Ringing in the new

31 DECEMBER 2011

For Indian stockmarkets 2011 was a bad year, and investors would not be unhappy to see the end of it. The sensex has fallen 24.8 per cent since end Dec 2010, whilst the Dow and the S&P are up in calendar 2011. This, despite the serious economic problems in the US which led to a downgrade of its bonds, low economic growth, and high unemployment. India's problems stemmed largely from poor governance and the impact of high interest rates, as directed by the RBI, on economic growth.

The Government was unable to push through the Lokpal (ombudsman to tackle cases of public corruption) Bill. A watered down version, less than what the Anna Hazare team desired, and bereft of a constitutional status, was approved by the Lok Sabha but not by the Rajya Sabha (or Upper House) where the Congress lacks a majority. It may either be tabled, as cleared by the Lok Sabha, after a few months, or may undergo changes demanded by the opposition, in which case it would be sent back to the Lok Sabha for clearance. ----------------------------- Now get free daily updates on Global Economy! -----------------------------

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Anna Hazare, the crusader against corruption, withdrew his fast under medical advisement and, perhaps, disappointed at the tepid response from the public. It seems as though the political class is not mighty keen to have the Lokpal Bill passed.

Earlier the Government was unable to have its way for greater FDI (foreign direct investment) in retail.

Until elections to five states are over, by March, it is unlikely that the Government would again attempt any meaningful economic reform as it has been unable to push through either of the two measures above. Investors would not be enthused to return at least till the State elections are over and the Government is in a position to take some sensible steps forward.

One should thus expect that the first quarter would see the market drift slowly downwards. The sensex level of 15,000 becomes crucial, but it seems probable that it will crack. The crack would be caused by external factors, possibly the default by a sovereign (Greece?) or by a bank which has invested in that country's bonds (French bank?). The ECB is trying to stave this situation by giving unlimited funds, at 1%, against acceptable collateral, to a European bank. Banks have borrowed and have bought sovereign bonds, yielding around 6%, to get a 5% carry.

How the crisis happened in different countries is beautifully explained by Michael Lewis in his book 'Boomerang'. Before it became a member of the European Common Market in 2001, the Greek Government's borrowing costs were too high at an unbelievable 18%. In order to get funds at 5% by becoming a member, the Government fudged figures of its budget deficit in order to bring it down to the required level of 3% which was needed to qualify as a member.

The book explains the role of investment banks like Goldman Sachs which made a series of 'legal but repellent deals' with the Greek Government, giving them access to $1b. of funds, for which Goldman took fees of $ 300 m. Investment banks taught the Greek Government to securitise any receivable and raise money against it. Greek debt piled up to unsustainable levels.

It was only when a scandal hit Greece and its Government fell, that the new Government discovered the serious state of affairs and realised that the books were so fudged that the true budget deficit was not 3% but was closer to 15%.

The scandal related to a monastery, Vatopaidi, in which the head monk managed to swap a worthless lake owned by the monastery for valuable agriculture land. The monk has now been arrested. But the malaise was much earlier, and much bigger, than that of the land swap.

In the case of Ireland, its banks, led by newly formed Anglo Irish Bank, lent far too much money to real estate developers. Bank lending for construction rose from 8% of total bank lending to 28%. Far too many houses were constructed because of the ease with which developers could borrow money, ultimately leading to the inevitable collapse in the absence of buyers for the houses. German banks were the largest lenders to Irish banks.

Here, too, the role of investment banks is suspect. An analyst at Merrill Lynch published a report pointing out the weakness of Irish banks, their dependency on developers and the likelihood of a collapse. The management of Anglo Irish Bank immediately called Merrill Lynch, whose investment banking arm was raising money for it, demanding the report be withdrawn if they wanted to continue with the mandate of the IPO. It was withdrawn and put back after changes. Merrill Lynch then went on to advise the Irish Government (for a substantial fee) that its banks were basically safe and only needed a Government guarantee in order to placate the nerves of nervous investors. The Government heeded the advice, gave the guarantee, the costs for which are being borne by future generations of Irishmen.

In the US, the then CEO's of mortgage lending institutions Freddie Mac and Fannie Mae understated losses for subprime mortgages, telling the world losses were some $ 4-6b. whereas they were actually $ 244 b.! The US SEC has now sued them.

So we should be thankful that a previous RBI Governor, YV Reddy, did not permit the introduction of securitisation and other derivative products and that the current Governor Subbarao is also monitoring sectoral loans in a bid to avert formation of bubbles. Reserve Bank of India (RBI) is now preparing the banks for Basel III, which would need them to raise more capital in order to meet the requirement of 5.5% Tier I equity capital as a proportion of risk weighted assets.

The Government is perpetually strapped of cash and can't manage to curtail expenditure even in boom years. It would, thus, be unable to fund its share of the capital required by public sector banks. This means it will have to think of other ways. One way would be to dilute its holding below 51%, allowing banks to raise capital privately. But political parties are loath to do this, for some reason, even though it is unlikely to affect the financial system so long as the Government retains majority stake in State Bank of India (SBI) and perhaps Punjab National Bank (PNB) (the largest after SBI) and maybe one more.

The other, more likely, option, would be for Government to allow banks to issue non voting shares, thus retaining a 51% or higher voice in the banks but a lower financial stake. Thus, whenever the IPO market permits, one could expect a spate of issues from PSU banks, which would be worth looking at.

The Government is strapped for funds, as always; subsidy bills for fertiliser, food and petroleum are way beyond budgeted. It plans to borrow Rs 40,000 crores in the first quarter of 2012. This further crowds out private sector borrowing.

Despite being unable to manage its own affairs within budget, Government wants others to be able to do so. The Petroleum Ministry says it would approve of a capex plan for another KG basin block by Reliance if it assured the Government that the capex would not overrun more than 15%. What RIL would be happy with is a gas price higher than the $ 4.2/unit fixed by the Government. When India imports gas at $15/unit, why does it not exploit its own reserves by raising the price, is the question RIL asks.

The Ambani brothers had a family reunion in Chorwad last week, and perhaps this may lead to favourable developments for both.

Last week the BSE-Sensex fell 283 points to end at 15454, and the NSE-Nifty dropped 89 to end at 4624.

Judging by the inability of the Government to push any meaningful reform through, it seems likely that the market would continue drifting downwards, at least till the elections to 5 states are over in March. If a crisis were to hit a European sovereign and/or a bank, the drift would convert to a collapse. Its time to look at the stocks one would buy when that collapse happens.

Wishing my readers all the best for 2012.

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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7 Responses to "Ringing in the new"


Jan 2, 2012

Wish you a very happy new year Mr. Mulraj. The 10yr US treasury has delivered more returns then any other asset in the world with 15% appreciation, followed by Gold with 10%. With dollor continuously strengthning and pessimism prevailing all over, do you think people still feel about US as safe hevens compared to europe and EMs when its facing downgrades of bonds, low economic growth and higher unemployment?



Jan 2, 2012

Mr. Mulraj, Keep the good work going. I live in Canada but i always read your weekly column. I like the way you cover the stock market with a political connection and affairs. Please give us atleast 10 stocks to buy if a collapse happen which i am pretty sure will happen.


Hasit Hemani

Dec 31, 2011

Its a clear case of anti national policy regularly adopted by Petroleum ministry over the past few decades. Their policies are always questionable and dubious. It seems the whole ministry is functioning under some foreign influence. Importing Gas at $15/unit but not allowing RIL to raise the price over $4.2/unit is highly suspicious and damaging to the national Economy. What CAGS are doing ? This is a bigger fraud with the country than 2G scam.


Dr Ram Babu

Dec 31, 2011

Very happy New Year.

Your letter is free from Govt. interference . Keep it up !

Ram Babu



Dec 31, 2011

Your article ended where we would have liked it to continue.

You point out that "Its time to look at the stocks one would buy when that collapse happens."

Perhaps you would begin your first newsletter of 2012 with precisely a list of such stocks,





Dec 31, 2011

the Indian markets fell by about 25 percent in 2011.

The manipulated U.S. market rose by 5.5 percent.

And they are boasting about it.

You should write how the U.S. market is being manipulated to keep investors calm.



Dec 31, 2011


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