Investors are cheated left, right and centre...

Nov 20, 2008

In this issue:
» Scams galore
» Modern day piracy hits shipping industry
» Indian banks' NPAs vs. NPAs of Chinese banks
» India's first private pension fund
» ...and more!

Bad times bring bad news...and lots of it. As if the stock market crash and slowing economic growth were not enough to scare investors, some have been duped by companies promising big rewards. And then there are other companies that are misrepresenting facts to grow.

In one such instance of fraud that Economic Times has reported, more than 200 investors have been duped of crores through a 'money-doubling' scheme from a Delhi-based company, Kanakdhara. Some of these people who thought the scheme to be flawless and one offering great returns at minimal investment, invested their life savings and even borrowed money only to find that they have been duped.

In a similar such instance, but not promising to double money, several investors from India, Pakistan, US, South Africa and Canada have been cheated by a UK based company (UKLI) which promised them land in that country. Some of these investors also squandered away their life's savings on the scheme advertised last year. A total of 4,500 people applied to the scheme and have been duped for a collective amount of £69 m (around Rs 5 bn). UKLI is now insolvent and is unable to meet liabilities.

Now for the third news that will also perturb the company's investors, a leading business daily has reported that Reliance Power misrepresented a key fact in its application seeking environmental clearance from the central government for its 4,000 MW project at Shahpur in Maharashtra. After getting a clearance, based on certain conditions, from the Ministry of Environment and Forests, the company got the Maharashtra government to change some regulations that were going against the company. So much for the environment and corporate governance!

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It is bad enough that the global financial crisis and the economic slowdown are taking its toll on the shipping industry. Unfortunately, the sector has another serious problem to contend with: piracy. Consider some numbers. According to the International Maritime Bureau, pirates seized 26 ships during the summer alone and have collected up to US$ 30 m in ransom so far this year. The most notorious region has been the Gulf of Aden, which is one of the world's most important sea trade routes. Thus, despite being a direct route, increased piracy has forced ships to make a much longer route around the southern tip of Africa thereby entailing higher costs for an industry which is already reeling under the dampening effect of a global meltdown.

The longer route too is not without its share of notoriety as was amply demonstrated by the unprecedented attack on the MV Sirius Star, carrying US$ 100 m worth of crude hundreds of miles from shore in the Indian Ocean. As a result, the cost of insurance and crews, including security guards on ships that take the longer route are just set to increase. And this alone is expected to punch a hole in the wallet far bigger than the cost of fuel. Indian ships are paying the price too as they are losing US$ 450,000 a month on cost overruns and delays in meeting deadlines as crew members are reluctant to sail in the Gulf of Aden. Quite a rough sea ahead for the shipping industry indeed!

After national highways, the Indian government's effort to provide all weather road connectivity in rural areas under the Pradhan Mantri Gramin Sadak Yojana (PMGSY) is beginning to bear fruit. It is finally triggering off meaningful socio-economic transformation and rapidly opening up new routes for growth. Quite literally! As per the government body, rural roads are the biggest contributors to poverty alleviation and an investment of Rs 10 m in roads carries the ability to lift 1,650 people above the poverty line. Also, rural connectivity has the potential to add to domestic consumption, which makes up 55% of India's economy, compared to 37% in China.

As per Bloomberg, the 100 kilometers (62 miles) of rural roads that India is adding each day may save Asia's third-largest economy from the worst of a global recession. New roads built so far under the US$ 27 bn program have brought urban markets within reach of 60 m village dwellers over the past five years, letting them earn money selling fruits, vegetables and milk that would have spoiled otherwise. These villagers are now spending their cash just as the world economy falters. Particularly because they not just have the roads for commuting to the markets but also extra income during the non harvest season due to the employment generation schemes.

Spending on the road project by the PMGSY was about 5% of GDP in 2007. A vision statement for 2025 drafted by the Ministry of Rural Development estimates that the investment needs to increase from current levels to US$ 8 bn a year until the 14th Five Year Plan (2022-27). Given the Finance Ministry's estimates that inadequate infrastructure can shave two percentage points off the nation's growth each year, the emphasis on rural infrastructure seems undeniable.

As per Bloomberg, the commodity bashing spree, especially for copper, is all set to continue. According to one of its reports, copper prices may plunge to less than US$ 1 a pound next year as global inventories see a huge pile up. China too is said to be sitting on a lot of unsold inventory as the credit crunch has significantly pared demand for the metal.

Copper last traded at less than US$ 1 a pound in December 2003. According to the World Bureau of Metal Statistics, copper production exceeded demand by 26,800 metric tons this year until September. The metal is known to be the momentum setter for other industrial metals and its myriad uses include its incorporation in making various alloys, in piping, electronics, wires, architecture, industry, utensils, house hold products, coins etc. Thus it is not surprising that a general global slowdown in demand for everything would have such an effect on the price of copper.

The stock price of Legendry investor Warren Buffett's company Berkshire Hathaway, rose in 17 of the past 20 years. However, this year, the stock has fallen the most in the past 23 years. Till date, the stock has slipped 41% compared with the 45% drop in the S&P 500 Index. Berkshire's shareholder equity, a measure of assets minus liabilities, fell by about US$ 9 bn in October as American Express, one of Berkshire's top 10 stock holdings, plunged 47% YoY as borrower defaults increased. Wells Fargo & Co., Berkshire's No. 2 investment, dropped about 35% YoY.

Indian banks are dwarfed by their Chinese counterparts when it comes to balance sheet size. However, the same may not be a cause for indignity at a time when global banks with massive sizes have had to counter some of the most colossal problems. As per China Banking Regulatory Commission, Chinese banks' combined assets totaled US$ 8.7 trillion at the end of September 2008. The RBI data revealed that Indian banks had outstanding loans of US$ 510 bn (approx. Rs 25 trillion) at the same time.

The global credit crunch has seen financial institutions around the world write off nearly US$ 966 bn worth of assets. However, as per the RBI, Indian banks have just US$ 1 bn of toxic western assets out of the total loan portfolio of US$ 510 bn. Retail loans, mortgages, credit cards, auto and consumer durable loans, which were among the fastest-growing segments, are now likely to be major risk areas as bad debts are expected to rise from 2.5% of advances in FY08 to 4% of advances by the end of this fiscal.

The same may increase provisioning pressure for Indian banks although not putting the banking system at risk due to its fragmented nature and high capitalisation rates. At the same time, while Chinese banks have had average NPA ratio of 5.5% at the end of September 2008, an increase in the same is expected to have a vicious impact on the economy given their balance sheet sizes.

The recent credit crisis has started taking its toll on the Indian hospitality sector. While several real estate and international hotel players have backed out or deferred their expansion plans, the existing domestic hotel companies are witnessing lower occupancy and a sharp drop in the average room rates, despite the current quarter being a peak season. Although hotel players had taken hikes in room rates in September to offset the rising operating costs, they have to offer them at a huge discount to sustain reasonable occupancy rates.

Recently, the Federation of Hotels and Restaurants Association of India had also asked major premium hotels to slash their rates by up to 15%, since India is perceived as an 'expensive' destination. In the recent past, average rates have increased by 24% YoY in FY06, 30% in FY07 and 12% in FY08 on account of demand supply mismatch making India expensive compared to other Asian tourist destinations.

As per estimates, around 90% of India's workforce does not have access to any form of guaranteed post retirement income. Furthermore with both living standards as well as life expectancies on the rise, wealth creation for retirement is going to become all the more important. Fortunately, there is some hope at hand. After a good four-year wait, it looks like the private pension funds will finally be allowed to manage pension money of salaried as well as non-salaried people in India. As per a leading business daily, Pension Fund Regulatory and Development Authority (PFRDA), the regulatory body, will invite bids from prospective fund managers and applications for points of presence, or POPs, where money can be deposited, around mid-December.

Hence, April 1, 2009 onwards, if everything goes as per planned, Indian residents could actually be in a position to deposit their hard earned money with a private sector asset management company, regulated by the PFRDA. What more, the investor will also have the option of choosing schemes with a more equity orientation, thus giving him the benefit of higher returns that usually come with the higher risk taken. The emergence of private sector pension fund management companies is also likely to bode well for the country's stock markets as it will enable them to reduce their dependence on dollar inflows, which can prove to be quite volatile, as is happening currently.

News these days is increasingly filled with references to the crash of 1929 and the Great Depression. Here is a graph that compares the current crash with three previous crashes the US stock markets have seen, including the crash of 1929.


In the meanwhile, showing no signs of breaking away from the trend of sharp sell-off witnessed in Asian markets today, the Indian indices witnessed a steep correction in heavyweights across sectors today. The benchmark BSE-Sensex closed lower by nearly 3%. The Japanese and South Korean markets were the worst hit losing as much as 7% each.

The European indices are also submerged in a sea of red currently. The fate of the US market is not expected to be any better either with uncertainty over the bailout of large automakers looming large on market sentiments. Federal Reserve officials yesterday pared their outlook for growth in the world's biggest economy to minimal levels and appear poised to cut interest rates further. Crude oil prices touched a low of US$ 53 a barrel, spooked by demand related worries.

We mentioned yesterday that the consensus among 27 national oil companies from 23 countries is that the price of crude oil will fall to about US$ 40 per barrel, before bouncing back to around US$50 to US$ 55 per barrel. Chinese companies including the China National Offshore Oil Corporation hold this view. The South Koreans however, have a different opinion. They believe crude prices will average around US$ 100 from 2008 to 2015. Going forward, additional sources of oil will all be from inaccessible fields thereby pushing the cost of production substantially higher. The Koreans have based their opinion on the World Energy Outlook report recently published by the International Energy Agency. In our opinion, oil prices will rise again simply because the world has not yet developed truly viable alternatives. However, cost of production from inaccessible fields will also not remain static. Technological breakthroughs will help reign in production costs.

Today's investing mantra
"Any fool can make things bigger, more complex, and more violent. It takes a touch of genius - and a lot of courage - to move in the opposite direction." - Albert Einstein

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