Nightmare on Dalal Street - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Nightmare on Dalal Street A  A  A

21 JANUARY 2008

Indian investors became born again Newtonians last week. They rediscovered gravity and saw the sensex falling a gut wrenching 1813 points last week, without a single uptick, to end at 19013. This column had last week mentioned that 4 stocks were keeping the index high viz. Reliance, ICICI Bank, Reliance Energy and DLF. Their slide last week resulted in the fall in the BSE-Sensex with Reliance contributing 351 of those points, ICICI 317, Reliance Energy 81 and DLF 71. This, despite good results for Q3 from Reliance, with a profit of Rs 3882 crores, aided largely from its refining business where it has made a net refining margin of $ 15.4/b (v/s 13.6 last year). The NSE-Nifty fell a little less than 500 points to end at 5703. What next?

One can expect a bounce, probably on Monday itself. On Tuesday the US Federal Reserve is to meet, and is expected to announce an interest rate cut of at least 50 basis points. Ben Bernanke, its Chairman, has gone on record saying that the Federal Reserve will act aggressively to counter recession. He has asked the US Government to also provide a fiscal stimulus to the economy as monetary stimulus can only do so much. Whether Bush has the kind of resources needed is, however, debatable.

There lies the root of the problem affecting stock markets globally, including India. How severe will the US recession be? The previous Fed Chairman had injected money into the system, creating the problems of asset bubbles. In the real estate market this was compounded by foolish lending, to subprime borrowers. Using a plethora of techniques, banks hid these loans under layers of off balance sheet entries. The chickens have now come home to roost (actually, thats a bad analogy, given the bird flu situation) and financial institutions such as Citi, UBS and Merrill Lynch are declaring huge losses in the Dec quarter. This makes Wall Street nervous. Having been profligate in lending, these institutions are now relying, mainly on sovereign funds, to bail them out, causing a wag to opine that UBS should now stand for Union Bank of Singapore!

In India the economy is expected to grow at 9.1% in 07-08 and, as per Chairman of the Planning Commission Montek Ahluwalia, this could be down by 0.5% if the US goes into recession. Given the fact that interert on bank deposits do not even cover inflation, hence eroding the value of the capital, there is an increasing diversion of saving into equity markets. This is helped by the fact that dividend income is tax free, as is long term capital gain (except that the IT Department is now quibbling senselessly and foolishly with the definition of an investor versus a trader).

Hence, there would be sufficient domestic money flowing into equity to help sustain markets. Added to this is the likelihood of the Government permitting some of the funds of public charitable trusts, and pension funds, to be invested in equity.

The problem in India is one of awful public governance. The Government and the political class are destroying valuations of some of their best companies. Examples abound.

Take the largest telecom player, BSNL, a 100% owned Government entity. It has aggressive capex plans, of investing Rs 60,000 crores by 2010 and was planning to list 10% of its equity which would, by some estimates, have allowed it to raise $10b. The Left parties have stymied this! For absolutely no valid reason. The fact is that politicians have no concept of how markets work and how they should stay away and let management of those companies decide. Remember, for example, the several failed attempts to list VSNL, when it was Government owned, simply because some bloke in Government decided that the pricing was too low? Ultimately it listed at a significantly lower price than when first mooted. No one in Government was ever questioned about this insane folly. Ultimately, BSNL will partially list, but probably when the boom is over and private sector companies have taken advantage of the growth potential. The Left parties, now blocking the IPO for reasons unknown, would never be questioned.

Take SBI, the largest bank, also with Government as the largest owner. The Government has only just allowed the bank to issue ESOPs to its employees, prior to its large rights issue. With pay and perks controlled in PSU banks, retention of talent is a major issue, to private sector banks able, and willing, to pay for performance. It is also worth noting that SBI, with its pedigree and an unmatched record of 150 years of dividend payment, is quoting at a market cap of $31b. whereas a more recent ICBC of China, the world's most valuable bank with a market cap exceeding Citi or HSBC, has a valuation of $ 250b. According to a ranking of the world's 75 most influential people in the financial world done by Institutional Investor (disclaimer: I am India representative) Jiang Jianqing, its Chairman is at #4. The only one from India is K V Kamath, at # 53, Chairman of ICICI Bank, a private bank. Do politicians not see the damage their outdated myopic policies and views are causing?

Then there are the three PSU oil marketing companies, IOC, HPCL and BPCL. The Government imposes a subsidy burden on them, destroying their P&L accounts and their ability to invest for the future. Then, rubbing salt in the wound, the Government now threatens to take away their ‘navratna' (nine jewels, which they were once part of) status, thereby removing whatever little freedom their managements had to take financial and investment decisions. It seems that it is the agenda of some people in Government to sell these companies at reduced prices, some time in the future, for they are destroying value with a vengeance.

Or take the wholly Government owned Airport Authority of India. According to an article by RN Bhaskar (DNA, Jan 17) its feet are being cut. It was not allowed to compete for Bangalore and Hyderabad airports. This, despite the fact that of the two airports AAI has modernised, Kolkata and Chennai, it is the latter that has got the highest service rating from international agencies.

Looking at it sector wise, the telecom sector is being constrained over the mess made through a non transparent spectrum allocation policy. The IT/ITES sector is reeling under the onslaught of a strengthening rupee which ought to end the year around Rs 37.75 or so to the $. The two wheeler sector has been jolted by the Nano and the auto sector growth is slowing due to poor infrastructure. Banks, infrastructure and a few others ought to be powering the next rally. Most of the problems are policy related and the solution therefore, lies in better public governance.

Why not think out of the box and give all MPs and senior bureaucrats units in a mutual fund, managed by UTI (so no issues) which is allotted options on all unlisted Government companies? Then it would be in their own self interest to have sensible policies to enhance their value. You think our comrades would accept this?

So be prepared for a rally early next week. Then be prepared for a sideways movement probably lasting a few months. Elections to the Rajya Sabha are in April and the UPA Government is likely to lose control of it, given the number of states it has recently lost. This means passage of legislation, especially of economic reform legislation, would get stymied.

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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