'Realty' bites - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

'Realty' bites 

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In this issue:
» Mounting government deficits
» October pinch for global auto majors
» Crisis teaches schools a bitter lesson
» The FCCB conundrum
» ...and more!!

00:00  Revenue deficit escalates
The government's finances have all gone haywire. As per a leading business daily, as at the end of September 2008, the revenue deficit was at an eye-popping 142% of the entire year's projection while the fiscal deficit stood at 77% of the budget estimate. What makes the scenario stark and gloomy is the fact that in the past five years never before had the revenue deficit in proportion to the budgeted figure been higher.

The reasons for the same are manifold. Additional expenditure catering to the demands for grants, increased recourse to the floatation of oil and fertiliser bonds, the latter especially causing off-budget liabilities to bloat are expected to put considerable strain on the government's finances.

While receipts in the form of tax collections have been buoyant, they have not been able to outdo expenditure, which has also soared. The worrisome aspect is that the expenditure has largely been skewed towards revenue and capital expenditure has taken a backseat. To put things into perspective, while revenue expenditure accounted for nearly half of the budgeted figure for the entire year, the capital spending at 28% paled in comparison. This does not bode well for an economy where bad infrastructure has choked the potential of the country to log in strong growth in GDP.

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00:33  Oxford's and Cambridge's Icelandic woes
At a time when the economy is facing its worst turmoil ever, worsening relations with its neighbour, long time friend, NATO ally and trading partner - UK - is making matters worse for the tiny nation of Iceland. The country has alleged that UK's recent hostile decision to brand Iceland as a terrorist state has pushed it back by 30 t0 40 years, to a time when it was an isolated country, dependent mostly on its fishing trade.

The trouble started brewing between when UK took the extraordinary step of using its 2001 antiterrorism laws to freeze the British assets of a failing Icelandic bank. This included Iceland in the reckoning of terrorist entities and states like Al Qaeda, Sudan and North Korea, among others. As a result of this, there was a complete freeze on any banking transactions between Iceland and other countries, which severely impacted the country's trade revenue.

While that was one side of the story, UK's version of the same is quite appalling too. Besides the obligation to pay up for the tens of thousands of accounts held by British citizens, companies, local governments and charities in the failed Icelandic banks, the amount to be paid is also in dispute. While under European regulations, Iceland is obliged to pay Euro 20,000, or US$ 25,000 to each individual account holder, considering the depreciated value of the Krona (declined 44% since last year) about US$ 5 bn is payable, which would amount to 60% of the country's GDP.

What is also worth noting here is that while the British government has guaranteed compensation to individual account holders, no such guarantees have been made to British companies, local governments, charities and universities - including Oxford and Cambridge - which alone is well over a billion dollars.

01:24  Crisis teaches schools a bitter lesson
Ever thought that schools, those hallowed institutions of learning would be embroiled in the financial crisis that has rocked the world? Apparently it has. Schools in the US which were running short of resources required to fund the teachers' retirement plan opted to invest in the increasingly complex and difficult to fathom collateral debt obligations (CDOs) without really understanding the mechanics of the same.

They chose to rely heavily on investment bankers who encouraged these schools to borrow from abroad and invest in these CDOs, which were supposed to ensure them consistent quarterly payments when actually their investments were used as insurance in case the payments on bonds defaulted. And the schools fell for the same.

The thing to be noted here is the fact that even these investment bankers did not fully understand the purpose of these CDOs. And now that the subprime crisis has erupted with tremendous force, these schools are left wondering as to what went wrong. Forget funding the retirement plan, schools are now having to dip into their funds to pay off bondholders as defaults mount. A hard lesson indeed that US schools have learnt - one, which will forever be etched in their psyche.

01:59  Europe is in a recession
While Europe's economy being shrouded in bleakness is hardly surprising, the European Commission put a number to it by stating that the region's economy probably entered a recession this year and will barely grow in 2009. Amidst such a desolate landscape, European central bankers and politicians are on their toes literally burning the midnight oil in a desperate effort to pull the region from the slump.

According to a report published by the Commission and reported on Bloomberg, economic growth in the Euro zone is likely to slump to 0.1% the next year and has revised its forecast downwards for this year to 1.2% from 1.5% in the early part of the year. Growth in 2010 is expected to be a wee bit better than 2009 at 0.9%. While the financial crisis has wreaked havoc in the region, record high oil prices and the Euro's strength at the start of the year were also instrumental in retarding growth.

While the good news for the region is the fact that lower crude prices will cool off inflation, unemployment rate is expected to soar to 8.4% next year as against 7.6% this year. Just like its peers around the world, the European Central Bank is set to cut its benchmark rate for the second time in less than a month. The scenario, however, for the next one-year atleast does not appear too enthusing.

02:34  In the meanwhile...
Asian stocks had a mixed day today with the key gainers being Japan (up 6%) and Korea (2%), while Singapore (down 2%) and China (1%) languished in the red. The benchmark BSE-Sensex closed 3% higher. Australia went in for a larger than expected rate cut of 75 basis points in wake of the global financial turmoil. Falling house prices and retail sales compelled the Australian central banks to go in for the most aggressive round of rate cuts since the economy was last in a recession in 1991. European indices are trading higher currently. As reported on Bloomberg, crude oil fell by 1% to US$ 63 a barrel as manufacturing in the US contracted in October at the fastest pace in 26 years, signaling weaker fuel demand.

02:53  US goes to polls today...
After days and weeks of frenzied campaigning, the two presidential candidates, Democrat Barack Obama and Republican John McCain will now take a backseat as American voters take centrestage on Election Day today. Given US' might globally, the presidential race is always a closely watched one, the outcome of which will have a major bearing on international relations and the global economy.

03:03  October pinch for global auto majors
Tata Motors has reported a 20% YoY decline in its vehicle sales volumes during the month of October 2008. If you think this performance is bad, what will you say when you know about the October performance of three of the biggest automakers in the world? The US auto industry has reported its worst monthly sales in 25 years, with General Motors (GM) leading the pack with a 45% YoY drop in volume sales during October. Then, while Chrysler posted a 35% decline, Ford's numbers came in lower by 30%. Compared to this, Japanese major Toyota's volume sales have dropped by 23%.

<>Auto industry is highly dependent on the financing environment. And with the situation remaining grim in terms of higher interest rate, lack of financing and weak consumer confidence, the auto industry worldwide has taken the flak. While there is considerable pent-up demand for automobiles in emerging markets (like India and China), until the credit markets open up and consumer confidence improves, the industry will continue to suffer.

03:35  'Realty' bites
Mutual funds are having a hard time in these falling markets. Especially when they have invested heavily in real estate. As reported by ET, due to concerns voiced over the portfolio composition of one such reputed mutual fund, which is skewed towards the risky real estate sector, the fund is believed to have offloaded a sizeable chunk of its real estate papers worth billions of rupees to a group entity. While it is not known whether these have been sold at a premium or not, assuming that they have, then unit holders of the fund will stand to gain while the shareholders of the group entity would have received a raw deal. Whatever the case may be, the crippling effects of the unjustified exuberance with respect to the real estate sector are being felt now with real estate stocks receiving one of the worst battering in recent times.

03:57  The FCCB conundrum
Imagine that you are running a partnership firm that is already strapped for cash. Wouldn't you get a big bolt out of the blue if your partners approach you and force you to liquidate their stake at a very short notice? Well, something similar has been happening to a lot of companies in India. Few years ago, they had tied up financing through a very docile financial instrument known as FCCB. It offered the companies the advantage of almost nil interest rates and equity dilution that was a comfortable 3-4 years away. Infact, the companies never thought of FCCBs as debt, always thinking of it as an equity infusion, which will not require a cash outlay. They were under the impression that capital markets will continue to function smoothly and hence, would make conversion smooth.

But things have turned out to be a lot worse than they can imagine. And all of a sudden, the holders of FCCBs, who are strapped for cash themselves, might not want equity but would want to call back their debt instead. For companies that are already substantially leveraged, this would mean a huge cash outflow. And there aren't enough avenues to replace the current one. If they go for equity financing, it would mean huge dilution for promoters at current depressed prices and if they go for debt financing, it may well prove very costly at current interest rates. It clearly is a situation that one may not want anyone to fall into.

04:33  United we stand...and divided we fall
Prime Minister Manmohan Singh, in a meeting held yesterday, has expressed his deep concern about India Inc. cutting jobs in the current scenario. His caveat to the major corporations was clear: "I hope there will be no knee jerk reaction such as large scale lay-offs which may lead to a negative spiral. Industry must bear in mind its societal obligations in coping with the effects of this global crisis."

To help make matters better, the government has decided to set up a high-powered committee, headed by either the PM or the FM, to ensure that the credit and liquidity crunch and other problems that industry faces are resolved and the growth momentum is sustained. Also, necessary monetary and fiscal steps would be taken to boost economic growth.

Some large corporates appear to be in sync with the PM's requests and have given the government a commitment of not laying off people for a few quarters. However, in the larger interests of the health of the company and the economy over a longer term, is that such a wise decision?

04:56  Today's investing mantra
"There are all kinds of businesses that Charlie (Munger) and I don't understand, but that doesn't cause us to stay up at night. It just means we go on to the next one, and that's what the individual investor should do" - Warren Buffett
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