Curbing the flow of hot money into the country has side effects. Bulls discovered this to their cost, when market regulator SEBI placed limits on participatory notes.
What is participatory notes?
Participatory notes (PNs) are instruments used by investors or hedge funds that are not registered with the SEBI (Securities & Exchange Board of India) to invest in Indian securities. Indian based brokerages buy Indian-based securities and then issue PNs to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors.
Participatory notes are instruments used for making investments in the stock markets. However, they are not used within the country. They are used outside India for making investments in shares listed in that country. That is why they are also called offshore derivative instruments.
Like any other derivative instruments, their value is determined on the basis of the underlying asset. In the case of participatory notes, the underlying assets are shares listed on the stock exchanges.
In the Indian context, foreign institutional investors (FIIs) and their sub-accounts mostly use these instruments for facilitating the participation of their overseas clients, who are not interested in participating directly in the Indian stock market. According to one estimate, participatory notes constitute more than 25% of the cumulative net investments in equities by FIIs.
Today's fall
India's stock market benchmark Sensex crashed by 1,743 points within the first few minutes of opening this morning (17 October 2007), prompting the suspension of trade for an hour.
This is fallout of market regulator Securities and Exchange Board of India (SEBI) clamping down on anonymous participatory notes (PNs) to arrest the flood of foreign inflows. The fall came just days after finance minister P Chidambaram expressed surprise at shooting stock prices - the Sensex had shot up by 5,000 points in less than two months - and hoped that things would cool down.
Soon after the stock markets closed on hitting the down-circuit, Chidambaram said in a live telecast that the government was neither against PNs, nor was it banning them. Proposals to moderate portfolio investment by foreign investors were part of a series of steps to moderate capital inflows, he emphasised.
Earlier, on Tuesday, SEBI proposed partial restrictions on investment through offshore derivative instruments, including participatory notes (PNs), equity linked notes and capped return notes.
SEBI issued a discussion paper suggesting that FIIs and their sub-accounts should not issue or renew offshore derivative instruments (ODIs) with underlying derivatives, with immediate effect. "They are required to wind up the current position over 18 months, during which period SEBI will review the position from time to time," the paper said, inviting comments from the public about the new proposals.
FIIs currently issuing ODIs the with notional value of PNs outstanding (excluding derivatives) as a percentage of their assets under custody (AUC) in India of less than 40 per cent should be allowed to issue further ODIs only at an incremental rate of 5 per cent of their AUC in India.
Those FIIs with a notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of more than 40 per cent should issue PNs only against cancellation or redemption or closing out of the existing PNs of at least equivalent amount.
Though only a proposal, the SEBI move effectively halted the FII-led rally. FIIs invested over $5.45 billion in October alone, taking their total investment for 2007 to $17.69 billion.
The huge inflows have pushed up the value of the rupee against the dollar. The year-on-year increase in ODIs, the anonymity that it provides to investors, and the copious inflows into the country from foreign investors have been areas of concern for the government and regulators like the Reserve Bank of India (RBI) and SEBI.
Earlier, the High Level Committee on Capital Markets (HLCC), as well as various committees set up by the government and regulators had made recommendations that included issuing of PNs only to regulated entities subject to know-your-customer (KYC) requirements.
Main causes for concern
The notional value of PNs outstanding, which was Rs31,875 crore (20 per cent of AUC) in March 2004 has grown over 10 times to Rs3,53,484 crore (51.6 per cent of AUC) by August 2007
The value of outstanding ODIs with underlying derivatives is Rs1,17,071 crore - about 30 per cent of total PNs outstanding
The notional value of outstanding PNs - excluding those with underlying derivatives - as a percentage of the AUC was 34.5 per cent in August 2007
At present, 34 FIIs and sub-accounts issue offshore derivative instruments (ODIs), against 14 in March 2004
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Wednesday, October 17, 2007
SEBI's mooted curbs on PN (P-Notes) flows causes BSE, Nifty to hit lower circuit
Tuesday, October 16, 2007
MMTC ousts Infy from top 10 m-cap club
An unfavourable business environment owing to a buoyant rupee has taken the sheen off information technology stocks. Reflecting the underlying market sentiment, industry bellwether Infosys Technologies on Tuesday was ousted by the state-owned metal giant, MMTC, from the Top 10 market capitalisation list.
The m-cap list, which featured Infosys for nine years (since 1999), on Tuesday does not figure a single IT stock.
| DETHRONED | ||
| Name | M-cap in Rs crore | |
| Oct 15, 07 | Oct 16, 07 | |
| Reliance Ind | 3,71,252 | 3,69,043 |
| ONGC | 2,54,742 | 2,51,587 |
| Bharti Airtel | 2,13,824 | 2,10,608 |
| NTPC | 1,87,008 | 1,90,677 |
| DLF | 1,52,882 | 1,56,599 |
| Reliance Comm | 1,53,899 | 1,55,524 |
| ICICI Bank | 1,21,952 | 1,28,629 |
| NMDC | 1,13,017 | 1,18,667 |
| BHEL | 1,18,111 | 1,17,274 |
| MMTC | 1,07,286 | 1,12,650 |
| Infosys Tech | 1,10,325 | 1,06,864 |
Compare this with the technology boom in 2000, where six stocks figured in the list. In 2006, the number fell to three Infosys Technologies, Tata Consultancy Services and Wipro.
On Tuesday, MMTC replaced Infosys with a market capitalisation of Rs 112,650 crore, as the stock went up by 5 per cent. Infosys was the largest loser among Sensex stocks. It fell by 3.14 per cent to Rs 1,868.25. As a result, its market capitalisation plummeted by Rs 3,461 crore to Rs 106,714 crore on the BSE.
The decline in net profit growth rate owing to the rupee appreciation has been the culprit behind the re-rating of technology stocks.
The net profit growth rate of the sector almost halved from 90 per cent in FY2000 to 40 per in FY2007. The rupee has appreciated almost 20 per cent from Rs 49.05 in May 2002 to Rs 39.38 in October 2007.
Infosys Technologies, which recorded an over 100 per cent growth in net profit till FY2001, reported a 56 per cent growth in 2006-07.
The company posted a 26 per cent rise in the first half of FY08. And even though the Sensex is hitting new highs everyday, the BSE IT Index has discounted 47 per cent from its lifetime high of 8,678, seen in February 2000.
The IT index is the largest loser, falling 1.77 per cent (83.34 points) to close at 4,629.09 on Tuesday compared with the marginal 6.81 points drop in the Sensex.
The IT sector, which accounted for 24 per cent share of the total market capitalisation of the BSE, declined to 12 per cent in 2006 and, currently, stands below 10 per cent at 6.79 per cent.
Reliance Industries, Oil and Natural Gas Corporation, Bharti Airtel, DLF, ICICI Bank, and BHEL are the others in the Top 10 club.
Sunday, October 14, 2007
Inflation rate dips to a five-year low at 3.26 percent
Annual rate of inflation based on the wholesale price index (WPI) declined to 3.26 per cent - a five-year low - for the week ended September 29, compared to 3.42 per cent in the previous week.
The annual rate of inflation stood at 5.41 per cent during the comparable period a year-ago.
The decline in inflation is attributed to a fall in prices of pulses and some food articles. The prices of pulses like moong and urad declined by 1 per cent during the week. Besides, a fall in tea prices, which declined by 4 per cent and edible oils (0.1 per cent), also helped to bring down the inflation rate.
The prices of vegetables, however, rose by 0.6 per cent, and fruit and milk prices remained unchanged during the week.
The index of fuel, power, light and lubricants, which have a weight of 14.23 per cent in the WPI, remained unaltered at its previous week's level of 322.
Manufactured products, which have a weight of 63.75 per cent in WPI, rose marginally by 0.1 per cent during the week.
It would be the seventh straight week inflation has been below 4 per cent and the 17th week it has been under 5 per cent, the RBI's upper floor for the 2007-08 fiscal year.
Annual inflation rose to a two-year high of 6.69 per cent in January, but softened after the central bank tightened policy and the government cut duties on a slew of items to cool prices.
Rupee futures volume in Dubai climbs 68 per cent in September
Rupee futures volume on the Dubai Gold and Commodities Exchange (DGCX) surged 68 per cent in September while the currency continued to trade below 40-a-dollar level on the domestic foreign exchange market.
The value of the total number of contracts traded on DGCX since inception now stands at $40.53 billion, of which gold contracts account for $20.87 billion.
Traders switched to currency futures and preferred to tread cautiously in the commodity markets following increased price volatility that drove gold, crude oil prices to their highest levels in several decades, a statement from the exchange said.
The exchange began trading the world's first Indian rupee contracts in June.
Gold futures prices recorded a massive jump of nearly 10 per cent, climbing to their highest levels in almost 28 years while Euro jumped by 4.45 per cent to reach an all-time high against the US dollar. Silver futures registered a big jump of 13.61 per cent during September.
Of the total traded volume (68,558 contracts) during September, gold futures remained in the forefront, contributing 42,323 contracts.
The British pound contract led the table accounting for a volume of 21,783 contracts out of a total of 25,692 contracts traded.
Euro futures volume saw a rise of nearly 7 per cent over the previous month while the traded volume in the Indian Rupee futures leapt by 68 per cent.
An unprecedented foreign investment flow into the rapidly growing economy has pushed the rupee higher into an "uncomfortable" zone, according to finance minister P Chidambaram.
"We must find ways to manage a competitive exchange rate without hurting investments," Chidambaram told a conference in Mumbai. The rupee is in an "uncomfortable zone," he said.
The rupee's rise was aided by a tide of overseas money into domestic shares following a cut in US interest rates last month.
The rupee finished the week (Friday) flat at 39.3 against the dollar, a nine-and-a-half year high. Some analysts expect the rupee to touch 38 to the dollar or even lower by the middle of next year.
The rupee has already risen by over 11 per cent this year against the dollar, making it Asia's best performing currency.
The Reserve Bank of India has been buying dollars to check the rupee's rally and protect slowing exports.
The rupee is expected to gain further as foreign investors buy shares and pour money into plants and infrastructure projects to exploit the booming economy.
Friday, October 12, 2007
What on earth have the markets been smoking lately?
A lot of, power, telecom and capital goods laced with a bundle of gas over some oil stocks.
What on earth is going on here? That must have been the reaction of most observers watching the vertical climb of our stock market indices, ever since Ben Bernanke decided to lower interest rates for inter-bank overnight borrowings in the US.
But stock market traders across the globe have reacted as if he has handed them a lottery with only one ticket to draw from. They reckon that Ben is a jolly good fellow who will keep on giving them lollies, every time they cry after making fools of themselves in the market.
It is no longer certain that Bernanke will be in a very benevolent mood when he sits down next to consider more gifts to market traders. It seems Uncle Sam, who put Bernanke in his chair, tricked him into handing out a big lolly last time by claiming that jobs were being lost. It has now turned out that Uncle Sam was bluffing, jobs were being added at a good pace.
Credit markets have stabilised and crude oil prices remain high, which may push up inflation -- more reasons for Bernanke to be less benevolent in future. But, global markets seem to be least bothered. They still seem to believe that there will be a pack of lollies at every corner.
We in India have been among the most exuberant in recent weeks. Except for a short blip when our politicians in Delhi seemed all set to challenge each other for a face off in a general election, our stock indices have been running on steroids. And the omnipotent Ambani brothers have led the charge and how!
Reliance Bubble?
As the Sensex moved past 18000, the Ambanis crossed another milestone - that of the richest family on earth. The combined wealth of Mukesh and Anil is now over $90 billion, more than the net worth of Walton family promoters of Wal-Mart. Now consider this, only 53 countries had GDP of over $90 billion in 2006 as per World Bank data!
Reliance Industries, Mukesh's flagship, is the best performing large-cap index stock anywhere in the world this year by a wide margin. The stock has been on a relentless up-move, triggered by speculation on pricing of natural gas from its KG Basin fields and expectations of fast expanding retail operations. The gas pricing has now been finalised and it is a fair deal to Reliance. High crude oil prices will ensure record refining margins at its refinery and the petrochemicals businesses are also doing very well.
But, do all these factors many of them known even earlier warrant a more than doubling of the stock price? Reliance's much talked about retail rollout is slowing down as the company is facing resistance in many states.
Given the uncertain political scenario at the centre and possibility of an early election, it is unlikely that state governments will move in favour of the company - though it has every right to receive protection from violent protestors.
Even if the company manages to expand its network, using the famous Reliance ability to work the system, how profitable are these stores going to be given the rush of new players into retail and prohibitive property costs? The small neighbourhood I live in already has seven modern branded retail stores on one street, including a Reliance Fresh! It is doubtful if anyone other than the landlords are going to make any money out of the retail revolution anytime soon.
Reliance Petroleum, the latest jewel in Mukesh's crown, now boasts of a market capitalisation of close to Rs78,000 crore. This is for a company, which is setting up an oil refinery and may start operations in another two years if all goes well. Many things can go wrong in between; the US economy may cool off further, which will lower fuel demand and bring down prices.
Margins are already under pressure despite record crude oil prices, though Reliance Petroleum will enjoy higher than industry margins by processing heavier crude oil. The US dollar may weaken further, making exports of refined products less lucrative. Domestic demand is not rising fast enough to absorb the possible surplus capacity.
RPL's market value of Rs78,000 crore seems even more incredible when the total project cost of the refinery is Rs27,000 crore! So, even when the project is at the implementation stage, the company is enjoying a value of nearly thrice the total cost. Once the refinery becomes operational, imagine the future value it must generate to justify these valuations!
To put it in another way, RPL's current valuation is nearly two-thirds of Infosys. That much wealth was created without even 5 per cent of the effort Murthy, Nilekani and thousands of Infosys employees put in over the last 25 years to make Infosys what it is today. Reminds you of website valuations in the late '90s? Wait until you hear about the miracles that the Anil Ambani Group stocks have performed.
Not to be outpaced, Anil Ambani has also taken a leaf out of big brother Mukesh's 'wealth creation strategy'. If Mukesh can generate so much wealth just by taking a new project public, why can't Anil? So, he decided to take hive off the big power projects from Reliance Energy and announced the creation of Reliance Power. How much capacity is Reliance Power going to build? The sky is the limit it seems, as the company has announced plans for 12 projects with an aggregate capacity of more than 24,000 MW. That is more than the existing capacity of NTPC, the biggest power generation company in the business now. Impressive, indded.
What else can Reliance Power do? There is some market talk of huge cement plants, which will use the fly ash from its own power plants as raw material. Some reports suggest that the potential capacity may be more than the existing capacity of the entire cement industry in the country. Even more impressive! Where will the company sell all that cement? Please don't ask such dumb questions!
But how profitable are these projects likely to be? Reliance Power's flagship project will be the 4,000 MW ultra-mega power project at Sasan, which by the way is its only project that can be implemented anytime soon.
This project was awarded to Reliance Energy after the earlier awardee, Lanco-Globeleq, was disqualified. The tariff quoted by Reliance is Rs1.2 per unit, which must be among the lowest anywhere in the world. When the project was awarded to Lanco, many doubted whether the project would ever be profitable at such low tariffs. Now that the project is with Reliance, the markets have no doubt it will be a money-spinner.
All the troubles Reliance Energy continues to face on its 7,500 MW Dadri project in Uttar Pradesh have also been overlooked. Even nearly two years after announcing the project, it is still not clear if the company has completed its land acquisition. It does not help that the current Uttar Pradesh government is sending not very supportive signals over the project because of Anil Ambani's political interests. Nothing much has been heard about a similarly ambitious project proposed in Orissa, announced last year.
When the Reliance Energy stock was moving on all these fantastic news flows, came the announcement that the company would develop a huge township in Andhra Pradesh. The centrepiece of this township is to be a 100-story high-rise, the tallest in the country - no less. And the stock jumped another 12 per cent!
All these stories of fantastic valuations pale in comparison to Reliance Natural Resources or RNRL. Here is a company that was originally supposed to buy natural gas from Reliance Industries and supply it to various Reliance Energy projects. In other words nothing more than a gas trader. Then markets started to see infinite possibilities for the company in the entire energy space from exploring for oil and coal bed methane to city gas distribution. The company won three or four coal bed methane blocks in Rajasthan and a small oil block in Mizoram in the last round of NELP bidding.
These are all exploration blocks, mind you, and RNRL has to drill and find something under the ground. But the RNRL stock has behaved as if the company is already sitting on huge oil and gas reserves.
RNRL now boasts a market capitalisation of around Rs13,500 crore. Incredible as it may sound, the last leg of the surge came after the company applied for a licence just an application that might have cost a few thousand rupees for city gas distribution. That news pushed up its market value by around Rs3,000 crore in a single day. Indraprastha Gas, the leading city gas distributor in the country with a monopoly in Delhi and now expanding to other cities, has a market value of just Rs1,900 crore!!
Can't we do a China?
'This week Chinese stock market traders could not make any money because the markets were closed for holidays', was the opening line of a recent article in a major international financial newspaper. Yes, over the last year or so this was the simple rule for Chinese traders. If the market was open, they made a truckload because the only way for prices to move is up.
The way our markets are behaving, we seem to be in a hurry to absorb this 'Chinese doctrine' of stock market investing. Also, it may impress M/S Karat, Bardhan, Yechury & Co. that we are following the 'Chinese model' of 'market socialism' and not the evil capitalism promoted by Uncle Sam and its cronies. Then may be, they will spare our markets from their 'tough-talk' whenever there is a political crisis next. Given the current political undercurrents, that can be anytime.
If the Mainland Chinese index can trade at an earnings multiple of over 50, why should the Sensex limit itself to a multiple of just half of that? After all, Indian companies are supposed to have better earnings visibility, better and more transparent managements, global capabilities and all that. And of course the clincher, we are a democracy! So, don't we deserve a better valuation than even the Chinese?
Those who argue on the these lines often fail to consider many factors that make the Chinese stock markets, well, different. As most companies are government-owned, supply of stocks is highly limited. When too much money chases too few assets, prices obviously go through the roof. Provincial governments own many Chinese companies and it is in the interest of government officials to push up stock prices, whichever way they can. There is also talk of massive price rigging and insider trading in Chinese stocks.
Anyone who has ever visited a casino in a city with even a small Chinese population would readily agree that the Chinese are inveterate gamblers. Watching them gamble, it may appear is their most natural of all pastimes. No wonder that the Chinese territory of Macau has overtaken Las Vegas as the gambler's paradise. The trouble is, the Chinese seem to approach stock market trading just the way they do gambling.
Those of us who have observed the markets for the last two decades or so have seen phases where it was difficult to differentiate trading from gambling. When our very own pied pipers like Harshad Mehta and Ketan Parikh played the tunes of 'replacement values' in the early '90s and 'ICE' economy later, we swallowed it all only to lose everything and regret it later. One of the constants in these earlier phases of exuberance was that the big falls were preceded by swift and vertical surges. Are we in for another déjà vu?
Most seasoned and sensible investors have long argued that Chinese stocks are way past bubble levels. For the Chinese, it may be just one of the many bubbles as they are now in the midst of 'bubbles among bubbles' stock bubble, property bubble, export bubble, FDI bubble, name your bubble, and they have it.
While it may be creditable if we can catch up with them in many areas of economic activity, stock market valuations are definitely not one of them. We will be better off without this fancy for creating bubbles. When they eventually burst, we may not be able to absorb the pain the way Chinese gamblers in casinos do... by lighting the next smoke and ordering another drink.
Wednesday, October 10, 2007
Fed explains the big rate cut
The Federal Reserve cited an "exceptionally weak" housing market and concerns that this summer's credit crunch could lead to a pullback in consumer and corporate spending as reasons for its decision to cut interest rates by a half percentage point on Sept. 18, according to minutes from the meeting released Tuesday.
The minutes showed just how seriously the Fed viewed the mortgage meltdown, which caused massive bouts of volatility in the stock and debt markets over the past few months.
The Fed said that a half-point rate cut, rather than the more conservative quarter-point cut that some investors were expecting, was "the most prudent course of action" in order to "help forestall some of the adverse effects on the economy that might otherwise arise" from deteriorating conditions in the credit markets.
However, it is uncertain what the Fed's next move will be when it meets again to discuss interest rates later this month.
Quincy Krosby, chief investment strategist for The Hartford, said that those in the "one and done" rate cut camp can point to the Fed's comments about inflation as a sign that the central bank wants to hold pat instead of cutting rates again.
At the same time, Krosby said it was telling that the Fed pointed out it felt "further slowing of employment growth was likely." That could be an indication the Fed is more worried about weaker economic growth than it is about inflation - signaling a reason to lower rates.
The government reported last week that the unemployment rate in September ticked up to 4.7 percent. Since labor costs are a major factor in determining inflation, it seems that the Fed would have less reason to be worried about pricing pressures in the coming months.
"The Fed acknowledged that the employment situation is slowing and that the economy is not producing as many jobs," Krosby said. "That gave some people hope that further easing is in the cards."
Last month, the Fed lowered its federal funds rate, a key overnight bank lending rate that determines what consumers pay on various types of loans, to 4.75 percent.
The central bank's policy making committee will announce at the conclusion of its next meeting, a two-day session that ends on Oct. 31, whether or not it will once again lower the federal funds rates.
According to futures listed on the Chicago Board of Trade, investors are pricing in the strong likelihood of at least one quarter of a percentage point rate cut between now and the end of the year. The Fed's final meeting is scheduled for Dec. 11.
However, the probability of a rate cut is not as high now as it was immediately after the Fed cut on Sept. 18. At that time, investors were pricing in a nearly 100 percent likelihood of a rate cut on Oct. 31.
Joe Balestrino, a senior portfolio manager for fixed income investments at Federated Investors in Pittsburgh, said that bond investors seem to be indicating that another rate cut before the end of the year is no longer "a lock" since the Fed also indicated in the minutes that is continuing to keep a close watch on inflation.
This might not be a bad thing though, he continued. He said investors may be coming to the realization that the Fed's half-point cut may keep the economy from sliding into a housing-induced recession and that the worst may be over.
"One could conclude that order has been restored to the financial markets. This may be just a growth slowdown with modest inflation," Balestrino said, adding that this is a "quasi Goldilocks" scenario similar to the mid-1990s.
In 1994, bonds and stocks had a rough year due to what Balestrino called "fears of a recession that never happened." The markets went on to experience several strong years of growth for the rest of the decade before tech stocks crashed in 2000.
Brian Stine, investment strategist with Allegiant Asset Management Co. in Cleveland, agreed that this could be similar to the mid-1990s. He said the main reason the stock market rallied on the Fed minutes is because it seems that the Fed has things under control.
"On the one hand, the Fed seemed to indicate that we're not headed for a recession but that they also think the outlook on inflation has improved. This is the path the Fed wants us to go on - moderate economic activity with inflation abating," Stine said.
Still, some are holding out hope for at least one more rate cut by year's end.
Matthew Smith, president and chief investment officer with Smith Affiliated Capital, an investment advisory firm based in New York with $1.7 billion in assets under management, said another reason investors may have taken comfort from the minutes is because another rate cut could mean that the dollar will remain relatively weak versus other currencies.
And while this would be a bad thing for bonds - a weak dollar makes Treasurys less attractive to international investors - the weak dollar should boost stocks, Smith said. That's because international investors will be drawn to large U.S. firms with significant operations overseas that will see profits rise.
"A weakening dollar is a positive for stocks since you get foreign investors coming in and there is a potential boost to earnings for multinational companies," Smith said.
Tuesday, October 9, 2007
Cabinet clears sugar industry sops
The government today announced a slew of measures aimed at helping the sugar industry.
These include subsidised loans to sugar mills to help them clear dues of farmers and making mandatory the blending of 5 per cent ethanol in petrol with immediate effect across the country, barring the North East, Jammu and Kashmir and the island territories.
It also allowed sugar factories to produce ethanol directly from sugarcane juice to augment its availability and reduce oversupply of sugar.
At the same time, 10 per cent blending has been made optional from this year, but this would become mandatory from next October.
A uniform nation-wide purchase price of Rs 21.50 per litre (ex-factory) for supply of ethanol for the next three years was also decided at a meeting of the Cabinet Committee on Economic Affairs here today.
The Indian sugar industry is facing its worst crisis, with mills not even able to recover the cost of raw material. This year's production, at 28 million tonnes, is 45 per cent higher than last year's 19.2 million tonnes.
Consequently, sugar prices have dropped sharply and most companies have incurred losses in the last two quarters. Mills have not been able to pay the cane prices to farmers.
In other decisions, the Cabinet also approved conversion of outstanding loans on account of harvesting and transport charges and short margins on sugar stocks, as appearing in the books of the sugar mills on April 1, 2007, into term loans up to a maximum period of five years, without any reduction in the existing rate of interest, and to provide higher interest subvention from budgetary support to the tune of Rs 600 crore.
The CCEA today gave its approval for providing loans to sugar mills from the banks under special guidelines. They would be entitled to loans of an amount equivalent to central excise duty paid by them, Finance Minister P Chidambaram told reporters after the meeting.
The government also gave its approval to extend the moratorium on outstanding term loans as on April 1, 2005, announced in September 2005 for co-operative sugar mills, from two to up to five years (reckoned from April 1, 2005) and to include co-operative sugar mills, not included in the earlier package, for availing the benefits of the earlier package.
The CCEA also extended export subsidy by one more year from April 19, 2008 to April 18, 2009, to target an additional export of 3 million tonnes of sugar.
It also decided to reduce Customs duty on denatured alcohol from 7.5 per cent to 5 per cent and on molasses from 10 per cent to 5 per cent.
The measures will be implemented once the mandatory 5 per cent ethanol blending comes into effect. It also approved extending the export assistance scheme under Sugar Development Fund to April 2009.
Prices are expected to fall further with yet another record production, projected at over 30 million tonnes, in 2007-08. Annual domestic demand hovers around 20 million tonnes.
The Union government has already announced incentives such as creation of a 5 million tonnes buffer stock and export subsidy (at a rate of Rs 1,350 a tonne for coastal sugar mills and Rs 1,450 a tonne for the non-coastal mills) to help the beleaguered industry.
Sunday, October 7, 2007
Can Fed support another rate cut?
Global equity markets, especially emerging markets, have surged to lifetime highs after last month's US Fed rate cut. But many of these markets are close to bubble territory while investors are ignoring the growing risks.
Ben Bernanke did what any sensible central banker would do when faced with demand slowdown in the economy. Size of a rate cut is always debatable, but it is well accepted that such measures should surprise if monetary policy is to be effective. A full-blown crisis in the financial markets and tight liquidity would have worsened the already weak outlook for the US economy.
Nobody likes a recession, not even central bankers, especially ahead of a presidential election. As a columnist said in the Financial Times yesterday, "in democracies bad stuff is outlawed" if politicians want to be re-elected.
But a large interest rate cut is like giving first aid to an accident victim, which in this case is the US economy. First aid is delivered without knowing or checking the full extent of injuries and it is often difficult to predict whether the patient's condition will improve. All that is known is that the victim is injured and will take some time to recover.
If the economy is weak, with increasing risks of it turning even weaker, and emergency support has been given in the form of an interest rate cut, why are markets so bullish? Strange as it may sound, but it is because conditions may get even worse and more rate cuts may follow!
Rate cuts bring the omnipotent force called liquidity into the markets and everyone will be happy and more prosperous. Declining corporate performance in a weak economy and soaring stock valuations be damned.
On the other hand, The Federal Reserve's decision last month to cut interest rates by a larger-than-expected half-percent point sent the already-weakening dollar to an all-time record low against a basket of six major currencies. In the third quarter, the euro appreciated more than 5% against the dollar, most of the gains coming in September alone.
Weakness in the dollar means prices of imported goods, particularly oil, will go up, raising the risk of inflation. American consumers will be paying more soon, with the looming threat of paying even more later on.
"The inflation risk from higher import prices will be the dominant initial effect," said Howard Chernick, an economics professor at Hunter College in New York. "The most immediate effect is imports denominated in dollars -- mainly oil. We already saw a spike in oil prices. So a bit down the line, that's 10 to 15 cents more per gallon of gas at the pump."
A weaker dollar can help narrow the U.S. trade deficit by making America's exports more affordable abroad.
Yet it could also make funding those imbalances more difficult. The U.S. has to attract billions of dollars a day from foreign investors, and a weakening currency makes dollar-based assets less attractive because of the consequences it can have on their long-term value.
That fear of inflation came into focus on Friday when a top Fed official suggested policy-makers have already cuts rates enough, a view reinforced by fresh data showing U.S. employment grew at a steady clip in September.
Inflation, as the late economist Milton Friedman once wrote, is taxation without legislation. Rising prices rob consumers of purchasing power, destroying the value of their savings over time.
Inflation turns savers into losers, at a time when America desperately needs more savers to fund its imbalances -- particularly if foreign investment starts to taper off. But fears of rising prices will keep consumers cashing their paychecks and heading to the mall, rather than depositing the funds in accounts whose returns might lag the inflation rate.
Having said this, What if Ben Bernanke decides that financial markets have partied enough, and decides to focus more on his pet peeve — inflation? Then he may hike interest rates or keep them steady and the markets will be in for a huge disappointment. We all know what happens when markets are disappointed, especially when the indices are at lifetime highs — investors panic.
Let us wait to see what will Fed vote for a rate cut to save recession ahead of presidential election or to save inflation in the next meeting?
Wednesday, October 3, 2007
India Trade Deficit Widened to $6.8 Billion in August
India's trade deficit widened in August as companies stepped up imports of oil and machinery to meet demand in the world's second-fastest growing major economy.
The trade deficit jumped to $6.8 billion from $5 billion in July, the Ministry of Commerce and Industry said in a statement in New Delhi today. Imports rose 32.6 percent to $19.5 billion. Exports in August grew 18.9 percent to $12.6 billion.
Imports are climbing as General Motors Corp., Honda Motor Co. and other automakers build new factories in India to cash in on the nation's auto demand, while refiners are buying more crude oil to fuel power generation. Exports have been hurt by the fastest gain in the nation's currency in at least 33 years.
`India's trade deficit is a result of its unprecedented economic growth,'' said D.H. Pai Panandiker, president at RPG Foundation, an economic policy group in New Delhi. ``The deficit is also under pressure because exports turned weak after the strong gain in the currency.''
India's rupee, Asia's best performer, has climbed 11.4 percent this year as international capital flows to the world's second-fastest growing major economy after China. India's economy grew 9.3 percent in the three months to June 30.
Non-oil imports in the April-August period rose 42.9 percent to $66 billion and oil imports gained 8.3 percent to $25.9 billion, today's report said. The trade deficit between April and August widened to $32.5 billion from $19.9 billion in the same period last year.
Rising salaries and borrowing from commercial banks have fueled spending by consumers in the world's second-most populous nation. Hewitt Associates Inc. forecasts salaries in India will climb an average 14.5 percent in 2007, the steepest gain in Asia for the second straight year.
General Motors, Honda, Volkswagen AG and half a dozen other companies plan to spend at least $6.6 billion on new factories. All are betting on a country where 7 people in 1,000 own a car, compared with 450 per 1,000 in the U.S. and 500 per 1,000 in Western Europe.
India's manufacturing growth accelerated in September as rising incomes spurred consumer spending, ABN Amro Bank NV said today. Manufacturing makes up a fifth of India's $854 billion economy.
The bank said its purchasing managers' index rose to 59.1 last month, the highest level since October 2006, from 57.9 in August. A reading above 50 indicates factory output gained.
Source - Bloomberg
Monday, October 1, 2007
Indian crude oil basket hits $78.46 a barrel
The basket of crude oil that Indian refiners buy hit another all-time high of $78.46 a barrel on Friday, the latest day for which data is available.
The high prices have pushed up revenue losses of the country’s three oil marketing companies to Rs 210 crore per day from Rs 190 crore a day in the first 15 days of September.
The government is, however, still sticking to its guns by not increasing retail selling prices of petrol and diesel. There is very less chance of a hike in prices of petrol and diesel. The government is under huge political pressure, and could face mid-term elections, said a senior official of the petroleum ministry. Fuel prices are more about politics than economics, the official added.
The official, however, said the Cabinet was closely observing the movement of the price of the Indian crude oil basket. We are keeping the Cabinet updated all the time, the official said.
The Indian basket, which comprises Oman-Dubai sour (high sulphur) grade crude oil and Brent dated sweet (low sulphur) crude oil in a 59.8:40.2 ratio, averaged $74.83 a barrel in September. In August the average price of the basket was $69.03 a barrel.
The prices of petrol and diesel were last increased in June 2006 when the average price of the crude oil basket was at $67 a barrel. The rupee was then valued at around 45 per dollar.
Since then, the value of rupee has risen to below 40 per dollar. This effectively makes the value of the crude oil basket around $72 a barrel, as the oil marketing companies are now paying lesser in terms of rupee for the crude oil they buy.
Early signs of easing seen in subprime lending
Former Federal Reserve chairman Alan Greenspan defended the U.S. subprime mortgage market Monday, arguing that the securitization of home loans for people with poor credit not the loans themselves were to blame for the current global credit crisis.
Greenspan also said there were some early signs of an easing in the crisis, but warned that the longer term effects on the economy were still being determined.
"Subprime mortgages were and are risky, but they are worth it," Greenspan said, adding that is better to have a larger property owning class with a vested interest in the system.
"I'm terribly concerned that we would cut back on the availability of subprime that has enabled a very significant increase in mortgages among minorities in the United States," he added.
The current credit market turmoil began with rising defaults in the United States on subprime mortgages. Those problems have since spread as banks repackaged risky loans with the more reliable and sold them to a wide range of investors, including several European banks.
Credit dried up in early August, roiling financial markets, as banks became wary of exposure to the risky loans.
Greenspan acknowledged that a number of people should not have been taking out those mortgages, but that the current crisis was due "not the subprime problem itself, but to the securitization of subprime."
Greenspan said there are "some positive signs" that the crisis is calming.
"For example, the yields on what has been the poster child of this crisis, asset backed commercial paper, have jumped up sharply," he said. "It has since come down, but not all the way."
Similarly, the interbank lending rate, which jumped in recent weeks amid fears about insolvencies, have started to come down, but "not all the way," he said.
"We are not through with this yet," he added, suggesting there could still be what he termed an "Act II," in which falling house prices feed into slower consumer spending.
However, he reiterated earlier comments that he believed the probability of a recession in the United States was "less than 50/50."
Greenspan also implicitly criticized the role of ratings agencies in the crisis.
"The problem was that people took that as a triple-A because ratings agencies said so," he said. Yet when they tried to sell the products they ran into difficulties, which shook confidence.
"What we saw was a 180 degree swing from euphoria to fear and what we've learned over the generations is that fear is a very formidable challenge," Greenspan said.
Ratings agencies such as Standard & Poor's Corp., Moody's Investors Service Inc. and Fitch Ratings have come under fire for being slow to lower their ratings on securities based on mortgage loans to U.S. borrowers with poor credit records.
Friday, September 28, 2007
Recession chatter gets louder
The fear factor has spiked in recent weeks as a series of indicators signal that Wall Street's troubles are starting to spread to Main Street.
Housing price declines. Slowing job creation. Profit warnings from the country's biggest retailers. To an Econ 101 student, those are telltale signs of an imminent recession. Not surprisingly, the R-word has dominated talk among bankers for weeks.
"We're very close to stall speed in the economy," says Paul Kasriel, director of economic research at Northern Trust. And it's not just the usual Chicken Littles talking about it: Everyone from top auto executives to normally ebullient tech venture capitalists are making noises about the slowing economy. Former Treasury Secretary Larry Summers, now at hedge fund D. E. Shaw, is adamant that there's a greater than 50% chance of a recession.
So what's really happening? By most economists' terms, a recession is defined as two or more consecutive quarters of GDP decline -- something we haven't seen since 1991. By that narrow definition we're not even close. Of 50-plus economists surveyed by research firm Blue Chip Economic Indicators, not one is predicting a recession. They still expect GDP to grow 2.6% next year.
But the broader definition, one put out by the National Bureau of Economic Research, is simply a "significant decline in economic activity, spread across the economy, lasting more than a few months." By that measure, many say the sky is falling.
Until now, problems with the economy have remained within the financial sector, with most of the pain hitting mortgage companies and investment banks. But in recent weeks a few key signs show that Wall Street's problems are seeping into the rest of the economy.
Of course, the biggest driver has been the downturn in the real estate market. After 15 years of rising home prices, a cooldown was expected. But the sharp price drops this summer showed that the downturn is deeper and broader than previously thought. In July home prices fell 4.5% from a year earlier.
Housing is closely tied to overall consumer spending. With homeowners facing growing mortgage headaches, there's been a simmering fear that they will curtail discretionary spending. Many retailers had already warned that the second half of the year would fall short of expectations. Then, in a one-two punch in late September, Target (Charts, Fortune 500) and Lowe's (Charts, Fortune 500) issued profit warnings on the same day - news that sent retail stocks plummeting and created new fears of a broader slowdown.
Another key metric is employment. The unemployment rate, at 4.6%, is not a worry so far. But when August figures showed the number of Americans with jobs had fallen for the first time in four years, it raised fears that the weakness in the economy had spread -- and was probably the main factor behind the Fed's Sept. 18 rate cut.
In fact, that rate cut is one of the most telling differences between today's outlook and that of 1991. Typically recessions follow aggressive hikes in interest rates, a deliberate slamming on the brakes by the Federal Reserve designed to halt consumer price inflation. This time the Fed has raised rates gradually, from a very low level. But because of consumers' big debt binges in recent years, the slightest tightening of the money supply may simply have been too much.
To be sure, not everyone is saying a recession is coming. After all, the S&P 500, driven by tech stocks, is trading close to its all-time high. Dean Maki, chief economist for Barclays Capital, says a surprisingly large proportion of overall personal spending comes from the wealthy, who are not likely to dial back their conspicuous consumption.
So where is the economy really headed? Some cooler heads say the more likely effect is a pullback to slower GDP growth. "It's much harder to get into a recession than people understand," says Drew Matus, senior economist at Lehman Brothers.
Others say recessions are an inevitable outcome of prolonged periods of growth and a way to wring excesses out of the economy. As anyone who balked at paying $1 million for a two-bedroom condo in a hot market would agree, there's nothing wrong with the economy that a few months of stalled growth wouldn't fix.
Ethanol - India Story
WHAT IS FUEL ETHANOL
Ethanol (ethyl alcohol, grain alcohol, ETOH) is a clear, colorless liquid with a characteristic, agreeable odor. In dilute aqueous solution, it has a somewhat sweet flavor, but in more concentrated solutions it has a burning taste. Ethanol, CH3CH2OH, is an alcohol, a group of chemical compounds whose molecules contain a hydroxyl group, -OH, bonded to a carbon atom. The word alcohol derives from Arabic al-kuhul, which denotes a fine powder of antimony produced by distilling antimony and used as an eye makeup. Alcohol originally referred to any fine powder, but medieval alchemists later applied the term to the refined products of distillation, and this led to the current usage.
ETHANOL AS A FUEL
Ethanol is used as an automotive fuel by itself and can be mixed with gasoline to form what has been called "gasohol" FUEL ETHANOL- the most common blends contain 10% ethanol and 85% ethanol mixed with gasoline. Over 1 billion gallons of ethanol are blended with gasoline every year in the United States. Because the ethanol molecule contains oxygen, it allows the engine to more completely combust the fuel, resulting in fewer emissions. Since ethanol is produced from plants that harness the power of the sun, ethanol is also considered a renewable fuel. Therefore, ethanol has many advantages as an automotive fuel.
Most industrial ethanol is denatured to prevent its use as a beverage. Denatured ethanol contains small amounts, 1 or 2 percent each, of several different unpleasant or poisonous substances. The removal of all these substances would involve a series of treatments more expensive than the federal excise tax on alcoholic beverages (currently about $20 per gallon). These denaturants render ethanol unfit for some industrial uses. In such industries undenatured ethanol is used under close federal supervision.
Ethanol has been made since ancient times by the fermentation of sugars. All beverage ethanol and more than half of industrial ethanol is still made by this process. Simple sugars are the raw material. Zymase, an enzyme from yeast, changes the simple sugars into ethanol and carbon dioxide. The fermentation reaction, represented by the simple equation C6H12O6 2 CH3CH2OH + 2 CO2 is actually very complex, and impure cultures of yeast produce varying amounts of other substances, including glycerine and various organic acids. In the production of beverages, such as whiskey and brandy, the impurities supply the flavor. Starches from potatoes, corn, wheat, and other plants can also be used in the production of ethanol by fermentation. However, the starches must first be broken down into simple sugars. An enzyme released by germinating barley, diastase, converts starches into sugars. Thus, the germination of barley, called malting, is the first step in brewing beer from starchy plants, such as corn and wheat.
ETHANOL IN INDIA
India imports nearly 70% of its annual crude petroleum requirement, which is appox. 110 million tons. The prices are in the range of US$ 50-70 per barrel, and the expenditure on crude purchase is in the range of Rs.1600 billion per year, impacting in a big way, the country's foreign exchange reserves.( Oil Prices touched a record high of $76 per barrel )
The petroleum industry now looks very committed to the use of ethanol as fuel, as it is expected to benefit sugarcane farmers as well as the oil industry in the long run. Ethanol (FUEL ETHANOL) can also be produced from wheat, corn, beet, sweet sorghum etc. Ethanol is one of the best tools to fight vehicular pollution, contains 35% oxygen that helps complete combustion of fuel and thus reduces harmful tailpipe emissions. It also reduces particulate emissions that pose a health hazard.
10% blending from October 2008: The Government is serious of considering 5% doping mandatory with immediate effect & are willing to increase it to 10% from October 2008. This decision will be directly benefiting the sugar cane producing states like Uttar Pradesh, Maharashtra, Karnataka, Tamil Nadu, Andhra Pradesh, Gujrat & Bihar. As all these states are facing a serious problem of excess sugarcane cultivation for the current year and also could face the same in future too.
Hard Road Ahead: The policy is now clear but still the question of comfort zone of Oil Marketing Company is important. The ethanol producers should concentrate on the technologies by bringing the cost of production at lower end & here Brazil’s input is important.
The Indian Sugar Mills and the private stand-alone ethanol manufacturers should cut the cost of production by using good technologies requiring less utilities like steam, water and electricity and they should also concentrate on co-generation through effluent generated by Sugarcane Juice & Molasses Route. The lower cost of production can still bring the ethanol prices down from the current Rs. 21.50 per liter. Suppliers from Maharashtra are supplying at Rs. 19.50 per liter. The ethanol suppliers should now focus on producing large quantum as this could drop the production cost creating a Win-Win Situation.
ETHANOL WORLDWIDE
Other countries are either producing and using ethanol in large quantities or are providing incentives to expand ethanol production and use. Brazil and Sweden are using large quantities of ethanol as a fuel. Some Canadian provinces promote ethanol use as a fuel by offering subsidies of up to 45 cents per gallon of ethanol.
India is initiating the use of ethanol as an automotive fuel. A move has been made by distilleries in India to use surplus alcohol as a blending agent or an oxygenate in gasoline. Based on experiments by the Indian Institute of Petroleum, a 10 percent ethanol blend with gasoline and a 15 percent ethanol blend with diesel are being considered for use in vehicles in at least one state.
In France, ethanol is produced from grapes that are of insufficient quality for wine production. Prompted by the increase in oil prices in the 1970s, Brazil introduced a program to produce ethanol for use in automobiles in order to reduce oil imports. Brazilian ethanol is made mainly from sugar cane. Pure ethanol (100% ethanol) is used in approximately 40 percent of the cars in Brazil. The remaining vehicles use blends of 24 percent ethanol with 76 percent gasoline. Brazil consumes nearly 4 billion gallons of ethanol annually. In addition to consumption, Brazil also exports ethanol to other countries.
Sweden has used ethanol in chemical production for many years. As a result, Sweden’s crude oil consumption has been cut in half since 1980. During the same time period, the use of gasoline and diesel for transportation has also increased. Emissions have been reduced by placing catalytic converters in vehicle exhaust systems which decrease carbon monoxide, hydrocarbon, and nitrogen oxide emissions. To address global warming concerns, the amount of carbon dioxide produced while burning fossil fuels must be reduced. Ethanol-blended gasoline and ethanol-blended diesel are being considered as viable alternatives to further lower emission levels.
Benefit to Common People
Comparative Current prices as in Brazil (per gallon) -
1. Pure alcohol (95% purity) ethanol = 1.35 R$ = 29.70 RS.
2. Gasoline with 25% ethanol mandatory by law = 2.46 R$ = 54.12 RS.
3. Gasoline with 25% of ethanol + additives (octane boosters)= 2.56 R$ = 56.32 RS.
Thursday, September 27, 2007
The rising rupee, foreign trade & inflation
As the popular saying goes, the difference between a pessimist and an optimist is that whereas the former sees the glass as half-empty, the latter perceives it as half-full. The reality is the same; it is the inference that matters.
Take the figures for the first quarter of 2007-08 in regard to foreign trade. Exporters rightly crib about the lower realisations consequent to the appreciation of the rupee against the dollar - by more than 10% over the same quarter of last year. Imports have accelerated, and may be attributed to the cumulative impact of an economy growing at a robust rate and possibly the lower price tag for overseas goods in rupee terms, which has also fuelled demand.
To those who see these issues in perspective, what is a cause for concern is the sharp drop in the import purchasing power of exports - from 71% to 61% - during the latest three-monthly period over that of the previous fiscal. In another era, the burgeoning trade deficit that has nearly doubled to $21 billion may be viewed as very troubling; now the context is different; with forex assets at more than $200 billion and swelling weekly, we are in a position to make light of it.
However, there is another angle to the steady climb of the Indian currency against the greenback, namely the possibility that its impact on inflation may be benign. In its latest monetary policy review, the Reserve Bank of India drew comfort from the fact that the pass-through effect of monetary, fiscal and supply-side measures, in conjunction with seasonal factors has brought the inflation rate to below the stipulated threshold limit - 4.4% from 5.9% as of end-March 2007. Perhaps this assessment was too laconic to permit an elaboration of the role of strengthening rupee vis-à-vis the dollar in influencing the inflation rate on a downward course. We shall revert to this topic later.
Let us dwell upon the several strands of the issue one by one. Exports have fared badly during the April-June 2007 period, rising by a meagre 7% in rupee terms, though in dollar terms, the growth rate is definitely better at 18%. The setback in terms of rupees is easily explained; the foreign buyer, finding that he has to fork out more dollars to buy Indian rupee-dominated goods, has tuned to other markets seeking price advantage. This has adversely impacted on the export performance. The exporters too are despondent that the declining fortunes of the dollar have meant diminished earnings in terms of rupees. This trend is a distinctive to our export effort and to the realisation of the target of $125 billion set for 2007-08. But gyrations in the forex market must be taken in stride and overcome through conscious drive for quality and cost-cutting to retain and expand overseas markets.
The second point to note is that our imports have maintained a high order of increase during the first quarter of the current fiscal - 34% in dollar terms and 22% in rupee terms. Despite a negligible rise of 4% in oil imports when denominated in dollars -in our currency, oil imports have recorded a negative growth rate -it is the non-oil imports that have really soared - by 50% in rupee terms and much more in terms of dollars. This is possibly a sequel to the high rate of economic growth that has led to a keen demand for capital goods, non-ferrous metals and export-related imports such as pearls and precious stones, chemicals and cashew. With the dollar weakening against the rupee, imports also became cheaper and hence the boom in overseas purchases. Seen in this context, this development is not a cause for worry.
The third fall-out of the firming up of our currency against the dollar may well be the easing of inflationary pressures of late. Unfortunately, the nexus between the two has not been highlighted in the RBI policy statement. In reality, this is quite simple. When the rupee strengthens in the forex market, it means lower prices of imported goods in terms of our currency. In turn, the cost of imported items tends to fall in the home market. They figure as intermediaries, raw materials and capital goods for which, in rupee terms, we pay less now than, say a year ago. Of course, bulk consumption goods like pulses and edible oils too which figure in our imports, for which we pay less rupees per dollar. The cumulative impact of all these factors is the moderation in the inflation rate.
In sum, the strong showing of the rupee in relation to the dollar is not an unmitigated evil as it is made out to be. It is not and the taming of the beast of inflation may be a direct sequel to this trend.
Thursday, September 20, 2007
Indian rupee breaks through 40 per dollar level for 1st time since 1998
The Indian rupee rose to a nine-year high against the U.S. dollar Thursday amid strong demand from foreign funds investing in one of the world's fastest growing economies.
The rupee rose 0.7 percent to 39.88 per dollar, breaching the psychologically crucial 40-per-dollar mark for the first time since May 1998.
The rupee has appreciated more than 10 percent against the dollar so far this year as global investors have flocked to India, where the economy is growing about 9 percent annually and the stock market has been climbing to record highs.
Analysts expect the rupee to remain strong through this quarter, although that could hurt exporters, especially the country's hugely profitable outsourcing industry.
"It will stay around 40 for some time," said Agam Gupta, head of foreign exchange trading at Standard Chartered Bank in India.
The rupee's strength has come despite measures by the Reserve Bank of India to counter a surge in foreign money into the country that also has fueled inflation. Last month, the central bank installed several curbs on overseas borrowing by Indian companies and ordered banks to hold more cash in reserves.
But Gupta said the central bank can do little to stem the flow of money from other sources.
"A lot of inflows have been in the form of foreign direct investment and investments in stocks and bonds," he said. "Those inflows will continue."
Foreign institutional investors have bought US$10.1 billion in Indian stocks and bonds so far this year, according to the Securities and Exchange Board of India. That money is on top of a record US$16 billion India received as foreign direct investment in the last fiscal year that ended March 2007.
The rupee got a boost after the U.S. Federal Reserve made a bigger-than-expected cut its key interest rate Tuesday, stoking expectations that investors will bring in more dollars to take advantage of higher interest rates here and a bull run in the stock market. The rupee gained about 1 percent against the U.S. dollar in Wednesday's trading.
India's benchmark interest rate is now 7.75 percent, 3 percentage points higher that the Fed's key rate, and it's unlikely that the Indian central bank will cut rate soon.
Market players will likely revise their projections for the rupee-dollar rate following the Fed move, Gupta said. Most foreign exchange traders earlier expected the rupee-dollar rate to average around 41 during the October-December quarter.
That is bad news for exporters, whose overseas earnings are eroded by the strong rupee.
Indian Commerce and Industry Minister Kamal Nath said the rupee's strength was "a cause for concern" and the government may have to revise the export target of US$160 billion set for the current fiscal year.
Trade data released earlier this month showed exports growth have already begun to decelerate.
"It is a new situation and requires a new response," Nath said, adding the government would explore measures to help exporters tide over the impact of a stronger rupee.
Tuesday, September 18, 2007
Subprime Lending Crisis and It's impact on the Emerging Markets
What is Credit Report?
credit report is, in many countries, a record of an individual's or a company's past borrowing and repaying, including information about late payments and bankruptcy. The term "credit reputation" can either be used synonymous to credit history or to credit score.
When a customer fills out an application for credit from a bank, store or credit card company, his or her information is forwarded to a credit bureau, along with constant updates on the status of his or her credit accounts, address, or any other changes made since the last time he or she applied for any credit.
This information is used by lenders such as credit card companies to determine an individual's or entity's credit worthiness; that is, determining an individual's or entity's means and willingness to repay an indebtedness. This helps determine whether to extend credit, and on what terms. With the adoption of risk-based pricing on almost all lending in the financial services industry, this report has become even more important since it is usually the sole element used to choose the annual percentage rate (APR).
What is subprime lending?
Subprime lending, also called B-paper, near-prime, or second chance lending, is the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history. The term also refers to paper taken on property that cannot be sold on the primary market, including loans on certain types of investment properties and certain types of self-employed individuals. Subprime lending is risky for both lenders and borrowers due to the combination of high interest rates, poor credit history, and adverse financial situations usually associated with subprime applicants. A subprime loan is offered at a rate higher than A-paper loans due to the increased risk.
Subprime lending encompasses a variety of credit instruments, including subprime mortgages, subprime car loans, and subprime credit cards, among others. The term "subprime" refers to the credit status of the borrower (being less than ideal), not the interest rate on the loan itself.
Subprime lending is highly controversial. Opponents have alleged that the subprime lending companies engage in predatory lending practices such as deliberately lending to borrowers who could never meet the terms of their loans, thus leading to default, seizure of collateral, and foreclosure. Proponents of the subprime lending maintain that the practice extends credit to people who would otherwise not have access to the credit market.
About Current Subprime Lending Crisis
The institution giving out the home loans in the subprime market does not stop here. It does not wait for the principal and the interest on the subprime home loans to be repaid, so that it can repay the loan it has taken from the bank.
It goes ahead and securitises these loans. Securitisation essentially involves, converting these home loans into financial securities, which promise to pay a certain rate of interest. These financial securities are then sold to big institutional investors. The interest and the principal that is repaid by the subprime borrowers through equated monthly installments is passed onto these institutional investors who buy these financial securities.
The institution then takes the money that it gets from selling the financial securities and passes it on to the bank, it had taken the loan from, thereby repaying the loan. And everybody lives happily ever after. Well, not really.
This part we had already seen in the last article. The entire problem arose because institutions giving out subprime home loans could easily securitise it. Once an institution securitises a loan, it does not remain on the books of the institution. Hence that institution does not take the risk of the loan going bad. The risk is passed onto the investors who buy the financial securities issued for securitising the home loan.
Given the fact that institutions giving out the loan do not take the risk, their incentive is in just giving out the loan. Whether the individual taking the home loan has the capacity to repay the loan, isn't their problem. Hence chances are that proper due diligence to give out the home loan is not done and loans are given out to individuals who are more likely to default.
Other than this, greater the amount of loan the institution gives out, greater is the amount it can securitise and, hence, greater the amount of money it can earn.
After borrowers started defaulting, it has come to light that institutions giving out loans in the subprime market had been inflating the incomes of borrowers, so that they could give out greater amount of home loans. As explained above, by giving out greater amounts of home loan, they were able to securitise more, issue more financial securities and hence earn more money.
These loans were floating rate home loans, once interest rates started to go up the equated monthly installment (EMI) to repay these loans, went up as well. The borrowers who had bad credit ratings in the first place, could not service the higher EMIs and started defaulting.
Another advantage of securitisation, which has now become a disadvantage, is that money keeps coming in. Once an institution securitises the first lot of home loans and repays the bank it has borrowed from, it can borrow again to give out loans. The bank having been repaid and made its money, does not have any inhibitions in lending out money again.
And so the story continues. Till, that is, one fine day when borrowers stop repaying. Investors who bought the financial securities cannot be serviced. So to make up their losses in the subprime market in the United States, they go out and sell their investments in emerging markets like India. Since the amount of selling in the market far outweighs the amount of buying, emerging markets like India have been falling.
