Anand Krishna’s musings

Given the continuing uncertainty in the financial markets (especially equities), the upcoming Q4 results of  India, Inc. become very important as a signal of “the India growth story”. Advance tax collections are higher and there are signs that Q4 results will be OK. However, the markets will focus on specific bellwether stocks from each industry. How TCS, Infosys and Wipro perform (and what guidance they give for Q1 of 2008-09) will be seen as a barometer of how much outsourcing is likely to be affected by the US slowdown. Some relief of course comes from the relative let up in the Rupee’s apreciation vis-a-vis the US$-but that can all change in one day. Already, there are concerns that Satyam, which did so well in Q3, may be impacted by what has happened to Bear Stearns, which was a Satyam client. HCL too is likely to be somewhat impacted. Pretty much every company in the IT services space will be impacted- including the Big 3. The question is by how much? And whether they can compensate for a slowdown in the BFSI space through growth elsewhere. And if so, to what degree the offset will happen.

Stocks like ICICI Bank will be under pressure, given their investments in derivatives that have soured. And because of the massive and unwarranted run-up in stock prices through much of 2007,  stocks like Reliance, BHEL, Bharti and Reliance Communications will find it hard-pressed to bounce back up to their early January levels.

All in all, the next month or so will be critical, as results start flowing in. Let’s hope for the best.

To stimulate growth or to rein in inflation. In the current global economic scenario, that is the question most Finance Ministers and Central Bankers are grappling with.

Take the example of India. Till a couple of months ago, a 9% GDP growth was very much on the cards. Inflation was fluctuating, no doubt, but was well under 5%. But now…? Inflation has inched up to almost 6%. It is clear that our GDP will not grow any more than 8.5 or 8.6%. To be sure, these are growth rates to die for, by most countries’ yardsticks today. It is close to triple India’s own historic “Hindu rate of growth”. But a less than 9% GDP growth rate upsets many calculations. Stock markets assumed that companies and indeed, entire sectors of the economy would grow fast enough to support an aggregate growth of 9%. But now that will likely not happen- at least for the next year. Sustained 9% growth for the next few years would mean that as a nation, we would start winning the war on poverty. Again, that won’t happen as quickly as many of us would like, because of a slowing growth rate.Is the growth rate in any one individual’s control? Clearly not- and even less so in a globally inter-connected world.

Growth needs capital to fuel it. And not everyone has enough of their own money (equity) to put into their business and grow it. Ergo, they rely on borrowings from friends, banks or even money-lenders (debt). But there’s a problem. Debt must be serviced regularly via interest payments and repayment of the principal. And as inflation rises, interest rates rise. Of course, inflation also increases the returns equity investors expect (so that their real rate of return is not adversely impactred). But unlike debt, equity investors take a bigger risk. They may not get to see dividends every quarter or indeed, each year. And there is no rule that says that the stock must appreciate by a certain percentage each quarter or year.

So there lies the nub of the trade-off. Should monetary policy be aimed at reining in inflation (so that credit does not become more expensive, in turn impeding growth)? Or should fiscal policy be used to provide tax breaks so that more money is put in the hands of consumers and hopefully, this money goes either into consumption (thus stimulating demand for goods and servcies) or goes into savings, and thus exerts downward pressure on rising cost of debt)?

I don’t know the answer…. if I did, I suppose I’d be a central banker or Finance Minister somewhere!

Till about two months ago, Indian stock markets were the toast of not just investors in India, but around the world. The rise of the BSE Sensex from about 12000 to over 20000 happened at breakneck speed, in perhaps 18 months or so.

And then the January effect happened- yet again. Fueled by the sub prime crisis, rising crude oil prices, worries about the US slipping into recession and so on, Indian stock markets have lost over $500 Billion in terms of market cap in the last 2 months or so. Individual stocks have declined by as much as 50%.

“The long term India story is intact”, say analysts, almost unanimously. But to paraphrase John Maynard Keynes’ famous observation, we’re all dead in the long run!

Personally, I think we’re in for an extended bear phase. At least till the US elections are over and there is clarity on who the next President will be, I don’t think the Sensex will stay beyond 18000 for any meaningful period of time. Hopefully, by then, the dust will start settling on the sub-prime home loans. Just keep your fingers crossed that credit card loans and consumer loans don’t start souring!

And with Indian inflation steadily inching up, interest rates have to go north too. And inherently, that will put more pressure on equities. Oh joy!

In a globally integrated financial system, it had to happen, I suppose. I am referring to Indian banks being affected by the US sub-prime crisis. In the last day or two, news is trickling in that a few Indian banks have had exposures to US housing loans that have now gone bad. It is not that these banks have lent to borrowers who have become delinquent. What has happened is that the original lenders have parcelled off bundles of asset-backed loans into what are called “Collateralized Debt (or Mortgage) Obligations”. The cash flows and hence returns from these CDOs/CMOs are derived from the cash flows and returns generated by the underlying assets- which are the lender’s receivables against the loans. That is why these are derivatives. And almost always, lenders package a mix of loans into each CDO “package”- some good, some more risky, some of relatively short term, others of longer term etc. The trouble is that investors do not fully understand the associated risk- manifested either as creditworthiness of the borrower and/or quality of the asset used as collateral. The problem becomes compounded when the original loan is made, say, in Texas, and the investor in the CDO is a bank in India- due diligence is that much harder.

Some estimates of the sub-prime crisis suggest that well over $1 Trillion is at risk. So far, only about $100B of write-downs have happened. Do the math yourself ($1 Trillion is roughly the total market cap of India’s equity markets). And start worrying about where your mutual/hedge fund has made investments, given that it promised to take advantage of investment avenues in global markets to deliver “superior returns”.

Finance Minister (FM) P C Chidambaram is only the second FM in the history of our country to present all 5 budgets of the government (after Dr Manmohan Singh, who was the first when he was FM in Mr P V Narasimha Rao’s cabinet).

Clearly, one eye was on the upcoming Lok Sabha elections, for he has presented a fairly populist budget for 2008-09. Over the last three days, experts have devoted hundreds of column inches in newspapers/magazines and hundreds of programming hours on TV, to discuss  the budget- fine print and all.

I do not have any specific opinion on specific proposals. However, the one big concern I have as a citizen of India is this: where will the government get Rs20,000 crores each year for the next 3 years to pay the PSU Banks to make good their loan write-offs to farmers? I am not questioning the decision per se- small, marginal farmers have been badly affected over the past several years and relief is welcome. But given the likely slowdown in the US economy and election year rhetoric against outsourcing, the IT services and ITES sectors are likely to slow down. This may well have a downstream effect on other sectors like banking, retail, automotive and so on (agreed there are others that consume these goods & services as well, but employees from the IT/ITES sectors have been quite conspicuous in their consumption and spending patterns). In turn, corporate and personal income taxes may not remain as buoyant as they have been in the last 2 years or so. And with inflation fears likely to force cuts in excise duty/levies on petroleum products and non-petroleum indirect tax collection not meeting targeted levels, I am very very worried about meeting the huge burden imposed by the write-offs.

I hope the thinking was not on the lines of “let me look good now. If we win the elections, we will raise taxes next year to meet the deficit and if we lose, let the next FM worry about financing the write-offs”.

The Union Budget to be presented by Finance Minister P C Chidambaram in a week or so will be his last as part of the current UPA government, assuming that the Lok Sabha elections are held on schedule.

Every year, the Budget is a huge event that shapes not just macro-economic and fiscal policies, but also sets the tone for how the stock markets are likely to behave. In fact, right from the first week of February, the stock market takes cues from second-guessing what the Finance Minister is likely to unveil.

In the last couple of budgets, the FM has acted on expanding the tax base. New services have been brought under the service tax net. However, agricultural income remains outside the income tax regime and this continues to benefit several large farmers. Excise duty cuts and sales tax rationalization hve also occurred over the past few years, and these are laudable. However, the introduction of levies like the FBT have raised more than a few hackles. Extending the tax breaks for India’s IT and ITES industries is something else that needs careful consideration. While the industry has matured and at least the large players no longer need fiscal breaks, it cannot be denied that these breaks attracted initial investment and these in turn helped create the ecosystem that is today India’s source of advantage via-a-vis some other destinations. The budget must also encourage Public-Private Partnerships to accelerate urban and rural infrastructure development. By “infrastructure”, I do not just mean roads, power and airports; I also mean schools, drinking water, sanitation and healthcare.

The FM has a great chance to use the budget to drive GDP growth past the magical 9% mark. But there will also be electoral compulsions to come out with a populist budget, so that the Congress can piggy-back on its “feel-good” wake and try to win the upcoming elections.

What choice the good Dr Singh and “PC” (Mr P C Chidambaram) make will be decisive in how fast India continues to grow. In the short term, the budget will also impact stock market sentiment, especially at a time when the dark clouds of US slowdown are looming large on the horizon.

The government has increased the price of petrol and diesel respectively by Rs2 and Re1/litre. The increase will kick in less than 2 hours from now. Petrol in Bangalore will cost almost Rs53/litre, which probably makes it the most expensive in the country. In fact, fuel prices in India are among the highest in the world. With supplies not increasing at the same rate as demand, price increases are only natural.

But how long can this go on? In a country like India, where LPG is a major source of fuel for domestic cooking and freight is hauled either by diesel powered trucks or diesel locomotives hauling goods trains, an increase in diesel prices will have an impact on almost all other prices in the economy. In other words, inflation will increase. This will put upward pressure on interest rates, while fears of slowing domestic growth will cuase bankers to revise interest downwards to ease credit. Which of these forces will have a greater effect depends on their relative strength. And higher interests can only mean a relatively depressed stock market.

Either way, hold on tight folks, for an economic roller coaster ride!

For years, economists and politicians have waxed eloquent about the wondrous benefits of globalization. Countries like India, that had erected protective trade barriers for the first 50 years after independence, started a regime of dismantling such barriers and “integrating with the global economy”.

Western corporations had (finally) got access to emerging markets and CEOs were salivating at the prospect of selling a range of goods and services to a rapidly growing middle class in Brazil, Russia, India, China and elsewhere. All was hunky dory as long as the going was good. But now, the world is faced with a disquieting reality: when things go sour, the very economic inter-connectedness that votaries of globalization were rooting for, causes pain. And apparently, lots of it!

In the last decade, the world economy has seen the Asian melt-down of 1997-98, the dotcom bust, the US recession/slowdown of 2001 and most recently, the sub-prime crisis. In the 20+ year old film “Wall Street”, Michael Douglas epitomized the typical investment banker in his famous line “Greed is good”. And it is exactly this greed that has amplified the current global economic crisis.

In their quest to deliver “superior returns”, managers of hedge/mutual funds have created “structured products” that tend to obfuscate investors’ (and possibly the managers’ own) understanding of risk. But it is axiomatic that higher returns go hand in hand with higher risk. In their greed for higher returns, people (investors and fund managers) lost sight of the difference between “alpha risk” and “beta risk” and when the sub-prime loans started unravelling, so too did a plethora of other asset classes. In many instances, there is poor understanding of the underlying risks. Compounding the situation further is the fact that because of globalization (which facilitated cross-border investment flows), investors in country X are being exposed to risks associated with economy Y. Ergo, the global economy has begun to feel the pain.

This pain is also being felt in other quarters. The largest Wall Street financial supermarkets- the Citigroups, Merrill Lynches, Morgan Stanleys and their European peers/competitors- the UBSs and Societe Generales- are taking substantial P&L hits. To at least part-offset these losses, some are considering a trade sale of assets like their captive back-office operations in locations like India- which represent a source of competitive advantage to these companies. Such sales, if effected, will affect the equilibrium of both the outsourcing industry (which may acquire such assets) and the domestic talent market- after all, captive BPOs do employ 50K+ skilled employees in India alone.

How all this will finally play out is a trillion dollar question. But for everyone involved- and that includes average investors like you and I- the next 12 months or so will be crucial.