Saturday, August 18, 2007
Subprime is prime news. 'Indian markets catch subprime chill,' declares Forbes. Subprime ills are not hitting the markets closer home, assures SEBI. Meanwhile, WNS, India's second-largest BPO, has suffered hit due to subprime crisis. 'Subprime l ender NovaStar firing 37 per cent of staff,' reports USA Today. 'Next wave in subprime mess could be fraud charges,' cautions International Herald Tribune. Scotsman talks about 'Merrill Lynch's painful lesson in subprime,' and Houston Chronicle says, 'EU to examine credit rating agencies.'
If, like many, you are clueless about subprime, this is just the right time to know the basics. So, here is Dr Sunil Rongala, Group Economist, Murugappa Group, answering a few elementary questions on the subject posed to him by Business Line.
First, what is subprime?
When banks lend money to people, they broadly classify them into prime and subprime debtors, where the former are people who are considered creditworthy and the latter, less so.
Normally banks don't lend to those who are not creditworthy, do they? While it will be prudent not to lend to anyone other than the creditworthy, banks do lend to subprime debtors. However, since these debtors are considered less creditworthy for reasons such as low income etc, banks usually lend to them at higher rates of interest.
Subprime borrowers pay a risk premium, may we say?
Yes. And in some cases, risks were high: loans were given to NINJA borrowers (that is, No Income, Job or Assets). This is the genesis of the 'subprime crisis' that is playing itself out currently on global markets.
How is subprime crisis defined?
Firstly, one must understand that though the word 'subprime crisis' is being used as a generic term, it actually refers to a credit problem among subprime borrowers (they account for 8 per cent of total mortgages in the US) in the residential market in t he US. Like borrowers anywhere in the world, the interest paid on residential mortgages in the US is linked to the central bank's benchmark and in this case, the US Federal Reserve's Fed Funds Rates.
Can we trace back the problem to find out when things began to turn messy?
Between 2004 and 2006, because of incipient inflation in the US economy, the Federal Reserve or Fed increased its discount rate from 1 per cent all that way to 5.25 per cent. Because of this, holders of residential mortgages too saw their payments on the ir house loans rise. This rise in rates was a disaster in the making for the banks that gave loans to subprime borrowers.
So, they would have defaulted?
True, because the first issue with subprime borrowers is that they are likely to be low-income people. When faced with higher mortgage payments, they fell behind on their payments and in cases, some also became delinquent and banks started repossessing h ouses.
The banks would have sold the repossessed houses to recover the dues?
In the normal course, yes. However, because of higher interest rates, people became more cautious in borrowing to buy houses and there was a general slowdown in demand in the housing market causing these banks to hold assets that people weren't just will ing to buy.
Did no one see the crisis coming?
The so-called subprime crisis started unfolding when people started defaulting on their housing mortgages. Initially, it was thought that the problem was only limited to a few lenders and people didn't give it much thought. A testimonial to the fact that people didn't give it much thought is best highlighted when one looks at the level of the Dow Jones Industrial Index. The news of the subprime defaults was highlighted earlier in the year itself but the Dow actually closed at its highest level ever of 1 4,000 on July 19. Then things started unravelling.
The lenders take the hit when borrowers default, but we find the crisis spreading far and wide. How so?
That is because mortgages held by banks are typically bundled and sold to other institutions. These institutions will then slice these mortgages into residential mortgage backed securities (RMBS) or in other words, securities that are backed by collatera l; the collateral here being the mortgages held by subprime borrowers.
These RMBS are then rated by rating institutions such as Moody's, Standard & Poors etc based on various parameters...
Which is why the wrath has now turned on the rating agencies?
That's right. These RMBS are then divided further and sold as collateralised debt obligations or CDOs to various investors; and investors will buy these CDOs based on their appetite for debt.
Obviously. The people who hold the riskiest debt also get paid the highest when times are good, and get hit first when times are bad.
When did the issue surface?
The CDO issue first arose in June when a Bear Stearns hedge fund borrowed money from Merrill Lynch and gave their CDOs as collateral. Merrill Lynch decided to sell the collateral but soon realised that there was something wrong when they were unable to s ell because their sale was driving down prices.
'Painful lesson in subprime', as the media reports?
And a costly one, too. Soon the market realised that there was a serious issue with the CDOs that went just beyond the Bear Stearns debacle. Essentially since these CDOs are part of RMBS, people realised that there was little or no solid collateral backi ng the RMBS because of the defaults by subprime borrowers.
An 'asset' that turned out to be hollow?
Exactly. And then two issues arose. One, no one knew how much of these CDOs banks and financial institutions were holding; and two, banks and financial institutions didn't know how much their CDOs were worth because the market for the CDOs had practicall y collapsed. Because of this, the markets started punishing the banks that held these CDOs and that is cause behind the volatility that one is currently seeing in global equity markets. It also emerged that there were more lenders caught in this subprime mess than was initially thought...
Do we know how many are affected by the problem on hand?
As of now, it has been estimated that 127 lenders have been caught in this. On August 15, the shares of Countrywide, the largest mortgage lender in the US, fell by 13 per cent after they issued warning about the potential hit on their balance sheet. One of the biggest concerns of this debacle is that instruments that were rated at AA have now started defaulting.
Have the rating agencies woken up?
Jolted from slumber, one may say. Rating agencies have now started to downgrade all RMBS backed by subprime mortgages and that will force banks to sell them because of capital norms and this will only cause a further plunge in prices.
Now, what are the lessons from the crisis?
This subprime mess raises two very important issues. One, the way banks lend money willy-nilly to people without properly checking their credentials; and two, the absolutely pathetic rating process used by the rating agencies. While both are hazardous to the system, the latter raises issues of moral hazard because the rating agencies profited massively from rating these RMBS.
Can we say that the worst is safely behind us?
Doubtful. It looks very likely that we are merely at the tip of the proverbial iceberg as far as the subprime crisis is concerned and that there is much more below the surface.
With a sustained growth of around nine percent, India is well poised to eradicate poverty in 20 years and emerge as the world's third largest economy, Finance Minister P. Chidambaram has said.
The country's fiscal requirement towards infrastructure stood revised to USD 475 billion at current prices over the next five years as against an earlier estimate of USD 320 billion, he told foreign diplomats attending the professional course organised by the Foreign Service Institute (FSI) at a valedictory dinner Friday evening.
'We are growing and continue to grow at around 9 percent,' the minister said.
'Studies show by growing close to 9 percent, we will become the third largest economy in 20-25 years,' he said. 'We must produce wealth and then divide it equitably. How can we have a welfare state without wealth?'
Chidambaram said infrastructure was the main constraint to growth and this was pulling the expansion of gross domestic product (GDP) down by as much as one-two percent.
'The challenge of infrastructure is huge. The requirement of funds is humungous. It had been estimated that between 2007 and 2012 we would need to invest over USD 320 billion in the infrastructure sector alone,' he said.
He said the level of estimated funds required has been revised upward by an official panel on infrastructure financing to USD 384 billion at 2005-06 prices, and that means USD 475 billion at current prices.
'But I can say with confidence that no country needs, and no country but India can absorb, such large funds for the infrastructure sector,' he said, adding that the increase in savings and investment rates gave him that confidence.
The minister said he was particularly concerned about the performance of India's farm sector, which had seen stagnation in both production and the area under food grain between 1998 and 2007.
While the area under food grain had stagnated at between 120-125 million hectares, the productivity stood virtually frozen at 68-73 million tonnes for wheat and 85-91 million tonnes in the case of rice.
'It is, therefore, necessary that we urgently address the issues relating to both production and productivity,' Chidambaram said, adding that the Rs.250 billion package announced recently should reverse the situation.
He was addressing participants of the 43rd batch of FSI's course for professional diplomats who were from countries including Bhutan, Sri Lanka, Mozambique, South Korea, Turkmenistan, Lesotho and Turkmenistan.
A recent study by Gartner, a global research and advisory firm, states that India will continue to be the next fastest growing wireless services market in the Asia pacific region after China.
The growth is mainly attributed to the fall in telecom tariffs and the introduction of affordable handsets. Bulk of this revenue will continue to come from voice services but with the increased growth in data services, the percentage of revenue coming from voice will reduce from 90% to 78% by 2011.
|What is your view on the impact of the US subprime crisis on emerging markets such as India?|
|Securities markets are definitely worried. That much is obvious from the recent declines. Having said that, the subprime issue itself does not have that much impact on India. What does have an impact is the change in the overall environment - widening credit spreads, falling risk appetite, and rising real interest rates. This is happening globally, even in India and that creates headwinds for the markets.|
|Markets such as India are suffering losses due to global cues. But at the same time, they are fundamentally strong. How long do you expect this situation to persist?|
|India has actually stood up quite well. However, I do not agree that there is no fundamental reason for the falls. “Normalisation” of risk appetite is a real thing.|
|Also, we must still be mindful that a slowdown in global growth will have some impact on Indian growth and a fall in global liquidity will impact India’s ability to finance future growth. These are real issues.|
|We certainly are focusing on domestic demand plays with strong earnings visibility and reasonable valuations. We find these particularly in the infrastructure and consumer sectors.|
|Do you think foreign investors could increase their exposure to markets such as India?|
|They may. Many investors have long argued that we will see a switching in the growth engine of the global economy - from a heavily indebted US consumer to a consumer in Asia that has high levels of savings.|
|This will cause current accounts in the US to move back towards surplus and those in Asia to move back towards deficits. This is the long-term view and accompanying it there should be dollar weakness and deleveraging in the US, mirrored by currency strength and re-leveraging in Asia.|
|Disappointingly, in the recent period of dollar weakness, it has not happened this way and Asian economies are still highly integrated with US demand, the US current account has widened and our economies have built up large surpluses.|
|Nevertheless, we do see signs of policy change in China to try and achieve the necessary rebalancing. India has perhaps already gone further down this route than anyone - strong domestic demand and currency strength being two key areas. I think we take a realistic view about how quickly this can happen and how smoothly it can happen. We remain strategically committed to domestic demand plays in Asia, but all the while willing to take tactical decisions to protect ourselves in periods of market volatility.|
|If our view is correct, then slower rates of growth in the West will probably lead to faster inflows to Asia over the long term, but there will be volatility along the way.|
|How do you look at the overall liquidity situation?|
|Liquidity has returned to what I would call a “normal” situation. I think many people have forgotten that the period of liquidity from 2002 until the middle of last year was extraordinary in the fact that real interest rates were very low compared to prevailing rates of growth.|
|The unwinding of this liquidity and the consequent fall in risk appetite has been shocking to the markets. But we are only returning to a more “normal” situation. That means ore normal levels of growth, more normal levels of profitability, and more normal valuations.|
|In my view, the FED will cut rates if it sees one of two things happening - a sustainable fall in core rates of inflation or a dramatic fall in GDP growth. In terms of inflation, a sustainable fall means that core rates must be slowing and that inflation expectations remain contained.|
|In terms of growth, the FED will be watching retail numbers in the US closely to see what impact the recent asset market problems and falling home prices have had on the sentiment of US consumers.|
|What is the impact of the turmoil in the US subprime loan market?|
|Many problems have come to light in the US, though the market has clubbed all of them under subprime. After the subprime assets problem came to light, rating agencies have taken action and 300-400 collateralised debt obligation (CDO) pools have been downgraded at one stroke.|
|Many of them have been downgraded by more than one stage depending upon their portfolio and the hit that they have taken. Though most of them have not defaulted, the spreads have risen three to four times and even 10 times in some cases. Spreads have risen by 40 basis points to 140 (in some cases even 240 basis points).|
|This has made the CDOs illiquid and burdened them with mark-to-market losses as the value of portfolios has grossly depreciated. Most of the larger losses, I feel, have already been announced and you can expect only smaller losses now, unless those who have announced big losses revalue their portfolios in the third quarter and come out with more losses.|
|But globally central banks are pumping in huge money. Doesn't this suggest that the problem may be even bigger?|
|What has happened was that the CDO pools were not able to sell their debt as there were no buyers. Portfolios became illiquid either because buyers have no appetite or money for such assets or due to uncertainties over the extent of the price fall.|
|Many funds didn’t want to sell them at current distressed prices and book losses. This has caused a temporary liquidity problem, which the central banks addressed. Asia doesn’t have a big exposure in such assets and India’s exposure (in such assets) is negligible.|
|How will this impact the future of the debt market?|
|The risk premiums have widened. Money was available earlier in the US without any track record. This scenario has changed for ever. Now no one will get loan without due risk premium.|
|This is good for the financial system but bad for those who are holding the portfolios, as prices of all papers, including AAA rated ones, have fallen and spreads have widened. The second impact is on project finances either through commercial banking or M&A deals.|
|Till now in big M&A deals, investment banks used to underwrite commitments which they were offloading in the market at a later stage. So the liquidity cycle was moving.|
|Many investment banks are now stuck with such commitments and are finding the going very tough. They have invested or committed investments and the rising spreads are making it difficult for them to fulfill commitments.|
|Henceforth, investment banks will find it costly to offer this facility and acquiring companies will have to go for the normal banking credit route. This is time-consuming and will result in a slowdown in M&A activity at least for three to six months.|
|How will PE investments be affected?|
|The slowdown will impact those whose sources of funds were leveraged. Those whose funds are not leveraged may start investing once the markets settle down. Many funds/investors have money but are not buying as they are not sure how long the downward trend will continue.|
|After some time, these investors will find some avenues for putting their money. This money will flow into S&P 500 companies, growth opportunities in countries such as India or even in gold. India may benefit positively as its growth story continues.|
|Will PEs be still attracted to realty?|
|Real estate prices are higher in India but that is more due to the holding power of developers. The buying speed has slowed down. Fresh funds from banks and private equity investors are drying up.|
|Prices will come under pressure once developers start feeling the fund crunch. We are also hearing that some securitised portfolios of housing loans are facing defaults. Crisil has already downgraded two CDOs.|
|What is happening in the mortgage market?|
|The riskiest segment of the US mortgage market, which serves borrowers with poor credit histories at high interest rates, has seen rising default rates in recent months.|
|The Mortgage Bankers Association said lenders began foreclosure against more than one of every 200 US mortgage borrowers in the fourth quarter, a record.|
|What types of loans are considered 'subprime'?|
|There are "no doc" loans. That's when you get a loan without giving the lender any documentation about your income. There are also "low doc" loans, or when you get a loan with just a little paperwork about your employment and income.|
|The number of non-traditional loans extended with low or no documentation jumped from 53.9 percent in 2003 to 65.7 percent in 2005, according to First American Loan Performance, which tallies home mortgage data.|
|How did this crisis come about?|
|While subprime mortgages have spread credit more widely and helped more people buy their own homes, critics contend a hot real estate market encouraged lenders to get more aggressive and offer increasingly complicated terms that borrowers did not always fully understand. These risks are being exposed as the housing market cools.|
|What's happening to the lenders ?|
|Waning demand from investors for home loans has toppled more than 70 mortgage companies and half a dozen hedge funds in the US since the start of last year. Concern over rising defaults has prompted bankers to reduce credit lines for home lenders.|
|Why is the meltdown among subprime lenders having an impact on the whole US stock market?|
|There is concern that the crisis could spread to more mainstream lenders and worsen the US housing slowdown. Delinquencies often foreshadow future loan failures and those bad credits could damage other mortgage-backed investments held by a wide range of investors.|
|Some economists worry that as house prices fall and lenders tighten credit terms, consumers will curb spending and drag down the US economy.|
|What would be the damages?|
|The US subprime mortgage crisis will cost credit investors about $150 billion in losses worldwide, according to Calyon, the investment banking unit of Credit Agricole SA, France's third-largest bank by market value.|
|Foreclosures may reach 20 percent of the $1.3 trillion of subprime mortgages outstanding, according to a research note. Assuming investors can recoup half their investments, losses would be $130 billion, it said.|
|A further $20 billion could also be lost from the $1 trillion of outstanding Alt-A mortgages offered to borrowers with better credit who fell just short of typical standards. Various other estimates for total subprime losses range from $50 billion to $200 billion, according to the report. Federal Reserve Chairman Ben S. Bernanke last month cited potential estimated losses of between $50 billion and $100 billion.|
|What's the outlook?|
|Some analysts believe the crisis in the subprime mortgage market could boost the chances of the Federal Reserve cutting its target for benchmark interest rates.|
|One of the factors driving the poor performance of subprime mortgages has been a series of interest rate increases by the Fed. From 2004 to last summer, benchmark rates rose 4.25 percentage points to 5.25 percent. That has led to a steep rise in payments on adjustable rate mortgages.|
|"The Fed is aware of the situation, and how raising rates might worsen the situation. " said John Kriz, managing director of real estate finance at Moody's Investors Service, a leading credit ratings agency. "Our view is that it is less likely that rates will rise and more likely they will fall."|
|The Fed may have done enough after adding $62 billion to the banking system on August 9 and 10 and pledging further funds as necessary, says Dominic Konstam, head of interest-rate strategy at Credit Suisse in New York. Stocks rallied worldwide on Wednesday, while the ECB said today it's optimistic that ``market conditions are normalising.''|
Market talk of Deutsche Bank picking up a stake in the mid-sized private sector IndusInd Bank has increased the trading interest and volumes in the bank’s stock. Despite the sharp corrections in the stock markets for the past few days, the counter has gained 6.31 per cent over the week to close at Rs 51.35 on the BSE on Friday.
The stock gained 3.15 per cent on Friday while the total traded quantity of shares stood at 5.90 lakh shares on the BSE against its two-week average volume of 2.91 lakh shares. On the NSE, 17,26,856 shares changed hands, of which 34 per cent is deliverable quantity.
However, top official in the IndusInd Bank declined to comment on the market rumours.
Stock markets registered the fourth straight weekly loss as the key indices, Sensex and Nifty, plunged nearly 5% taking cues from the global sell-off triggered by the unfolding US subprime mortgage crisis.
The Sensex crashed 726.73 points (4.89%) to a 10-week low of 14,141.52 when compared with the previous weekend close of 14,868.25. The Sensex has dropped 1,424.03 points (9.15%) in the last four weeks.
The Nifty tumbled 225.30 points (5.20%) to end the week at 4,108.05 from the last weekend close of 4,333.35.
A slew of factors like the unwinding of yen carry trades, hedge fund redemptions, heavy selling by foreign institutional investors (FIIs) and fears of a global credit sqeeze cast a shadow on the local bourses.
FIIs pulled out Rs 7,033 crore, including the provisional numbers for August 17, during the week.
Cluster: Apple Green
Price target: Rs395
Current market price: Rs300
Beaming with confidence
- HCL Technologies has reported a revenue growth of 2.2% quarter on quarter (qoq) and 28.6% year on year (yoy) to Rs1,612 crore for the fourth quarter ended March 2007. For the fourth consecutive quarter, it has reported close to double-digit sequential growth in revenues in dollar terms (up 9.2%). The sequential growth was driven by a 6.6% growth in volumes, a 1.7% improvement in the blended realisation and a one-time income (0.9%). However, the appreciation in the rupee by close to 7% limited the growth in revenues in rupee terms.
- The earnings before interest, tax, depreciation and amortisation (EBITDA) margin declined by 170 basis points to 21.6% on a sequential basis, due to the adverse impact of the steep appreciation in the rupee (a negative impact of 300 basis points) and higher selling, general and administration expenses (up by 60 basis points as a percentage of the sales) and unfavourable revenue mix (a negative impact of 30 basis points). This was partially mitigated by better realisation and an improvement in the utilisation rate. Consequently, the operating profit declined by 5.3% to Rs347.4 crore.
- However, the five-fold jump in foreign exchange (forex) fluctuation gains to Rs250.4 crore (up from Rs41.8 crore in Q3FY2007) and 87.3% growth in the other income component to Rs36.9 crore enabled the company to post a robust growth of 46.7% qoq and 108.9% yoy in its consolidated earnings to Rs486.7 crore. The company had taken an aggressive forex cover of $900 million at the beginning of the quarter, which was further increased to $1.16 billion as on June 30, 2007.
- In terms of operational highlights, the company signed seven large deals (multi-million, multi-year) during the quarter. The deals are spread across geographies and industry verticals, reasserting the company’s positioning as a strong contender for total outsourcing deals. Encouraged by the continued flow of large deals and the consequent growth momentum across the service lines, the management has given a broad guidance of a 30% growth in revenues (in dollar terms) for the next two years.
- To factor in the appreciation in the rupee and the charges related to the employee stock option scheme ($24 million in FY2008 which was not factored in earlier), we have revised downward our earnings estimate for FY2008 by 11% to Rs18.4 per share. However, the earnings estimate for FY2009 remains unchanged at Rs23.8 per share. We maintain our Buy recommendation on the stock with a price target of Rs395.
Cluster: Apple Green
Price target: Rs2,425
Current market price: Rs2,145
Beating all expectations with 62% growth
- Bharat Bijlee Ltd (BBL) has once again delivered a spectacular performance. Beating all market expectations its revenues grew by 62.8% to Rs115.6 crore in Q1FY2008.
- The operating profit moved up smartly by 161.5% to Rs19.9 crore, translating into an operating profit margin (OPM) of 17.2%. The OPM expanded by an impressive 650 basis points. The profit after tax (PAT) jumped by a whopping 194.4% to Rs12.6 crore, resulting in earnings per share of Rs22.5.
- The increase in the revenues and profits was due to improved realisation in both transformer and motor businesses. The margins expanded on the back of a lower cost-to-sales ratio. The raw material cost-to-sales ratio declined by 410 basis points to 65.2% during the quarter.
- The interest cost declined by 13.1% to Rs0.9 crore while the depreciation charge grew by 48.1% to Rs0.8 crore.
- At the end of the quarter the order backlog of BBL stood at Rs300 crore with the majority of the orders coming for transformers (about 65-70%).
- At the current market price of Rs2,145 the stock is discounting its FY2008E earning by 15.8x and FY2009E earnings by 11.7x. The stock is trading at 8.4x FY2008E enterprise value (EV)/earnings before interest, depreciation, tax and amortisation (EBIDTA) and 6.0x its FY2009E EV/EBIDTA.
With the markets around the globe sliding on US subprime worries, we will desist from giving any intra-day calls. Traders should employ strict stop losses as the undertone is fairly weak. Meanwhile, we are giving some investment calls for long-term investors. They are Punj Lloyd, SBI, ICICI Bank, Ranbaxy and Unitech.
Conceived in a partitioned cradle of blood and uncertainty, it would not have been difficult six decades ago to foresee a future for India similar to the macabre chaos in countries like Iraq and Rwanda, or even neighbouring Pakistan. Instead she embraced the tenets of secular democracy, and found her awkward way through it, and thrived.
She’s turning 60! Turn up the volume, bring out the band baja and let’s call it a celebration. As she steps into a new decade, India has a lot to be proud of, and a lot more that she still has to do.
Conceived in a partitioned cradle of blood and uncertainty, it would not have been difficult six decades ago to foresee a future for India similar to the macabre chaos in countries like Iraq and Rwanda, or even in neighbouring Pakistan. Instead she embraced the tenets of secular democracy, and found her awkward way through it, and thrived.
As easy as it is in hindsight, to criticize the founding fathers of the nation, they did shape in words, in actions, and in the constructs of our democratic system, a higher goal - a shared vision of a future that was better than the past. Subsequent generations of different spots and stripes left their own mark, testing the threads with which the country was sewn together. Imperfect as it is, our democracy is better than none at all.
A few numbers that flashed on Reuters two days ago piqued my interest. 60 years ago, agriculture accounted for 56.5 per cent of India’s GDP. The figure today is only 20 per cent for a population that has tripled over that timeframe. Services have expanded dramatically from 28.5 per cent of the economy to 61 per cent. Life expectancy at birth, then 32 years, is now 64 years. All good things, now let’s see the bad ones.
India’s infant mortality rate, then 146 per 1,000 live births is a much diminished 56 today, but that is still a far cry from Singapore’s 2.28 (India is ranked 152nd of the 208 countries for which data is collected, which puts her even behind countries like Nicaragua and Kazakhstan). The poverty rate, then 45 per cent is now supposedly at 28 per cent, which I find hard to believe, looking at the penury that the vast majority of the country lives in. Lastly, the sex ratio, a numerical testament to the daily murder of thousands of female foetuses and babies, then 946 women per 1,000 males, now stands at 933, and in real terms is much lower for the current generation as this number captures older women who outlast their male counterparts. These are just a few statistics.
I don’t mean to rain on the parade, but this threshold in time, this rite of passage, needs to also be a moment of introspection. I can’t believe how the ‘national conscience’ has been more concerned with the collapse of the U.S. sub-prime mortgage market, than with the millions of Indians dying, starving, and left destitute by the floods that have inundated parts of the country. Will it take the proverbial water at our feet for us to realise that we are in a flood?
India has done well on many fronts, and for that the Nation deserves credit. The software services industry has achieved more than anyone had dreamed of and manufacturing and resource-based businesses have slowly and steadily grown and matured on the world stage over a very short span of time. But, if India has to prosper, it is not going to be with superficial gimmickry like "India Shining" and our slick TV adverts that try and bait the finicky vagaries of international tourism and portfolio investments to fuel a nation this large. India has to pass up short-term, flashy fame for a steadier, focussed, and slower effort to create a self-sustaining, stable economy that relies not on consumption, but on economic, environmental and material sustainability, coupled with investments in human capital, education and health. An economy that is its own engine and driven from within, not without.
The Government must play a more active role too, not in tinkering with caste-based mechanics, fidgeting with investment quotas and subsidies, and pandering to the greed of overweight, local autocracies, but by getting into and staying in the business it was created for- ensuring access to water, shelter, health and education, keeping law and order, using taxation to deliver services, creating jobs, and redistributing wealth to achieve equity in every sense of the word.
For those that are proponents of the "trickle down" economic theory for India’s future prosperity, my own take is that it is akin to expecting the water dripping out of your leaky toilet flush tank to fill a lake. I’ll take the example of India’s second-largest bank, ICICI, which has prospered iconically on the country’s newfound energy. With 74 per cent of its equity in foreign hands, barely 26 per cent of its distributable profits stay within the country. How will this residue ever trickle down to have any meaningful impact on the poorest villager who lives from hand to mouth?
On this 60th anniversary of nationhood, Indians need to take a good, hard look at their personal and collective futures and enter into a covenant that rededicates the National interest and our secular ideals, not to just one more generation, but to several more. It might seem difficult, and many will ask "why?"… In our personal lives, we fret that in the crucible of the present, in the heat of its immediate desires and disappointments, our hearts will perish, unaware that they are being tempered in that furnace of passion and fullness for stronger things. Nationhood is no different.
It is in the present spirit of euphoria, in this flame of ascendancy, that Indians must mould the promise of a stronger, better future. India’s silent majority have given us more than we could ever have hoped for- 60 years of unquestioning, dedication to the idea of a nation. We now owe it to them to deliver…
Bear show on prime time
World equity markets were thrashed this week by a fresh wave of selloff amid heightened concerns about the impact of the turmoil in the US subprime mortgages on the global financial markets. This despite the ECB, Federal Reserve and Bank of Japan continuing their liquidity-boosting moves by infusing cash into the banking system. The trigger this week was a warning by a leading Wall Street firm that Countrywide Financial Corp., the largest American mortgage lender, could go bankrupt due to sharp losses in subprime mortgages. Countrywide's shares slumped after the troubled mortgage lender said it had drawn down all of an US $11.5bn credit facility to fund its operations amid tough conditions in the credit markets. Standard & Poor's cut Countrywide's credit rating after the mortgage lender was hit by liquidity and earnings pressures.
The string of bad news on Countrywide coupled with the unwinding of the so-called carry trades, funded through loans taken in Japanese yen, sent global markets into a tizzy, led by US stocks. Metal shares too plunged, led by gold and crude oil. However, by the end of the week, things had started stabilising, buoyed by a recovery in the US market on Thursday and a similar show by their counterparts across the Atlantic. Continental stocks surged and US market futures turned higher after the Federal Reserve cut the discount rate to 5.75% from 6.25%, saying it wanted to narrow the spread between the primary credit rate and the targeted federal funds rate. The yen lost most of its gains versus the dollar after the release of the Fed statement. European stocks rallied, with the FTSE 100 jumping 2.1% in London. Gold and crude too climbed after the rout suffered earlier in the week.
Govt in trouble?
Even as the stock, bond, currency and commodity markets were being pounded, an intriguing story was shaping up in the capital. The ties between the Left parties and the Congress took an ugly turn with both sides refusing to budge from their stated positions on the just concluded nuclear pact with the US. While the communist parties ruled out withdrawal of support to the UPA, senior CPI leader AB Bardhan said the withdrawal of support appeared to be inevitable. But, CPI-M patriarch, Jyoti Basu, ruled out withdrawal of Left support from the UPA government on the Indo-US nuclear deal. Last week, the UPA Government's communist allies had rejected the 123 agreement, which set in motion the landmark civilian nuclear agreement between the two nations.
As expected, the Parliament proceedings were thrown out of gear in the first week of the monsoon session, with the Left along with the BJP-led opposition parties trying to corner the Congress-led alliance over the nuke deal with the US. Prime Minister Dr. Manmohan Singh vehemently defended the deal, saying there was no sellout and that it in no way hurt India's sovereignty. He also said that the deal would benefit India a great deal. The BJP termed the Indo-US nuclear deal as humiliating for India and asked the Prime Minister to either renegotiate it or quit. The party moved breach of privilege motions against him in Parliament following Washington's assertion the pact would be terminated if New Delhi exploded a bomb.
Bulls go underground
Worries kept mounting one after another. Sub prime crisis, global liquidity crunch, strengthening of the Japanese Yen, heavy selling by the FIIs and growing tension between Left parties and the Congress-led Government over the recently concluded civilian nuclear deal with the US were some of the highlights of the week. Don't be surprised if the same is repeated next week too.
Key stock indices fell by around 5% over the week in line with a rout in global markets, recording its worst weekly performance in five months. Investors concerns over the riskier assets have resulted into a sharp decline in the emerging markets. Finally, the BSE 30-share Sensex fell by 4.9% or 727 points to close at 14141.52 and NSE Nifty lost 5.2% or 225 points to close at 4108.
At the start of the week, major central banks across the global injected huge sums of money into the liquidity system. Central Bank’s action provided some support to the Financial Markets, by solving liquidity crunch. However, it failed to stabilize and markets lost further ground with Hang Seng Index recording its biggest weekly decline since September 2001.
Metal stocks have been the worst hit over the week. A slowdown in US housing continues to have a negative impact on the metal stocks on Dalal Street. Metal index nose-dived by 9.7% during the week being the top loser among the BSE sectoral indices. Index heavyweight Tata Steel was the top loser among the Sensex stocks as the scrip plunged by over 14% to Rs544. JSW Steel lost 9% to Rs568 and SAIL dropped 8.2% to Rs137.
Capital Goods index was the second biggest loser led by a fall in the frontline stocks. BHEL lost by over 8% to Rs1558, L&T dropped 5.2% to Rs2305, Punj Lloyd slipped 4.7% to Rs62 and Gammon India declined 4.4% to Rs410.
Despite the weaker local currency against the dollar, IT stocks fell sharply in line with other major indices, erasing gains of last week. TCS fell nearly by 8% to Rs1056, Satyam lost 8% to Rs440 and Infosys dropped 5% to Rs1854. The rupee fell to its weakest level in almost four months as overseas funds turned net sellers.
Concerns over the exposure of Banks to the credit market brought the banking stocks lower. BSE Bank Index fell by 5.4%. Index heavyweight SBI lost 5.4% to Rs1519, HDFC Bank slipped 5.5% to Rs1068 and ICICI Bank was down by 5.5% to Rs824. Others like Kotak Bank, Corporation Bank and OBC were the top losers among the Mid-Cap Banks as each slipped over 10%.
Selling was also seen in real estate stocks over the on-going saga of subprime worries. Unitech lost 5.4% to Rs484, DLF edged lower by 0.6% to Rs580, Sobha lost 4.1% to Rs778 and Akruti was down 0.8% to Rs489.
Right said Fed, but what about our Left !
Market outlook changes faster than one can imagine. Just when global pangs were threatening to rock bourses the Fed stepped in bringing cheer to US market futures.
The Federal Reserve cut its discount rate to 5.75% from 6.25%, saying it wanted to narrow the spread between the primary credit rate and the targeted federal funds rate. But back home the US nuclear deal threatens to shake the ruling government. The nuclear deal will come up for discussion in Parliament on August 20. The Congress will be in a tight position as opposition pressure is mounting against the deal from the Bharatiya Janata Party and the Third Front and of course the Left parties.
Stock specific action will continue. For instance ICICI Bank could be in action as the Foreign Investment Promotion Board (FIPB) has reportedly accepted ICICI Bank’s application for infusion of foreign funds into a holding company for its insurance venture. Value buying may be seen in select heavyweights. Buy with a medium to long term horizon. Should you make some quick gains in a strong bounce back, don't hesitate to lighten your positions. Single events appear to have a cascading effect across sectors. WNS (Holdings) Limited, a leading provider of offshore BPO services has been told by one of its client (in the mortgage business) that they expect to stop substantially all work WNS does for them. Be prepared for many more such developments.
If global cues are anything to go by (they are everything to go by these days) the start of the week promises to be positive. Stay alert and avoid falling into bear traps. Keep some amount of cash and invest with a long term view. For day traders, God help you.
Global Market Analysis (13-08-07 to 17-08-07):
1) US & EU Markets:
· In the world's financial markets, the subprime mortgage collapse may finally be contained. Stocks in the U.S. and Europe rallied after the Federal Reserve unexpectedly cut the discount rate to ease a credit crunch. Crude oil, copper and gold advanced on reduced concern that the U.S. economy, the world's largest, would slow. Three- month U.S. Treasury bill yields leapt as the safe haven of government debt faded and the dollar fell versus the euro for the first time in a week.
· European stocks advanced for the first time in four days after the U.S. Federal Reserve unexpectedly lowered the rate at which it loans money to banks to ease the effects of a rout in global credit markets.
· The biggest rally in four years for the Standard & Poor's 500 Index helped the U.S. stock market wipe out most of the week's losses after the Federal Reserve reduced the discount loan rate.
2) Asian Markets:
* Asian stocks tumbled for the fourth week, posting their biggest drop in 17 years as a deepening U.S. housing slump and spreading credit crunch cooled investor demand for equities.
* Hong Kong & South Korean stocks dropped, completing their worst week since the terrorist attacks of Sept. 11, 2001.
* Asian Stocks tumbled worst in August till day by 11-16 % on US Subprime worries and funds withdrawal by Hedge Funds.
3) Emerging Markets:
· Emerging-market stocks also fell by 6-8% during the week and 7-11 % till day in August on Global Concern.
4) Commodity Markets:
· Crude oil rose 1.4 percent in New York, the biggest gain in almost three weeks, as the U.S. Federal Reserve lowered its discount rate to prevent an economic slowdown and a hurricane bound for the Gulf of Mexico may threaten oil rigs, pipelines and refineries.
· All Non-Ferrous Metals has lost 4-8% during the week on Global Sell Off.
5) Currency Markets:
* The dollar fell versus the euro for the first time this week after the Federal Reserve cut its discount lending rate to prevent credit market losses from slowing the economy.
* Australia's central bank bought the nation's currency for the first time in six years to stem the steepest drop since it was allowed to trade freely in 1983.
* Asian currencies tumbled this week, wiping out this year's gains in the Singapore dollar and South Korean won, as losses linked to the subprime market sparked the worst five-day decline in the region's stocks since 1990.
* Indian INR faced its biggest weekly fall of 1.73 % to Rs.41.33 since May 2004 on continued selling of equities by foreign funds, particularly hedge funds, on the fears the credit squeeze in the US would spread.
6) Bond Markets:
· Two-year Treasury notes gained after the Federal Reserve cut the interest rate it charges to banks, suggesting that central bankers are moving closer to lowering borrowing costs as credit market conditions deteriorate.
· The Federal Reserve reduced the interest rate it charges banks and acknowledged for the first time that an extraordinary policy shift is needed to contain the subprime-mortgage collapse that began roiling the world's financial markets two months ago.
· The Federal Reserve's surprise interest rate reduction failed to revive demand for asset-backed commercial paper and mortgage securities, the very markets the cut was intended to help. The cut “may help add confidence that action will be taken when it's necessary, but further action is needed to actually offset the credit contraction we have had,” Ashish Shah, Global Head of Credit Strategy at Lehman Brothers Holdings Inc. said.
* China will probably raise interest rates by the end of September to cool the economy after inflation accelerated to a 10-year high and record trade surpluses pumped cash into the financial system.
Japanese save a lot. They do not spend much. Also Japan exports far more than it imports. Has an annual trade surplus of over $100 billions. Yet, the Japanese economy is considered weak, even collapsing. (Comment: The Japanese economy is in a recession for the last three quarters of 2004.)
Americans spend, save little. Also US imports more than it exports. Has an annual trade deficit of over $400 billion. Yet, the American economy is considered strong and trusted to get stronger.
But where from do Americans get money to spend? They borrow from Japan, China and even India. Virtually others save for the US to spend. Global savings are mostly invested in US, in dollars. India itself keeps its foreign currency assets of over $50 billions in US securities. China has sunk over $160 billion in US securities. Japan's stakes in US securities is in trillions.
Result: The US has taken over $5 trillion from the world. (Comment: While the US has indeed received over $5 trillion in non-resident saving, this is not "taken by the US" but freely invested by foreign investors who want to invest in primarily US treasury bills. Since no one forced these investors to do what they did with they savings, it has to be assumed that they were made because the investors did not believe they had better alternatives! As long as the US is in the situation where "everyone" believes the US is
a safe place to invest then it is a safe place to invest. The big question is if at some point foreign
investors lose faith in the strength of the US economy. Once the world loses faith in the strength of the US economy then "everyone" will try to sell their US securities and the US$ could easily collapse and we will all be in deep trouble.) So, as the world saves for the US, the Americans spend freely. Today, to keep the US consumption going, that is for the US economy to work, other countries have to remit $180 billion every quarter, which is $2 billion a day, to the US! Otherwise the US economy would go for
a six. So will the global economy. The result will be no different if US consumers begin consuming less.
A Chinese economist asked a neat question. Who has invested more, the US in China, or China in The US? Answer: The US has invested in China less than half of what China has invested in US. The same is the true for India. We [India] have invested over $50 billion in the US. But the US has invested less than $20 billion in India.
Why the world is after US?
The secret lies in the American spending, that they hardly save. In fact they use their credit cards to spend their future income. That the US spends is what makes it attractive to export to the US. So US imports more than what it exports year after year.
The world is dependent on US consumption for its growth. By its deepening culture of
consumption, the US has habituated the world to feed on US consumption. But as the US needs money to finance its consumption, the world provides the money. It's like a shopkeeper providing the money to a customer so that the customer keeps buying from the shop. If the customer will not buy, the shop won't have business, unless the shopkeeper funds him. The US is like the lucky customer. And the world is like the helpless shopkeeper financier.
Who is America's biggest shopkeeper financier?
Japan of course. Yet, it is Japan which is regarded as weak. Modern economists complain that the Japanese do not spend, so they do not grow. To force the Japanese to spend, the Japanese government have exerted it self, reduced the interest rates on savings, even charged the savers. Even then the Japanese did not spend (habits don't change, even with taxes, do they?). Their traditional postal savings alone is over $1.2 trillions, about three times the Indian GDP. Thus, savings, far from being the strength of Japan, has become its pain.
Hence, what is the lesson?
That a nation cannot grow unless the people spend, not save. Not just spend, but borrow to finance their spending.
(Comment: It is clear the domestic investment in real assets in the US is significant and a key question then is if the non-resident saving is greater or smaller than this real investment. There is nothing wrong with borrowing to finance investments, provided, of course, that the investments that are being financed yield a higher return than the interest paid on the loans! While US households do not save significantly and, therefore, is not a significant source of funds for financing investments, it is then
not obvious that using foreign sources of funds is a bad thing. Strictly speaking the US households do earn enough income to pay for their consumption (the saving rate is about .01) It is clear, however, that the Federal Government has a significant deficit – i.e. spending in excess of tax revenues, and that deficit has to be financed out of Gross Domestic Saving (incl. non-resident saving.). The key point here is that we know for a fact that, as a mater of definitions, gross domestic saving (incl. non-resident
saving) is identical equal to domestic real investment. What we cannot do is trace where individual dollars saved are being used – e.g. either to finance private or public domestic investment or the deficit on the Federal budget.)
Unknown Source, Unknown Date
The reverberations generated by the subprime shock-waves could have an impact on some of the initial public offerings (IPOs) due to hit the markets in the near future. A look at the latest grey market premium of some of these IPOs reveals that the premium has declined sharply.
Experts said while pricing an issue, usually 20-25% listing gains are left for investors. However, when markets fall, this premium shrinks, with many a stock losing its sheen, thereby making it unattractive. Hence, current market conditions being what they are, experts feel depending solely on the grey market numbers would not be the right thing.
Take, for the instance, the issue of Zylog Systems, which made its debut on the bourses on Friday. Pre-listing, the company was quoting a premium of Rs 200 in the grey market, down from about Rs 250 early this month. The issue price had been fixed at Rs 350 and the stock closed at Rs 431 on BSE. When the stock touched a high of Rs 525 in initial trade, investors were quick to book gains despite the grey market pricing being substantially higher.
In issues like KPR Mills, where the premium was Rs 20 per share in a price band of Rs 225-265 on August 1, is being quoted at a discount in the grey market. The company’s issue price has been fixed at Rs 225 now. Others like SEL Manufacturing, which had a premium of about Rs 4-5 till a few days ago, saw the same shrinking to about Rs 2.
The issue has a price band of Rs 80-90. If the global meltdown continues, investor apathy could spread to more issues.
“Listing successfully and leaving enough gains for the investors help keep the company’s image as a positive one among investors. Investors usually look for a minimum of 20-25% upside on listing. This price is fixed in consultation with institutional investors, pre-markets rounds and based on market feedback,” said Mumbai-based financial services company Keynote Corporate Services’ managing director Vineet Suchanti.
In issues like Asian Granito, the premium has come down from 20% earlier to about 5% now. The recently-listed IVR Prime, which had an issue price of Rs 550, was being quoted at a premium of about Rs 15-20 at the beginning of the month. But the issue closed at Rs 418 on Thursday, after touching a low of Rs 388, much below its issue price. While Puravankara Project’s lowering of price band from Rs 500-525 to Rs 400-450 was more a case of an overpriced issue, it was made further unattractive due to volatile markets.
“There is a large pipeline of issues slated to hit the market in the coming months. If the global markets continue to slide further, the issues that have already closed for subscription could see a decline in premium. Some of the issues could also see a re-pricing,” said a merchant banker.
“Bankers have become more careful while pricing an issue, keeping in mind the probability of a market fall. The recent gains on listing was witness to substantial under-pricing in many issues,” he added.
Short-sellers, who covered back their futures positions amid the panic on Friday, must be thanking themselves for not having become too greedy. With the US Federal Reserve cutting its discount rate to banks by 50 basis points in a bid to ease liquidity, beleaguered equity markets across the globe seem poised for a relief rally.
Already, on Friday, US and European markets were trading higher. Analysts expect Dalal Street players to liquidate the rest of their short positions in futures and create long positions on Monday, if the US markets manage to sustain gains on Friday.
Most traders covered a large chunk of their short positions in Nifty and stock futures mid-way through the session on Friday tracing the bounceback in the CNX S&P Nifty, thanks to the rebound in European and Asian markets. The short-covering resulted in discount between CNX S&P Nifty and Nifty futures narrowing to 5 points from 50 points earlier in the session. The discount, however, widened to 26 points at close on Friday due to the fresh creation of short positions at the fag end of the session.
Driven by the hectic activity, total turnover in the equity futures and options (F&O) segment on Friday stood at
roughly Rs 65,000 crore. The highest-ever turnover on the domestic F&O segment was recorded in July at Rs 80,000 crore.
Analysts said several short-term and day traders have profited immensely by going short in Nifty futures, when the underlying index was 200-300 points higher. These investors had created short positions at higher levels mainly in anticipation of a sharp fall in the indices. The Nifty, which closed at 4,108 on Friday, after touching the day’s low of 4,002, has fallen 200 points, or roughly 5%, in the past couple of sessions.
Analysts said several day traders wrote (sold) Nifty puts at strike prices between 4,020 and 4,050 on Friday, after the market rebounded. An investor writes a put option when he expects the price to remain steady or rise.
Religare Securities AVP-derivatives Anil Gupta said: “The Nifty has strong support at 4,050-levels, breaking which the key support level is at 3,850.”
On Friday, the US markets rose sharply in opening trades after the Federal Reserve approved a 50 basis points cut in its discount rate on loans to banks. Investors cheered the cut in the discount rate to 5.75% from 6.25%, despite the US Fed’s statement that “downside risks to the economy have increased appreciably”.
The move is expected to free up some money to the economy’s banking system, which had dried up considerably after the crisis in the US subprime mortgage market.
Yen, Fed rate cut to breathe life into markets; rupee expected to strengthen.
Stocks grazed a three-month low in gyrating trade on Friday, sending the Sensex to its worst weekly loss in five months.
But analysts said the weakening of the yen following the Federal Reserve’s decision to cut the discount rate would have a stabilising effect on Indian markets next week.
The Sensex ended at 14,141.52, down 216.69 points, or 1.51 per cent, from yesterday.
The outlook for all global markets, however, appears positive after the Fed reduced by 50 basis points the rate at which it gives direct loans to banks.
This is the first reduction in borrowing costs between scheduled meetings of the Federal Open Market Committee since 2001 and Ben S Bernanke’s first as Fed chairman.
The Dow was up 167.21 points at 13,012.99(at the time of going to the press) after the Fed’s surprise move, while the FTSE ended 205.3 points, or 3.5 per cent, higher at 6,064.2 indicating a rebound in global markets next week.
The Indian markets yesterday fell sharply in initial trade but short covering in post-noon trades and recovery in other Asian and European markets helped shares to regain more than 400 points from the day’s low.
Still, a third of the stocks on the Bombay Stock Exchange (BSE) were in the red, after foreign funds sold another Rs 3,536 crore worth stocks on Friday, to add to yesterday’s Rs 3,108 crore sales.
Total sales by foreign institutional investors (FIIs) for August have now touched Rs 11,820 crore (nearly $3 billion), beating last May’s net sales figure of Rs 11,558.57 crore ($ 2.81 billion).
But domestic institutions made a record net purchase of Rs 5,957 crore this month, beating its previous single biggest purchase in a month of Rs 4,560 crore in June.
The Nifty ended the day at 4108.05, down 70.55 points, or 1.69 per cent.
Yesterday’s weakness, coming after yesterday’s rout on reports that the biggest mortgage lender in the US, Countrywide Financial Corporation, was on the brink of bankruptcy, may not persist for long, as newer funds might see values in markets such as India soaring after a fall of nearly 12-13 per cent from the peak, said experts.
The broader S&P CNX Nifty ended the day at 4108.05 points, down 70.55 points, or 1.69 per cent. Nifty futures for August delivery fell 1.4 per cent to 4,082.
Infosys Technologies tumbled by 2.91 per cent to Rs 1,854.80 a share on fears that the housing slump in the US will curb consumer spending. Satyam Computers (down 5.81 per cent to Rs 440.20 a share), Tata Steel (down 5.40 per cent to Rs 544.30 a share) and ONGC (down 4.41 per cent to Rs 782.70 a share) were the top losers.
“We do not know the extent of the damage. With over Rs 3,000 crore worth of net sales by foreign institutional investors yesterday, the markets cannot rebound in a day,” said a research head of a brokerage.