Sarkozy and Fischer sat on a wall

14 JANUARY 2012

Presidents Nicolas Sarkozy, of France, and Heinz Fischer, of Austria, last week fell off their debt walls and were downgraded by S&P, losing their AAA rating one notch. This is one more indication that the Eurozone crisis is far from over, and investors can expect a shock. Last week S&P cut by one notch the ratings of France and Austria.

Earlier in the week, the Greek Government failed to reach an understanding with its creditors. If one recalls, the EU Governments had compelled Greece's private creditors to voluntarily agree to a 50% haircut of their debts. Though that may sound like an oxymoron, anyone who has seen 'Godfather' would realise it was an offer the creditor's couldn't refuse. The purpose of compelling the agreement to be voluntary was to avoid the triggering off of insurance payments called 'credit default swaps'. ---------------- Revised And Updated Edition Of "Multibagger Stock Ideas" ----------------

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Now that the creditors have refused to be armtwisted into voluntary submission, its likely that the Greek Government will default in March, when payment falls due, and will trigger off demands from holders of the CDSs. Credit default swaps are the financial equivalents of WMDs (weapons of mass destruction), in which some banks were asinine enough to provide insurance, for a remarkably small premium, to debt issued by Governments, on the presumptions that Governments don't, and can't, default.

The Greek Government, as explained by Michael Lewis in his wonderful book 'Boomerang', joined the European Union by fudging its books to bring down its budget deficit to 3%, as demanded as a condition for entry (it turned out to be 15%). Joining the EU made it eligible for substantially cheaper loans and the investment bankers swooped down to Greece, to show it ways to borrow from the future and live beyond its means. All sorts of Government future dues were used as security for borrowing by issue of bonds. In order to make investors buy the bonds, they were offered insurance by creating the fuzzy sounding products called 'credit default swap'. If Greece defaults in March, as it will, holders of the CDS will demand payment and that would lead to runs on banks holding them. French banks are large holders; hence the downgrade.

So within the next few months one can expect another crisis emanating from Europe.

In India the election to five states, including the largest, UP, will take place before March and no major economic policy decisions can be expected till results are declared mid March. Last week the Government notified 100% foreign direct investment (FDI) in single brand retail. The earlier permission to go upto 51% in multi brand retail was stalled amidst political protests and has been deferred. Should the ruling Government put up a strong showing in the coming elections, one guesses it would be reintroduced. If not, it would be quietly buried.

In the Indian system of government everyone and his uncle has a say. This confuses investors. For example, in about 80% of joint ventures for FDI in different projects, especially infrastructure, equity investment is made by foreign investors subject to the condition that if certain milestones of progress are not achieved, the local partners would have to buy out their equity stakes. DIPP (Department of Industrial Policy & Promotion, Ministry of Commerce & Industries) had cleared it, then withdrew the clearance when Reserve Bank Of India (RBI) objected, then cleared it again when investors objected! Now RBI has objected again as it believes these are actually foreign loans masquerading as equity. Whatever the view, the Government should sit down with DIPP and with RBI and take a joint view; the flip flops do not do anyone any good.

The Civil Aviation Ministry had asked SEBI to waive the condition of a public offer if a foreign airline were to buy a significant stake in an Indian one. Security And Exchange Board Of Indian (SEBI) has, rightfully, refused. Had it not refused, the owners of airlines such as Kingfisher, which have not run it well, would have got for themselves a higher price than they deserve to, and it would be rewarding failure. What with a German bank is threatening to sieze two of its planes and the resignation of a number of its pilots for non payment of salary, KF is badly in need of a rescue.

So is Air India, which has been bankrupted by an unaffordable purchase of aircraft, probably under political pressure. Its pilots, too, are on strike, and the banks are refusing to accept the Government's programme to restructure its debt. The heads of public sector units are often very competent but are under political influence, as Government is a majority owner. Afraid of being hauled up, as they are, for any major decision, by the CAG and other bodies, they prefer not to take any decision.

So whilst many of them have a mountain of cash and need to make capex decisions, they go slow. During 2011, capex of PSUs feel 40% to Rs 4.43 lac crores, also partly due to higher interest rates. The capex of private sector companies fell 47%, to Rs 6.03 lac crores. Combined, it fell 44%.

This fall in capex will definitely lead to a fall in GDP for the year 2012-13, and is a large factor keeping investors away. Investors await the turning of the interest rate cycle, and to see if industry, once interest rates start coming down, will start investing for the future again.

Interest rates would start falling only if inflation, especially food inflation, is seen as being in check. However, the weather is not helping. With AP, Karnataka and now Maharashtra declaring drought, its likely that food prices, of things like sugarcane, pulses, soyabean and coarse grain, will rise.

Despite rise in tax collection (indirect tax collection was up 16% in December, uncontrolled spending by Government on subsidies and leaky social welfare schemes, would cause the fiscal deficit to by higher than the forecast 4.6%. The subdued stockmarket has put paid to its effort to raise Rs 40,000 crores by divesting shares. The Government is working on innovative ways to hit the target. It may be tempted to accept the offer by Sterlite, which holds 51% of Balco, to buy over the residual 49% stake held by the Government. The innovative way includes borrowing against the shares of 3 private sector companies, viz. ITC, L&T and Axis Bank, and using the borrowing to buy out its holding in other PSUs. If that were to happen it would further reduce the pool of bank resources for private sector and thus further delay capex plans.

The poor fiscal show is also compelling the Finance Ministry to delay plans by the armed forces to increase firepower of all three services. In contrast, China is increasing its defence spending and, should it choose to flex its muscle, would cause huge jitters.

Two companies announced corporate results for the quarter ended Dec 31. Infosys showed a 31% rise in rupee sales and a 33% rise in profits. A lot of the rise was due to the fall in the rupee vis a vis the US $, from which more than half of its revenue comes. The guidance for the next quarter was flat in terms of its sales in $, which disappointed investors, who sold. HDFC showed a 34% increase in revenue and a 10% increase in profits, which was the lowest increase in 3 years. Last week the BSE-Sensex rose 305 points to end at 16154, and the NSE-Nifty gained 119 to close at 4866.

Looking to both domestic factors (state elections till March) and international factors (another Eurozone crisis when Greece defaults) one cannot be sanguine in this quarter. If corporate results of the two best companies, Infosys and HDFC, failed to enthuse, the other's won't either. If another Eurozone crisis hits, its possible that Indian stock markets would, like the Indian cricket team Down Under, get thrashed, and go, well, down under!

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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3 Responses to "Sarkozy and Fischer sat on a wall"

ramawatar saraogi

Jan 18, 2012

The Indian situation thus appears to be frightening.


V S Gurumani

Jan 15, 2012

This refers to the comments on investments and their impact on future GDP. These may be overstated. It has been the experience of most practising managers that in any given situation, focused attention on implementation and operational productivity can yield savings of up to 15%. If the Indian government were to simply buckle down to getting things done and not bother with making big, high decibel policy announcements, the savings could more than offset any new investments. What is more, such an approach will impress investors. To start with, why not begin with the Indian Railways, the PDS and post harvest losses in the agriculture sector?



Jan 14, 2012

GREAT WRITEUP...AND I LIKED SOME LINERS ESP. THAT ONE, "an offer the creditor's couldn't refuse"

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