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1.

ILL-CONCEIVED STATEMENTS

Something missing

US President George Bush’s statement that rising food consumption in fast-growing India and China is a major cause of the rapid increase in world food prices is both ill-timed and ill-conceived. The statement comes at a time when there is a need for food-production and cooperation in easing global supply and distribution of food.

Currently many food-producing economies have gone somewhat into a panic mode and are putting curbs on grain exports. It is a problem that needs a rational global response. The US could have played a positive role in this. Bush’s statement will not help the cause at all. On the contrary, it may provoke some food-producing countries to put further restrictions on trading of agricultural items.

Bush’s statement lacks the rigour of facts. The United Nations data released by Food and Agriculture Organisation (FAO) reveals that American cereal consumption has grown close to 12% since 2006 compared to less than 2.5% increase in cereal intake by India and China, the world average being 2.6%. So, cereal consumption in the US is way higher than the world average, largely because it has been encouraging diversion of large quantities of grains like maize, into bio-fuel production.

The classic theory of demand, the foundation on which other principles of economics are built, states that prices are determined, other things being equal, by the demand and supply forces in the market. The current spiralling of agricultural commodity prices is also by and large ‘justified’ on the same logic. However a look at the supply-demand data of agricultural commodities reveals a different picture: the global scenario has not changed that drastically to warrant such spiralling prices.

There have been umpteen columns analysing the effects of substitution, diversion of food crops for bio- fuel, etc. on prices. Still something was missing in the whole casual loop till the subprime crisis in the US, and the recent sharp fall of sensex. These events bought out the definitive link between the financial market and the commodity market and provided the missing plank. The link is the speculators, whose needs are simple: just need to make money. So when the financial sector is in the mood of embrace them in its bearish hug, they deftly move away and sit on the bull riding high in the commodity market! And they are not disappointed.

However, what is important is the impact of their games on the real economy. As players in the financial market, their activities do not impact the real economy much; in fact everybody is happy when the sensex is northward bound. The same activity in the commodity market, however, brings cheer to only those players. This is because the underlying is a commodity that is very much ‘real’. Add to this the impact of substitute. For example, crude prices breached the $ 135 per barrel mark mainly due to speculators. This led to a greater demand for its substitute, namely bio-fuel products, which in turn increased their raw material prices and fuelled more speculative activity in the now booming commodity market.

Earlier it is said that unlike the real sector, the financial sector is global and shocks are felt immediately. However, the recent experience in both the financial and the commodity markets prove otherwise. The shocks felt at CBOT or BURSA gets transmitted, in real time, across the globe, whereas the shocks of the US subprime crisis is being dissipated with a definite delay. So, the impacts of commodity shocks are far reaching and fast. What is needed is to develop the immune systems in order to provide a protective shield against the ‘vagaries’ of markets; a sort of decoupling of the real and financial sectors domestically, at least. Our immune system lies in the development of the real sector. Growth led by growth in financial sector will certainly boost the overall GDP, but may not sustain without growth in the real sector.

US official adds fuel to Bush fire

ILL-CONCEIVED STATEMENTS

The perpetually outraged in the political spectrum got fresh ammunition for their anti-US rhetoric when the White House faulted India and China for the surge in oil prices. The statement comes on Tuesday, 6 th of May ’08 – three days after politicians here interpreted a statement of President Bush – growing prosperity and increased consumption in India and China was one of the factors contributing to the food shortage – as a US diktat to eat less.

White House deputy spokesman Scott Stanzel said to calm the frayed nerves over President Bush’s remarks saying the US saw “higher living standards” of people in India as a “good thing”. Three days ago, President Bush had referred the case of Indian middle class to argue that its demand for better nutrition was a factor in pushing the global food prices up. “There are 350 million people in India who are classified as middle class. That’s bigger than America. Their middle class is larger than our entire population. And when you start getting wealth, you start demanding better nutrition and better food, and, so demand is high, and that causes the price to go up.”

Clarifying President Bush’s remarks on Indian’s food habits, Mr Stanzel added: “We think that it is a good thing that countries are developing; that more and more people have higher and higher standards of living. The point that I think was to be made is that as you increase your standard of living, the food that you eat can venture more into meats that require more commodities to feed the livestock which, you know, uses more of those commodities, whether it’s corn, or wheat, or other commodities and it drives up the price. So that is just a function of how those food prices that we’ve seen spike around the world.”

IMF blames India, China for rising commodity prices

After the US President George Bush and White House deputy secretary Scott Stanzel, it now the turn of the International Monetary Fund (IMF) to blame India and China for rising global commodity prices.

Warning that the recent pickup in inflation rates around the world in part reflected the impact of higher energy and commodity prices, IMF first deputy managing director John Lipsky said that the demand for commodities has remained robust because of strong growth in emerging and developing economies, led by China and India. These economies’ growth is more energy- and commodity-intensive than that of more developed economies.

In fact, emerging and developing economies as a group have accounted for about 95% of the growth in demand for oil since 2003. As spare capacity and inventories have dwindled, the oil market has become highly sensitive to news of supply disruption and geopolitical events. This has pushed oil prices all-time highs in real terms, surpassing their 1979 peak.

The IMF also forecasts that food prices will remain high. “With only temporary relief likely, we expect that agricultural prices will remain high for the foreseeable future, as supply responses may require both new investment and policy reforms. This will take time”.

Hopefully, the inflationary impulse from higher food prices will wane, even if prices do not retreat significantly. However, this also indicates that the humanitarian challenges of higher food prices will not disappear anytime soon.

ILL-CONCEIVED STATEMENTS

Lipsky warned that the recent pickup in inflation rates around the world in part reflected the impact of higher energy and commodity prices. “This inflation speed-up must be taken seriously as it creates potentially significant challenges to economic stability that could undermine prospects for resorting the combination of solid growth and low inflation that prevailed earlier in the decade”. To put the issue starkly, inflation risks have reemerged as a global challenge following a long absence.

He called on governments to initiate steps to encourage investment in energy, reduce biofuel subsidies and improve agricultural policies. He said the IMF was also working to help developing countries that have been worst affected by the commodities hikes and to develop strategies that can be adopted by member countries. Lipsky said that, in the IMF’s view, policies will need to adjust both to the reality of permanent relative price shifts and, in some cases, to a broader resurgence in inflation.

BRIC meeting scheduled to find solution

At a time when the US and EU are blaming food and oil shortages on countries like India and China, foreign minister of India, Brazil, Russia and China will be meeting soon in a small town in Russia to discuss the issue of biofuel, energy security, food security, global financial trends, and impact of the slowdown of the US economy.

Food security and increasing prices were bought into the international limelight when food riots broke out in some parts of the world. The developing countries have argued at the WTO that the fault lies with industrialised countries which are using agriculture subsidies to undercut the agriculture output of other countries leading to reduced food production.

India is likely to argue that one country cannot be held responsible for the rise in food prices and there is a need for a global approach to resolve the issue. In this scenario, the meeting of the BRIC countries comes at an opportune time and is being seen as an opportunity for the four countries to provide their own assessment of key economic issues facing the world.

Plan, Preserve or Parish

We are watching the death of just-in-time (JIT) school of inventory management. Since the beginning of agriculture, farmers have recognised the need to manage stocks of grains to prevent starvation in times of scarcity. In the Hebrew Bible, the Egyptians were directed to stockpile seven years of harvests in preparation for seven years of famine.

We hadn’t come too far from that. To ensure food security, many countries stockpiled strategic gain reserves. Grains are an easy-to-store and nutritious way to provide the basic needs of a population facing a food emergency until alternative food supplies can be arranged. But in the late Eighties, management Gurus began chiding companies for locking up resources in inventories. The guiding principle was don’t waste time, energy and cash in stockpiling inputs when you can get suppliers to deliver at the precise moment your factory needs them.

ILL-CONCEIVED STATEMENTS

To be fair, JIT did appear to make sense 10 years ago. With rapid developments in IT, freight handling, shipping and ample supply; it was the sensible thing to do. At around the same time, IMF and the World Bank began preaching the wisdom of liberalised agriculture trade. So governments in the world’s top grain consuming and exporting nations brought into the JIT-argument.

The US dismantled its strategic grain reserves with the 1996 Farm Bill. By year 2000, China had discarded its low-quality, low-value grain reserves. India reduced its buffer stock norms in 2004. The EU had intervention stocks of 16.5 million tonne at the start of 2005-06. By April 2008, they were whittled down to only 236,000 tonne corn held in Hungaria. Overall, the EU grain ending stocks in 2007-08 will be down to 27.1 mt compared to 46.1 mt just two years earlier, all of this in commercial hands.

For the private sector, the cost of holding stocks, use of JIT and years of readily available global supplies provided incentives to reduce stock holding. Over the last decade, the shift toward more liberalised trade reduced trade barriers and facilitated trade, which in turn reduced the need for individual countries to hold stocks. Since 1999, the global stock-to-use ratio for the aggregate of grains and oilseeds declined from about 30% to less than 15% currently.

But it took only 24 months, a bull run in crude oil and a couple of bad harvests to bring votaries of JIT to their knees. Any policy maker today, banking on just-in-time delivery of food or raw materials can only appear quixotic. It’s simply too dangerous. The global aggregate stock-to-use ratio for grains and annual oilseeds is the lowest since 1970. Stocks in major exporting countries are particularly low. Obviously, importing countries are anxious because they now have fewer sources. Even a relatively small import order from Egypt makes CBoT jump. This has scared importing countries into buying additional supplies, even at record high prices.

In Asia, the World Bank constantly assured the Philippines, even as recently as last year, that self- sufficiency in rice was unnecessary, and that the world market would take care of its needs. Now the government is in a desperate plight: Its domestic supply of subsidised rice is nearly exhausted and it cannot import all it needs because traders’ asking prices are too high.

When there is no guarantee of how oil prices, weather, politics or hedge funds will move tomorrow, how do you feed your population? The answer is suddenly staring at us in the face.

Across the world government are junking JIT. Stocking up is the new mantra. There is a clamour to increase strategic grain reserves in the US, China, Russia, Indonesia and India, to name a few.

As, Dennis Olson from the Institute for Agriculture and Trade Policy says: “Strategic reserves would help reduce the dangerous volatility that can harm everyone”. Simultaneously, the market is slowly realising that it needs to pay people to hold stocks to be consumed in future. Traders are showing a willingness to pay carrying cost in grains such as wheat to help build up inventories. You can see that in the way price of far month contracts is slowly rising above expected future spot prices.

ILL-CONCEIVED STATEMENTS

Crude prices at record high

The inflation is the name of the game. The fires of oil prices surges sweep across the globe and nobody will come out unscathed. But there will be winners and losers. Crude oil at $ 135 per barrel – this is the stuff of fantasy for the commodity punter and a nightmare for the rest. The explanation put forward for why price of oil has been going up so much can be categorised into: rising demand from India and China; fear of supply disruption, i.e., geopolitical risk; fall in the US dollar; and thin supply cushions because inadequate investments were made in the nineties when oil prices were falling.

However, these arguments do not explain why oil prices are where they are. Global demand for oil between 1980 and 2003 grew by 1.3% to 1.6% per annum. In 2004 it soared 3.9%, mostly because Chinese consumption jumped and partly because US consumption rose. In 2005 world demand growth was more again modest at 1.7%. In the course of these two years, crude oil prices doubled. In US dollar, this at the end of 2005 was $ 61. In 2006 world demand grew by 1.1% and in 2007 by just 0.9%. But price today has touched $ 135/bbl. Thus while world oil demand rose by just 1% p.a. crude prices shot up more than double in US dollar terms over the past two years.

So, first, oil demand at the aggregate level has not been blowing. Second, the geopolitical risk, there were tensions and conflicts aplenty in the past several years; thus there is a kind of plausibility in the argument. Till November 2007 there was a risk of something happening about Iran and this was offered up the reason for oil rising past $ 90/bbl. Since the US National Intelligence Estimate cleared the air on that, and with conditions in Iraq clearly improved, there is no current crisis that can be used to explain ‘geo- political premiums’. There is some substance to the argument that investments lagged in the nineties, but hardly adequate to explain why output cannot keep pace with demand rising at 1% annually.

The answer lies elsewhere. To reverse the decline in oil prices in the fall of 2006, after the Lebanon war, OPEC cut its production quota by 1.2 mb/d in November 2006 and by another 0.5 mb/d in February 2007. That is a total of 1.7 mb/d, taking 2% of global output off the market. Normal market forces thus have nothing to do with this calculating and adept leveraging of monopolistic powers in a market where the negotiating powers of the consumer nations are depressed. Oil exporters have discovered that the inept consumers of today can live with $ 100 plus /bbl. The waters have been thoroughly tested at $ 60, $ 70, $ 80 and now $ 100, $ 110, $ 120, $ 130 plus per barrel.

The whole idea thrives on scarcity : When we speak of ‘future trading’ in commodities, we may be referring to a situation in which traders and hoarders buy out the produces cheaply and then raise prices by creating false scarcity. The most appropriate, and therefore the worst, example of this has been the astronomical rise in the price of crude oil. A US senate panel has not only conducted an enquiry but also has come to the definite conclusion that the uncontrollable surge in crude prices is without doubt the outcome of Hedge funds having taken bets worth $ 12 trillion and more on oil futures. That this could raise the price of crude to over $ 200 a barrel in the next four to five months seems no longer an implausible or impossible proposition.

An April 24 report on the Dow Jones online Financial News notes that oil speculators have offered to buy more than the producers can produce, and even artificially raising prices among themselves. This spike, clearly, has nothing whatsoever to do with the actual scarcity or not of a commodity. Commodities are being traded on in this profligate manner because stocks and shares have failed to deliver.

Crude prices at record high

2.1

SECURITY MARKET

Great returns are invariably made by investing amid panic and pessimism

Equities have traditionally outperformed all assets classes over a longer period of time. In a growing economy like India, exposure to equities is essential in the overall asset allocation of every investor. Of course, many investors know this. But there are still many others, who haven’t joined the ‘ring’ as yet, waiting for an opportune time. In fact, the recent correction from the heady level of 21,000 is an opportunity that first-timers need to capitalise on.

Yes, the times are uncertain and markets have been highly volatile. But remember most successful investors have made money by investing in uncertain times. That’s because perceived risk and actual risk seldom go hand in hand. At 21,000 Sensex level, the actual risk was much higher but optimism was at its peak. Similarly, at around 15,000-16,000 levels (with a correction of close to 25% in the benchmark index and that of around 30-40% in many fundamentally sound stocks), the actual risk was far lower but pessimism was written all over. Clearly, sentiments tend to overshoot fundamentals in both the directions.

Notwithstanding the recent correction and continued volatility, the long-term bullish outlook on equities in India remains intact. Fundamentally, even after factoring in the recent deterioration in the macro- economic environment domestically, India would continue to be among the fastest growing economies with a growth of around 8% in 2008-09. The GDP growth would be supported by the continued upturn in the investment cycle, spending on infrastructure and industrial capital expenditure. On the other hand, the demand push will be aided by boosting consumption through a lower personal tax and the implementation of the Sixth Pay Commission’s generous recommendations.

The reasonably decent Q4 results and expectations of a normal monsoon this year should provide the required trigger for bringing about a change in the overall market sentiment. Consequently, notwithstanding the volatility in the short term, we believe that Indian equity markets will provide handsome returns and outperform the other asset classes in the longer term. Keep the faith.

APRIL 2008:

Inflation fails to dent market mood

The Indian stock markets seem to be outperforming even as inflation is hitting new highs. India outperformed the emerging and Asia Pacific markets in April ‘08 after three successive months of underperformance finished the month as the sixth best performing emerging market.

However, India has been among the worst performing emerging markets since the beginning of the year and despite the strong performance in April, year to date, India ranks twenty third out of 25 emerging markets, according to Morgan Stanley.

According to the Morgan Stanley, FII flows in the future market remained strong in April ’08 for the fourth month running. Domestic institutions turned into marginal buyers after large scale selling in March. FIIs have bought $ 6.5 billion worth of stocks and derivatives since the start of 2008 (12% higher than the corresponding period last year) whereas domestic institutions have bought $ 1.6 billion.

In April, cash trading volume (number of shares) rose 8% month on month (MoM), after falling for three successive months, although it is still off 40% from its December 2007 peak. Trading volumes in value also rose by 3% MoM, but they are still 44% below is January 2008 peak. Market breadth gained a further 27% MoM in April but remains 27% below its January high.

SEURITY MARKET

1 st week of May ‘08 – trade on single day out of two – Sensex shoots up 313 points to 17,600

Inflation fully discounted again: Inflation rose yet again – to scorching 7.57% for the week ended April 19 – registering a 42-month high. However, there are some signs that the rise in the price index is moderating. Strong procurement of wheat to the tune of 154 lakh tonnes for the government’s buffer stock is likely to dampen inflationary expectations somewhat. Reacting to inflation numbers, Finance Minister provided hope by saying current inflation is likely to be contained.

It may appear that above a certain point, inflation is actually a good thing for the stock market. Even as inflation climbed to a 42-month high; Sensex shot up 313 points on Friday. Markets again discounted inflation concerns with global markets showing signs of stability. On 30 th April, the Reserve Bank’s surprise decision to keep the key lending rates steady in its annual monetary policy had cheered the market. Another major development was the Federal Reserve’s meeting on 30 th April. The Fed’s rate cut by 25 basis point taking it to 2% from 2.25% earlier followed by a surprise decline in US jobless rate only showed positive signs for economy after several months of stagnation.

Daily review

30/04/08

01/05/08

02/05/08

Sensex

17,287.31

0

312.81

Nifty

5,165.90

0

62.30

Weekly review

30/04/08

02/05/08

Points

Percentage

Sensex

17,287.31

17,600.12

312.81

1.77%

Nifty

5,165.90

5,228.20

62.30

1.19%

WEEK AHEAD:

The test’s over, now wait for reaction

Last week there were two economic events lined up – the RBI credit policy on 29 th April and the US Fed meeting on 30 th April, which were keenly awaited by the markets. Both these events passed off smoothly. Both these factors had a positive impact on our markets which saw both the Sensex and Nifty cruise in positive territory.

Moving ahead, the markets now seem to be in a more vibrant mood considering that two key macro economic events are through smoothly and corporate results are by and large positive, although profit margins in select sectors have been impacted by higher input and interest costs. Nevertheless, the sense is that despite competitive pressures, earnings growth for Sensex companies would still be in the range of 15-16% annually for FY09E which is attractive.

With the corporate results season getting more or less completed, the market focus would now hereon be on the forthcoming monsoons and how quickly the government reins in inflationary trends in the economy. However, inflation levels are likely to remain high for the next two to three weeks before we see some noticeable improvement. Also, currently the market sentiment is edgy and slightly cautious towards equities from all market participants such as FIIs, domestic mutual funds and HNIs. The retail investors may find opportunity to buy in to fundamentally strong companies that have lost ground significantly along with the market.

SEURITY MARKET

2 nd week of May ‘08 – Sensex down 4.90%

Daily review

02/05/08

05/05/08

06/05/08

07/05/08

08/05/08

09/05/08

Sensex

17,600.12

(109.22)

(117.89)

(33.70)

(258.66)

(343.58)

Nifty

5,228.20

(35.95)

(47.60)

(9.15)

(53.80)

(99.10)

Weekly review

02/05/08

09/05/08

 

Points

 

Percentage

Sensex

17,600.12

16,737.07

 

(863.05)

 

(4.90%)

Nifty

5,228.20

4982.60

 

(245.60)

 

(4.72%)

The capital market during the week mirrored the weak US market trends and closed on a negative note. Clearly, two events which impacted market sentiments were the unrelenting sharp rise in crude oil prices

– touching a record high level of $ 124 a barrel – and the rupee falling sharply by 3% in a span of just four days from 40.61 per $ to 41.74 per $ during the week.

Rising crude prices coupled with a weakening rupee, are definitely not good signs for India as these would lead to higher trade deficit since the country still imports 70% of its crude oil requirement. Already, Indian oil PSUs are losing around Rs 450 crore daily on account of under recoveries. Several user industry segments such as aviation, automotives, fertilisers, FMGC and pharmaceuticals are expected to bear the burnt of higher inputs costs as they go ahead.

Nevertheless, despite the short term pains, India still remains a strong economy and is now structurally in

a much stronger position, leading the people to believe that the GDP growth will still average around 9%

during 2008 – which is not bad as compared to other Asia-Pacific countries. Interestingly a recent research study by Barclays Wealth UK has indicated that India would become the eighth wealthiest nation by 2017 in terms of a significantly large number of Indians becoming dollar millionaires over the next decade with the entire wealth held by these households likely to total an estimated $ 1.7 trillion. A major composition of these assets is likely to find its way into financial assets, especially in Indian equities, which puts India in a sweetspot when compared to global peers.

WEEK AHEAD:

Markets attain normalcy as volatility subsides

The renewed stability in markets is here to stay, after months of turmoil, if indicators in the futures and options segment are any thing to go by. The volatility index or VIX on the NSE – an indicator of investors’ perception of future volatility – has sustained below the 30 levels for over a week now, for the first time since the crash that happened mid-January. The VIX is a measure of the amount by which an underlying Index is expected to fluctuate, in the near term, based on the order book of the underlying index options. India VIX is based on option prices of components on the Nifty 50 Index.

Usually, when market volatility is high, volatility index tends to rise. As volatility subsides, option prices tend to decline, which in turn causes volatility index to decline. Traders prefer options to futures in volatility times, as losses are limited in case of option buyers. In the beginning of this year, before the market crashed, Index was at 25-28 levels. The index thereafter jumped to over 50 levels in the last week of January and subsequently traded in 40s, with the benchmark Nifty melting roughly 30% from its high. On Friday, the volatility indicator closed at 27.53 points.

SEURITY MARKET

3 rd week of May ‘08 – Sensex up 4.17%

Daily review

09/05/08

12/05/08

13/05/08

14/05/08

15/05/08

16/05/08

Sensex

16,737.07

123.83

(108.04)

225.49

375.19

81.40

Nifty

4982.60

30.05

(54.85)

53.95

103.50

42.45

Weekly review

09/05/08

16/05/08

 

Points

 

Percentage

Sensex

16,737.07

17,434.94

 

697.87

 

4.17%

Nifty

4982.60

5157.70

 

175.10

 

3.51%

The rally during the week has cheered the bulls. However, the time gap between the market recoveries this time after correction has given them a reason to rethink if the rally will continue.

Past analysis has shown that the recovery time after the market corrects (nearly 15%) from their peak has been going down steadily. Market participants say this time around, the correction was quite steep and local and global sentiments were badly affected. Even if there is not much bad news that comes, it might take a while before the market touches its new peak.

WEEK AHEAD:

Momentum-driven rally

The Indian capital markets witnessed a typical momentum-driven rally last week with indices closing in positive territory. A large part of this momentum was triggered due to the continued depreciation of the Indian rupee during this week, taking the rupee to a low of $ 42.92 and finally closing at $ 42.53 by the end of the week.

The other soothing factor for the markets was the cooling-off effect from higher crude prices which, after touching a high of $ 126 a barrel, came off by 2% during the week to close at around $ 124 a barrel.

Both these developments were strong enough for the markets to overshadow the steep fall in IIP numbers declared, to 3% during March 2008, with annualised IIP numbers growing slower at 8.1% in fiscal 2007- 08 from 11.6% last year.

Experts estimate that Indian GDP growth is likely to slow down. On the positive side, however, they still maintains that India’s external fundamentals continue to remain robust enough to withstand a wide range of potential shocks, especially from sudden reversals in short term capital flows and any sharp global slowdowns.

On the domestic macro front also, expectations of a record wheat crop during the current year and arrival of normal monsoons a week ahead before the June 1, 2008, deadline are all positive indications that inflationary levels are likely to cool off in the near term.

However, the market rise during the last week was not supported by healthy volumes both from the FIIs and domestic mutual funds. Domestic institutional support is yet to be seen at current levels and FII flows are also not expected to rise significantly in the near term. So, during the week ahead, the markets are likely to move in a narrow range and continue to display edging in the absence of any new triggers.

SEURITY MARKET

4 th week of May ‘08 – Sensex down 4.50%

Daily review

16/05/08

19/05/08

20/05/08

21/05/08

22/05/08

23/05/08

Sensex

17,434.94

0

(204.76)

12.98

(336.05)

(257.47)

Nifty

5157.70

0

(52.75)

12.70

(92.20)

(78.90)

Weekly review

16/05/08

23/05/08

 

Points

 

Percentage

Sensex

17,434.94

16,649.64

 

(785.30)

 

(4.50%)

Nifty

5157.70

4,946.55

 

(211.15)

 

(4.09%)

With crude oil prices touching a high of $ 135 a barrel and the US Fed comments indicating slower economic growth with higher inflationary trends likely in 2008, the market agony is being tested to the limits. Incidentally, crude prices which came off by 2% last week, saw a spurt of almost 8% this week from previous week level, on news reports that US inventories of crude had depleted sharply.

Rising crude oil and food prices are proving to be a deadly combination for the US economy – increasing fears of a longer recession. Mirroring these fears, the US Markets displayed a high degree of nervousness and negativity during the week. The Indian markets last week continued to remain edgy and displayed a narrow range bound movement during this week with the indices closing in negative territory.

WEEK AHEAD:

Looking for triggers

Clearly, the present market mood indicates that everyone is keenly awaiting key positive triggers like good monsoons and lower inflation numbers to boost the present sentiment which has been impacted by a series of negative news flows coming in from rising crude prices, increased rupee depreciation and weaker US markets.

On the domestic macro front, the monsoons are bow keenly being awaited by the market as this remains the only big positive trigger in the short term. Also, with a higher agriculture growth expected this year, hopefully the rising trend in food prices, which has contributed largely to the sharp spike in inflationary levels, would get arrested. However, we may have to wait for at least a couple of months before we see some noticeable improvement here.

While valuations of most large cap stocks have turned reasonable of late, the short term upside potential has also been capped. This is also one of the key reasons that money flows – both from domestic mutual funds and FIIs – are lacking in a big way and this is apparent from the shrinking volumes both in the cash and derivative segments.

Trading in such shallow markets is extremely risky, with the risk reward ratio completely against market players and more so in a market which is extremely hungry for positive news flows at this point of time.

The Indian capital markets are likely to remain in indecisive mode and continue moving in a narrow range in the coming week until there is more clarity on near term domestic news triggers such as monsoons, inflation numbers and the rupee movement.

SEURITY MARKET

5 th week of May ‘08 – Sensex down 1.41%

Daily review

23/05/08

26/05/08

27/05/08

28/05/08

29/05/08

30/05/08

Sensex

16,649.64

(301.14)

(72.91)

249.78

(209.11)

99.31

Nifty

4,946.55

(71.50)

(15.25)

58.55

(83.05)

34.80

Weekly review

23/05/08

30/05/08

 

Points

 

Percentage

Sensex

16,649.64

16,415.57

 

(234.07)

 

(1.41%)

Nifty

4,946.55

4,870.10

 

(76.45)

 

(1.55%)

The Indian markets continued to remain volatile and directionless during the week with the indices closing in negative territory. More importantly, the market movement was driven significantly by domestic issues such as the quantum of oil price hike expected from the government, impact of rising petrol and diesel prices on existing high inflationary levels and increased volatility coming in the form of May F&O series which concluded on last Friday.

The US markets, however, remained moderately positive during the week consequent upon the Fed’s announcement of the Q1FY08 GDP growth being much batter at 0.90% from the earlier estimated 0.60% levels during April ’08. Also US home sale data during April ’08 for the first time saw a rise of 3.3% which has turned positive after a span of six months since October last year. Both these events had a positive impact on markets which saw the Dow closing the week on a positive note.

There is also good news on domestic economic front. The fourth quarter GDP growth for fiscal 2007-08 came in at a healthy 8.8%, taking the GDP growth rate for the year as a whole to 9%. First time since independence, the economy has grown at an average of 9.3% over a period of three years. Also, the RBI in a recent move has liberalised the ECB norms for inflow of external debt capital, clearly signaling the intent to rein the softening rupee and providing adequate liquidity to corporates to sustain growth in the current business environment.

The week ahead is a crucial period ahead for the markets while markets have largely discounted the high inflationary levels, the oil price hike is expected to be moderate and may not be very harsh on consumers.

MONTHLY REVIEW

Month

March ‘08

April ‘08

May ‘08

Date

31.03.08

30.04.08

30.05.08

Sensex

15,644.44

17,287.31

16,415.57

Points

Base

1,642.87

(871.74)

Percentage

Base

10.50%

(5.04%)

2.2

INDIAN ECONOMY

Sill on roll: GDP scores a hat-trick with 9% growth in FY08

The Indian grew at the rate of 9% in 2007-08, faster than the advance estimate of 8.7%, according to Central Statistical Organisation (CSO). The economic growth was 8.8% in the fourth quarter ending March 31, 2008, though interest rates at six year highs hit consumer demand and investment. The economy grew 9.7% in Q4 of 2006-07.

With this, the compound annual growth rate for the last four year has touched 8.9%. Growth averaged 9.3% over the last three years. The economy grew 9.6% in 2006-07 and 9.4% in 2005-06. These are historic figures and prompted finance minister P Chidambaram to confidently assert a GDP growth rate of 8.5% in the current fiscal. He also promised to take corrective measures to address the slowdown in manufacturing.

The total value of goods and services produced in the economy – this is what GDP measures – at current market prices stood at Rs 47.13 lakh crore. The population in 2007-08 stood at 113.8 crore, which yields a per capita GDP of Rs 41,416. At constant prices (1999-2000), the per capita income moved up to Rs 24,321, representing an increase of 7.8% during 2007-08.

Mr Chidambaram said: “It is matter of great satisfaction that 2007-08 has returned a growth rate of 9%. As the year progressed, doubts were expressed on whether we would complete the year with a growth of 9%. I had said on many occasions that the economy would grow at close to 9%. Now, it has turned out to be 9% and this improves the UPA’s average for four years at 8.9%.”

Economists feel that the strategy now being followed was not strictly a trade-off between inflation and growth. The external commercial borrowing norms have been eased a bit with rupee being in the comfort zone. The growth numbers are on the expected lines and matches the Plan panel’s and RBI’s forecast. The view now seems to be to drive growth while containing inflation. However, the current financial year is more difficult. Agriculture has grown by 4.6% to 4.7% in 2007-08. It would be difficult to grow on such a high base. Investment is going to continue to pose some problem of financing and some projects may get delayed. The ECB easing has been done to primarily address this. So we will grow, but needs to be seen at what rate as mood is not so upbeat.

Mr Chidambaram said: “the gross fixed capital formation in 2003-04 was 28% and 32.2% in 2004-05. This grew to 35.5% in 2005-06 and to 35.9% in 2006-07. Investment as a proportion of GDP has gone up by 9.3% in four years. This has never happened before in India’s history.” The minister said this growth coupled with rise in per capita means that more is available in the hands of people.

Reliance Energy finishes fifth of buyback The Anil Dhirubhai Ambani-controlled Reliance Energy has completed a fifth of its total targeted share buyback at a cost of Rs 400 crore. The promoters’ belief that shares were undervalued after the January crash in the stock market had prompted them to announce the buyback. Before January crash in the stock market, shares reached a high of Rs 2632. The company intends to buy back equity shares worth Rs 2,000 crore from the open market. As per earlier estimates, the transaction was to enable promoters to hike their stake by close to 2%. Since the commencement of the buyback on March 25, 2008, Reliance Energy has so far bought back 30 lakh equity shares. When a company buys back its shares from the open market, those shares are ‘extinguished’ and subsequently the shareholding of the promoters increases.

2.3

INDIA INC: EXPENDING HORIZONS

Billion-dollar club

It’s the first time the two stars of the new economy, telecom and IT, have managed to enter what was until now an exclusive preserve of the old economy. The fantastic four of new age India Inc – Bharti Airtel, Reliance Communications, TCS and Infosys – have finally made it to corporate India’s ‘Ivy League’. A league where the only way to gain admission is to post profits of over a billion dollars.

All four companies figure in list of 10 companies that generated more than $ 1 billion in net profit (PAT) during FY08 based on available results. Last year, a mere six companies managed to make the cut. With only 1,000 companies having declared results, there is a good chance that this time the list could see many more new entrants.

A detailed comparison between telecom and IT throws up some interesting facts about how these two new economy bellwethers got to the billion-dollar club. Though the two sectors have entered the list simultaneously, this mammoth milestone was achieved much faster by the two telecom Moghuls, Bharti and RCom, than it was by their IT counterparts, Infosys and TCS. This reflects the breathtaking speed with which the telecom revolution has taken place, given that it was software and not telecom that has been at the helm of the new age economy for much of the last two decades.

Bharti, which was incorporated in 1995, took 13 years to reach the mark, while RCom took just about four years after its separation from Reliance Group in 2004. Even if we consider the year 2001 when the Reliance Group decided to venture into the telecom space, RCom has taken just over seven years to post a billion dollars in profit.

In contrast for the IT industry it has been a long march. TCS which was incorporated in 1968 has taken over four decades while Infosys though faster still took a quarter of a century plus to reach the milestone.

However, in the euphoria following the success of the new economy, it would be unwise to forget that the list is still dominated by the old economy bellwethers. Reliance Industries, India’s biggest private sector company, is right there on top of the list with $ 4.8 billion and is followed by the country’s largest bank State Bank of India, which clocked $ 2.2 billion in profits.

Anil Agarwal’s Vedanta group has put up an impressive showing with both group companies, Sterlite and Hindustan Zinc, having broken into this listing. Among the 10 companies on the list, DLF, the real estate giant that was listed last year, saw the sharpest jump in its profits with RCom taking second place.

REC conferred Navratna status The government granted Navratna status to Rural Electrification Corp (REC), giving it financial and administrative autonomy. The department of public enterprises (DPE) has issued the order for giving the coveted status to REC, which will now be able to expand its electricity business in the rural areas. REC is working throughout the country with big network. It is a pioneer in the area of rural electrification. REC is the 16 th PSU to have been named as the Navratna firm. The company can now take decisions of investing up to Rs 1,000 crore or 15% of its net worth independently.

2.4

INDIANS > NETIZENS

49- million Indians logon to internet in 2008

Call it the democratisation of internet in India. Every one in 10 urban Indians (12%) is now net connected; over two-third (70%) of all internet users reside outside metros; and across urban and rural India. Internet using population is evenly spread across all socio-economic classes (SEC). What’s more, over 70% internet users prefer to access the net in Indian languages, with English users at just 28% down from 41% in 2007. The number of urban net users has increased by 33% in the last one year, 30 million to 40 million.

There are over 49-million internet users in the country. Urban users account for the bulk of it, 40 million, with rural net users numbering 9 million. Regular net users, defined as anyone accessing the net at least once a month, number around 35 million (30-million urban and 5-million rural). Internet penetration (as % of population) has crossed double-digit in urban India at 12%, up 3% from 9% last year, and rural penetration stands at 4.5% according to online research & advisory firm JuxtConsult’s ‘India Online 2008’ - an offline survey of over 12,500 households across 40 cities and 160 villages countrywide to gauge the online behaviour of Indians.

Surprisingly women account for less than a fifth, just 17.6%, of the 49-million odd Indian netizens. The females’ net representation is just marginally higher for urban India at 18.2%.

What explains this adverse female skew in internet usage? A seemingly unrelated figure in the survey may perhaps hold some clues. The survey says that over half of all net users (51%) in the country are salaries employees in the corporate world. Is internet’s low traction among Indian women a result of their lower representation in corporate jobs compared to men?

CA ads may create new category

In months to come, your tax consultant’s name might carry more snob value than the Louis Vuitton in your wardrobe. Courtesy the new advertising permissions by profession governing body, the friendly neighbourhood chartered accountant can now choose to morph into super brand.

India-based finance professionals including the CAs, and company secretary (CS), who have been allowed to advertise services and areas of expertise, are set to evolve as a new category in the advertising industry – one that is led by an individual as a brand. The decision by the Institute of Chartered Accountants of India to let their member advertise might unwittingly shift the advertising focus to individuals. If an individual can support large-scale advertising, it could emerge as a new category.

There will be significant impact when professionals advertise. Financial industry is one industry which is depends to a great extent on individual expertise. Also, financial product is one category where the common man requires huge amount to help in saving and planning investments. The guidance aspect is increasingly becoming important and hence the advertising around it is likely to evolve. People would want to know of a specialist who is ready to offer guidance services. Amarjit Chopra, chairman, accounting standards board said that advertising enables ICAI members to project themselves on a bigger platform rather than create a marketing blitz. “Initially, only mid-sized accounting and auditing firms are likely to capitalise on this (change of law). Small firms may not come forward aggressively since ICAI might allow advertisement only in print medium, which is very expensive.

2.5

FOREIGN INSTITUTIONAL INVESTORS

PE turns to open market as valuation tumble

With primary deals slowing down, private equity (PE) firms are tapping the secondary market route to pick stakes in listed companies. The PE firms are picking small stakes from the open market to either enter a new firm or increase their exposure in existing portfolio companies. In some cases, this strategy could be linked to bringing down the average cost of acquisition given that the PE funds originally invested in the respective companies when valuations were sky-high.

Some of the recent cases include buyout firm Apax Partners picking shares from the open market in healthcare services provider Apollo Hospitals, Standard Chartered Private Equity buying additional shares of M&M Financial Services and New Vernon in recently listed Shriram EPC. This apart, UK-based Promethean has picked shares from the open market in EIH, which operates the Oberoi Group’s hotels.

A strategy to pick shares from the open market is more commonly used by foreign institutional investors

who are typically stock traders and get in and out of a stock frequently. As against, this PE funds have an investment period ranging from 3-10 years and usually invest in a listed firm through a preferential allotment of fresh shares or other convertibles like warrants. The difference between the two routes of investment is that in the latter the shareholding pattern changes as the total number of shares increases. This could result in decrease in promoter holding unless they issue shares to themselves as well.

In case of Apollo Hospitals, Apex Partners picked 1.87% stake last month to take its total holding to 14.52%. It had originally picked 11.41% in Apollo Hospitals through a preferential allotment in October 2007. Apex had acquired this stake at a price of Rs 605/share in a deal worth Rs 426 crore. In contrast, its secondary market deals were struck at a price between Rs 505 and Rs 550 per share.

Blackstone is also believed to have taken the secondary route to hike stake in Gokaldas Exports. Blackstone, which had acquired a majority stake in the textile firm as a part of its buyout from the local promoters, had come up with an open offer for additional 20% stake. While it had acquired a 67.89% stake in total including the shares mopped up during the open offer, it added another 0.39% stake in April

to take the cumulative holding to 68.28% according to market disclosures.

The PE firms have taken the secondary market route not just to add stake but also to enter a new company. Last year, Promethean had picked a 8.5% stake in Nitco Tiles through open market purchases and had even secured a board seat in the firm. Moreover, sometime back the firm had also picked a minority stake in leading listed hospitality company EIH.

In some cases funds which sealed pre IPO deals also picked stake in the company after it went public. For

instance, New Vernon Private Equity upped its shareholding in the Chennai based engineering and construction company Shriram EPC, post-IPO. Before the IPO, New Vernon held 4.62% in Shriram EPC which had come down to 4.08% during the public offer. The PE firm picked another 1.06% on the date of listing of Shriram EPC.

Family businesses invite PEs as strategic partner Tight liquidity conditions may have dented private equity investments in large corporates, but closely- held family businesses in India are increasingly bringing in PE firms as strategic partners. Volume of PE deals in mid-sized family businesses has been growing sharply. Since, such businesses are more professional now. In India, PE funds have emerged as a growing option for funds as the young generation in business families are open to bringing in PE funds as strategic partners.

2.6

WARNING SIGNALS

Industrial growth slumps to 6-year low in March

The sharp drop in industrial production in March’08 to a six-year low of 3% may have triggered fears of a slowdown but economists are still holding onto an 8%-plus growth projection for 2008-09. The optimism among policymakers and economists, however, is not shared by industry players, who believe that high interest rates and rising input costs have started impacting demand.

High inflation, however, rules out any possibility of rate cuts to stimulate growth. Industrial production, as measured by the Index of Industrial Production (IIP), grew at a disappointing 3% in March 2008 compared to 14.4% in March 2007. As a result, industrial production growth slipped to 8.1% in 2007-08 from 11.6 in 2006-07.

The industrial slowdown is largely because of the sharp drop in manufacturing, which has a high weight in IIP. Manufacturing grew 2.9% in March 2008 against 16% in March 2007. Even electricity (3.7%) and mining (3.8%)

The industrial growth for March 2008 is the lowest since February 2002. But the government has very little leverage to boost growth. Crisil principal economist DK Joshi says: “In view of high inflation as well as inflationary expectations looming over the economy due to spiraling crude and commodity prices along with the depreciating rupee, maintaining price stability will be difficult task for the central bank. Thus, expecting any kind of rate cut is completely out of question.”

There is a silver lining, though, in that part of the drop appears to be because of the base effect – industrial growth in March 2007, the base for calculating growth in March 2008, was unusually high.

Rising inputs costs threaten growth

Despite apparent moderation in macroeconomic activity, corporate topline growth appears to be holding firm. Rising costs and higher extraordinary expenses have taken a toll on profitability though. An ET intelligence Group analysis of January- March 2008 quarter results of 799 companies’ shows net sales growth at 21.6% y-o-y, which is marginally higher than the topline growth in the previous two quarters, but lower than the 25.5% growth in the April-June 2007 quarter. Net profit growth has, however, fallen sharply in the January- March 2008 quarter to 18.8% against 40% in the previous quarter.

As expected, sharp increase in expenses, namely raw material costs, have caused operating profit growth (profit before depreciation, interest and extraordinary items) to fall sharply to 26.16% from more than 40% in the previous quarter. And unlike in the previous quarters where strong growth in other income provided support to earnings, in this quarter, growth in other income was a lot lower at 27.9%. The extraordinary expenses (read derivative losses) further ravaged the earnings. These charges on profit grew 130% to Rs 1,262 crore for these 799 companies.

Citigroup aims to sell $ 400-billion assets Citigroup, the largest US bank, said it aims to shed $ 400 billion of assets over the next two or three years, in a drive to become more efficient. Citi, hit hard by subprime mortgage meltdown and ensuing turmoil, said it has about $ 500 billion of “legacy assets”. It said it expects to reduce this amount to less than $ 100 billion within two to three years. Although Citi said previously it plan to shed assets to boost its capital position, the magnitude of sales worries analysts and is likely to prompt fresh speculation of a break-up of the Wall Street giant.

3.1

MUTUAL FUND

Fund houses are reiterating their positive outlook for the future

What goes up must come down. That’s the law of gravity for you. Investors in the stock market will be able to empathise with this maxim, given that at all that was earned in the last six months of ’07 was washed off with the first tsunami of ’08. The period from January to March ’08 can be described as ‘brutal’, with the Sensex and Nifty losing over 20% each since close on New Year’s Eve.

A bad quarter for the market justifies a bad quarter for the mutual fund industry as well. Almost all the mutual fund schemes have registered dizzying falls and posted negative returns in each of the three months of the quarter. Equity diversified or balanced funds, contrarian or sector themes, index funds or mid-caps – schemes across the board faced the wrath of a falling market. The falls have been pretty sharp, with net asset values of most schemes being eroded by 20-30%. However, monthly income plans (MIPs) and income schemes, which have little or no correlation with the equity market, have offered some respite. MIPs registered a marginal fall of 1-2% and income funds, though positive in the first two months of the quarter, disappointed in March. The damage, however, was not severe, with the fall in most schemes being less than a percent.

The market slowdown has hit the MF industry not only in terms of returns, but also in terms of asset collections. Through fund houses did not witness heavy redemptions, investor reluctance for fresh investments, both for existing and new schemes, was evident. The industry’s assets under management (AUM), at Rs 505,152 crore for March ’08, are the lowest in the past six months. But this setback has not dampened the spirits of the MF players. And there is more than one reason to justify this sentiment.

Despite low collections by the new schemes launched during January-March’08, the industry remains upbeat about launching new products. So, while ICICI Prudential launched its Focused Equity Funds, Sundaram has come out with theme funds, which target the banking and financial services sector, as well as the entertainment industry. Giving due consideration to the slowdown in the equity market and taking advantage of rising gold prices, AIG investment launched its World Gold Fund, which invest in stocks of gold mining companies across the globe. Reliance Quant plus Fund was also launched after the market crashed. It won’t be correct to call this a new launch since Reliance is converting its index fund into a quant fund. Quant uses mathematical models to select stocks, thereby reducing the sentimental risks of stock-picking. For those who trust machines over men to manage their money, these funds are just another step in the ladder of innovation in the MF sector.

So, be it bears or bulls, the MF industry seems unperturbed. MF industry’s confidence is reflected not only in the variety and number of products, but also in terms of the new players seeking entry into this business. Just 15 years ago, this industry was the oligopoly of a few public sector companies, the most prominent among them being UTI. Privatisation made headway only in 1993, with Kothari Pioneer being the first private sector fund house.

Today, we already have 33 MF players, which include well-known global asset management brands. And this number is still increasing. While Mirae Asset Management made its debut early this year, nearly a dozen new fund houses are set to launch their products in due course. These include Bharti-AXA, Religare-Aegon, Edelweiss, DLF-Prudential and Bajaj Finserv.

We’ve come far, but there’s still a long way to go. Even after 55 years of MF history, India lags global peers in terms of AUM and number of players. But the industry has many opportunities, which are waiting to be explored. Where on the one hand, there are many potential customers to be tapped, on the other, billions of rupees locked in pension funds are waiting to see the light of the stock market via MFs. With such opportunities on the horizons, the future’s bright for this industry.

3.2

COMMODITY MARKET

Futures ban no panacea for inflation: Assocham

The government’s decision to expand the ban on futures trading to cover potatoes, soyabean oil, chickpeas and rubber would not help in bringing inflation down, feel Indian Inc. The real culprit is virtual stagnation in food production since 1999, says a study by Assocham. The study says that rather than banning futures trading, the government should ensure high volumes and strong liquidity in the futures market to stabilise prices. The study comes close on the heels of a study by Planning Commission member Abhijeet Sen which has not recommended scrapping of the ban on futures trading in key commodities. After the report was submitted, the government expanded the ban on potatoes, chickpeas, soyabean oil and rubber.

“The ban on futures trading in rice and wheat has not helped. Prices of these foodgrains have only increased.” Assocham president Venugopal Dhoot said, “When experience shows results to the contrary, how can we expect the ban on items like potatoes and soyabean oil to help in reducing inflation.”

Without speculation, there is no opportunity for risk management. The chamber feels that “too much regulation” is hampering the functioning of the commodity futures market and this was highlighted in the case of urad and tur. Rumours of ban in trading drove away market-makers and this resulted in low volumes and wide price swings. “It is important to realise that futures market and physical markets are influenced by a common set of factors – supply and demand. An efficient futures market is merely a reflection of the future spot markets. Hence the ban on futures trading is devoid of economic logic.” While population is growing at 1.9% per annum, foodgrain production is stagnating. “Hence consumption of cereals has declined from a peak of 468 gm per capita per day in 1990-91 to 412 gm per capita per day in 2005-06, indicating a decline of 13%. In other words, the writing was on the wall and efforts should have been made to improve production and supply.

Is it a premature start?

Futures’ trading was reintroduced in India as part of financial liberalisation policy, which has been pursued since 1992. Being the last mile in the road to financial liberalisation, after all the other segments such as banking, capital markets, insurance, NBFCs and so on were opened up; the logical corollary was to extend the same to the commodity sphere. The response of the market has been quite remarkable as seen by the enthusiasm shown in all the commodity segments. The challenge has really been to take the benefits to the farmer’s level so that they can gain from futures trading. We have seen a fair participation of end-users in areas such as pulses, edible oils, cereals and spices, where processors and dealers are participating on the exchanges.

Farmers in some areas are gradually getting aware of future’s prices, which are being disseminated by the exchanges. This is an important step before direct participation, which is the final goal. Further, the exchanges have made some significant advances in the creation of infrastructure like warehousing, grading and assaying, which is in the short supply in the country. However, while the progress has been satisfactory, the absence of integration with the disparate spot markets is a challenge to overcome.

The important point here is that in any venture, especially as complex as commodities, there would always be problems in terms of misconceptions, absence of market integration, efficient price discovery and so. It is also true that in the capital market, the spot market developed before the derivatives market, which made things easier. In the commodity space, the derivatives have come before the so called ‘integrated spot market’. The route is different and probably difficult, but, a start has to be made some time. Therefore, no time is premature on the road of innovation.

4.

FINANCIAL SECTOR: TRANSFORMING TOMORROW

1. FINANCIAL ADVISORS:

Market mechanics

Weigh impact on investors

A zero sum game

There are no free lunches and money-making is never a simple task. Investment needs patience and discipline. One has to give time for the stocks to perform, as the share price is only a proxy of the financial health of the company, which unfolds gradually.

There is no reason why someone else should tell one to buy a stock. If by telling some one to buy the stock, share price moving up, it is to the advantage of the person giving the tips. The tipper is always interested to increase his share prices where he has some financial interest, or else he is distributing the shares. A broker makes money by either through buying and selling stocks. Following blindly the tips thus is a sure way to move to pits of doom.

When a retail investor buys a television or refrigerator, he checks three shops to get the lowest price. Similarly the retail investor needs to check why he is buying a stock, what that share represents. The effort to know the company does not mean the investor must know the financial performance of the company, but at least he must know if the company actually exists, whether they are profitable or not. The information is available easily through internet.

In summary, any investors in the stock market must understand that there is risk in the market to earn superior return. To judge the risk, he needs to be informed: he has to do the due diligence as he does to acquire any other assets. If he only follows tips, he is at the mercy of market, which is a zero sum game. Sooner he is going to lose, because someone at this cost has made the quick buck.

2. FINANCIAL PLANNERS

Value unlocking for all stakeholders

Retail shareholding shrinking

The share of individual investors in Indian companies has been shrinking steadily so much that the average individual shareholding in private sector companies has dipped to around 13% and public sector companies, about 2%. According to a study of top BSE 200 Indian companies, among private sector companies, Bharti Airtel (1.2%), GVK Power (2%), Educomp Solutions (2.1%), Sobha Developers (2.1%) and Tata Communication (2.2%) are languishing at rock-bottom levels with regards to individual shareholders. In the PSU list, National Aluminium, Hindustan Zinc, Neyveli Lignite, ONGC and SAIL have 0.7%, 1.5%, 1.5%, 1.7% and 1.8% respectively as public shareholding.

Policy changes over the years have played a major role in edging out small investors from the market. The concept of public listed companies has been hugely diluted. Public offer as a % of a company’s equity capital has been bought down from 75 to 25% and in some cases to just 10%. Taking a view on dwindling share of minority stakeholders, the Finance Ministry has floated a concept note, seeking public comment with regards to mandatory raising public shareholding (including institutional investors) from 10% to 25%. The move is expected to increase public participation, transparency and overall governance in the market. Currently, only 7 out top 200 Indian firms have public shareholding in excess of 25%.

3. WEALTH MANAGERS

MARKET MECHANICS

Map out the details to translate into benefits

Minimum required public float

The concept note had proposed that if for any reason, public holding reduces below 25%; the promoters, management and the company may be jointly and severally be liable to bring it to 25% within three months or face action including delisting.

The government now feels that three months is too short a time. It is now evolving a phase out schedule which is more workable and may not lead to sudden fall in share valuations due to offloading of promoter stake in one go. The stock exchange data show that despite reservation of 35% for retail at the public issue stage, the public hold about 13% of the capital. Therefore, if the government finally decides on 25% minimum floating shares, then a further dilution of 12% on an average has to be made. For this, the finance ministry is likely to grant around three to five years. The exact percentage to be diluted in a year would be finalised only after the government decides the minimum required public float.

Private placement, ESOP won’t count as public: The government also proposes to tighten the definition of public holding in a listed company. Promoters who disguise their stake by making preferential allotments to closely-linked companies, which are now classified as public holding, may soon lose this flexibility and may have to offload such stake in favour of the public. The new norms that the government is working may also strip employee stock options of the status of public holding as employees are closer to the company than the public. This would ensure that promoter and other entities closer to the promoter and enjoying greater rights than the public cannot eat into the public’s share in a listed company. The idea is to infuse more liquidity into the market and reduce volatility due to concentration of shares in few hands.

4. INCLUSIVE CEOs

Innovative responses to problems

Apply now, pay later

As part of its efforts to narrow the time between the allocation of shares in a public issue and their listing, the Sebi gave an ‘in principal’ nod to marking lien on bank account as an alternative mode of payment in public and right issues.

What this means is that the application money will remain in the bank account of the applicant till the allotment is finalised; thus eliminating the cumbersome process of refunds for the unallotted portion. Until the allotment of shares, the investor cannot use those funds even though no physical transfer of money has taken place at the time of application (of shares). Once the allotment is made, the registrar can instruct the bank to transfer funds, based on the number of shares that has been assigned to an investor, and remove the lock on the funds.

Sebi hope to eliminate the movement of instruments both ways – as application money and refund, thus hastening the whole IPO process. Sebi chairman CB Bhave, had said that he wants to kick off the primary market reform process exercise by cutting down the time between a company’s public issue and its listing from 21 days to seven days. The approval to marking lien on bank account should be seen as the first step in that direction. There have been innumerable instances of delayed refunds in the past, even in the public issues of reputed corporates. At times, the issue could be genuine, while often, the companies delay the refund process so that they can earn interest on those funds for some time.

Cross-margining

MARKET MECHANICS

In a move that will help stock market investors and brokers use their margin funds efficiently, the Sebi gave approval to cross-margining across the cash and derivatives segments.

What this means is that if an investor is buying a stock in which he already has a short position in the futures segment, he will not have to pay margin twice over. In its circular, the capital market regulator has said that for positions in the cash market that have corresponding offsetting positions in the stock futures, value at risk (VaR) margin shall not be levied on the cash market position. However, it will be only to the extent of the off-setting stock futures market positions.

For instance, assume that an investor wants to buy 1200 shares of ACC. He is already holding a short position of 1000 ACC shares in the futures segment. Any losses due an intra-day fall in the price of ACC shares will be neutralised by gains on the corresponding short-positions held by the investor in the ACC stock futures. This means that is the value of the transaction, that faces potential volatility risk, is of only those 200 shares (1200 shares minus 1000 futures) that do not have a corresponding short position. Accordingly, the exchange will levy the VaR margin only on two hundred shares.

5. TECH SAVVY PROFESSIONALS

Take first step to ensure efficient and reliable system

Fraud detection system

Call it a red alert for companies indulging in fraudulent practices. As part of its Gen-next e-governance initiative, the government is developing a system which will provide early warning signals on corporate frauds. The system will look for possible trends of fraudulent practices using company data filed with the ministry of corporate affairs.

According to estimates, India is losing a whopping $ 40 bn per year because of corporate frauds, which is more than 4% of the country’s gross domestic product. The early warning system, which is going to be mechanised in nature, will help ministry to detect frauds at early stages.

The ministry has begun working on the system after the successful launch of the MCA 21 initiative which provides both citizens and corporate an easy and secure on-line access to service including filing and registration. The ministry said: “As we have all the data in an on-line format, it won’t be difficult to analyse those and detect frauds at early stages”.

The frauds include those committed for the country, and those against the company such as embezzlement of funds and payroll frauds which, in turn, affect the bottom-line of a company. The proposed early fraud detection system would check the books of accounts to find out whether any company is resorting to fraudulent practices which will adversely affect interest of shareholders, employees and others.

At present, various government agencies including intelligence bureau under the ministry of home affairs, and Central economic intelligence bureau and financial intelligence unit, both under the finance ministry, detect frauds in financial sector. According to the initial concept, if the early warning system detects evidences or any trends indicating frauds or cheating, the ministry will have the right to initiate an inspection under the provisions of Companies Act, 1956. The data on frauds will also be passes over to various Central government agencies dealing with money laundering, auditing and other financial frauds.

6. CREDIT COUNSELORS

MARKET MECHANICS

Resolve convertibility and recompensation issue

Manipulation of shares on the first day of listing

Few investors had heard about the stock, fewer still took notice when it delisted from stock exchanges seven years ago. But on 21 st May 2008, when the share of ‘Royal Finance’ listed under a new name ‘KGN Industries’, it gained instant fame, and notoriety.

In what will go down as an outrageous to manipulate a low-priced stock, shares of KGN Industries (formerly known as Royal Finance) opened at Rs 72 and went on to touch an incredible Rs 55,000 within two hours on the first day of relisting; All this, with just 827 shares changing hands.

This wild swing in share price immediately caught the attention of the stock exchange surveillance department which suspended trading in the stock at 12.20pm. Surveillance officials then met in the evening to discuss the issue and made enquiries with the promoters about the price rise. Late in the evening, BSE issued a release saying further investigations will be carried out, but trading in the stock will resume on next day at an adjusted price of Rs 5,216.30.

The incidence has once again put the spotlight on the manipulation of shares on the first day of listing since the intra-day circuit filters are relaxed to enable better price realisation.

However, manipulators often use the opportunity to ramp up stock prices. Last year, capital market regulator Sebi had proposed to introduce a 20% circuit filter on the first day of relisting for companies that had undergone corporate restructuring. But the regulator is yet to take a final view on it.

Z group belongs to a list of violators

It appears to be a busy season for stock manipulators. On 21 st May, KGN Industries shares soared to an unbelievable Rs 55,000 on relisting after nearly seven years. A day later, another obscure firm, Sylph Technologies, which last traded at Rs 0.80 a share at the time of its delisting five years ago, climbed to an intra-day high of Rs 800 on relisting, before setting at Rs 200.

The common thread running across these cases in that both stocks figure in Z group of the BSE – the exchange’s hall of shame for firms violating listing norms – and both companies have no fundamentals worth mentioning.

While these two Z group stocks made headlines because of the bizarre levels to which they rose, brokers claim that price fixing is also routine in quite a few stocks in the T group – in which only delivery-based transactions are allowed – because of lack of liquidity.

In many stocks, the shareholding pattern disclosed to the stock exchanges is not what it appears to be. Shares held under the heading of corporate bodies are usually indirectly controlled by the promoters - either through own holding companies or those owned by close relatives. As a result, actual public holdings are very low, making the stocks an easy target for price rigging.

7. MICRO-FINANCE PROFESSIONALS

MARKET MECHANICS

Developing alternative credit delivery models

Portfolio management services

Sebi has enhanced the net worth requirements for entities providing portfolio management services. Now, an entity seeking to register as a portfolio manager will need to have a net worth of Rs 2 crore, four times the previously stipulated level of Rs 50 lakh.

Existing portfolio managers with a net worth of less than Rs 2 crore at present, will have to increase it to at least Rs 1 crore within a period of six months and thereafter to the prescribed net worth of Rs 2 crore in the next six months.

Also, portfolio managers have also been barred from pooling the resources of their clients and floating a scheme on the lines of a mutual fund. They would be required to keep assets of each client separately and not in a pooled manner. The portfolio managers have been given six months time to convert their operations managed on a pool basis to individual basis.

The portfolio management services (PMS) schemes are generally pooled in nature today due to the operational conveniences. The small ticket size like retail type are pooled and given the benefit of large size with diversification and economical way of handling. It facilitates buying and selling at ease in bulk providing the benefit of size, cost and time. The brokerage incurred on such large pool will be on wholesale basis, and therefore cheaper than retail brokerage. The purchases of shares are allotted pro-rata on the same day to all the clients. This also ensures minimum documentation and facilitates easy operations for the portfolio managers. Sebi’s new norm banning the pooling of clients assets by portfolio managers under their portfolio management services (PMS) has flustered most players who have cited increase in costs as well paperwork as key negatives to the move.

However, Sebi’s new norm has many positives to it:

For PMS clients, it clearly means more transparency. They will be able to track and trace trades and ensure there is no manipulation in their account. India’s capital market in the past two decades has many instances of the flagrant violation of regulatory norms for PMS by various market participants.

The new norms are also welcome at a time when the number of high worth individuals (HNIs) in India is sharply going up and the need for PMS is on the rise.

In a non-pool system, it would be very difficult for anybody to mask proprietary trades as client trades or proprietary losses as client losses.

Moreover, clients with higher portfolio values could now expect to get some level of customisation rather than get bunched up with the rest.

Also, due to the recent stock market boom, a number of small outfits have propped up providing PMS services, many of which followed lax reporting practices.

The new non-pool system automatically raises reporting standards.

8. RISK MANAGEMENT CONSULTANTS

MARKET MECHANICS

Educate – Engineer and Enforce

INDIA VIX

In a milestone for Indian stock markets, the National Stock Exchange recently launched the country’s first volatile index – India VIX. The index, also known as ‘investor fear gauge’ and ‘fear index’ reflects investors’ best prediction of near term market volatility. Till now, there was no indicator to predict market volatility or gauge the extent of uncertainty. But with the launch of VIX, this void has been filled. Here’s a lowdown on the intricacies of this index, and why you should follow it to gain that elusive insight.

VIX value provides the expected fluctuation perceived by the market over the next 30 calendar days. In India, it is calculated using the methodology adopted by Chicago Board Options Exchange (CBOE). CBOE offers volatility indices based on S&P 500, Dow Jones S&P 100, NASDAQ, and Russell 2000.

From the near and mid-month options bid and offer prices of Nifty 50 index options, a volatility figure is calculated which denotes the expected volatility in the near term. Typically a high VIX (increased volatility) is taken as an indicator that investor fear has increased, whereas a low value is interpreted that investors are being complacent.

The volatility index starts rising during times of financial stress and lessens as investors become complacent. In fact, during period of market turmoil, the VIX spikes higher, largely reflecting the panic demand for puts as a hedge against further declines in stock portfolios. During bullish periods, there is less fear and therefore less need for portfolio managers to buy puts. Currently, VIX index is not tradable in the Indian market and its rates are provided at the end of the day.

Why track?

Market moves are a function of sentiment and one of the indicators of sentiment is volatility. Increase and decrease in volatility are always a signal of the extent of fear within the sentiment.

For instance, when the fear is high, volatility is always high in the stock markets. India VIX indicates how traders and investors feel about the immediate future.

As a retail investor, you can plan effective entry and exit in stocks.

The volatility index is more relevant for short-term investors and traders, who are reliant on market sentiment to a large extent. However for a long-term investor, the underlying fundamentals are more important from a medium to long-term perspective.

An investor can utilise the volatility index for multiple purposes. It depicts the consensus of the market on the expected volatility and is helpful in predicting market uncertainty. An investor can balance his risk taking help of VIX. Further, you can use it for identifying mis-priced options. For instance, if VIX rises sharply, you can avoid taking long position in derivative products. You can also use it as guiding instrument for hedging portfolio, by buying options.

However, cautions using it as a sole indicator to predict the market direction. VIX is only one of the sentiment indicators that guides in market direction.

9. CONTINUING LEARNING CENTRES

MARKET MECHANICS

Take informed decisions

Pyramiding:

Portfolio leveraging is a method of raising loans where investors leverage on their own fund portfolio to raise a loan that will be reinvested in the market, either in mutual funds or stocks.

Super portfolio leveraging is leveraging again on an already-leveraged portfolio, also called pyramiding are done by investors who have high return funds, stocks and gilted instruments. The investor is safe till the time the portfolio yields decent returns – more than the interest payable on the leveraged portion.

The more money you have, the more debt you take is an old adage that is coming into play in portfolio leveraging. According to analysts, investors had pledged their fund portfolios when the market and the NAV of the portfolio were at the peak. Investors had taken loans from NBFCs attached to their brokerages to extend their presence in the market.

According to fund managers, bulge-bracketed investors pledged their mutual fund portfolios – often run into crores of rupees – to reinvest in mutual funds and stocks. With mutual funds logging huge losses and equities maintaining a downturn, big-ticket investors have become willing victims to MF leveraging.

Adding to their woes, MFs have logged their worst quarterly returns in over a decade. The entire spectrum of equity mutual funds has seen erosion in returns of 20-55% over three months. When the NBFCs see the value of underlying asset depleting, they ask the investor to meet the differential in hard cash. If the investor fails to do so within the deadline, the NBFC asks its broking arm to redeem the entire portfolio.

10. ONE-STOP-SHOPS

Dedicated to offer related services under a roof

PO small saving rates may be on par with banks

There’s good news for those investing in post office small savings schemes. The government is considering an increase in interest rates offered by these schemes to bring them on a par with fixed deposit schemes of commercial banks. Interest rates offered by post office small savings schemes range from 3.5% to 7%, depending upon the term of deposit, while banks offer about 8.5% interest on similar schemes. Only term deposits for more than six years earn 8% in the case of post office while comparable schemes of banks offer 9.5% to 10%.

There has been a sharp fall in the post office small saving schemes, particularly in the term deposits, monthly income account and senior citizen saving schemes continuously for the past three years. Unless interest rates of small saving schemes are revised upwards, there may not be any change in the present situation due to which post office small saving schemes will keep losing their attractiveness rapidly.

The government has recently taken some steps to make postal savings attractive and this includes a 5% bonus on monthly income scheme (MIS) and tax exemption on investment in 5-year term deposit and senior citizen schemes. These measures, however, have not proved sufficient to bring the shine back on post office small savings. Very few people in rural areas come within the income tax net and tax benefit does not appeal to them, it is felt.

11. GLOBAL OUTLOOK

MARKET MECHANICS

World is a village

Black money in grab of FDI

Many Indian businessmen have discovered that the neatest way to bring back money stashed abroad is to show it as foreign direct investment (FDI) in a small unlisted firm that few would notice. It involves a string of transactions that not only escapes the regulatory radar but also has a touch of legitimacy. But just when they seemed to have perfected the practice, small change in banking rules could complicate matters for such money laundering.

The laundering trail, honed by experts in tax and foreign money laws, begins with a simple overseas investment allowed by the Reserve Bank of India under its liberalised remittance scheme. The investment, which can be up to $ 200,000, is made to float a shell company in Dubai’s Free Trade Zone. That’s the first step. Owning such a company is no big deal – no tax is paid, regulations are simple, and hundreds of professionals are available to tell you how to go about it.

Once done, the undisclosed money lying with banks in the tax havens in other parts of the world is brought into the Dubai Company, which just holds it in a bank account. The next step is to bring the money back home. And here lies the shady ingenuity of the transaction.

To make this happen, the protagonist of the story, whose money is now lying with a Dubai company, sets up a firm anywhere in India or uses one of its existing unlisted firms to get the money back. The way this happens is that the Dubai Company buys the shares of the Indian firm at a hefty premium. A high premium allows you to bring in as much as money as possible, and also ensures the firm’s capital post- transaction is within the authorised capital, so that no extra charge is paid to the local authorities.

The money that comes in is the form of FDI through the automatic route, where the inflow is not scrutinized by the government agency or the Foreign Investment Promotion Board. With this, the Dubai Company becomes the predominant shareholder of the firm. The final step is buying out the shareholding of the Dubai Company. This happens after a year to avoid suspicion. However, when the Indian firm buys out the Dubai Company – a transaction that restores control back to the local shareholders – it pays only a small fraction of the price it received a year ago.

12. ISSUES OF THE PRESENT

Freedom to get & fail in the system of free enterprise

ILLIQUID securities

The Home Trade scam that rocked the bond market in 2002: besides reaffirming the banker-broker nexus in a chain of deals, exposed co-operative banks as the financial system’s weakest link. Six year later, the rules of the game have changed; cooperative banks have cut new deals while the same tribes of brokers have found ways to mask their identities and the smarter ones have spotted smaller banks to dump illiquid securities. The latest mischief has drawn the RBI’s attention.

Since April ’08, a team of RBI auditors has been inspecting the investment books of co-op banks in Gujarat to trace irregular transactions between brokers and entities controlled by the intermediaries.

MARKET MECHANICS

The move followed a tip-off from Nabard, the apex institution for rural credit that Orissa State Co-op Bank has taken Rs 30-crore hit after buying ‘deep discount bonds’ at prices way above the market price.

Further enquiries by Nabard revealed that state co-op banks of Himachal Pradesh and Karnataka have cut similar deals, though their sizes were smaller. These co-op banks have bought zero-coupon deep discount bonds from brokers at off-market rates. These are long-dated papers (10-20 years) issued and traded at a big discount from par value. Paying Rs 70 for a bond that on maturity will give Rs 100 may appear as a profitable deal, but it isn’t. The fair value – which can be calculated in standard excel sheet formats – can actually be Rs 60. The broker or its front entity may be buying the paper at Rs 60 or below only to palm it off to a co-op bank at Rs 70. Here, the bank takes a mark-to-market hit of Rs 10. Indirectly, the co-op bank ends up funding the broker.

Z-security syndrome

The recent abnormal price movement in a couple of stocks that relisted after a gap of many years again underscores the need for more firmness in dealing with the ‘Z’ group stocks of the Bombay Stock Exchange. Ii is time Sebi and the stock exchanges came up with an equitable strategy of cleaning the ‘Z’ group – it houses thousands of companies that are in default of the listing agreement or are perceived to be risky because of their weak fundamentals – that sees frequent price manipulations.

KGN Industries stock recently relisted after nearly seven years at a price of Rs 72 and subsequently soared to Rs 55,000 on thin volumes. Sylph Technologies, last traded at Rs 0.80 a share five years ago, climbed to an intra-day high of Rs 800 on relisting. Clearly, something is amiss here; fundamentals do not justify these prices. KGN Industries reported a profit of Rs 1.5 crore for 2007-08 while Sylph had a turnover of Rs 15.8 lakh for quarter ended March 2008. Obviously, low floating stock, because of fewer dematerialised shares available, has made manipulation easier. BSE is investigating the case. It should not allow trading in such stocks where floating stock is limited, even if temporary.

5.1

BANKING PRACTICES

ICICI loan paper

ICICI Bank-originated securitised paper has been downgraded by rating agency Crisil, following higher- than-expected defaults. The rating agency said that it has downgraded the securitised paper issued by largest private bank ICICI Bank, which comprised personal loan and car loan. According to sources, a large chunk of these securities are currently held by mutual funds.

The two series of pass-through certificates – A13 and A14 – in the asset back securities (ABS) pool were issued by ICICI Bank in March 2007 have been downgraded from ‘AAA’ to ‘AA’. The outstanding amount in the series A13 was Rs 105.73 crore and it has a residual maturity of 33 months while that in case of A14 was Rs 98.23 crore with a residual maturity of 43 months. Meanwhile, rating to 16 other PTCs in the ABS pool has been reaffirmed to ‘AAA’.

In a statement to media, Crisil has said, “Delinquency levels for the pool in the 12 months since securitisation have been higher than expected, with collections significantly below expectations. This has led to the rating revision on series A13 and A14, which have longer tenors than the other rated PTCs. However, at ‘AA (so)’, the PTCs continue to enjoy a high degree of credit protection.”

In its recent reports on retail assets, Crisil had noted that delinquencies, across all retail asset categories, have gone up and is likely to further increase in 2008-09. It said that housing loans constitute over half of the total retail loans in India. Gross NPAs in home loans increased to 2.2% in March 2007 from 1.8% in 2005, while Crisil expects these to increase to 2.7% in 2008-09. Car and commercial vehicle asset segments comprise of one-third of total retail loans. Crisil has estimated that gross NPAs in these segments in 2008-09 would be around 3% for car loans and 5.5% for commercial vehicles.

RBI pulls up ICICI over I-Venture investments

The Reserve Bank of India has taken a tough approach to the largest bank ICICI’s investments in ICICI Venture – the country’s biggest private equity fund. The regulator feels ICICI may be using its venture capital arm to make investments that could have been difficult to fund from the bank’s book. Besides, owning I-Venture, ICICI Bank also invests in some of the funds managed by the fund. Just as in mutual funds, a string of financial investors subscribe to such funds where the bank also join in. RBI told ICICI Bank to include its investment in the PE fund in fulfilling the exposure limits that the bank has to stick to.

Under the prudential norms, the maximum exposure a bank can have to a company or a business group is linked to its capital. Earlier banks used to float non-banking finance companies (NBFCs) to sidestep this regulation and lend to corporates. This was stopped last year, when RBI asked banks to treat lending by their NBFCs as part of the consolidated financial statement. RBI’s argument was that an NBFC owned by the bank should not be used to do business which the bank can’t.

But in case of I-Venture (which manages assets of $ 2 billion), RBI is taking a stricter stance. A fund which manages third-party money is not an NBFC. It’s more akin to an asset management company of a fund house. Nonetheless, RBI has spelt out its stand in meetings with senior officials of the ICICI group.

Crisil lowers rating for ICICI CV loan: Credit rating agency Crisil has downgraded the commercial vehicle loan receivables originated and serviced by the country’s second largest bank, ICICI Bank. The rating have been downgraded by four notches to BBB+(so) from AA-(so). The lowered rating indicates a moderate degree of certainty regarding timely payment of financial obligations on the instruments.

Derivatives deals set to become tougher for banks

BANKING PRACTICES

Banks will have to organise more capital and make higher provisioning (that could lower their earnings) for off-balance sheet exposures like currency, interest rate swaps and options they enter with corporate clients. Derivative losses announced by a string of corporates and their refusal to pay has led the Reserve Bank of India to propose accounting changes that would protect banks’ books in the long run.

According to the draft guidelines issued on 30 May, 2008, banks will also have to treat overdue receivables under derivative positions just as they treat bad loans, better known as non-performing assets.

The combined impact of the guidelines would be that the same derivative position would require five times as much capital as it did earlier. Also profits of banks, whose clients are delaying derivative related payments, will take a hit as they will now have to provide for the overdues.

Forex derivatives are contracts that allow borrowers to take a position in a currency. Although the purpose of derivatives was to insure against forex risks, some corporates increasingly used them to take currency bets. When the bets went wrong the corporates ended up owing money to banks. This money due will now have to be treated as a loan falling due.

Classification of the overdues as bad loans will hurt the borrowers as fresh loans will be denied to them and they risk debt recovery proceedings.

Bankers said that institutions following Basel II norms will only be marginally affected as they already adhere to the stricter exposure norms. Internationally active banks such as State Bank of India, ICICI Bank, Bank of Baroda, Axis Bank and Bank of India are among those already following Basel II norms. However, even these banks would require additional standard asset provisioning that is prescribed for all derivative exposures.

Bank differ on pension hit

Banks are divided over ways to provide pension liabilities according to new accounting norms that mandate disclosure. While some bib banks have dipped into reserves and taken a one-third hit, the others have decided it over five years. Experts are of the opinion that given greater capital adequacy requirement of banks, a one-time hit may not be preferable. State Bank of India, Union Bank, Canara Bank, Punjab National Bank and others took a one-time hit on reserves while adopting the new AS-15 norms, others such as Bank of India and Bank of Baroda have been amortising the hit over five years.

Analysts feel, “Since banks have stringent capital adequacy set under Basel II, a sudden hit on their reserves was not preferable and, in some cases, would probably have meant falling foul of their capital adequacy requirements. However, some top bankers said, “There is no point in being over-capitalised. We can afford to dip into our reserves and take a one-time hit. Going forward, we will only need to make provisions for the current year.

For banks, the revised accounting standard for employee benefits is set to impose a huge burden. Their existing liability is estimated at a staggering Rs 26,000 crore. Because of AS -15 accounting methods the new standard necessitates, this liability is likely to go up by another Rs 14,000 crore.

BANKING PRACTICES

Prior to the revised norms, banks were not mandated to provide for their pension liabilities and disclose it in their balance sheets. Therefore, banks were under no compulsion to regularly fund their pension liabilities. This would have ultimately resulted in huge unfunded pension obligations which banks might have found difficult to honour.

When a company first adopts the accounting standard AS -15 (revised 2005), it is likely that the net asset or liability recognised on the balance sheet under this revised standard is different to that recognised on

the balance sheet under the old AS-15 (1995) standard. This is called the transitional asset/liability and is

to be adjusted against the Company reserves.

A transitional asset must be recognised against reserves immediately. Some banks have therefore used the

limited revision to the AS-15 (revised 2005) standard and have spread the hit on their reserves to be recognised over 5 years. Any transitional liability not recognised against the reserves is still required to be disclosed as an unrecognized liability.

For example, Punjab National Bank has dipped into reserves for Rs 1,600 crore to provide for new accounting norms for pension liabilities, instead of staggering it over a period of 5 years. Despite this, its capital adequacy ratio as per Basel II norms stands at 13.46$%. Going forward, the bank only needs to provide for the current year’s pension liability.

Bank of Baroda made a provision of Rs 180 crore against its profits for employee benefits under AS-15 and also made a provision of Rs 100 crore for salary arrears.

6.1

TAX UPDATES

TDS on rental income: Taxpayers need not deduct tax at source on service tax component of rental income. In a move that is expected to reduce tax liability of a large number of taxpayers, the CBDT has said TDS would be required to be made on the amount of rent payable without including service tax. The recent circular issued by the CBDT says: “Service tax paid by the tenant doesn’t partake the nature of income of the landlord. The landlord only acts as a collecting agency for government for collection of service tax. Therefore, it has been decided that the TDS u/s 194-I of the Income Tax Act would be required to be made on the amount of rent paid/payable without including the service tax”.

Service tax on forex trade:

The foreign exchange business was in a tizzy on 16 th of May ’08 as a service tax on forex broking services came into effect. For retail customers, the levy makes buying and selling forex more expensive as most banks have hiked rates on transactions. The notification issued by CBSE says both ends of the forex transaction, buying and selling, would be taxed, on the lines of the securities transaction tax – a transaction tax applicable on trades in the stock market.

Wholesale dealers of forex like banks and full-fledged money changers (FFMC) say, this would make the business unviable and complex. “Margins on large forex transactions are wafer-thin, between 0.35% and 0.75%, and if 0.25% of this is paid as tax, there is nothing left. Small forex outfit, called restricted money changers in the RBI classification, have begun charging customers at either 0.25% of the transaction cost or a flat processing fee plus 12.36% of the fee as a service fee. The fixed fee varies between Rs 100 to Rs 500 depending on the size of the transaction.

Service tax notices on BCCI: It’s double trouble for the Board of Control for Cricket in India (BCCI). The service tax department has issued summons to the premier cricket body seeking information about the services rendered by the body as event management, advertising and details of its franchisee arrangements. Summons are primarily issued to extract information from an assessee and is legally binding unlike the show cause notice. BCCI had come under the scanner of the service tax department soon after the IPL auction.

Industry chambers liable to pay service tax: CBEC: Industry and business chambers are liable to pay service tax. The Central Board OF Excise and Customs clarified that the trade association falls within the scope for ‘clubs and association services’. The board said that the services provided by these associations are not of charitable, religious or political in nature. They collect membership fees and other charges from their members and they work for the interest of trade and industries. Therefore, they do not have objectives which could be categorised as public services.

Service received from Group Company must trigger tax payment: Companies that source services from associate companies will now have to pay service tax even before they make adjustments of the payments in their books. This follows an amendment in Finance Act, 2008. The amendment provides that service tax liability has to be discharged where the service is provided to an associate enterprise even if no payment is received, provided the amount for such service is credited in the books of the service provider.

Reforms on track: CST reduced to 2% from June Ending uncertainties over the major tax reform initiative, the central government notified reduction in Central Sales Tax (CST) to 2% from June 1 as compared to the current 3%. CST, which was reduced from 4% to 3% on April 1, 2007, was to be slashed to 2% from April 1, 2008. The reduction could not be carried out with both central and state government falling to agree on the compensation package.

6.2

INTERNATIONAL ACCOUNTING STANDARDS

In a major step to avoid any hardship to nearly 200 Indian firm listed on European bourses due to ‘differences’ in Indian and EU accounting norms, the government on late Saturday, 10 th of May 2008 announced its decision to adopt international accounting norms.

This salvages these firms that have raised capital from EU investors from any tough action that EU might have taken for lack of compliance with globally accepted accounting standards. Non-compliance would have forced these Indian firms to either get their securities de-listed from EU exchanges or get their book re-audited by audit firm in Europe. This would have added compliance cost manifold for Indian firms, which are the largest non-EU companies that have raised capital from the trading block.

EU had announced it would examine the equivalence of accounting standards followed by non-EU countries during 2008 and would spare companies from any tough action only if their home countries adopt a convergence programme.

The statement by ministry of corporate affair is aimed at assuring the EU of India’s plans to converge with international financial reporting standards (IFRS) by 2011. These standards issued by the International Accounting Standards Board (IASB) are adopted by about 100 nations.

Since India has already adopted a programme of convergence with IFRS, a public confirmation of the approach leading to convergence with IFRS would enable EU to determine equivalence of Indian accounting standards, the ministry stated.

Global accounting standards help M&A

The judiciary may soon have a lesser role in dictating the way corporate houses show valuation of companies they acquire. Come April 2011, the country is all set to adopt global accounting standards making it easier for India Inc to get large valuation M&A deals executed without the court breathing down their necks.

The present rules put the courts at a higher pedestal over the prevalent accounting standards. The ministry of corporate affairs along with the apex accounting body ICAI is working on harmonising the legal and other regulatory requirements with the International Financial Reporting Standards (IFRS). IFRS does not recognise the judiciary prescribing accounting policies which are highly technical in nature.

Under the present regulatory mechanism, the companies which intend to enter into M&A agreements first apply before the concerned High Courts seeking permission to hold a shareholder meeting and subsequently to execute the deal. The process could drag for several months before the courts approve such M&A agreements as it involves considering the interests of all stakeholders including lenders and minority shareholders.

Even as the courts have been given wide powers to examine the procedural formalities as well as for evaluating the financial position of the companies, on several occasions courts have taken view divergent to the prevailing accounting standards. Now, the scenario wherein the existing accounting standards had to make way for judiciary prescribed accounting treatment is soon to change. IFRS has laid down extensive accounting regulations relating to business combinations including amalgamations and acquisitions.

INTERNATIONAL ACCOUNTING STANDARDS

In India, it is generally believed that law overrides accounting standards. Therefore, accounting is done based on treatment stipulated by the High Court in its approval, even though it may not be in accordance with Accounting Standards. The harmonisation of IFRS with Indian Accounting Standards is at a deliberative phase wherein ICAI is formulating a work plan to ensure that the regulatory provisions of the globally accepted accounting norms are adopted in India from April 1, 2011.

Disclosure norms for derivatives

Companies will soon need to disclose the nature and extent of risks arising from the financial instruments they hold and the steps taken to manage such risks. In a step which is likely to give shareholders a clearer picture of the health of the company they own, accounting regulator ICAI on 16 th of May ’08 approved a new accounting standard on disclosure of all sorts of financial instruments. It would also keep investors abreast of the steps taken by the companies to guard against potential financial losses.

Companies are recommended to disclose these details from the beginning of next fiscal. The accounting standard AS-32 pertaining to disclosure of financial information will become mandatory from April 1, 2011. These norms are based on international financial reporting standards, which India has formally decided to adopt. Compliance to these standards would become compulsory from 2011. Disclosure of the ‘financial engineering’ of companies allows shareholders to make informed decisions.

AS-32 follows two other accounting standards (AS-30 and AS-31), wherein the regulator had laid down rules pertaining to recognition and measurement and presentation of financial instruments by companies. ICAI president Ved Jain says “AS-32 will bring greater transparency in disclosures related to financial instruments such as derivatives and how the entity manages risks associated with such a portfolio”. He also expressed hope that the new norms would be a step towards empowering the citizens.

Prudent reporting builds confidence

Much has been written and debated about the recent announcement by Institute of Chartered Accountants of India (ICAI) that encourages early adoption of accounting standards on recognition and measurement of financial instruments (AS 30).

The announcement further mandates that those companies which do not adopt AS30 should measure and recognise unrealised losses on financial instruments using the principles of prudence, as explained in accounting standard on disclosure of accounting policies (AS 1).

AS1 states that in view of the uncertainty attached to future events, profits are not anticipated but recognised only when realised, though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information.

Therefore, as per principle of prudence, corporates with outstanding financial instruments, and which have not adopted AS 30, will need to measure unrealised gains/losses on financial instruments and record unrealised losses while ignoring unrealised gains.

Companies recognise uncertainties that inevitably surround many events and circumstances by disclosing their nature and extent and by exercising prudence in preparation of financial statements.

INTERNATIONAL ACCOUNTING STANDARDS

Prudence is the extent of caution used in making estimates, required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated.

However, the exercise of the prudence does not allow creation of hidden reserves or excessive provisions or deliberate understatement of assets or income or deliberate overstatement of liabilities or expenses.

Frequently, assets and liabilities are measured in a context of significant uncertainties. Determining a loss or liability using prudence does not imply absolute certainty or precision. Sometimes, a range of an estimate could convey information more reliably than can a single estimate. Taken as a whole, financial statement users prefer that possible errors in measurement be in the direction of understatement rather than overstatement of net income and net assets.

All accounting frameworks recognise that a difference between an estimate and an accurate measurement may be material in one context and not material in another. Consequently, what constitutes a significant loss or gain may vary and thereby, may be impacted by the precision of estimate of losses and liabilities.

When evolving times, the convention of prudence, which was once commonly expressed in the admonition to “anticipate no profit, but anticipate all losses”, too has evolved. For instance, who are the principal external users of financial statements, understatement for its own sake is widely considered to be desirable, since greater the understatement of assets, greater the margin of safety the asset provided as collateral. However, with periodic reporting it is evident that understated assets frequently lead to overstated income in later periods.

ICAI’s announcement requires companies, using the principles of prudence, to record unrealised losses on derivatives, whilst ignoring unrealised gains. However, accounting standard on foreign exchange (AS 11) allows recognition of unrealised gains on certain foreign currency items. Similarly, AS 30 also allows recognition of unrealised gains on assets available for sale or held for trading. Therefore, conceptually this would insinuate that the principles of prudence and recognition of unrealised gains are not meant to be mutually exclusive.

To conclude, in uncertain times the best way to avoid the injury to investors that imprudent reporting creates is to try and ensure that what is reported represents what it purports to represent. The reliability of financial statements is enhanced by accounting and/or disclosing the nature and extent of the uncertainty surrounding events and transactions reported.

In assessing the prospects that as yet incomplete transactions, such as outstanding derivatives, will be concluded successfully, a degree of scepticism is warranted. The aim must be to put the users of financial statements in the best possible position to form their own opinion of the probable outcome of the events reported.

Prudent reporting based on a healthy scepticism builds confidence in the results and, in the long run, best serve all the divergent interests of different constituents.

6.3

RELAXED CAPITAL CURBS

Easier access to foreign investor: Listed foreign companies with an asset of not less than $ 2 billion and a profitability record, and foreign individuals with a minimum net worth of $ 50 million can now trade in local stocks. They can operate as sub-accounts, where FIIs registered in India manage the investments. Sections in the market, however, feel that the $ 2 billion floor may be a little too high. The changes introduced by capital market regulator Sebi would also enable more overseas entities to invest as sub- account of FIIs, foreign portfolio managers take to collective investment schemes like art funds, and FIIs to issue participatory notes (PNs) to entities like some hedge funds.

Till now, sub-accounts, on whose behalf investments are made in India by an FII, had to be primarily broad-based. This meant sub-accounts had to have at least 20 investors, each with 10% ownership. Now, a sub-account investor can have as much 49% stake, which would make it possible for just 3 investors to form a sub-account – two with 49% stake each and one with 2%. This is over and above any foreign individual or corporate setting up a sub-account where it is the sole member. Significantly, the new regulations will also allow NRIs to set up their own advisory companies and get the funds registered as FIIs with Sebi. Here, the NRI acts as the fund manager while the investors are foreign nationals and corporates. Sebi has received several applications from such entities.

“Relaxed Sebi norms for FII investment would enable more overseas entities to invest in Indian stocks through sub-accounts. The change would allow NRIs to register as FII and manage funds, enable FIIs to issue PNs even to some hedge funds and permit foreign portfolio managers to invest in collective schemes such as art fund.”

External Commercial Borrowings: Resource constraints infrastructure companies and corporate houses can now raise more low-cost funds abroad and repatriate them for domestic spending. The finance ministry eased the ceilings on ECBs by companies. From now on, infrastructure companies could raise ECBs up to $100 million for domestic expenditure in rupee, up from the existing cap of $20 million. Other companies will be able to bring into India up to $50 million, up from $20 million.

“The increase in limit on overseas borrowing for rupee expenditure from $ 20 million to $ 50 million ($ 100 million for infrastructure) together with 50 basis point higher interest ceiling of 200-basis point over Libor makes borrowing easier, particularly for smaller companies. But given the global credit crisis and the uncertainties in the Indian economy, it is unlikely that easier norms foe ECB and FIIs would make overseas borrowing easier for Indian companies or cause portfolio inflows to accelerate. Credit market conditions have deteriorated in the US and other major market, which means funds, may not be easily available even at higher permitted interest rates”.

Government and corporate bonds: The government also raised the ceiling on foreign investments into government and corporate bonds, in a bid to deepen the band market. The idea is to enhance volumes in the debt market and evolve it as a reliable means of raising resources, particularly to improve infrastructure and sustain economic growth.

“The increase in FII investment limit in corporate bonds ($ 3 billion from $ 1.5 billion) and government securities ($ 5 billion from $ 3.2 billion) is unlikely to have an impact in the near term. The rising current account deficit due to increasingly expensive oil imports and weak portfolio investments would keep up pressure on rupee. Since currency risk is with the FIIs in case of bond investments, the outlook on rupee makes such investment unattractive. Added to this is the increasingly uncertain business climate given rising inflation, which could cause corporate growth to slowdown. To top it all, real short-term interest rates are negative in India”.

7.1

LIVING WITH INFLATION

Desperate measures!

The current inflation scenario is a global phenomenon, being spurred by a host of factors, such as escalating commodity prices and buoyant demand amidst slowdown in some countries. Governments around the world are doing many things to rein it in. The measures include using trade policies, fiscal actions and what not. India too is struggling to tame the beast, with looming elections guiding some of the pronouncements and short-term measures. But what is lacking is a long-term view of an effective regulatory framework, which can curb anti-competitive practices, hoarding and black marketing.

Government plans to come hard on inflation

The government decided to adopt a carrot and stick approach to combat inflation and discipline the industry. The finance minister declared tax concessions, duty cuts and export disincentives. The minister also extended tax waiver for refineries and export oriented IT enterprise and exempted all categories of electric vehicles from excise duty.

The fiscal package included export duties on select steel items and basmati rice, which seek to make export costly and augment domestic supplies. At the same time, custom duties have been cut on steel, ferro alloys, coking coal, zinc, skimmed milk and butter oil to ease supply crunch and soften prices. The import duty on newsprint, too, has been cut from 5% to 3%.

These anti-inflation measures primarily target steel, which contributes a fifth of the current spurt in prices. The Prime Minister warned industry to show restraint and to hold the price line rather than going for a quick buck. Finance Minister Mr P Chidambaram followed it up and said the government would also consider adopting ‘administrative measures, to discipline sections of the industry taking undue advantage of short-term shortages.

Futures ban in soya oil hots up spot market

The ban on commodity futures has fired up spot markets as refiners and traders use lack of transparent price discovery gaps in information to make a killing. All vegetable oils flared on 8 th of May ’08, as the ban on futures trading in soya oil takes effect. Soyabean oil has gone up by a sharp Rs 1/kg immediately in Indore after the ban was announced on 7 th of May ’08. What’s more; oilseeds’ trading has become highly active as a proxy for soyabean oil.

To make matters worse, edible oil importers may shy away from contracting large soya and crude palm oil volumes overseas with no avenue left to hedge their risk in the domestic market. That would further raise prices in the country by depleting the supply pipeline.

As soya oil is the basis on which all vegetable oils are priced in India. It pulled up the entire edible oil table. Market watchers said, India would also end up importing inflation faster. “Refiners are now free to charge the higher edible oil prices prevailing overseas because there is no local price discovery mechanism left to act as a counterbalance.

Pig iron export by PSUs banned

In yet another move to check spiraling steel prices, the government has imposed a temporary ban on export of pig iron by public-sector companies, Steel Authority of India (SAIL), Rashtriya Ispat Nigam (RINL) and MMTC-controlled Neelachal Ispat Nigam (NINL).

The Centre is planning to hold an auction for the pig iron produced by the PSUs for domestic buyers at their existing prices. Domestic buyers will get 10 days to make purchases, following which PSUs will be allowed to export the left-over metal. The move is aimed at supporting the export-oriented foundry and casting units that have been complaining about steep rise in prices of pig iron and supply constraints. Since prices of PSUs are much lower than those maintained by private companies, giving first preference to domestic buyers will ensure that the foundry and casting units will have access to more supplies from them than before. This may also encourage other private sector players to reduce prices and look for opportunities in the domestic market itself.

Inflation shows signs of peaking, hits another 3 ½ - year high at 7.61%

The annual inflation rate rose yet again, to a fresh three-and-a-half-year high of 7.61% for the week ended April 26 ’08. The Inflation was a ted lower at 7.57% in the previous week. For the moment, it looks the worst in year-on-year basis. However, what’s heartening is the week-on-week rise that has definitely cooled down. From the week ended April 19 to the week ended April 26, price have risen much slower by 0.08%, compared to the 0.8% week-on-week rise in early March.

Inflation shows signs of peaking, hits another 44-month high at 7.83%

The annual inflation rate rose yet again, to a fresh 44-month high of 7.83% for the week ended May 3 ‘08. The last time inflation hit a high was in September 2004, when it touched 7.86%. Despite the high base effect and slew of fiscal and monetary measures initiated recently, inflation accelerated from 7.61% for the week ended April 26, suggesting the government may have to initiate more steps to hold the price line. The worrying factor this time is rise in price index across all categories, including primary articles, manufacturing and fuel and lubricants, in both y-o-y and m-o-m terms. What are worse are the revised figures for WPI for the week ended March 8, which has been revised to 7.78% from the provisional estimate of 5.92%. Going by this trend, the actual inflation for the week ended May 3 may be over 8%.

FM says have patience

Finance Minister P Chidambaram said high inflation, which scaled a fresh 44-month peak of 7.83%, was indeed worrying, but the government would wait to see the impact of price cuts in cement and steel sectors in the cost of living index before taking further administrative steps. “Our expectation is that inflation will moderate. We are waiting for the roll-back in steel and cement prices to come into force. You have to be patient.”

Major steel makers had decided to reduce prices by Rs 4,000 a tonne after meeting Prime Minister Manmohan Singh on May 7, while some cement companies have announced a reduction of Rs 3 to Rs 7 per bag in prices. Steel and cement sectors together contribute about 12% to overall inflation. These are very difficult times; inflation moving up from 7.61% to 7.83% is indeed worrying. But even amid dark clouds, there is a silver line. Inflation rates of a number of primary articles have declined. Inflation of many food items have come down.

The rise in the wholesale price index is because of inflation in two other groups – the fuel, power and light group, and the manufactured products group. Products in fuel group may not decline unless global crude oil prices decline. In the fuel, power and light group category, every item is linked to crude oil. In this class, lignite has shown a very sharp rise of 16.3% because of overall high fuel prices. In the manufactured products group, aluminium, sulphate, synthetic yarn and agricultural implements have shown a sharp rise, pushing up inflation.

Spike in crude prices may significantly dampen market rebound: IMF

The International Monetary Fund’s chief economist Simon Johnson said; “Rising global oil prices could significantly dampen progress that has been made so far in calming financial markets. The banks that suffered losses as a result of a US originated mortgage lending crisis have had greater-than-expected success in raising new money but he worried that progress could be undone by soaring energy costs.” Johnson said the rise in stock markets reflected success by banks in raising capital. Still, the US Federal Reserve’s senior officers’ survey indicates banks may be tightening or reluctant to lend too many customers. Johnson said the large increase in oil prices since March, from about $ 100 a barrel to $ 125, not only hurt consumers but also has effected inflation expectations and makes policy harder to run.

Wheat buy set to cross record levels

With the political cost of spiraling prices bearing high on the minds of the government leaders, Union food and agriculture minister Sharad Pawar would have some confronting news when the briefs the cabinet about the food situation in the country. Mr Pawar is expected to apprise his cabinet colleagues about wheat procurement across the country. The Food Corporation of India had, as of 21 st of May 2008, procured 203-lakh tonnes of wheat, well above the targeted of 150-lakh tonnes. Going by the present trend, the procurement figures may touch an all-time high of 210 lakh tonnes by the end of the season. The record till now had been 206.3 lakh tonnes, attained in 2001-02.

With the FCI going on an over drive to procure wheat from the farmers, it was only natural that the private players, and as a corollary, the availability of the food grains in the market, would be affected adversely. This, fortunately, has not happened, and the wholesale and retail prices of wheat, as also rice, have remained stable in the main markets across the country.

While the government could afford to breathe a sigh of relief on the food front, it is the actually the prices of other commodities, including cement, edible oil, petrol, pulses, steel and other metals which are pushing the prices to newer highs every week. It is the global prices of these items which are determining inflation-rates. And the government can do very little to rein them in.

Inflation loses momentum at 7.82%

The government, which has been trying every possible way to keep commodities prices under check, seems to have got temporary relief. Data for the week ended May 10 saw inflation rate at 7.82% steady at the previous week’s level of 7.83%. The bad news is that revised figures for March 15 showed that inflation rate scaled 8.02%, triggering fears that the latest figure too may be an understatement.

Inflation at 45-month high of 8.1%

The wholesale price index for the week ended May 17 crossed the 8% mark and rose to a record level of 8.1%, the highest in 45 months. The unrelenting increase in the price index has put the government in a spot as it is not left with too many options to rein in prices. According to finance minister P Chidambaram, inflation is unlikely to decline unless global crude oil prices fall. The minister said even though food inflation may moderate because of record procurement of wheat and rice, the global crude and commodity prices would continue to play a crucial role in bringing the overall prices down. Meanwhile, the government would continue to take steps to contain, moderate and, to some extent, reverse the headline inflation.

7.2

DOWNWARD TRAIL

Rupee slips to 13-month low of 43/dollar

The outlook of the rupee has changed dramatically suddenly. The currency, which was in the news in 2007 for being one of the best performing Asian unit, is now back in the limelight for its downward trail versus the greenback. The rupee, which recently fell, to the 41-mark against the US-dollar in the last week of May, is now turning towards the 43-mark. On 14 th of May ’08, the rupee fell a 13-month low of 42.67 per dollar, almost 6.8% lower from the levels of 39.95/96 seen in April.

Exporters, who suffered due to RBI’s non-intervention last year, are now holding back from selling dollar holdings aggressively in the hope the rupee could fall further. On the other hand, rising crude prices have petrified oil companies to such an extent that they have been on a massive dollar mop-up spree over the past few weeks. Put together, this has led to a severe mismatch in demand and supply in the forex market.

Is rupee depreciation in line with fundamentals?

The recent depreciation of the rupee against dollar has been sizeable but orderly, packed within a short time, and caught almost all off-guard. Interestingly, the RBI has not intervened in the foreign exchange market. There are four key factors behind the recent depreciation:

1. Recovery of the US dollar;

2. Higher global crude oil prices, which widen the current account deficit and also increase dollar buying by oil companies;

3. Slowdown in capital inflows, which decreases the supply of dollars;

4. Unwinding of positions that were betting on rupee appreciation to check inflation.

Analysing the evolving balance of payments dynamics is crucial for figuring out where the rupee is headed. Surging crude oil import bill, continued strength in domestic demand, and expectations of moderating export growth suggest that the current account deficit will worsen this fiscal year, probably to slightly more than 2% of GDP. A $ 10/bbl increase in crude oil prices increases the merchandise trade deficit by around $ 6.5-7.0 billion.

Firms that have raised external commercial borrowings (ECBs) and happily kept the proceeds unhedged assuming super-optimistic scenarios for the rupee should be losing some sleep. Admittedly, a weaker rupee will increase the subsidy bill for the government but the impact will be marginal on a situation that is already on an unsustainable path for reasons that have nothing to do with the RBI. In particular, the government should not rush into easing the restrictions on ECBs. It is somewhat amusing that many of the analysts who argued for no RBI intervention when there was pressure on the rupee to appreciate are now making the case for intervention to avoid depreciation.

The rupee could weaken further against the US dollar, unless either global crude oil prices ease or there is a sharp improvement in global risk appetite that increases capital inflows into India. Further delays by exporters in converting their export earnings will increase the mismatch between dollar supply and demand, thus strengthening the case for further rupee weakness.

It is an important lesson for all, especially by uninitiated: even currencies that are expected to appreciate sometimes go off-course. Get used to flexible exchange rates, and manage risk in a better manner.

New day, New challenges

India’s policymakers have been confronted with a new set of challenges this fiscal, brought about due to sudden reversal in the country’s economic fundamentals. Until a few months ago, most indicators seemed

to suggest that the India story was strong. Prior to the hiccups now, the major tasks which policymakers

had to deal with was to tackle inflationary expectations and strong currency.

But in the course of last two months, policy challenges have altered. Besides high inflation and rising food and commodity prices, the external sector is now showing some wobbly signs with the rupee

weakening against the dollar. Industries output growth too had decelerated, indicating a general slowdown

in the economy. While there were some signs of consumption slowdown since last year, there are signs of

brakes being applied on investments as well.

Policymakers, including Planning Commission deputy chairman Montek Singh Ahluwalia and RBI governor Y V Reddy, are saying that both the IIP and inflation numbers might not be reflecting ground realities; Which means that the inflation rate which is closing in on the 8% mark may actually be higher while the drop in IIP may be far more serious than what the current figures show.

The government, it may be recalled, had tightened foreign borrowing norms in August last year and imposed some end-use restriction to stem the appreciation of the rupee. While the policy seemed to have

served the purpose to some extent, it seems to have had an adverse impact on industrial output. Given that

it is a pre-election year, policymakers will have to clearly spell out their trade-off. Arguably inflation is

expected to take precedence over growth. With crude prices hovering close to $ 135 a barrel and with the

political compulsion of not forcing a pass through on a majority of petroleum products, there could be a severe impact on the fiscal deficit as the government will have to bear the burden of servicing the oil bonds subscribed by oil companies.

In addition, other fiscal measures to rein in prices could well upset crucial development projects on account of the FRBM compulsions to rein in fiscal deficit. High oil prices have also led to the rupee weakening against the dollar. A weak rupee could further impact imports and indirectly add to the inflation of imported goods.

In

this scenario, economists are still not willing to write off the growth story completely. According to D

K

Joshi, principal economist, Crisil, a lot will depend on how oil prices move. “We expect oil prices to

stabilise in a few months and given that the RBI’s target of 5.5% is likely to be achieved. Food inflation too could come down on a good harvest and expectations of normal monsoon. We have revised our growth target to 8.1% from 8.5% for the year.”

8.

MISCELLANEOUS UPDATES

BIG CINEMA

Process of rebranding

In line with the rebranding of Reliance Entertainment to Reliance Big Entertainment, the media and entertainment arm of the Anil Dhirubhai Ambani Group (ADAG) is now in the process of rebranding its Adlabs multiplex business. The Adlabs brand name will slowly be phased out and will be replaced by Big Cinema. The rebranding is in line with its aim of ensuring one brand name across all its entertainment verticals, such as Big FM, Big TV, its DTH services and Big Pictures etc.

The company will also start screening Indian films across 200 theatres in the US under the Big brand franchise. Called the ‘Big cinema’ chain, it will screen Hindi and regional languages films from India as well as movies from Asian sub-continent to cater to the growing Indian diaspora in the US.

However, ADAG is not changing the company’s name – Adlabs Films – at the moment. But eventually, a name change is also on the cards for Adlabs Films, which will encompass the ‘Big’ brand name – in tandem with the other entertainment brands of the group. Adlabs Cinemas has presence across 43 cities at 54 locations with 158 screens. Last year Adlabs launched 100 screens. The company is also building a vertically-integrated studio under the ‘Big’ brand.

GSM HANDSETS

Big splash into handset retailing

Anil Ambani’s Reliance Communications (RCom) is readying itself for a big splash into the Rs 20,000- crore GSM handset retailing. It will enter into the new avenue by selling GSM handsets in the existing eight circles of Reliance Telecom, a part of RCom. It has signed agreements with major handset vendors, including LG, Samsung, Motorola, Sony Ericsson, Spice, Fly Mobile and HTC. It is expected to sign a similar agreement with Nokia shortly.

The company plans to sell GSM handset in all of its 2,500 retail outlets. RCom has been distributing cutting edge and affordable CDMA handsets at the entry price of Rs 777, the cheapest handset in the world. RCom has also launched colour handsets at Rs 999. RCom has built significant capabilities in CDMA handset retail business, which can be readily utilised to channelise a diverse suite of consumer electronic gadgets. RCom has always believed in giving better than the best quality and price to the many million Indian consumers, and the same philosophy is the guiding force whenever the company plans to evaluate opportunities for portfolio expansion. RCom is the second largest handset distributor. It sold over 15-16 million CDMA handsets last year.

According to sources, the foray into the GSM handset retailing is part of the company’s nationwide launch of GSM business by the end of this year. RCom aims to grab a pie of the GSM handset market. Also, it plans to use its bulk buying capability to offer the best GSM handset bargain and aims to tap the new subscribers coming on mobile networks. Over 27 million subscribers were added on the country’s telecom networks between January-March 2008, out of which 10 million subscribers were added in March alone. At this rate, the new subscribers during the current fiscal are estimated to cross the 100- million mark. For the launch of GSM business, RCom has placed equipment order of $ 1 billion. It doesn’t need to spend additional money for passive infrastructure and other associated expenditure like any other typical green field Foray. Industry sources said the entry of Reliance in this segment may lead to consolidation of the handset retail sector.

RPL Jamnagar Refinery

World slips on oil mess as demand outpaces supply

India could play a vital role in softening the pressure on the global fuel market as Reliance Petroleum (RPL) Jamnagar refinery readies for commercial production by the third quarter this fiscal. RPL’s 60- million-tonne export-oriented Jamnagar refinery will pump fuel to world markets including the US and Europe and ease supply crunch.

This should come as a relief to oil-guzzling economies as they struggle to keep their oil import bills in check. Even as crude oil prices held firm at over $ 128 a barrel, prices of petrol and diesel scaled new heights at $ 138 per barrel and $ 170 per barrel respectively.

Analysts said, “RPL will bring in significant volumes in the market and this should lead to softening of petroleum product prices. High fuel bills have hit consumers across the world. While Londoners have taken to street riots over fuel price hikes, pump dealers in the US are beginning to protest as prices reach all-time highs. Most developing economics are taking a huge fiscal burden by heavily subsiding fuel.

So, while Thailand is contemplating emergency measures to regulate refining margins and keep prices under control, the Indian government has taken over direct control of fuel pricing and is doling out bonds to compensate the oil companies. Neighbouring countries like Sri Lanka, Pakistan and even Bangladesh have increased retail prices, but India is still debating when and how much the increase should be.

The ethnic strife in Nigeria, which has disrupted petroleum exports from the country, has led to a supply crunch in petroleum products. Added to this is the shutdown of two major refineries in Japan and South Korea with an estimated refining capacity of 29 million tonnes. The breakdown of the Ceyhan Turkey pipeline that feeds European markets has added the supply constraints. And even as fuel supplies are hit, demand for some products like gasoline is set to rise in the coming months. The advent of the holiday season in the northern hemisphere countries like the US during the summer months leads to a spurt in gasoline demand. Low inventories in the US have added a premium to the price.

The blundering explorer

ONGC, our main oil & gas producer is clearly in the dock now that third-party audit has reportedly revealed considerable laxity in its operations. The public sector major has, according to an ongoing review, by petroleum consulting firm DeGolyer and McNaughton missed hydrocarbon leads in at least 20 wells drilled during 2002-05. The missteps and lapses seem particularly galling given that private sector majors have had a much better record of striking petroleum during the same period, and in the same sedimentary basins.

The point is that ONGC’s lackluster finding record seems essentially to have systemic causes. The ONGC brass, like Brutus, needs to mull over the fact that the fault is not in their stars, but in themselves. The domestic major surely needs to take sustained proactive action, if it is to substantially improve on its rather drab finding record. Note that its last major find was over two decades ago. Since then it has practically been sitting on its laurels. Such a business-as-usual approach will just not do. ONGC would need to revamp strategy for key operations like drilling, logging and data management. And, ONGC would need to shore up its expertise and ability to strike oil.

LAND DEALS

Losing stream in prime location

The soaring land deals in prime location of metro cities, which had scaled astronomical levels in the past few years, seem to be losing steam. The deals being struck this year are at an increasingly lower price than the ones last year. Parsvnath Developers has bought 1.18 acre land, jointly owned by Mahajan Industries and Videocon group in Connaught Place for Rs 200 crore, compared to hotel major Leela group’s acquisition of 3 acres in Chanakyapuri last year for Rs 611 crore. Parsvnath land deal has come at a discount of almost 17% at Rs 169 crore per acre.

Parsvnath plans to develop retail and office space, while Leela is building a hotel. Real estate experts say Connaught Place and Chanakyapuri are comparable locations in the capital and should fetch similar rates if transactions happen at the same line. In addition, the FAR (the ratio of developable space to total land) for both retail/office and hotels are the same at 1.5, according to Delhi’s new master plan.

Real estate experts argue: “We have come to the end of one property cycle. Speculators have existed the market and we are seeing a softening in the housing market. This will now spread to the commercial market and then finally impact land prices. So with borrowing cost going up, and prices softening, the euphoria towards land acquisition has certainly died down.” They, however, caution that there may still be several takers for prime properties such as those in Connaught Place in Delhi and Nariman Point in Mumbai. “The land deals in prime city locations are very few and far between. So the prices, although, reflect the market sentiments, do not give you a trend.”

Realty does reality check, prices fall 15-20% in Q1

If high prices have been holding you from buying your dream house all these years, here’s something to cheer about. In the first quarter of this year, there has been a 15-20% price correction in markets across the country. In fact, in many markets, the levels of transactions have gone down drastically, which has resulted in this dip. This is also because residential capital values in some micro markets in the metros have shown negative growth in the first one quarter.

Real estate markets have observed high growth levels in the recent past. A large number of supply is in offering indicates that there are not many buyers for the prices quoted for various real estate typologies at this point of time. The exceedingly high price points and spiraling interest rates have contributed to a reduction in interest from speculative investors due to decrease in holding power, resulting in a clear shift to a largely end-users-led demand. Realty developers feel that the biggest risk to growth in this sector is sales to speculators. Of course, how this inventory build-up will affect prices going forward remains to be seen. Further, the developers’ tendency to divert money from one project to another – rather than to keep a financial cushion – can lead to a chain reaction.

Slowdown, falling market demolish real estate stocks The uncertainty in the capital market has hit realty stocks hardest. The BSE realty index is the worst performer this year, having shed 51% of its 52-week peak reached in January. With increasing evidence of a slowdown in the realty sector, rising input costs and little chances of interest rate softening, realty stocks may see further dip in valuations. Real estate sector is seeing a major slowdown in the sales volume in most markets of the country. The speculators have exited the market and Mumbai and NCR, the biggest real estate markets in the country, are seeing subdued sales. In Gurgaon and Noida, which had seen prices almost treble in four years, sales are down 70%, leading to a price correction of 10-20%. Experts believe if the negative news flow continues for the realty sector, the scrips may see a further dip

9.

INSURANCE

Money back policies

Money back insurance policies rank high on the popularity chart. And for good reason: they offer dual benefits of insurance and redemption of money at regular intervals. But little do people realise that they pay more towards premium amount in comparison to term policy. Here’s a lowdown on what it takes to buy a money back policy and the issues involved.

First things first

Money back policies fit perfectly in the scheme of things of traditional investors who seek financial instruments that provide insurance and investment, with a low risk element and guaranteed returns. In other words, the plan is meant for individuals who require money at certain intervals in their lifetime to meet fixed long and short-term financial needs (buying a house or car, vacations abroad).

Unlike ordinary endowment insurance plans where the survival benefits are payable only at the end of the endowment period, it provides for periodic payments of partial survival benefits during the term of the policy, of course as long as the policy holder is alive. What makes these products even more attractive is that in the event of death of the policyholder at any time during the policy term, the death benefit is the full sum assured without deducting any of the survival benefit amounts, which may have already been paid as money-back components. Similarly, the bonus is also calculated on the full sum assured.

Read the fineprint

Before buying a money back plan, insurance advisors recommend that you should carefully check out the actual amount allocated towards the premium, how much of it going to be accumulated and how much is the insurance company’s charges. The most crucial aspect, they believe, is reading the terms and conditions thoroughly and understanding each clause well.

Also, you should make sure that the periodic payouts are sound enough to meet your anticipated needs. It is also beneficial to analyse the past performance in terms of declared bonuses. Though the past is not necessarily an indication of future performance, it gives a fair idea of the insurance company’s commitment to its policyholders.

The flipside

One of the primary disadvantages, insurance advisors feel, with money back policies is its low rate of return, when compared to market-linked insurance-cum-investment products. Also, while on the one hand, payout intervals are fixed and helpful for crucial lifestage planning, on the other, you don’t have the flexibility to increase or decrease premiums and have a choice of sum assured to suit growing incomes and lifestyle.

You don’t have the freedom to change the payout intervals. In case of surrender as well, it offers low paid-up value. For those who like to ascertain the charges of their investment products, it may not be right choice as it is not disclosed to the policyholder.