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Sunday, April 01, 2007

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Banks mull strategy after RBI hikes rates

A day after ICICI Bank upped its lending rates following RBI's key rate hikes, several lenders were mulling their response even as IndusInd Bank hinted at a possible rise this week.

Two private sector players - Yes Bank and ICICI Bank - hiked their prime lending rates (PLRs) over the weekend in response to RBI's move to hike repo and CRR rates on Friday.

"The days of absorbing increasing cost of funds are over. The RBI's move will definitely impact our cost of funds," IndusInd Managing Director Bhaskar Ghose told media here.

The bank will take a "balanced view" so that its business does not get affected by any sharp rise in its lending rates, he said.

"Some banks have already hiked their rates. We will see what the larger banks do," he said, adding "while we have no intention of absorbing the cost of funds, we will take our decision next week."

"You can certainly expect a minimum 0.25 per cent hike but it could go up to 0.50 per cent." IDBI Bank Deputy Managing Director Jitender Balakrishnan, while admitting that the cost of funds would go up, however, said the public sector lender would take a decision on hiking its lending rates only after "discussing the matter".

"The hike in repo and CRR will definitely impact our cost of funds. But whether we increase our lending rates or absorb the costs will be decided only at our board meet," he said.

Decisions to hike rates are taken at the Board level and IDBI Bank's Board is not scheduled to meet till end-April, he said, indicating that any possibility of an immediate response by the bank was remote.

Auto, housing sector to be hit most by rate hike

With the days of low interest rates that boosted demand for homes and cars behind us, real estate players and automakers fear that potential buyers would divert their rising wealth to savings instruments than spend it.

On the flip side, slumping sales could soon force housing and vehicle prices lower, but not just yet. "The rise in interest rate will put major strain on middle income buyers. They are really squeezed up as the EMIs have gone up by almost 50 per cent in last three years," said a real estate company official.

For instance, those who borrowed home loans in 2003 at an interest rate of 7 per cent are today paying over 11 per cent.

India's second largest lender ICICI Bank has already announced it would raise home loan rates by one per cent and other banks are likely to follow suit in the wake of RBI increasing its key short-term lending rate (repo) as also the percentage of mandatory bank deposits on Friday.

Real estate agents and bankers agree that potential buyers would postpone their decision to purchase a home or car after the hike in interest rates.

According to Hero Honda Chief Financial Officer Ravi Sud, hardening interest rates are going to slow down sales of two-wheelers as buying interest is getting negatively impacted owing to increasing interest rate.

"Our March sales are likely to be flat on a year on year comparison basis. Sales are being impacted primarily because of hardening interest rates, which makes monthly installments higher," he said.

Consumers who have surplus cash are also choosing to invest in various savings instruments rather then spending on purchases, he added. Bankers admit that interest rates on home and personal loans are set to shoot up further as a result of Reserve Bank's monetary policy decisions to cool inflation and temper the high demand for loans.

The central bank had made borrowing costlier, by hiking the inter-bank short-term lending rate by 0.25 per cent and the mandatory deposits banks with the RBI by 0.5 per cent.

RBI's measures are in response to inflation, which is now hovering around 6.46 per cent against this fiscal's target of 5-5.5 per cent.

In the last two years or so, banks have increased home loan rates from 6.5 per cent to 11 per cent, resulting in equated monthly installments rising by over 40 per cent.

Some economists, however, expressed doubt whether RBI's monetary measures to squeeze liquidity in the market will bring down "inflation pushed by supply-constraints" and when flow of capital through FIIs in the stock market is leading to rise in liquidity.

"RBI's measures seems to be just to balance the flow of liquidity through investment by foreign institutional investors in the stocks market, with little success to curb inflation," said a banker, adding that the Central bank was unnecessarily hurting borrowers and economic growth.

The Asian Development Bank last week forecast that India's economy would grow by a moderate 8 per cent this fiscal, as against the estimated growth rate of 9.2 per cent in 2006-07.

Is inflation bad?

Why does inflation matter that much? What is the "real" deal? Inflation isn't necessarily bad if it is contained to around 2-3 per cent. Obviously, anything above it isn't desirable because it can affect the economy. A case in point is Zimbabwe. In fact, a low inflation rate is desirable.

Now, consider a country that has deflation — that is, the opposite of inflation, where prices are falling. While it may seem good on the face of it, it's in fact bad for the economy.

Effect of deflation

Japan, for instance, has had deflation from the early 1990s till recently, and its economy has been in bad shape since. What deflation does is when the prices of goods are reduced, the profits of companies fall and they hire less people. People, anticipating possible layoffs, start saving more and consuming less. When consumption is reduced, it will reduce the demand for goods and therefore their prices, again leading to further reduced profits for companies. And this typically leads to increased idle capacity.

When companies have reduced profit, it reduces their ability to pay back loans and this then starts hitting the banking sector. The only way for the central bank to come out of this situation is to reduce the interest rate. But once interest rates are lowered, people are actually unwilling to invest long-term in banks, which further worsens the recession.

Zero interest is called liquidity trap because at this rate banks are unwilling to lend money and the liquidity that the central bank created has been trapped in banks that are unwilling to lend. To get out of the liquidity trap, Milton Friedman made this fanciful suggestion: that the central bank take hoards of money in a helicopter and drop it in the streets, so that people and companies get money directly!

Signal to investors

Inflation matters because it is a signal to investors that an economy is being managed well and that it has good overseers. Every episode of high inflation the world over has always been the result of gross economic mismanagement and investors are right to use that thumb rule.

The other thing about inflation is that it defines what is "real", in other words, the nominal minus the inflation rate. The real number is what concerns investors. What will be their real return, etc? The reason is that inflation can lower the value of a currency and this can be a bit of a problem for investors when they need to repatriate profits.

Gold: Not always a bright idea

After a long wait, Indian investors finally have the means to "gild" their portfolio when they draw up their financial plans. With gold Exchange Traded Funds making a debut in India, you no longer have to visit the local jeweller, fork out making charges/wastage and take your chances on caratage when you buy gold.

Instead, you simply buy ETF units and hold them in your demat account, and you can be sure that your investments will closely mirror trends in global gold prices. But is investing in gold really a good idea? What return expectations can you have from the precious metal, if you hold it for the long term? We analysed monthly gold price trends for the past 10 years in the global and Indian markets, to arrive at some answers. Gold, in the global context, has delivered a compounded annual return of 6.6 per cent over the last ten years. The return for Indian investors in gold has been a shade higher, at 6.9 per cent (all returns annualised), mainly as a result of the depreciating rupee.

Expect modest returns

If this seems like a decent, inflation-beating return, do note that you would have earned this return only if you had managed to time your investment rather nicely to end-March 1997, and had held on till date. The recent ten-year window has been a particularly good one for gold, with rising oil prices and a weakening dollar prompting investors to rediscover the metal as an investment option. For those who didn't display such a fine sense of timing, long-term returns from gold have been much more modest.

If you invested in gold with a 10-year horizon sometime between 1987 and today, your returns could have ranged anywhere between a negative 4.8 per cent and a positive 6.7 per cent annually, depending on the month of initial purchase. In comparison, equities appear to have a much better track record of delivering long-term returns, irrespective of the timing. The minimum 10-year returns the Sensex managed between 1997 and 2007 is a negative 0.14 per cent; while the maximum return was as high as 24.7 per cent.

Message: If you are a long-term investor, gold, obviously, cannot substitute equities in your portfolio. In the Indian context, gold has an inferior track record to equities, both in terms of return potential and the probability of losses. Use gold as a supplement to your equity portfolio.

Five years better than ten?

When you buy equities, you are usually urged to hold on to your investments longer if you would like to improve the return potential. But evidence of the past 10 years shows that gold has delivered better returns if held for five years rather than 10. The best five-year return managed by gold between 1997 and 2007 was 19.7 per cent. This is much higher than the best 10-year return of 6.7 per cent. In equities, a shorter holding period pegs up the chances of earning negative returns on your investment.

But if history is any indication, the reverse has been true for gold. Investors who held gold for five years registered negative returns on fewer occasions (5 out of 10) than those who stayed invested for a 10-year period (6 out of 10)!

Message: Invest in gold with a 5-year horizon.

Likelihood of losses

Gold is generally preferred for its "safe-haven" qualities; it performs well when investor confidence in other asset classes such as equities is at a low ebb. However, this does not mean that your investments in gold protect you from losses.

Going by the record of the past 10 years, the probability of losing money on gold is fairly high, even if you stay invested over a five- or 10-year period. For 10-year holding periods, gold has delivered negative returns on 77 out of 122 occasions between 1997 and 2007. It has delivered negative returns on 64 out of 122 occasions for five-year holding periods.

Whatever the investment horizon, the odds of earning a negative return on gold appear higher than those on equities, going by the experience of the past 10 years.

Message: Gold is not a substitute for your safe, fixed return investments, such as bonds.

If gold has only moderate return potential and can erode in value over long horizons, why at all should one consider investing in gold, you may ask.

The case for gold

There are three key factors that support investments in gold:

Diversifier: Gold could be a stabilising influence on your overall portfolio. Trends in monthly returns on gold over the past 10 years show that gold prices seldom move in sync with returns on other asset classes, whether equities or debt. This makes the metal a good portfolio diversifier.

The correlation of monthly returns on gold with the Sensex over the past 10 years is at a negligible 0.06. Though this correlation has risen to about 0.2 in the recent five-year period, it remains statistically insignificant.

This means that if you hold both gold and equity investments in your portfolio, there is a negligible chance that values of both will decline at the same time, making a big dent in your net worth!

This is also borne out by anecdotal evidence. Gold was among the best performing asset classes just after the tech stock meltdown of 2000-01. Gold prices actually appreciated about 4 per cent in the aftermath of the dotcom bust between March 2000 and October 2001, a period when the Sensex lost a whopping 48 per cent in value!

During the recent corrective episode in May-June 2006, gold prices did peak out at the same time as stock prices and fell when stock prices did. However, the magnitude of decline in gold was much lower than that in equities.

Though gold has historically displayed a low correlation with equities and other assets, investors in gold need to be aware that this relationship could change in the years ahead.

There is a view that the commodity, currency, equity and bond markets across the world are developing stronger inter-linkages due to their dependence on liquidity from large institutional investors (read hedge funds) with a presence across markets and asset classes. Episodes such as the May meltdown (which encompassed stocks, commodities and gold) seem to support this view.

Less volatile: Though gold has offered lower return potential than equities, it has also witnessed lower volatility from month to month. Based on monthly returns for a 10-year period, gold prices have displayed significantly lower variation (standard deviation) than the Sensex.

Similarly, though gold has frequently registered negative returns, the magnitude of decline has been much lower than that on equities. The worst monthly return for gold between 1997 and 2007 was a negative 9.3 per cent, while that for the Sensex was a negative 15.8 per cent!

Insurance against crisis: The above analysis uses historical data to provide a reasonable indication of what gold has to offer as an investment option.

However, in the world of investments, past performance may not always be an accurate indicator of future returns.

Though gold delivered a modest performance over the past 10 years while stocks and bonds have done much better, there are several risks that could materially alter this situation over the next decade.

Gold has traditionally been a sought after asset during periods of intense crisis — a spike in oil prices, a run on a currency, runaway inflation, and so on.

Holding a portion of your portfolio in gold could help you ride out phases in which other assets don't deliver — say, steadily rising inflation (which could hurt bond returns), spiralling commodity prices (which could hurt corporate earnings and thus stocks) or a withdrawal of liquidity from the financial markets (which could hurt the entire range of assets).


In a great book Six Impossible Things Before Breakfast the author, Lewis Wolpert, writes about the nature of belief. Investor should find this book interesting as it deals directly with the formation of mental models which could be wrong.

“The word belief, while freely and widely used to account, for example, for causes is nevertheless not easy to define. Neither philosophers nor scientists have been successful. David Hume, my hero philospher, said of belief that he regarded it as a great mystery. And some 200 years later, Bertrand Russell recognised that belief was a central problem in the analysis of mind. For many, belief is intimately associated with religion, and religious beliefs will be dealt with in detail. It is the everyday use of the word that I deal with in this book, and I will focus on those beliefs that relate to the causes of events that affect our lives in significant ways. Beliefs relating to moral issues will receive much less attention.

The anthropologist Rodney Needham has analysed the origins of the word belief. In Middle English, from around the twelth to the fifteenth century, the verb bileven already had the sense of believing in a religion, of being valid or true, of having a convic­tion. Going further back, one finds galifan in Old English and galaubjan in Gothic - laub is related to the Indo-European to love, want, desire. The English concept of belief is clearly linked to Christianity and the acceptance of the Christian faith.

Needham finds it so difficult to define reliably what we mean by belief that he seems almost tempted to abandon the word altogether. He does not do so, however, but points out that state­ments about belief need to be analysed within the framework of the different cultures, and a mastery of the local language, including its subtleties, is essential. For example, he says that the term kwoth for the spirit of the Nuer religion in Africa is very hard to understand. Needham goes on to say that 'Belief is not a discriminable experience, it does not constitute a natural resem­blance among men, and it does not belong to the "common behaviour of mankind.'" Thus, he argues, when one talks of the beliefs of other people, particularly in relation to non-Western religions, one has little idea of what is going on in their minds. I am not at all sure Needham is right, for all cultures have beliefs about causes, but whether there are similarities in different cul­tures as to their beliefs, and how they arise, is a central problem.

Another problem, as Needham points out, is how belief affects the behaviour of the individual. For example, a Saultaire Indian may endanger his life by believing a bear can understand what he is saying, and an Australian Aborigine believes that he will feel pain if a lock of his hair, taken away, is cut. How can such beliefs be reconciled with their experience? Belief is itself a word not always easily translated from one language to another.

The Shorter Oxford Dictionary gives two definitions of belief: 'The mental action, condition, or habit, of trusting to or con­fiding in a person or thing; trust, confidence, faith.' A second definition is 'Mental assent to or acceptance of a proposition, statement, or fact, as true, on the grounds of authority or evi­dence; the mental condition involved in this assent.' And for 'believe', 'To have confidence or faith in, and consequently rely upon.'

A key feature characterising something as a belief as dis­tinct from factual knowledge is how reliable the evidence is for the belief. But while evidence is a key word in relation to the validity of causal beliefs, it too presents severe problems of def­inition. How does one obtain reliable evidence? By authority? By direct observation? By science?

A distinctive feature of belief is that it may be graded true or false to varying degrees, depending on the evidence available, but it usually carries conviction. Unlike common knowledge, beliefs always have a true and false value - how right or wrong they are - regardless of whether or not the individual is aware of this. Reliable knowledge, by contrast, refers to what is clear­ly known - how to drive a car, for example, or that this is a page in a book, are facts. Probably the same could be said of all, well nearly all, of mathematics. There cannot be anyone who could dispute the validity of Euclid's planar geometry unless they were to totally abandon rationality. And as we shall see, much of science can be considered to be reliable knowledge.

But belief sometimes comes close to knowledge for the indi­vidual - for those, for example, who have seen ghosts, a belief in their existence becomes knowledge, though to others it is unbe­lievable. Knowledge provides us with a disposition to behave in a way that is constantly subject to modification - we know where we are when we are walking home — while belief is a disposition to behave in a manner that may be quite resistant to correction by experience - it is quite safe to drive after a few drinks./Beliefs can be very strong, with little reference to knowledge or evidence/ and it is often other people's beliefs that seem the most fallible.,

Beliefs are held about factors that have an important effect on our lives: why we get ill, what will happen when we die, how someone we love will respond, how to change things in our environment to our advantage. Memory can be viewed as a type of belief, not least because it can be unreliable. Indeed memory itself can be shaped by current beliefs. For example, in relationships, individuals' recall of important events, especially those involving some sort of conflict, can be greatly at variance.

A common characteristic of beliefs is that they explain the cause of an event, or how something will occur in the future. It is causal beliefs that are the main focus of this book since they have a particularly strong influence on human behaviour. Many beliefs guide the way a person chooses to behave. Belief in God can make a difference to a person's behaviour - that is almost a definition of a true belief, for if it did not influence how the person behaved, it would have no consequences and would be irrelevant. As the French philosopher Descartes put it: 'I needed in order to determine what people really believed to notice what they did rather than what they said.' David Hume also emphasised how beliefs affected our actions: 'Nei­ther man nor any other being ought ever be thought possest of any ability, unless it be exprest and put in action.' This fits very nicely with the view of the evolution of the brain in relation to action that I will propose.

In 1739, David Hume put forward his doctrine about causality. Our idea of causality, he claimed, is that there is a necessary connection among things, particularly actions. However, this connection cannot be directly observed, and can only be inferred from observing one event always following another. He thus argued that a causal relationship inferred from such observations could not in fact be rationally inferred. While this may be philosophically true, it is a problem for philosophers which need not concern us, as it is obvious what the cause is if, for example, I cut my hand with a knife.

David Premack, a psychologist, has pointed out that there are two classes of causal beliefs. One, as Hume suggested, is based on one event being linked to another, and can be called weak or 'arbitrary', for there need not be any obvious connec­tion between them, like switching on a light. Animals can learn connections by the pairing of events through this process of associative learning. The other, which is uniquely human, is strong or 'natural' causality, and is programmed into our brains so that we have evolved the ability to have a concept of forces acting on objects. Such strong causal beliefs are already present in human infants. A key question is how this type of belief evolved. Causal beliefs are a fundamental characteristic of humans; ani­mals, by contrast, as we shall see, have very few causal beliefs.

Beliefs come from a variety of sources that include the indi­vidual's experiences, the influence of authority, and the inter­pretation of events. At their core, beliefs establish a cause and effect relationship between events, and thus can be used as a guide to how one should behave in particular situations and how to judge the behaviour of others. From an evolutionary point of view, beliefs should help the individual survive, and I will argue that they had their origin in tool making and use. But beliefs are much wider in their nature, and often serve to make the person feel better by, for example, promoting self-esteem, and providing satisfactory explanations for events that are not well understood.

In the following chapters I will distinguish between several kinds of belief in relation to the topics they deal with. The dis­tinctions are not hard and fast, and the boundaries are often fuzzy. I will start with the acquisition of causal beliefs by children and then compare them to animals, and will argue that the latter rarely have causal beliefs. Then, considering tools, I will claim that the origin of human causal beliefs is related to tool use and manufacture. Once there were causal beliefs for tool use then our ancestors developed causal beliefs about all the key events in their lives, and I will examine the proposed mecha­nisms by which we now acquire our beliefs. False beliefs that result from abnormalities in the brain like confabulation and schizophrenia can provide insights into the way normal beliefs are formed. Religious beliefs that had their origin in attempts to account for crucial events in our ancestors' lives will be given special attention, together with the possibility of their being genetically programmed.

Then there are also paranormal beliefs like astrology and witchcraft, which vary across cultures, and for which evidence is rarely required. Beliefs about health, which are particularly important, also vary enormously, and are all too seldom based on proper evidence. Political and moral beliefs can determine how societies behave and include democracy, communism and racism. Scientific beliefs, which had their unique origins in Greece, have a special validity and are not personal but shared by the scientific community. A key question is: how similar or different are the belief processes involved. Finally, we may ask what sort of beliefs does the future hold?

I will be putting a big emphasis on the biological basis of belief, and also on evolutionary aspects of human behaviour. A very useful set of principles in relation to biological explanations was put forward by Niko Tinbergen, one of the founders of the sci­entific basis of behaviour in animals. He argued that behaviour can be explained in four separate but related ways: the physical cause, how it develops, its function, and its evolution. Consider, for example, hunger and sadness. The basic mechanisms, the physiological bases, are those that cause us to feel sad or hungry; how these develop - both in the embryo and after birth - is the second question; then there is their function and advantage to the individual: hunger to ensure eating, sadness to make up a loss; and finally, how did these behaviours evolve? It is such questions that we need to consider in relation to belief.

It may be helpful to briefly explain the role of genes in evolu­tion, in order to clarify what I mean when I refer to a particular character, even a belief, being genetically determined. Genes are unique in that they are the only elements in the cell that replicate, and thus can be passed to successive generations. The genes provide a programme for the development of the embryo by controlling how the cells in the embryo behave to give rise to the adult. Genes are basically boring and passive, as they do nothing but provide the code for making proteins, which are the true wizards of the cells. But they provide a programme for where and when particular proteins are made and so control, for example, how the cells of the brain connect with each other, and how one region of the brain connects with other regions. Thus, in evolution, changes in genes can result in changes in the form and behaviour of an organism; and depending on whether or not it is adaptive, that is, leads to better survival, that change in the genes will persist. That genes can determine behaviour is evident when one looks at the enormous variety of behaviours that animals are programmed to carry out, from sex to nest building.

Evolutionary psychology is based on the idea that in evolution the human brain acquired a number of specialised computation­al mechanisms - sometimes called modules - that determine emotion, reasoning, pattern seeking, and so on, and thus affect what we believe. The modules may not be physically separated in the brain, and there is considerable fluidity. Michael Shermer, who has thought deeply about these issues, considers modules like these to underlie what he calls the belief engine. There may be a causal operator in the brain that compels us to try and find out why things that matter to us happen. Without this impera­tive, we would not be successful in developing technology, on which we are so dependent.

An inability to find causes for important events and situa­tions leads to mental discomfort, even anxiety, so there is a strong tendency to make up a causal story to provide an expla­nation. Ignorance about important causes is intolerable. This also makes sense from an evolutionary perspective, as our ancestors needed to account for events rapidly even when they had little knowledge - delay could be a great disadvantage.

Belief has not, unfortunately, been the subject of much neuro-scientific research, and so the nature of the brain mechanisms that give rise to beliefs are poorly understood, though the study of mental illnesses that give rise to false beliefs may help. All this makes it difficult to know how the brain generates beliefs, as well as how to change people's beliefs - and as we all know, that can be very difficult.

One evolutionary approach to beliefs might make use of the meme, a concept introduced by Richard Dawkins in 1976. It refers to a unit of complex ideas, a unit of information that plays a role analogous to genes. Memes are memorable and can be likened to mind viruses. It is claimed that memes replicate and the selection of one meme over another may have no advantage to the individual in whose mind it rests. Since memes are claimed to have variation, heredity, and differential fitness, they could have the necessary properties for evolution by natural selection. Dawkins even claimed that we do not choose our memes, but that they choose us and manipulate us to their own ends. Just what a meme is, and how it is distin­guishable from beliefs, I find difficult. Is the word 'bird' a meme, and is the second law of thermodynamics also one? Apparently the song 'Happy Birthday to You' is a meme. There is no distinction made between memes relating to belief and knowledge. Moreover, no mechanism is proposed for the so-called replication of memes, or what they are selected for. Nevertheless, memes raise important questions on how social learning occurs, and why certain memes are so stable. Under­standing memes could help in understanding beliefs.

To understand the evolutionary origins of belief, it helps to understand what the brain is for. Belief is a property of the brain, which is made up of billions of nerve cells whose func­tion is totally dependent on the signals between them. But what is the primary function of the brain itself? I believe it has just one: to control bodily movements; and so this must be at the core of any attempt to understand belief. The evidence comes from the evolution of the brain.

Movement was present in our ancestral cells which gave rise to multicellular organisms some 3,000,000,000 years ago. They could move either by using flagella and cilia, whip-like struc­tures that are a bit like oars, or by amoeboid movement, the cells extending processes at their advancing end, and then pulling themselves forward to where these attach. This move­ment was a great advantage in finding food, dispersal to new sites, and escape from predators. A key point is that the protein molecules that produced these movements are the precursors of all muscle cells. Muscle-like cells are found in all animals, including primitive ones like hydra, a small freshwater creature with just two layers of cells arranged in the form of a tube, which uses the movement of its tentacles to capture prey.

In higher forms, like flatworms and molluscs, muscles are well developed and the ability to move is a characteristic of almost all animals. One only has to think of such forms as diverse as earthworms and squirrels. Again, this ability to move is fundamental to animal life - not just finding food and shelter, but the ability to escape from enemies. And this is where brains come from. The first evidence for brain-like precursors is the collection of nerves that are involved in controlling movement, like the crawling of earthworms or flatworms. Getting the mus­cles to contract in the right order was a very major evolutionary advance, and required the evolution of nerves themselves. Here we find the circuits of nerves that excite muscles in the right order: the precursors of brains.

The first advantage of the ability to move was most likely dis­persal and finding new habitats, but once the ability to move had evolved, it opened up new advantages such as finding food and avoiding danger. It became necessary to perceive the nature of the environment in order to decide when and where to move. There was a need for reliable senses. Light-sensitive cells are present among single-cell organisms so it is not too dif­ficult to imagine light coming to control movement. Then, later, came the eye. Of course there were other sensory systems that could detect touch, temperature and odours. All these had and have but one function, to provide information for the con­trol of movement. Emotions evolved to help animals make the appropriate motor movements like flight, attack, or sex. And that is why plants do not have brains. They are very successful but they do not need brains for they neither move significantly, or more importantly, exert forces on their environment in order to modify it for their own survival. No muscles, no brain.

There is no human or animal emotion that is not ultimately expressed as movement; in fact the argument is somewhat cir­cular, for what else is human behaviour? Sense organs have only one function, to help the organism decide how to move. Once the brain developed, it took on other functions such as those related to homeostasis, like hormonal release and tem­perature regulation. Our brain, with all its imagery and memo­ry, somehow enables us to decide how to behave, and it has only one ultimate function and that is to control bodily move­ments. The evolution of the brain that gave us beliefs is no more than an expansion of the original circuits that controlled movement in our ancient animal ancestors.

An internal representation of self arose in evolution from coordinating inner-body signals to produce appropriate behaviour. Increased accuracy and planning of movements was achieved by having mental models of the body in relation to the environment, and realising how these were causally related. Thus, when a stone falls on one's toe, one knows it, and one has to decide how to respond. More generally, as David Hume made clear, there is no experience of ‘self’ as something distinct from our body. Given that the main function of the brain is to control movement and to choose the appropriate movements for survival, it is not that unreasonable to suggest that belief arose in relation to tool use and manufacture, as both require a belief in causal interactions. This is a different view from that widely held, namely that the evolution of the human brain is related to social interactions. It will be helpful to look first at how human children acquire their causal beliefs, and then to compare them with those of animals.”

Religare - Monthly Technical Report

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India's Marauding maharajahs and Bush & Congress

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On CRR hike .....says Economists

So long as economy is growing and GDP has not shown declining nos for even one quarter, there was no reason to panic and resort for monetary measures such as CRR rate hike to combat inflation. In 1992 when Mr Manmohan Singh was the Finance Minister we had a GDP
growth of 4% with inflation in double digit. But now due to huge inflow of funds and liquidity the economy is on roll and has taken off very well. We require bold reforms which can accelerate the pace of investments as well as FDI which can in turn lead to higher cycle of

It is also argued that the inflation of 6.5% is in fact could have been 9% had Govt not resorted artificial curbs on steel, cement, sugar, fuel etc. Why is then Govt doing this even at the cost of
serious impact of slow down due to the reduction in credit expansion....?

The ruling Govt failed miserably in the recent elections in two states and chances that it may not fair well even in Uttar Pradesh in coming elections. SP has a strong hold irrespective of Hon'ble Supreme Court's direction to CBI to investigate assets of Mulayam Singh. SP
are the front runners. SP has a strong backing by India's leading corporate house and India's no 1 brand ambassador.

Only 2 years are left for election at the center and if inflation is not controlled then there could be big set back for the ruling party. This is simply because in India majority of the voting community is below poverty line and they do not understand growth, FDI, globalization, high standard of living etc. For them ROTI KAPDA aur MAKAN are three essentials of life and inflation has direct nexus with all these three elements. BJP lost last time only due to the single factor of wrong campaigning of FEEL GOOD FACTOR and holding the election in May where water played crucial role. Even Chandababu Naidu who created Cyderabad which is respected even by Washington got lost to this sole factor.

Naturally going forward, it can safely presume that political motto has taken over the country motto and therefore high priority has been assigned to inflation.

It is also asserted that the timing of this CRR rate hike is really a matter of debate...? Few economists say that Govt could have differed this CRR rate hike by at least one quarter to see the monsoon effect.
If monsoon is good once again then probably the inflation could have been tackled by higher agricultural produce. This is also due to the fact that this could be the last CRR rate hike and for Govt to raise further CRR rate is too difficult.

RBI is exhausting the monetary measures speedily which will leave Govt to take other measures.

How far this will impact market....?

The immediate reaction has to be knee jerk reaction as the timing was really unexpected. The banking stocks will be largely affected due to CRR shock whereas manufacturing sector could pass on its impact due to strong demand pattern.

However going forward, it will have neutral effect on the market for one that this could be the last rate hike and market always likes certainty.

One more aspect ought to have been taken into account is that Govt had already sucked Rs13000 crs couple of months back and now Rs 15000 crs but at the same time allowed to use 5 bn USD from foreign exchange reserve which is equivalent to the liquidity already sucked and hence can be a neutralizer.

The factors which are likely to govern market in coming days are monsoon, UP election, corporate earnings, central election and pace of fresh reforms. Most of the funds have increased their exposure to cash from 7% to 20% odd percentage.

Sectors to outperform are realty, pharma and steel. Mid cap and small cap will be on invent trajectory and will catch valuations of peers whereas A gr shares where FII ownership is large will be more or less capped or have limited upside due to portfolio churning.

Volatility will rise further in most dangerous way due to divided opinion of experts on market which could kill large retail clienteles indulging in speculation. The only way to survive will remain to educate yourself ...........

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Mkt Outlook: Watch out for global cues

After exhibiting range-bound movement last week, the markets are likely to move in a narrow range for yet another week with major action seen in the second week of April when the earnings season unfolds.

Keep an eye on global events, which have been one of the prime reasons for the recent volatility in the markets.

The markets began the holiday-shortened week on a dismal note. The Sensex opened with a positive gap of 60 points at 13,346, which also turned out to be the week's high, and then slipped to a low of 12,833 - a loss of 513 points - before recovering some lost ground towards the end of the week.

The Sensex finally ended the week ended March 30 with a loss of 214 points. While the index was up 134 points for the month, it was down 715 points for the first quarter of the calendar year.

The broader range of the Sensex remains as follows: on the downside, the index may test 11,800, while on the upside the index is likely to face stiff resistance around 13,800 levels.

On a weekly basis, the Sensex is likely to face resistance around 13,270-13,330-13,390, while support on the downside would be around 12,875-12,815-12,755.

The Nifty moved in a range of 135 points - from a high of 3885, the index dropped to a low of 3750 before settling with a loss of 39 points at 3822.

The Nifty is likely to face resistance around 3875-3890-3905 above which the index could rally to 3965 level where one may see considerable profit-taking. In case of a down-move, the index may find support around 3770-3755-3740.

A break of last month's low, i.e. 3550, could see the index drop to 3400 level.

Investment Nuggets

Eugene Fama is credited as the chief architect of the Efficient Market Hypothesis. A ground breaking article in the May 1970 issue of the Journal of Finance titled "Efficient Capital Markets: A Review of Theory and Empirical Work" laid the foundations for the development of the Efficient Markets thesis and, in turn, created the field of passive investing. He is a Director of Dimensional Fund Advisors, an investment advisor with $126 billion of assets under management. Fama is also an author of two widely acclaimed books: Foundations of Finance published in 1976 and another one co-authored with Nobel Laureate Merton Miller titled The Theory of Finance.

"The efficient market theory and the random walk theory aren't the same thing. The efficient market theory is much more powerful than the random walk theory, which merely postulates that the future price movements can't be predicted from past price movements alone. One extreme version of the efficient market theory says, not only is the market continually adjusting all prices to reflect new information but, for whatever reason, the expected returns — the returns investors require to hold stocks — are constant through time. I don't believe that. Economically, there is no reason why the expected return on the stock market has to be the same through time. It could be higher in bad times if people become more risk-averse; it could be lower in good times when people become less risk-averse."

"Correction is only something you can talk about with hindsight. An efficient market person never talks about a correction. It may turn out to be a correction, but it was not something you would have predicted in advance as a correction. How many people since 1982 have been saying that the market is too high year after year? I am glad I stayed in. That is the benefit of being an efficient market person in all this time (laughing). I never got out. There is so much mispricing out there. How is it that all of these, all the smart money cannot seem to find it.

"When it is entirely simple, it is not there. The prices are right, but there is no evidence that active managers add value. I will go back to Warren Buffett because maybe he can do it, ok. But how does he do it? He does not claim he can pick a thousand stocks or a hundred stocks. He claims he can pick one every couple of years. But even he who has taken to be the prime example of the successful active manager does not claim he can do it in general. He just claims he can do it in very few particular cases."

"If you had the right risk and return story, you'd be able to identify the kinds of information that were not incorporated into the price. There are lots of studies where people study the adjustments of stock prices to splits, earnings announcements, mergers, everything. Another way is to look at the performance of active managers. They tout themselves as people who have information that is not in the prices. Well, you can test that. Testing investment performance is basically testing market efficiency."

UTV Software: Buy

Investors with an appetite for high risk can consider exposure in the stock of UTV Software. The company is laying the foundations to become a media conglomerate by 2010, with interests in television, movies, broadcasting and new media, that include gaming and animation. There is potential for strong revenue growth over the next two years with a long pipeline of movies set to hit the market, channel launches and acquisitions into untapped areas such as gaming.

It may not be appropriate to evaluate the company on its current operating metrics. UTV's current market capitalisation is now about three times its sales. But if UTV succeeds in its forays, it may move to a higher growth trajectory. The company is just on the verge of turning around, thanks to its first truly successful film production Rang De Basanti released in early 2006.

New forays

Last year may have, however, been an inflection point for UTV. The company sold its children's channel, Hungama, to Walt Disney for $30 million. Disney also picked up a 14.85 per cent stake in UTV. The company's international tie-ups have further expanded since and its partners in co-production and distribution include the likes of 20th Century Fox and Sony Pictures.

The tie-ups are part of UTV's strategy of choosing films that can crossover to international markets. UTV has co-produced the just-released Mira Nair's The Namesake with Fox Searchlight.

In a short span, the company's plans to foray into new segments have quickly gained ground. The additional cash flows from Disney's investment have helped UTV bankroll acquisitions in the gaming space, providing it access to new media platforms. In December, it acquired a controlling stake in Indiagames, a mobile phone and online gaming operator and a 70 per cent stake in Ignition, a UK-based, console gaming company for the likes of Sony and Nintendo for Rs 128 crore. Ignition is developing a game, WarDevil, exclusively for Sony's Play Station 3, which is likely to be launched in 2009. These businesses had a combined turnover of about Rs 100 crore. UTV plans to double this in the next two-three years.

After the sale of Hungama, UTV has once again returned to its plans of broadcasting, forming a 50-50 joint venture with the Malaysia-based Astro Measat for the launch of the youth channel `Bindaas'. The channel is likely to be launched by the second half of FY-08 and is targeted at those between the age of 15 and 24. The space has, so far, been explored mostly by music channels. UTV's experience in developing content for Hungama is likely to stand it in good stead with Bindaas.

Earnings outlook

With a channel launch and a dozen movies in the pipeline, there is potential for significant revenue growth. UTV's business remains strongly content-driven, be it television or films. Therefore, its attempt to diversify its revenue mix does not necessarily insulate it from the risk of failure.

UTV's choice of scripts and directors appears to have an urban, multiplex-goer- appeal rather than the mass-appeal movies that usually draw in blockbuster revenues.

The quarter-to-quarter performances in the medium term may take on a lumpy profile, depending on the timing of film launches and their success. This may change once film production takes a less significant role in the overall revenue mix.

The company is also in a heavy investment phase. It plans to invest Rs 200 crore over the next two years in broadcasting and gaming. About Rs 135 crore will be invested in animation over the next couple of years, while the outlay in its proposed film projects, some of which will be co-produced, will be Rs 150 crore.

It may take a year or two before the company's investments in broadcasting and gaming and animation, which are in their nascent stages, deliver. Earnings growth may lag that of revenues in the interim. Aggressive investors can consider exposure with a two/three-year perspective. Use market-linked weakness to buy the stock.

B. L. Kashyap and Sons: Hold

Investors can continue to hold the stock of B. L. Kashyap and Sons (Kashyap) with a two-year perspective. We had recommended investment in the company's initial public offer in February 2006 with a one-year perspective. Growth in numbers, a robust order-book and relatively lower risks compared to other real-estate players add clarity to the company's earnings prospects.

However, the current valuation does not offer an attractive entry point to the stock. Further, the company's foray into joint real-estate development through its fully-owned subsidiary has to pass the litmus test before the stock can command premium valuations. Investors holding the stock must watch this development.

At the current market price, the stock trades at 16 times its likely earnings for FY-08 on a standalone basis. Revenues from the company's furnishing and real-estate subsidiary are likely to be earnings-accretive on a consolidated basis from FY-08.

Unique play on real-estate

Kashyap undertakes construction contracts in the commercial, residential and industrial segments. In other words, it is a construction services provider to real-estate players and corporates. Thus, the company is relatively insulated from uncertainties involved in land development or correction in market price of land, which have affected construction stocks. In this respect, Kashyap is a play on the growth prospects for real estate minus some of the key risks to the sector. While a pure contractor's business does not offer attractive margins, Kashyap has managed to ramp up its operating profit margin (OPM) from less than 6 per cent in FY-04 to over 10 per cent in FY-06. The company's ability to undertake turnkey construction projects that include electrical and mechanical services has helped improve the OPM.

Kashyap's execution period for a good number of projects on hand is about 15 months. This is much less than than two-four years taken by real-estate projects to realise revenue (due to legal and other procedural compliances involved). Kashyap's order-book, as of December 2006, stood at Rs 1,350 crore, almost three times its FY-06 revenues. Over 65 per cent of the orders are from the commercial space with about 17 per cent from the residential segment. With clients such as IBM and Oberoi Hotels and the continuing robust demand for commercial space, the growth prospects for Kashyap appear bright.

Kashyap seeks to offer integrated construction services and as a step towards this, has used a part of its IPO proceeds to set up a fully-owned subsidiary which makes interiors such as wooden doors, frames and cabinets. This unit, expected to go on stream by April 2007, is likely to provide an edge over other civil construction players in terms of providing a one-stop solution, especially in the commercial space.

The other fully-owned subsidiary — Soul Space — is into real-estate development. This space carries the risks associated with land development. However, if the company is able to execute its plan of joint development with landowners, it may well mitigate the risks linked to procurement and holding of land. The company has already started two projects in Bikaner and Pune through joint ventures.


Uncertainties on cement supply and pricing may affect margins. Further, while the construction activity in the commercial and residential space is robust, any slowdown can affect order ramp-up for the company and profitability.

Reliance Communications: Hold

Investors can retain their exposure in the Reliance Communications stock. The proposed listing of Flag Telecom, the international undersea cable subsidiary at the London Stock Exchange, may be a near-term positive trigger for the stock. Fundamentally, Reliance Communications is likely to remain one of the key beneficiaries of the explosive multi-year mobile expansion story.

With steady improvement in its operating margin and return parameters and strong capital expenditure programme lined up for 2007-08, the company is in a good position to maintain its mobile market share in line with its peers. With tower-sharing coming into vogue, the network expansion and efficiency parameters will also improve over time. And the other non-mobile business such as enterprise broadband may offer additional fillip to the stock.

However, in a highly volatile market, investors can avoid fresh exposure in the stock which trades at Rs 420. While the price-earnings multiple at 30 times its likely 2006-07 earnings is not cheap, there are operational concerns that are to be addressed. Eligible players, including Reliance Communications, are still waiting for scarce spectrum to be allocated for their GSM business, which it has forayed into in addition to its CDMA business.

Second, competition has gone up sharply in the mobile space, with Vodafone snapping Hutch-Essar and the recently-listed Idea Cellular outlining its expansion plans. And till these prevail, the valuation gap between Bharti and Reliance Communications will take time to narrow.


Flag Telecom listing: The listing of Flag Telecom, Reliance Communications' wholly-owned subsidiary, is expected to unlock value for Reliance Communications. Deutsche Bank and Goldman Sachs have been appointed as lead managers for this proposed listing at London Stock Exchange. The details are sketchy at this point, but 10-15 per cent of equity may be issued. Reliance Communications has turned around the performance of Flag Telecom and it is now on a high growth path, with significant expansion plans such as its recently announced FLAG Next Generation Network.

Fundamentals intact: Reliance Communications may have lost out the Hutchison Essar deal to Vodafone, but its consolidated financials remain healthy. Not only have its operating margins and returns improved over the past three quarters, the company have also lined up aggressive network expansion plans. It has indicated that its capex for the year-ended March 2007 is expected to cross Rs 7,700 crore and it has announced that it will be investing about Rs 11,000 crore in the financial year 2007-08. During the year, it plans to add over 20000 new towers to support its wireless business.

It currently has tower-sharing agreements with Hutchison, Idea, Bharti Airtel, Spice and MTNL for Mumbai and Delhi.

The company management has also indicated that it plans the commercial launch of IPTV and DTH in the third quarter of 2007-08.


GSM Spectrum Allocation: Reliance Communications will be disappointed with the Hutchison Essar outcome as, among the bidders, the company stood to gain the most from the acquisition. This would have fulfilled its aspirations of switching to GSM in a single stroke, with hardly any overlapping circles.

The acquisition could have also helped Reliance march past Bharti to garner a dominant market share.

This has inevitably brought the focus back to its organic strategy of growing its GSM business. While the company has lined up expansion plans for its GSM business on a pan-India basis, its execution will hinge on the availability of spectrum.

According to government policy indications, the allocation may happen only by the second half of 2007. Since Reliance is straddling both GSM and CDMA, the possibility of a slowdown in mobile subscriber addition during the transition phase and the seamless growth in GSM subscribers over the next year remains a live risk.

Intensifying competition: The entry of Vodafone through Hutchison Essar and the listing of Idea Cellular may have the potential to shake up the mobile market share in terms of incremental subscriber additions.

Since Reliance Communications operates both GSM and CDMA technology, it may be exposed to a greater risk of market share erosion.

It is likely to face the heat from Vodafone on several fronts that include aggressive promotional campaigns and schemes, lower price points and pan-India competition, once Hutch Essar completes its expansion programme.

Elecon Engineering: Hold

Investors with a medium-term perspective and a high-risk appetite can consider retaining the stock of Elecon Engineering, a major player in the manufacture of bulk material handling equipment and industrial gears. With an established set-up, Elecon Engineering would be among the key beneficiaries of the increased investment in sectors such as power, coal and steel, which contribute significantly to its bottomline. Further, the changes in the product mix, entry into the wind energy segment, coupled with a healthy order-book, lend greater confidence to its earnings visibility. At the current market price, the stock trades at 17 times the expected per-share earnings for FY-08. However, one can use stock price weakness or market corrections to take fresh exposure.

Investment Rationale

Elecon operates in two business segments — material-handling equipment (MHE) and industrial gears. The company enjoys a dominant presence in the former segment and will stand to benefit from the increased government allocation and spending on power and infrastructure. This apart, the shift in Elecon's product profile, with an increased thrust on the MHE segment, is likely to drive its revenue growth.

The 125 per cent increase in segment revenue from MHE for the quarter-ended December 2006 compared to the corresponding previous period reinforces our optimism.

In the industrial gear segment, Elecon's conscious effort to shift its revenue mix has augured well for the division's profitability. The increased focus on the manufacture of customised gears, which enjoy better realisations than the standard ones, has added stability to the segment's overall margins. In addition, the increased sales in the MHE division will also rub off positively, since MHE involve the use of industrial gears.

Elecon also plans to sell windmill gearboxes and has entered into a technical collaboration with the Belgium-based Turbowinds for the same. However, it is likely to face stiff competition from Shanthi Gears in the gear segment.

New opportunities

To diversify its business, Elecon has decided to make and sell windmills, for which it has lined up a capex of Rs 40-50 crore.

However, most of the components for the windmills are likely to be imported while turbines are to be procured from domestic manufacturers.

The gearboxes for these windmills will, however, be made in-house. Nonetheless, given the nature of this business, we believe the margins are likely to be low. Elecon has also planned to set up a ship fabrication facility and has signed an MoU with Pipavav Shipyards.

While the latter would be responsible for designing ships, the former will fabricate ship blocks. Elecon has planned a capex of about Rs 15-20 crore to set up facility for the same. However, revenues from this business depend on orders received by Pipavav Shipyards.

For the quarter-ended December 2006, Elecon posted an 80 per cent increase in earnings compared to the corresponding previous quarter. In the same period, contribution of revenues from the MHE segment rose to 56 per cent, and the industrial gears division chipped in with the rest. On the operating margin front, the MHE division saw a margin expansion by about 560 basis points to 13 per cent year-on-year. Margins in the industrial gears division, however, remained stable at 21.2 per cent.


Growth in both the segments of the company hinge directly on the capex plans across its user industries. Any slowdown or delay in the capex plans of these industries will have a negative impact on Elecon's earnings.

Any sharp rise in raw material cost such as that of steel, nickel or chrome may also affect operating margins and earnings growth.

Marico Industries: Buy

FMCG stocks appear to be a good defensive proposition for investors under current market conditions, given the companies' strong cash coffers, low debt in the balance sheet and the relatively low sensitivity of consumer spends (on FMCGs) to interest rate increases. Marico Industries offers a strong growth play on the sector, with its focus on the lucrative beauty and wellness segments of the FMCG market. Improving product mix and the prospect of a ramp-up in earnings from new and recently acquired brands suggest that the company could manage a 25-30 per cent growth in earnings over the next couple of years. Investors can consider adding the stock to their portfolio, particularly during any decline in price over the next few days linked to the broad markets. At Rs61, the stock trades at about 24 times expected FY08 earnings, a valuation that is in line with peers.

Though Marico Industries has traditionally derived the bulk of its revenues from hair oils (Parachute) and edible oils (Saffola and Sweekar), it has transformed its product portfolio in recent years through a slew of product launches and new category forays. The company's portfolio now encompasses premium products in segments such as hair care (Parachute Advansed, After-Shower cream and hair gels), baby care (Sparsh) and soaps (Manjal), apart from skin care services and salons (Kaya Skin Clinics and Sundari LLC). On another front, a string of overseas acquisitions has helped the company acquire a pan-India footprint, with significant market shares in hair care and soap markets in West Asia, Bangladesh and Egypt. An improving product mix has led to operating margins expanding significantly from the single digits in FY05 to 16 per cent levels in FY07.

A focus on premium products and niche categories in the FMCG space, where competitive intensity is relatively low, also contributes to superior pricing power for Marico. Having held the price line on its key products over the past couple of years, the company enjoys the leeway to take some price hikes to offset input cost increases over the next year. With a turnaround in the Kaya Skin Clinic business and benefits from recent acquisitions expected to flow in by the next financial year, there appears to be scope for significant scaling up of earnings from current levels. Integration issues and overseas exposures associated with Marico's inorganic growth strategy are the key risks to earnings growth.