Bankers beware! Take too much risk and your... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Bankers beware! Take too much risk and your... 

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In this issue:
» Cap on Wall Street pay packages that increase risk
» India's worsening fiscal balance
» Inflation touches 20 week high
» Narayana Murthy turns venture capitalist
» ...and more!

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For a tribe that has poured so much grief upon the world in recent times, bankers from the Wall Street certainly have a strong sense of entitlement. Their pay packages just don't seem to come down. That might all change with the US Federal Reserve set to crack down on pay packages that encouraged bankers to take excessive risks. Compensation of employees of the biggest banks will now be scrutinised by regulators. Meanwhile the US government is also imposing limits on the compensation of top executive at the seven companies that received the most bailout money.

While these measures are meant to encourage only those who generate profits over the long term, much depends on their implementation. Bankers are notorious for tweaking the rules and will eventually find new loopholes to inflate their bonuses. As such, the regulators have to constantly be on their toes. Only time will tell if these measures achieve their intended effect and whether Wall Street will now be a less risky place. In our opinion, unless Wall Street's emphasis on the fast buck changes, it is unlikely that the bankers will let go of their excesses.

00:43  Chart of the day
Amidst all the talk of GDP growth rates, we must not overlook India's worsening fiscal stability. Today's chart shows how the fiscal situation has deteriorated sharply in FY09 after a steady improvement, particularly since legislating the Fiscal Responsibility and Budget Management Act in FY04. The high growth of revenues from direct taxes and service taxes had also helped. But of late, the revision in pay for civil services, loan waiver and expansion in the coverage of National Rural Employment Guarantee Act have all taken a toll on government finances.

Although, the government had no choice but to continue spending in the face of an economic slowdown, we believe the recent spike in fiscal deficit is a matter of concern . It is unsustainable because the government needs to borrow to bridge the deficit and sooner or later it will push interest rates higher, beyond the reach of private borrowers.

Note: Includes oil, fertiliser, food corp and other bonds. FY10 as per budget estimates
Source: Economic outlook for FY10, Economic Advisory Council to the PM

Engineering major L&T announced some sombre results yesterday. Its sales saw a growth of only about 6% YoY. That too was due to its engineering and construction (E&C) segment keeping its head above the water by feeding off its comfortable order backlog. Without any order book feature to support them, its other two segments of machinery and industrial products and electrical and electronics witnessed a fall in sales due to the lack of a full blown recovery in capital investment in the country. L&T's management has attributed the dull performance of the E&C business to a delay in execution of some infrastructure projects due to various reasons. Nonetheless, the company expects to clock in a topline growth of roughly 15% YoY for FY10. As much is not being expected out of the other two segments, the E&C segment will have to really pick up for the rest of the year to achieve the 15% target. Can they do it? Only time will tell...

Inflation has once again started rearing its ugly head. The annual rate of inflation, as measured by the wholesale price index (WPI), touched a 20-week high of 1.2% for the week ended October 10. The week before the number was 0.92%. With the RBI being reluctant to tighten its monetary policy anytime soon, economists believe that the central bank will have to revise its inflation target for March 2010 from 5% to 6.5%.

The government is a slated to release the WPI inflation data on a monthly basis (as against weekly releases currently) from November 14. But clarity is yet to emerge on when India will move to a new WPI. That which will factor in the prices of goods that are not redundant and will show the correct statistics with regard to price changes.

Further, another fact that continues to disturb us is that while the WPI numbers continue to grab the headlines across newspapers, there is very little emphasis on inflation at the consumers' level . For most of the time when the WPI was near zero, the consumer price index (CPI) figures had a completely different story to tell. Not only that, India is the only major country that uses a wholesale index to measure inflation. Most countries use the CPI as a measure of inflation, as this actually measures the increase in price that a consumer will ultimately have to pay for. Thus, for all practical purposes, inflation in India currently is much higher than 1.2%.

Earlier during this week former Fed Reserve Chairman Paul Volcker had strongly voiced his opinion that US banks need to be prohibited from owning and trading risky securities. It appears that he is not the only one with this view. Similar sentiments have also been echoed by Mervyn King, the Governor of the Bank of England who believes that structure of the financial system needs an overhaul. He believes that commercial banking should be separated from the riskier investment banking and that bailouts have created the biggest moral hazard in history.

While the US and UK governments are not comfortable with the idea of separating the two banking activities and believe that stricter regulation will do the trick, Mervyn King is vary of the same. He says, "It is in our collective interest to reduce the dependence of so many households and businesses on so few institutions that engage in so many risky activities. The case for a serious review of how the banking industry is structured and regulated is strong." We couldn't agree more.

Some people just adore looking at past history and making similar predictions for the future. Kenneth Fisher, the billionaire investor and author of a few best-selling books seemed to be in a similar mood in his latest column in Forbes. He has opined that if history repeats, the current V shaped recovery that is underway is far from over and if it keeps up for another five to six months, the global stock markets will be higher by 20% to 25%. Considering that the economic environment currently is a lot different from the one in the past, such a generalization would indeed be a dangerous thing to do. Furthermore, with the real economy in developed markets like the US still in the doldrums, the rise that Fisher is expecting could be more sentiment based and hence, vulnerable to a pullback.

That the recovery has not yet taken shape was also evident from the quarterly results coming out of the US. While there are some like Apple and Amazon that have beaten analysts forecast on the back of sales of new products, on a broader basis, US Inc has still some way to go before the year over year sales gains that existed before the recession could be seen.

Infosys' co-founder Mr. Narayana Murthy has off loaded 800,000 shares of the company from his personal holding to raise Rs 1.8 bn for starting an India-focused venture capital fund. However, Mr. Murthy's and his family still control 4.83% in the company. The proceeds of sale will be used as a seed capital for funding young Indian entrepreneurs with brilliant business ideas. Given his track record, we believe this is a welcome development and hope to see many more Infosys' emerging under his guidance.

Meanwhile, the Indian markets could not hold on to their earlier gains as selling was being witnessed in heavyweights from the engineering sector. At the time of writing, India's benchmark index, BSE-Sensex was trading lower by about 12 points. As for global markets, Asia was trading in the green, while Europe began the day on a firm note.

04:51  Today's investing mantra
"It is no difficult trick to bring a great deal of energy, study, and native ability into Wall Street and to end up with losses instead of profits. These virtues, if channeled in the wrong directions, become indistinguishable from handicaps." - Benjamin Graham
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3 Responses to "Bankers beware! Take too much risk and your..."

K G Rao

Oct 25, 2009

I agree with u entirely about the need to monitor CPi rather than WPI. However, most people, self included, just cant find a clue anywhere as to why the GOI does not use CPI, as all logical thinking would stipulate. Can u tell us something more as to the reasons.


Prem Singh Dhankar

Oct 23, 2009

your views are interesting and I have developed interest in reading them daily. I read them like breaking news.....keep up the good work.Thanks .



Oct 23, 2009

your comments are sharp and useful, especialy chart of the day!i eagerly await for your wrapup daily.thanks a lot!

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