Is there a silver lining to this cloud? - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Is there a silver lining to this cloud? A  A  A


The global financial crisis that is ongoing has been the worst, ever. This is because, of the four factors of production, viz. money, men, material and machinery, it is money that moves the fastest, since it is the only one capable of being digitized. As such, it moves on the click of a mouse, thereby spreading both its benevolence and its blight, instantly. Movement of men gets tangled in immigration issues, and of material/machinery in transport and customs delays.

The crisis has arisen because the financial system has betrayed its fiduciary responsibility. Commercial banks, in order to boost income (and hence bonuses for their management) created and offloaded, through securitisation, mortgages. When they ran out of good buyers, they gave loans to ninjas, or those with no income, no jobs or assets. Worse, the mortgages were 'no recourse' ones, a system peculiar to America (Economist Oct 25). That is, they were not backed by any other collateral, and, if the market price fell below the loaned amount, the home owner simply vacated the house with no further liability! This, of course, encouraged speculation, causing the bubble, and then the bust. But primarily it was the lackadaisical bank management, which sacrificed safety for the sake of their bonus inducing growth, that was to blame.

Then there were the investment banks which created a lot of these derivative products which nobody really understood, and then did the deals to market them globally.

Mutual and other funds were more of a marketing success, managing to grow to a size larger than the banking industry, than a product success; the majority of funds underperformed the index. As mentioned in an earlier column, fund managers also do not consider it their duty to get investors out of the market (or at least partially out) at points where they consider it excessively stretched. They assume that the decision to exit belongs to the investor.

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Given their size, one would expect funds to exert pressure for good corporate governance. Sadly, few do; most vote with their feet and exit the stock.

So we have a whole host of institutions, commercial banks, investment banks, different types of funds, who are not mindful of their fiduciary responsibilities and have squandered the trust of their investors. This is going to take time to replenish.

Indian banks are, thankfully, much better managed than the US ones. Yet, it is pathetic that the Government only insures deposits of Rs 1 lac and no more! This must be instantly and significantly increased. Unlike investing in equity, where investors are driven by greed to earn a higher return and so cannot expect to be bailed out should they zig instead of zag, those who save and deposit in banks, cannot be so accused. The only greed on display is a difference, perhaps, of a half percent at most, in interest rates.

The actions taken by central bankers and Governments may, fingers crossed, be leading to some hope that the crisis, though not resolved, is abating. The spread between LIBOR and 3 month treasury rate is reducing, which indicates a greater willingness of banks to lend to another (Economist, Oct 25). Since commercial banks lend 10 or more times their deposits, they need the backup of an interbank market to meet asset liability mismatches. Banks had frozen lending to each other for fear of the borrower going bust.

The Oct 29 issue of Time has an article that there are signs the US housing bust may be bottoming out; the Case-Shiller housing price index has recorded the lowest monthly drop in prices. The US should consider an idea to allow savings in 401K accounts to be used to repay housing mortgage. Money managers have destroyed a lot of value of financial assets in the 401K, on the one hand, and the threat of foreclosure would lead to loss of the physical asset viz. the house. Why not allow the financial asset to be used to save the physical one?

In India, according to astute HDFC fund manager, Prashant Jain, there are positive factors which present silver linings for the Indian market. With crude oil prices coming down (and staying down) India's current account deficit, now at 2.9%, may become a surplus. Will oil prices stay down, despite cuts by OPEC? According to Edward Hadas on the website, production from mature oilfields is falling at an alarming 6-9% rate annually. Newer discoveries are needed and newer technologies to extract more from old fields. However, over 80% of oil reserves are with National Oil companies and not with listed companies. Perversely, a lower oil price encourages them to buy the technologies needed to extract more production; higher prices only encourage xenophobia (Russia is a classic example) and production cuts.

Moreover, once the dispute between RNRL and RIL over gas is sorted out, hopefully soon, and the KG gas starts to flow, it would add 40% to India's current production. This can save some $20b. which would reduce the trade deficit. Use of gas in fertiliser would wipe out the Rs 100,000 crore subsidy on fertiliser manufacture and make a big dent on oil subsidy. This would reduce our fiscal deficit. It would also release bank funds, now going to oil marketing companies to fund purchases, for other uses.

The Government, as per news reports, is likely to ask the Mumbai High Court to lift the injunction on production of oil and gas, on the ground that they are Government assets; the dispute between RNRL and RIL ought not to prevent their exploitation, in national interest.

Jain also points out that Indian markets have fallen to their lowest P/E multiples and now, both India and China are in the same range of multiples (10-11) as mature markets, thus bereft of any growth premium. But both Indian and Chinese companies have significant earnings growth. The Indian economy is expected to grow at 7.5% this year. Results for second quarter to Sep of banks like SBI, Punjab National, Bank of Baroda and Union Bank have been good.

Earnings growth, with low valuations, an improving fiscal position, reduced budget deficit, a positive current account balance and a safe banking set up, are some of the silver linings. At some point in time global and domestic investors would notice them.

Most central banks have cut interest rates, led by the US, which has cut them by 50 basis points. RBI can also be expected to follow, as this is a coordinated global action, and this would add further fillip to stockmarkets for the moment.

So there is an ongoing rally in the Indian stockmarket. Last week the BSE-Sensex went up 1086 points to end at 9788. It notched up a gain of 743 points on Friday, doubtless inspired by the performance of the Indian cricket team against Australia. The divisive politics which results in violence and terrorist attacks can easily derail a further rally unless sense and goodwill prevail. If an early call for general elections is given in December, markets would become nervous. Buying good stories with honest management is advisable, but without the need to chase up the price, since the bus won't speed away.

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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