ends has already spread to the innards.The cancer is working overtime and each passing day leads us to the precipice of a catastrophic disaster in which the common citizen suffers endlessly.



Aug 22, 2012

For public sector undertakings, debt restructuring is not a one off exercise. It is a continuous one, each restructuring exercise following an earlier one that failed in cleaning up the previous mess ! PSUs exist solely to benefit politicians, bureaucrats and their mollycoddled employees all of whom milk the PSU for all it is worth secure in the knowledge that it will be kept alive through tax payer money. Customers and the tax paying public are the silent sufferers. At least customers can go somewhere else if the PSU is not a monopoly - but the poor tax payer keeps paying the bill !!

Unless the PSUs are fully privatized they will not improve one bit. Governments cannot run commercial activities. They must confine themselves only to making policies, monitor their implementation, creating the right environment for investment, regulate the economy effectively to ensure protection of customers and investors and through intelligent fiscal policy provide incentives and penalties to foster equitable development.


madanmohan bhatia

Aug 22, 2012

All the decisions should be taken on economic factors. Stop cross subsidies. Increase price of deisel, gas etc on the basis of cost price and give cash subsidies to economically poor people. People should understand that we are paying for subsidies indirectly through increased inflation.

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