Monday, March 17, 2008

Financial Contagion

The bloodbath on India’s capital markets continues. On Thursday 13 March the Bombay Sensitive Index plummeted 770.63 points, losing 4.78 % of its value. The Sensex closed at 15,357.35, down 27.5 % from its all-time high of 10 January, wiping out Rs 20 trillion worth of investor wealth. Investor fears were stoked by more bad news from Wall Street: Carlyle Capital Corp. a subsidiary of US private equity firm Carlyle Group, admitted that it had defaulted on $16.6 billion (Rs.67,000 crore) of debt and was likely to be liquidated. On 11 March, five central banks had announced a huge cash injection, including $200 billion from the US Federal Reserve, but even this failed to inspire confidence.

Shares of Carlyle Capital are down 97 % over the past year. Carlyle’s strategy of borrowing to invest proved to be its nemesis. Carlyle Group chairman David Rubenstein’s speech at the World Economic Forum in Davos earlier this year gave investors a forewarning when he observed that “the golden age of private equity” was over. “The industry has now entered its purgatory age. We have to atone for our sins a bit,” he said. Sure enough, there was even worse news when Bear Stearns, a marquee US investment bank went under, the latest victim of the sub-prime mortgage crisis.

In India, a steep fall in industrial production exacerbated an already delicate situation. Industrial growth slipped to 5.3% in the month of January, compared to 11.6% in the same month last year as growth in all major sectors comprising manufacturing, electricity and mining declined. Industrial growth, as measured by Index of Industrial Production (IIP), has moderated to 8.7% in the first 10 months of the current fiscal year, against 11.2% during the corresponding period of the previous year. The manufacture of consumer durables registered negative growth both in January and the first 10 months of this year. Production of consumer durables fell 3.1% in January against a 5.3% growth in January 2007. Between April and January, production declined 1.7% against 10.6% growth in the same period in the previous year.

These statistics pose a conundrum. As the saying goes, “Statistics are like bikinis, they hide more than what they reveal.” It is not possible for industrial production to tumble so drastically. Whatever a company produces is the result of a planning done from at least a couple of years back. Machinery, labour and inventory costs are planned in advance so it in unlikely that the IIP could face such a dramatic reversal in so short a period, despite slowing demand and high interest rates. While the data is being questioned, it was largely academic for Indian markets which panicked, treating the news as confirmation of their worst fears.

There is no doubt that the Indian economy is indeed slowing down amid fears of a full-blown recession in the US and record high oil prices. US investment bank Goldman Sachs estimates the price of crude oil could hit $175 a barrel in the next couple of years. Analysts believe it is highly unlikely that the markets will rebound in the next three to four months. Nevertheless, current valuations in Indian stock markets appear driven more by sentiment than fundamentals. Even 7% growth in a $1 trillion economy represents a huge increase in wealth. India, unlike much of East and Southeast Asia, is fortunate in that its economy is driven by domestic consumption. Its growing savings rate and steadily expanding middle class provide domestic manufacturers a cushion against global uncertainty.

But the contagion from the US sub-prime crisis is yet barely understood or accounted for. Financial institutions around the world are only now beginning to discover the extent of their exposure to the bad debts created by the reckless lending of US mortgage sellers. India is no exception: ICICI Bank has already had to take a write-down of Rs. 1,050 crore on its $ 2.2 billion credit derivative exposure. The next few months will surely bring more bad news as the scale of the problem unfolds. Credit markets all over the world will take time to digest their losses, as banks rebuild their capital through liquidation of assets and mergers. JPMorgan Chase Bank’s bargain basement purchase of Bear Stearns is an indication of the deadly price that investors will have to pay. But till the world’s financial services industry gets its house in order there’s little hope for a return to stability and growth. As the axiom has it, an economy is only as healthy as that of its banking system.


Bully: You will either love this movie or find it too repulsive. But either way its a must watch because of the moral questions posed by it.

House of sand and fog: If you are the kind who believes that testosterone stuff is what turns you one then watch this movie for a crash course in thought provoking cinema.

Thursday, March 06, 2008

A Please All Budget

In more ways than one, the Union Budget 2008-09 tabled by P.Chidambaram is the “mother of all UPA budgets”. This is the last full Budget under the incumbent UPA government. It comes in the run up to general elections, as of now, scheduled for 2009, following back-to-back losses for the Congress in state elections in Gujarat, Uttar Pradesh, Punjab and Himachal Pradesh. No wonder then that the budget has been devised with a firm eye on the rural and urban voter.

A huge waiver of Rs 60,000 crore to the farmers is its centrepiece and a political masterstroke even though it’s not clear how this money is going to be raised. The moot question is whether this largesse is really going to benefit the farmers it is intended for marginal farmers with land holdings of up to 2 hectares. Only the debts taken from formal sources of credit- public sector banks will be waived. According to the National Sample Survey, nearly three in four farmer households have no access to formal sources of credit. Hence, the small and marginal farmers will continue to be beholden to rural moneylenders. Despite recognising the scale of the agrarian crisis, the Finance Minister had nothing to offer the 30 million small and 10 million marginal farmers who continue to bear usurious rates of interest.

This budget could be the swansong of Prime Minister Manmohan Singh and his chief economic advisor, Planning Commission Deputy Chairman Montek Singh Ahluwalia. They have sought to leave a legacy by making a very big investment in rural development. Hence the increase in outlays for the National Rural Employment Guarantee Scheme, which will now be extended to all the country’s 596 districts. Bharat Nirman, the flagship rural infrastructure development programme received an allocation of Rs 31,280 crores. Health and education found a substantial increase in the allocation, by 20% and 15% respectively. Calling them “twin pillars on which rests the edifice of social sector reforms” the Finance Minister has allocated Rs 34,400 crore and Rs 12,050 crore for education and health respectively. But the budget is found wanting on the rural roads front. The corpus for rural roads is a paltry Rs 4,000 crore.

In a column published in the Times of India on February 3rd, economist Swaminathan S Anklesaria Aiyar argued that roads are much more important than Sarva Shiksha Abhiyan and NREGS. He wrote that, “For every million rupees spent, roads raised 335 people above the poverty line. Every million rupees spent on education reduced poverty by 109 people, and on irrigation by 67 people. The lowest returns came from subsidies that are the most popular with politicians - subsidies on credit (42 people), power (27 people) and fertilisers (24 people).” Lip service is how one would describe the Rs 5,000 crore allocation for rural electrification.

The Economic Survey tabled by the Finance Minister on February 28th is a complete antithesis of the budget. It makes one wonder whether both came from the same Ministry. No measures have been undertaken to increase the cap on Foreign Direct Investment (FDI) into domestic market. To sustain a 9% growth the Survey demanded a raise in FDI for insurance to 49%, opening up the retail sector to foreign equity and 100% FDI in greenfield private agri banks. But these demands were not met. Instead Chidambaram endeared himself to the taxpayers by increasing the threshold taxable income by a steep Rs 40,000 to Rs 1,50,000 while for women it is Rs 1.8 lakh. The lowest tax rate of 10% cent will extend all the way to Rs 3 lakh, after which 20% tax will apply and 30% for salaries above Rs 5 lakh. This means an additional Rs 4,000 in the hand of a person who earns Rs 1.5 lakh. On the whole, the FM wants to put more money in the hands of the consumer, which would give them more spending power.

The Sensex reacted to the hike in short-term capital gains tax (the tax paid on a profit-making investment held for a year) from 10% to15%, by falling 1.38%. The revenue deficit, the excess of current expenditure over current receipts, was to have been brought down to zero by 31 March 2009 according to the Fiscal Responsibility and Budget Management Act. “This will not be done in 2008-09, but the year after that,” explained Chidambaram. That too could be wishful thinking once all the subsidies and the huge payout under the Sixth Pay Commission are counted.

Some Recommendations:

Young Poisoner's Handbook: A kooky thriller from the stables of British cinema that makes us believe that Mike Leigh and Ken Loach are not the only British auteurs.

Le Diable Probablement: Probably Robert Bresson's most underrated film. Placement is going on in my J-School and people are taking jobs solely on the basis of pay package. And in these tumultous moments, this movie makes me believe that my passion for journalism should hold precedence over a few more pieces of paper.

Grbavica: I dislike reading history verbatim. Its englightening to watch a movie which has historic backdrop. One such is Grbavica. The agony involved in the aftermath of Balkan War is portrayed in the most humane way. The chances of you not liking this movie are as much as me hanging myself- Zero.