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Crude, currency & more...

Apr 28, 2008

  • A handful of commodities including iron ore and oil have fired the inflation rates to historic levels across the globe. Crude oil prices show no signs of cooling off. This is at a time when not just the US but also the emerging economies are vying for added supply of the commodity to sustain growth. According to the International Energy Agency (IEA), China, India, Russia and the Middle East will for the first time consume more crude oil than the US, burning 20.7 m barrels per day in 2008, an increase of 4.4% YoY. In fact, the demand from the US is expected to contract by 2% YoY to 20.4 m barrels a day during the year.

    Clocking economic growth in excess of 8% per annum coupled with increasing vehicle ownership among the countries' combined population of 2.5 bn people, is certainly expected to drive China and India's energy requirements (to grow by 4.7% YoY in 2008) beyond that of the US. At the same time, oil usage worldwide will increase 2% YoY in 2008 because of the growth in emerging markets, as per the IEA. Having said that, the study conducted by IEA shows that the emerging markets burn a fraction of the energy consumption of the US, thus leaving room for growth. The 2.5 bn people in China and India used only half as much crude as the 301 m Americans in 2007. The average person in China consumed less than 20% as much energy as the average American in 2005, according to the US Energy Department. In India, the per capita energy consumption is less than 10% of that of the Americans, notwithstanding the acute power shortage.

    The view that the demand for energy will continue to rise in the coming years, despite limited supply, is drawing investors to this asset class by the hordes. Investors have transferred money into commodities, especially energy, during the past year because their returns have outpaced equities and bonds. To put things in perspective, oil prices gained 22% in the last 12 months, while the S&P 500 slid 5.6% and the BSE-Sensex gained 19.8% during the same period.

  • Currency risks have never before appeared as perilous as some of the top banks in the country succumb to losses of billions of rupees due to derivative positions taken on behalf of corporates on the same. Many banks like SBI, ICICI Bank, Axis Bank and HDFC Bank are undertaking profit hits as their customers are repudiating contracts and refusing to accept the losses in certain derivative transactions they entered into. In a currency derivative transaction, a customer tries to hedge against the losses due to movement in the value of currencies. However, with the sharp movement of the rupee against the US dollar in the past few months, some companies that have faced losses on their derivative positions have filed cases against banks on certain disputed transactions. SBI has declared that it needs to provide around Rs 6 bn against the losses in derivatives transactions in the domestic market. On the same lines, Axis Bank has declared in its FY08 results that it has as provided for Rs 720 m against such loss making derivative transactions. Further, there are matters pending in courts pertaining to the other banks.

    Apart from derivatives fiasco, banks are also paying for their exposure to the mortgage (subprime) crisis in the US. Banks having international investment portfolios are having to book mark to market (MTM) losses on their portfolios, as the value of these securities depreciated after the interest rates shot up in the aftermath of the subprime crisis in US. While the cues of economic growth and credit off-take are certainly muted in FY09 as compared to the last fiscal, the heavy write-offs are clearly signs of diminishing profit margins for most large players in the banking sector.

  • The Chinese government is expected to limit the listing of new shares and allow investors to borrow money to buy equities in an effort to boost the world's sixth worst performing equity market. The Chinese markets have underperformed in recent times on concerns that the government's initiatives to curb inflation would hurt corporate profit. The year-to-date decline in the value of equities wiped out US$ 1.1 trillion in market value (Source: Bloomberg). Further, the necessity to revive the equity markets is pertinent as transactions on the two main stock exchanges in the country slipped to a weekly average of 6.3 bn shares in 2008, from 14.7 bn shares in 2007.

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