The paradox of shortage, with plenty - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
The paradox of shortage, with plenty A  A  A

12 MAY 2012

The world's stock of financial capital (i.e money invested in financial assets such as stocks and bonds) is estimated to be around $ 204 trillion, more than 3 times the global GDP. Since global GDP growth is anaemic at around 3.5%, it does not provide an adequate return on the stock of financial capital. The managers of that capital, largely in the US, where the bulk of it resides, then do several things. They take higher risks in deploying the capital, and they concoct and sell derivative products to generate additional income.

JP Morgan, a large US Bank that came out of the global financial crisis in far better shape than others, last week announced a $ 2b. loss in trading which immediately led to a downgrade by rating agency Fitch, and a likely downgrade by S&P.

Thus, when almost all nations of the world are desperately searching for capital, there are various pockets where it is plentiful, and playing around.

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Consider the selling of derivative products. Michael Greenberger, a former director of US CFTC, opines that if two derivative products, (a commodity index swap and synthetic ETFs) were banned, the artificial demand for oil created by these products would vanish, and oil prices could come down. Whilst derivative products admittedly improve liquidity, and thereby reduce volatility, the considered opinion is that a mix of 30% speculative trade and 70% commercial players, is fine. It is now the reverse, with more speculators than commercial players, and, perhaps, $ 23/barrel is added to oil cost by speculative positions. The two derivative products mentioned were introduced in 2004 by Goldman Sachs and Morgan Stanley.

One of the factors contributing to the US financial crisis of 2008 was the derivative product acronymed NINJA bonds, issued to facilitate home ownership by those with No Income, No Jobs or Assets. These bonds were then sliced into different parts, and the highest slice even got AAA ratings from some rating agencies! Amazing! This allowed the originators of the bonds to sell them, armed with the generous ratings, to investors (read suckers). Rating agencies did not know the products well, and rated them without any history or experience. Moody's, one of the rating agencies, did a 5 day review of one type of bond called Alt A, and, at the end of the review, downgraded some 92% of them from AAA to junk! This is exceptional, because rating changes are one step at a time and never the sort of Greg Louganis dive from AAA to junk in one go! It only shows how the whole financial system has been debased, to originate complicated fancy products, get them rated by agencies who, too, need to earn income from fees and may thus water down their standards, with the back up plan of an Uncle Sam to bail out those, like Citi, which are 'too big to fail'.

So there are large pools of capital around the world, wating to be invested (or used in trading) in good investment opportunities. If India got its act together, we could have attracted a lot of this capital which is waiting to be deployed. Alas, we do not have our act together.

Last week the UPA Government did not have the, err, backbone (I would be editorially disallowed to use another term) to hike FDI in insurance. That would not only have brought in foreign exchange (thereby also helping stanch the alarming decline in the rupee, which is sliding against the $), it would also have helped ailing insurance companies, and would have shown the UPA Government's commitment to carry on with economic reforms. I had hoped that it would have the backbone to undertake reforms, perhaps when the Parliamentary session got over in third week of May, but it now seems unlikely.

The Government can, for example, invite foreign capital to set up food storage, including refrigerated storage, facilities. We badly need more storage. In foodgrains. Ashok Gulati, Chairman of Agricultural Costs & Prices says that after the current procurement season ends in June, India will have a 75 million tonne of foodgrain stock, and covered storage capacity of only 50m. The balance 25 m. will lie out in the open, and be eaten by rats, or spoilt by weather. This, when millions of Indians don't get two meals a day! The paradox of plenty and shortage!

It is with issues such as these that our lawmakers ought to devote their time. Yet we saw our Parliament stalled over a cartoon in our textbooks that appeared in 1949!

There are plenty of claimants for the excess capital that is swishing around. According to International Financing Review corporate will need a whopping $ 46 trillion to meet debt redemption and for new debt to be raised.

The Finance Minister tried to do his bit to clarify the fuzziness created by the GAAR rules, reversing for a year his stand on GAAR on Monday. Funnily, reversing GAAR leads to RAAG, which was sweet music to investors' ears, causing a rally on stockmarkets. The rally, however, was very brief, and the downtrend resumed the next day. Investor mood is bad; foreign investors sold aggressively last week and though there is plenty of scope for the Indian economy to grow, and plenty of demand to meet that growth, our leaders excel in shooting themselves in the foot. If the foot was the target, Abhinav Bindra would have plenty of competition.

The Government is firm on its path to recover from Vodafone the tax amount payable by Hutchison on the capital gains the latter made when selling a controlling stake to the former in its Indian telecom operations. The claim is Rs 20,000 crores, comprising Rs 7900 crores of tax liability, an equivalent penalty and the balance by way of interest. Vodafone wants to invoke the provision of an India-Netherland treaty, but the Finance Secretary says the provisions of this treaty are inapplicable.

The Government's stand is that it had made clear its intention to collect tax from Vodafone on the deal, before it had been consummated. Given the prior notice to Vodafone, its case for collection seems better than other cases which are reportedly being re-opened. Such as the 2007 purchase of Sesa Goa by the Vedanta group, in a $981 m. or others. Since in the other cases, its intention to collect tax from the buyer, on behalf of the seller, was not announced prior to the consummation of the deal, it would be unwise to pursue

The BSE-Sensex lost 538 points last week to end at 16292, and the NSE-Nifty dropped 157 to end at 4928.

Though the next support level is at 15,500 on the BSE-Sensex, the Indian market is technically oversold at the moment, and a technical bounce is possible. It would be a short one. There are problems galore in Greece, whose consequences would be felt on Spain.

Greek election results did not throw up a winner, and the parties have been unable to form a coalition. The Left party, Syriza, threatens to tear up the agreement with the troika. That would result in Greece having to leave the eurozone, which in turn would put pressure on Spain. Spain's is a much larger economy, and the EU warchest has only enough funds in it to rescue Spain once (unlike Greece). So if Greek leaders cannot form a Government and stick to the bail out plan they have signed, it appears that Europe's Lehman moment would arrive.

Any technical bounce that occurs can be an opportunity to exit, for if the Greek Trojan horse were to enter Spain, it would not be rain that falls in the plains but something else.

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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9 Responses to "The paradox of shortage, with plenty"
May 16, 2012
In 2012 I spent over months in Bombay.Though I live in the USnormally.

I concluded that the government of India is inept. They can do no more than tax. Tax on product. cess on tax. Levy on cess and tax on levy.
The great Indian solution for all ills and to raise revenue.

Give me a break. We are in deep trouble.
May 14, 2012
Mr. Mulraj, you are absolutely right about the lack of b's in the Govt. However I must disagree with your premise that FDI in insurance and other financial service outfits is the way to rectify our depleting FE reserves. These businesses are not rocket science and I do not understand why local players cannot successfully run them without foreign know how or management expertise. This very same expertise caused a lot of grief in 2008 and continues to make windfall profits at the cost of their customers. No, we do not need foreign capital in insurance, airline industry, and liquor. These are excuses made by Indian businessmen in order to skim money out. There are hundreds of examples of professionally run businesses making profit and needing no foreign funds. Foreign funds will beg to invest in India if we Indians got our act together by displaying political integrity, eschewing crony capitalism, a professional corporate ethos, and an efficient and speedy justice system. Till then we will remain a sleeping giant and conserve our potential! Like 
May 14, 2012


May 14, 2012
One point (on the Vodafone issue) made often in various columns always bothers me...That the tax dept had served notice on vodafone and since vodafone was aware of the possible tax liability, it cannot crib, now that the govt is retrospectively changing the law. As a layman (and not having studied the intricacies of "clarificatory retrospective amendments v/s substantive retro amendments", it seems to me that Vodafone took a certain view on this, and was later VINDICATED in its stand by the Supreme Court of the, how does it matter whether the tax dept had served prior notice or not???

Moral of the story - never fight a case with the govt on any issue of importance (meaning high value) as the govt will win the case, no matter what.
Rajnikant Nireshwalia
May 13, 2012
Excellent--as usual!!!!!!!!!!!!!! Like (1)
May 12, 2012
The Americans have messed up long enough and a whole bunch of mentally sick here in Mera Bharat Mahan has been playing the proverbial second fiddle long enough. Under the English Law a (well as our one Banking Development Regulations Act) banks are specifically prohibited from any activities other than those listed therein. After the American style of banking caught up, they have been engaging in any and all activities many of them clearly in conflict with the rule of fiduciary relationship with the clients. The trends in forex trading is a case in point.

It is plain bull you-know-what-I-mean to say that there is capital and the same can be used to productive efforts. The truth is money is not capital and all the presses in all the countries of the world doing 24/7 will not and can never produce a loaf of bread nor a piece of loin cloth. What The fiat money really is mere donkey feed and nothing more.
What JP Morgan really lost is not even donkey-feed but mere non-existent. It is not 2 billion worth of tangible products but mere digital entries. To come to think of it, it is not even lost when you are talking at the national or the global levels. It is simply the entries in the digital records of JP Morgan has moved out of the digital account of that bank to elsewhere, may be one or many accounts (again digital that cannot be seen or touched)

What is bad about banking is worse in Insurance industries. The entire insurance business needs to be looked at afresh. The kind of plunder that insurance business is continuing to do is several shades worse than the banking frauds we have seen in the recent years seen. The only legitimate insurance is Islamic Thakafful.

While on the subject, these rating agencies themselves have no rating and have no business to rate others based on their levels of ignorance. There is no legitimate basis for their work, like the Transparent International which is mere haberdashery work attached to the PR department, another six wheel in a system of fifth wheels.
Like (2)
May 12, 2012
As an American citizen I am just as upset with the US as some Indian citizens are with their government. Today's USA slogan should be, "If it's too big to fail, it's too big to bail." Even if the Congress doesn't re-instate the Glass-Steagall Act and other reforms, there may be a catastrophic moment when the humongous financial institutions do break up.But not due to reform, it would be due to a massive fail and no more $$$ to bail them out. Why our "representatives" don't prevent that from happening by passing the imperative legislation is answered by who owns the government. Due to massive amounts of money needed to campaign, that's a no brainer now that Citizens United has been empowered by the Supreme Court and corporations are persons !! Like (1)
Anupam, Garg
May 12, 2012
the author's pre-occupation with European financial crisis creeps me out everytime i read the can only hope against hope that pessimism on europe is already priced by the markets during earlier negative news....coz if its not, i wonder if equity would remain a prudent asset class for couple of years Like (1)
May 12, 2012
Great Article... one of the best around. You guys should have a paid subscription for his articles. Like (1)
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