You canít cure an addiction by feeding it, Mr Bernanke - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
You canít cure an addiction by feeding it, Mr Bernanke A  A  A

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20 SEPTEMBER 2008

The global financial crisis that is making headlines was the result of excessive liquidity fed into the system by the US Federal Reserve, and other central bankers, in a bid to keep up their economic growth by encouraging consumption. The excess liquidity did, indeed, boost consumption but a chunk of it also went into different asset classes, at increasingly absurd prices. This helped create asset price bubbles which are now being burst by the market. Market forces ultimately correct mistakes, such as in pricing, overlooked by regulators. The addiction that has created the global financial problem was excess liquidity, combined with foolish investment practices and lax supervision, but the solution to the problem is to feed the addiction with more liquidity! This can only have the effect of postponing a bigger problem later.

US Treasury Secretary Hank Paulson has proposed a bail out package of $ 800 b. He allowed Lehman Brothers (no, it is not pronounced lemon brothers but Leeh-mon brothers) to file for bankruptcy, allowed Merrill Lynch (no, it is not pronounced merrily lynched) to be taken over by Bank of America in an all stock deal, and has pumped in $80 b. to take an 80% stake in A.I.G. (no, it does not stand for all is gone). Other central banks such as ECB, Bank of Japan etc have chipped in with funds to avert a crisis of confidence when financial intermediaries become wary of lending because of fear that the borrower may be tainted.

Together with this financial intravenous injection, regulators banned short selling, causing global markets to rally sharply. The BSE sensex recovered as a result, on Friday, and actually ended the week up 41, at 14042, the major contributor being Reliance Industries with 124 points. The Nifty ended up 16 points, at 4245.

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Interestingly, up until Thursday (data for Friday is not publicly available) the foreign investors were net sellers on each day whilst domestic mutual funds were net buyers on each day! FIIs have sold over $ 8.2b this year, to date.

The markets could, thus, rally a bit more on the strength of domestic money flow, perhaps to around 15,500 on the sensex. However, the global financial crisis is not over but has only been given a financial IV. There could be other big name financial institutions that could tumble, causing more crisis of confidence and more panic. Investors should, therefore, get lighter on rallies in anticipation of lower prices.

All crises have their beneficial fallouts and effects. These could be a few:

Americans would undergo a lifestyle change: American society is a consumer society, with consumption contributing to over 70% of GDP, which is what led to Government encouraging financial institutions to lend to sustain consumption. They are now going to encourage them to save. Currently households have a negative savings rate; they were spending more than they earned, borrowing the difference against, e.g., rising home equity as property prices had been rising. Already the auto industry is feeling a drop in consumption due to high gasoline prices. Lower consumption by Americans would have global impact, especially for China which has a huge trade surplus with it.

The nuclear deal would get speedy clearance: In order to maintain a higher lifestyle, America needs to sell products/services in which its technological superiority gives it a pricing power. Nuclear technology is one such; ergo, one could expect a speedy passage of the 123 agreement with India. This would benefit engineering firms, power utilities and other companies involved in this business.

The Iraq withdrawal would be expedited: Whether McCain or Obama becomes the next US President, the occupation of Iraq would end faster than before the crisis. $800 b. used for rescuing American financial institutions is $800 b. less for other uses, especially maintaining troops in a foreign country.

Shareholder capitalism would be tweaked: A lot of the problems emanated from excesses of shareholder capitalism, under which 'shareholder value creation' superseded rights of other stakeholders, in contrast to stakeholder capitalism, which sought to balance the varied interests. Investors thus pressured companies and financial institutions for better performance, quarter on quarter, leading to a quest for superior returns, often at greater risk. The chickens have come home to roost. Some of the tools of shareholder capitalism, such as ESOPs, which tied managerial remuneration to higher profits (never mind the higher risk) would thus come into scrutiny and change.

And many others....
In India, corporate results for the half year ending Sep would start flowing from mid October and would probably not meet expectations, being affected by oil prices, inflation and higher interest rates. Public leadership is abysmal and getting worse. Crunched for cash, both Central and State Governments are Shylockian in their approach.

The Centre, which attracted bids for its new exploration and licensing policy (NELP) based on certain contractual agreements, now wants legal opinion to renege on these agreements. It wants to impound 40% of profits on gas as windfall gains, never mind that gas prices, being controlled, are about a third of market prices, thus not a 'windfall' gain by any stretch of imagination. Should this be cleared, it would affect profits of companies like RIL, Essar and Cairn.

The Government of Gujarat is trying to impose a tax of 30% of PBT, on profitable PSUs in the state, which would go into a Gujarat Socio Economic Development Society fund.

The Finance Ministry is trying to compel ONGC to park its surplus liquidity of Rs 25,000 crores only with public sector banks, instead of through competitive bidding with all banks. This is nonsense.

This brings to mind the speech by Francisco D'Anconia in Ayn Rand's Atlas Shrugged in which, when instigated that money is the root of all evil, he asks what is the root of all money? 'Money is a tool of exchange, which can't exit unless there are goods produced and men able to produce them.' ' It is not the looters or moochers who give value to money. Those pieces of paper are a token of honour -your claim upon the energy of men who produce' One wishes that Bernanke, Chidambaram, Mamta and others read this book.

In corporate news of interest, RIL is expected to start producing oil from KG basin; if it produces at the expected rate of 40,000 bpd it would generate a revenue of $3.5b a year. It has made another gas discovery in KG basin, probably larger than the first.

Ranbaxy is facing a bar on import of 30 drugs into the US, imposed by the USFDA, and has hired Guilani, the former mayor of NY, to lobby on its behalf. Indian stockmarkets have yet to price in such risks.

Unitech has been sensible in getting in a chunk of cash, which would be needed to sustain its real estate business through some tough times, by selling 49% of its telecom business to Telecom Italia for $2b.

The market may rally a bit more but prudence should be the better part of valour. After a stress test, the cardiologist advised me to get lighter. I would pass on the same advice to investors who have also recently undergone a stress test!

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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