This could burst the realty bubble...

Oct 27, 2009

In this issue:
» RBI keeps the rates unchanged for now
» High consumer prices persist in India
» US stocks to drop painfully from current levels
» Asian banks do not want to repeat US mistakes
» ...and more!

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The RBI announced its much awaited monetary policy today and as expected, has left the key rates unchanged. While this should have brought some cheer to the markets, they plunged deeper into the red not only because the RBI looks set to raise interest rates going forward, but also because the central bank has upwardly revised its target inflation by March 2010 end to 6.5% from 5% earlier. The upward bias in interest rates was apparent from the RBI's move to hike the statutory liquidity ratio (SLR) to 25% from 24%. Having said that, whether interest rates in the future rise or not will depend on whether the inflation continues to rise the way it is doing now, and the economic momentum continues to pick up pace.

Meanwhile, real estate companies are set to face some challenging times ahead. This is because the RBI has indicated its worry about rising property prices by increasing the provisioning requirement for advances to the commercial real estate sector from 0.4% to 1%. This is surely going to hit realty companies that are looking to borrow from the banks to fund their commercial real estate development plans. Not only will the RBI's SLR move action make it difficult for realty companies to get sufficient loans, the higher provisioning norms will also likely raise their interest costs on such loans.

Thus, while we had highlighted in yesterday's 5 Minute Wrapup about how real estate companies are looking to stage a comeback, the RBI's recent move will only make it that much more difficult, especially for the commercial real estate.

Moving on to other highlights of the monetary policy, the RBI believes that there has been a visible improvement in the global economic outlook since July 2009 and the same is seen in India as well. Accordingly, it clarifies that attention around the world, as also in India, has shifted from managing the crisis (by looking to cut and maintain interest rates at lower level) to managing the recovery (by trying to ward off rising inflation).

The RBI has also reiterated its dilemma whether to wait or start raising interest rates soon. The dilemma is because if its waits, inflation can spiral out of control. And on the other hand, if it starts raising interest rates anytime soon, it might cut short a fledgling economic recovery. So, by not touching any of the key interest rates, the RBI has opted to wait and watch for now.

 Chart of the day
Concerns over rising inflation began to make their presence felt ever since the monsoons turned out to be weak this season in India. The wholesale price index (WPI) which had been languishing in the red for a year moved back into the positive as food prices started soaring. But the real picture is painted by the consumer price index (CPI) in which food receives higher weightage and is the one most tracked by other countries as far as inflation is concerned. As today's chart of the day shows, consumer prices in India are considerably higher than the US and Europe and even its BRIC peers (based on latest data). These prices have remained considerably high for a long time now and even at the time when the WPI was into the negative. Thus, even if the RBI has left the interest rates unchanged for the time being, it looks increasingly likely that these will head northwards in the coming months.

Data Source: The Economist
Prices for India and Japan are available for August 2009, while for the rest prices are for September 2009

It is believed that the demand for commercial vehicles (CVs) is a crucial indicator of where the economy is headed and hence, quarterly results of India's largest CV manufacturer Tata Motors, which were announced yesterday, assumed great significance not only from the company's but also the economy's point of view. And it did not disappoint on both the fronts. Domestic economy seems to have put itself on a strong footing as M&HCV segment's decline was restricted to 11% YoY as opposed to a decline of 36% in the previous quarter. What more, even the LCV segmented posted a robust growth of 10% YoY during the quarter.

Tata Motors' own performance came in better than expectations. While topline growth came in at 13%, thanks to a strong jump in operating margins and lower forex losses, bottomline growth came in at an impressive 110% YoY. Although the management has indicated that maintaining the same level of operating margins will be a challenge, it did sound positive on the volume growth front what with various new launches in the pipeline.

Not everyone is convinced that the US economy is on its way to recovery and that the stock markets are poised for a long term rally. In his quarterly letter, Jeremy Grantham, who oversees about US$ 89 bn in investments, says US stocks will "drop painfully from current levels".

In the scathing letter, he hammers everyone in the US economy from Bernanke, Geithner and the CEO of big banks to home builders, mortgage borrowers and consumers. He wonders how the markets are so cheerful when in fact little has changed with the underlying economy. In fact, he believes "we have learned nothing. In doing so we are probably condemning ourselves to another serious financial crisis in the not too-distant future."

While we wouldn't go as far in criticising policy makers and investors in India, we do believe that the return of optimism since March this year has led valuations to levels where the odds of investment success has gone down considerably.

Many engineering companies in India constantly win large orders and build up large order backlogs thus assuring them of revenues for anywhere between 1-3 years, or even more in some cases. What's more, they never miss a single opportunity to boast of the above fact. Consequently, the valuations that many such companies have been enjoying have been nothing short of amazing. However, even though order backlogs mean that orders have already been placed and there is a high amount of revenue visibility, what those high valuations arrogantly overlook are the inherent execution risk in a project based business.

Cost overruns, delay in financial closures, cash flow problems with customers, time overruns, problems with sub contractors, delays in getting approvals etc are just some of the potential problems that can always turn out to be just around the corner. You wouldn't have to look any further than engineering major Punj Lloyd's September 2009 quarterly results to get a taste of what we are talking about. Or even L&T's for that matter. Moral of the story? There's more to engineering companies than just large order backlogs.

US Fed chief Ben Bernanke may have failed to anticipate the bubble that formed in the US mortgage market which churned out the biggest financial crisis since the Great Depression but his Asian counterparts want none of that. Given that the Asian markets of late have been awash with liquidity as the developed markets have lost their sheen, stockmarkets and real estate prices in this region have soared to unjustifiable levels.

Not wanting the US phenomenon to be replicated in Asia, policy makers in South Korea, Hong Kong and Singapore for instance have told banks recently to tighten their lending standards. Some of the Asian banks including India have signaled their readiness to raise interest rates in the coming months. The idea is to constrain excessive leverage before it destabilizes the economy and Asian central banks are using a combination of monetary and regulatory policies to do away with the problem of bubbles. This could mean a slowdown in the recovery process, but then nobody would want the financial crisis to occur all over again.

With the RBI signaling the possibility of raising interest rates in the future, markets plunged deep into the red and were trading lower by 2% at the time of writing. Banking and metals stocks led the pack of losers on the bourses. At the time of writing, the Asian markets were trading weak. Europe began the day on a mixed note.

 Today's investing mantra
"The most important quality for an investor is temperament, not intellect...You need a temperament that neither derives great pleasure from being with the crowd or against the crowd. " - Warren Buffett

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8 Responses to "This could burst the realty bubble..."


Oct 28, 2009

Dr Sivaramakrishnan: I don't track Educomp as such, but I believe that the company has declared a 1:5 stock split recently, which must have come into effect today. For every one share of Educomp of Rs. 10 face value held by shareholders they would have got five shares of Rs. 2 face value. Thus, if you previously held one share for Rs. 4900 before the split, you now have 5 shares of Rs. 900 each; 900 x 5 = 4500. Thus the effective fall in value is from 4900 to 4500...



Oct 27, 2009

I disagree with daryl, this govt has failed to control inflation... in just 18 months, most of the food product prices are doubled or tripled. Remember its not Chidambaram who is the financial minister anymore. Pranab Mukherjee is not dynamic as Chidambaram in controlling inflation. Bashing the govt is no issue. We had real estate bubbles even during previous government, but never the food prices and daily commodities were so badly effected.



Oct 27, 2009

Excellent - as usual!

By the way, can we ask questions about the Economy or the Stock Markets and request answers from your team of experts?



Oct 27, 2009

Indian stock market is based on sentiments.
one good news market is up.
one bad news market dips immediately.
Investor run with crowd.



Oct 27, 2009

Your analysis and updates of market trends are very good. Can you please let me know what happened to Educomp Solutions's down fall in market today from Rs. 4900 levels to Rs. 900 levels. None of the market news talks about this nor I get to see anything from the company side as well. If you could throw light on this based on your unbiased views always, it would be really useful..

Dr Sivaramakrishnan



Oct 27, 2009

I am really tired of the govt bashing you guys keep giving. I mean we should thank this govt for watching out for the mistakes the west has made and putting their people in trouble. We have one of the best brains in Manmohan, Chidambaram and Montek and here you guys keep bringing some morbid graphs and articles.

I am a regular reader of your articles and they are interesting but i am just getting sick of your constant critism of this govt. This sounds more like a mayapuri / filmare stuff in finance. Also i am not a congressman lol. Lets talk about inflation being bought down from double digits to zero. Guys give us some good news for a change, i think there's lots happening in India.



Oct 27, 2009

pithy. to the point. educative.


dr vijay barve

Oct 27, 2009

excellent .we badly need a good correction in real estate prices in india as most of the land is owned by 2% of population . and they are literaly exploiting the rest by there holding position with the help of banks financial institutions and starts sending notices and paper advertisement about small defaults by ordinary people for few thousand rupees but when large developer were defaulted they were shielded well and those defaulting guys have raised additional billion dollers to hike the prices further. i dont know what type of economy we are running and for whose sake if most of the population cannot afford simple house and simple commercial place. if not looked after urgently it will have a serious repurcusions on socioeconomical stability and security of our country and democracy. dr barve

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