The art of illusion - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
The art of illusion A  A  A

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20 JUNE 2009


'Cold hearted orb that rules the night,' crooned the Moody Blues, 'removes the colours from our sight, red is grey, and yellow white, but we decide which is right, and which is an illusion'.

It is the same with stockmarkets, it is the perception of investors that decide what is right and what an illusion. That perception is influenced by what we read and see in our media, as much as by the events themselves.

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As wonderfully pointed out by V Nageswaran in Mint of June 16, the US media is accepting, and reporting, the spin put out by the US Government on economic data. It thus reported that factory orders (encouraging news) were slightly better, ignoring the downward revision in previous months' data (discouraging). It reported that continuous claims for unemployment benefits were down (encouraging) whilst failing to point out that once a maximum limit of such benefits is reached, the person's claim is dropped anyways. It reported an increase in monthly retail sales (encouraging) whilst not mentioning that it was due to higher petrol prices.

The tremendous bailout financial packages have succeeded in temporarily changing perception, by inundating the system with liquidity. Part of this liquidity, which is a lot (the US has pumped in just under $4 trillion), has gone into assets, including stocks, driving up markets, and into commodities, driving up prices of, say, oil, which has more than doubled to $ 71/b.

US President Obama is now taking steps to try and ensure that this liquidity will not cause similar asset bubbles that led to the global financial crisis in the first place. Last week he announced plans for a regulatory overhaul. Paul Krugman writes in New York Times that the plan doesn't live up to the diagnosis. It has some good elements, such as bringing under regulation chunks of the financial system that constituted a parallel banking system but had no safeguards such as deposit insurance. These institutions, such as Bear Stearns, or Lehman Bros., behaved imprudently, borrowing short and lending long, and were so big that they proved a systemic risk. Obama plans to bring them under regulation. This is good.

It has, however, not addressed enough the issues that caused the problems in the first place. Housing loans, for example, were initiated by banks who didn't keep them on their books, but securitised them to investors who did not know the risks. Obama plans to make banks retain 5% of such loans; not enough of a deterrent by far. Nor does the plan address executive compensation that rewards short term performance unmindful of long term risks.

The US is, however, coming down hard, as it should, on white collar crime. Last week it indicted Allen Sanford, a hedge fund manager, for a $ 7b. fraud. A US court imposed on Richard Scrushy, of Health South, a $ 2.8 b. fine, atop a 7 year jail term, for falsifying accounts. Contrast this with the absence of punishment suiting the crime, meted out in India.

The biggest corporate news of the week was the Bombay High Court judgement that decided in favour of RNRL, in its dispute with RIL, over price relating to a 17 year supply of gas from the latter to the former. The court held an MOU between the two to be valid and asked the two parties to sign an agreement within a month, to supply gas at $2.34/mmbtu. RIL had sought to supply it at $4.20/mmbtu, which the Government, which owns the gas, had fixed as the fair price. The difference between the two works out to about Rs 1000 crores/year. After the judgement, the share price of RIL dropped 7.5%, bringing down the sensex, whilst RNRL was sharply up.

The case would probably go in appeal to the Supreme Court, although the court has asked the brothers to settle it between themselves. It is uncertain how the Government will proceed; if it demands that for its share of profits the price of $ 4.20 should be taken, and royalty on this price paid, RIL would be hit. If it were to decide that its allocation policy would supercede the MOU, then RNRL would be hit.

The Government has decided to double the auction price for 3G spectrum, to Rs 4020 crores. It hopes to garner Rs 25,000 crores from sale of spectrum. There are two views on spectrum pricing. One views it as a scarce resource of the Government to be exploited, as the Government is now doing. The other view is to see it as ‘commons' and to price it low so that the users (you and I) benefit. Pricing the spectrum high would push up cost for the user. Britain, e.g. is working on a plan to make 3G spectrum free for consumers (despite the sorry financial condition of the country), as Korea has done. This spurs innovation. The argument for the first view is that companies which buy spectrum become squatters and can make a profit (as Unitech did) on sale of spectrum, even when the business itself fails. The better way would be to allocate spectrum at a low price but give the allottee only the right to use and not to sell the spectrum.

But such an approach would not feed the insatiable appetite for funds of a profligate Government. Look at it this way. The Government subsidises petro products, including petrol and diesel, which, by no stretch of imagination, can be for the benefit of those below the poverty line and needing a helping hand. These subsidies (excluding those on LPT and kerosene, which could be justified) are over 3 times the Rs 25,000 crores sought from the 3G auction. Which means the Government is seeking to subsidise those who travel on the concrete highways and load those who travel on virtual highways. Hmm.....

It ought to have taken a cue from Mahindra Holidays and Resorts, which is making an IPO of 9.2 m. shares in a price band of Rs 275-325. The vacation ownership gives the right to a one week vacation for 25 years and not an ownership right to the resort, or to the time share in it. The ownership of the resort vests with the company, which gets not only income from the sale of the time share but also an annuity from annual maintenance of it plus from the interest on the EMI for buying it, and from the sale of food and beverage.

The BSE-Sensex yo-yoed last week like a kangaroo on a trampoline, but ended the week at 14521, for a weekly loss of 716 points. The NSE-Nifty ended down 269, at 4313. For the first four days of the week, for which figures are available, FII's were net sellers on all four. Have they decided that red is grey?

India is a good long term story, but we must get our act together in terms of good governance. The first sign of it, much like the sparrow that heralds spring, would be in the Union Budget, due early next month. Should the market dip nervously prior to it, it may be a good idea to buy.

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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