Outlook for the month of March

• Markets not showing any signs of resilience and lacks sanguineness.
• Expect 15-20% earnings growth this fiscal year.
• Valuation multiple may come down a little bit by the year end.

• Concerns:

1. High crude oil price
2. Foreign flows
3. Inflation

• Beginning of 2010, we had rising inflation, so central bank had done much work on rates, the current a/c deficit was widening. Now in 2011, it is likely that current a/c deficit will narrow. Across Asia, no central bank has worked so extensively as ours. So, the rates are almost normal and inflation has peaked out well.

• The tricky thing is, what is happening in the world- at the one end of the spectrum you have Europe still struggling with its debt problems and at the other end you have US surprisingly achieved a lot in the last 2 months. QE 2 happened and got some consensus on the tax breaks, for which now on the street arguing for higher US growth.

• This will lead to rise in commodity prices, which could create an issue for India. How?

US growth rates accelerates, crude oil prices rise and to that extent it does upset India’s macro balance.
If oil prices got to $110-120 per barrel then things looks a bit worrisome for India.

• India is trading at about 35% premium on the forward multiple to emerging markets. So, it is slightly on the richer side. So that multiple may come off a bit.

• Consider if a bull case, 30% upside if crude oil prices remain range-bound say, $80-100 per barrel.

• In 2011, focus may shift to developed world than emerging markets, so these countries will have to deal with inflation, because developed world export inflation into emerging markets. If one closely observes can say, “Developed stock markets respond to growth and emerging stock markets respond to rates”.

• But talking about India, it is actually quite nicely perched because, India has already done its work on rates.

• India attracted $29 billion in 2010 and now in 2011?

We will need lower flows because the current deficit is shrinking. For September data, it stood at 4% annualized, in terms of flows means, we need $50 billion to fill that hole. And definitely this deficit is going to reduce for 2011.

• In fact, 2 factors drove this deficit,

1. Negative real rates
2. High level of fiscal deficit

Now these 2 are receding, so a contraction in this deficit. And to that extent, savings rate in the economy will rise. So, the current a/c deficit will decline.If one excluding an assumption of a runaway crude oil price, probably flows will reduce from $50b to $35-40b
For 2010, these flows were largely in the form of FII, but this year, can expect a mix of FDI and FII

• A lot of people see inflation peaked out but the pace at which it will decline is not sure. This may become a wild card for the coming 6 months.

• Actually, there is a genuine problem with food, because of structural factors, less to do with cyclical factors. It is well known about India’s protein consumption, which is going up, so all the protein basket like milk, eggs, poultry, meat and soya bean are experiencing huge demand for this the prices of these items are elevated. And some of these items prices were anchored at higher levels. So, any shortage in particular food commodities will be leading to higher levels. So, this year we will see some base effect in terms of growth of inflation and interest rates rise. So to that extent, I do think that consumption will slow. A mix of growth in India will shift from consumption to investments.

• We have seen 2009- a great year, 2010- a tepid year, 2011- expecting a range bound

• Other indicators:

1. Credit growth:- need to assess whether banks are pulling back on credit
2. Fuel subsidy:-

• On financial companies?

A reason to under-performance, which was a star performer in 2010
1. These institutions were too bullish, so ownership levels had earlier reached record levels. So valuation got rich;

• On IT companies?

In 2010, there was a skepticism that developed markets struggling, will lead to domestic IT companies struggle. But it was so wrong because what happened was when developed markets struggled, companies in the developed world reacted by cutting cost very sharply and IT companies in India benefited. Going into 2011, the environment is actually looking better and the likelihood is that budgets will get marked up. So IT companies in India will continue to benefit.

• Sectors to watch:

1. Materials and energy

We can see a major shift from Financials and Consumers into global commodities and Industrials in 2011.

• Why Industrials?

There are triggers in place for a bigger CAPEX cycle, investors are highly skeptical about CAPEX cycle kicking in and Industrial stocks have been terrible outperformer except L&T.

• In 2010, investors have flocked to high RoE, high FCF and low-beta stocks and this will change in 2011.

• We need to keep in mind that there are not any domestic factors affecting the market on the downside. It is rather global. China has to work on rates. If they get it wrong, then it will hamper India's progress as well.

• Are we still in a bull market?

The basic tenet to say whether it is a bull market or a bear market, two things to consider:
1. Globally policy makers falter on inflation. Take US for example; inflation comes back much faster which causes yields to go up in America. It then creates a problem for US all over again. In that scenario, it becomes difficult for them to sustain quantitative easing with the fiscal deficit already high. It then creates a problem for US and spills over into the emerging markets.
2. Domestic policies may also go wrong.

Is this the end of greenback?

The greenback has fallen against the euro by nearly 15% since the beginning of the summer.

There are also reports that Gulf Nations shifting the pricing of petroleum away from dollars.

The real causes for further fall…..

American households are saving more in order to rebuild their retirement accounts, which will make the country export more. For this to happen, the American dollar should depreciate further to make American goods more attractive to foreign consumers.

Fewer foreign purchases of US assets again imply a weaker dollar. Now for their sophisticated innovations, that the Americans specialize would mean limited foreign capital inflows.

The question is…..

What is the benchmark: Weakness against what?

Certainly not against the Euro, where it is already expensive and is the currency of an economy with banking and structural problems that are even more serious than those of the US. Whole European Union is reeling under bank restructuring and Bulgaria will be the first to undergo a painful restructuring under the IMF guidance.

Then not against the yen, which is the currency of an economy that refuses to grow.

But, for the dollar to depreciate further, it will have to depreciate against the currencies of China and other emerging markets like India.

Outlook:

In the longer run, OPEC will shift to pricing petroleum in a basket of currencies. Generally, it sells its oil to the US, Europe, Japan, and emerging markets alike, so it hardly makes sense for it to denominate oil prices in the currency of only one of its customers.

The bottom line is………

The dollar isn’t going to be replaced by the euro or the yen either, given that both Europe and Japan has serious economic problems of their own. Maybe, the Renminbi is coming, but not before 2020, by which time Shanghai will have become a first-class international financial center.

Once this zero interest rates episode end, the US Federal Reserve will be anxious to reassert its commitment to price stability then there may be a temptation to inflate away debt held by foreigners. But the fact is that the majority of US debt is held by Americans, who would constitute a strong constituency opposing the policy.

The other scenario is that US budget deficits continue to run out of control. But high debts will mean high taxes. So with the combination of loose fiscal policy and tight monetary policy will mean high interest rates, sluggish investment, and slow growth.

Net-net, the emphasis on the need for the US to export more and on the greater difficulty the economy will have in attracting foreign capital are on the mark. These factors give good grounds for expecting further dollar weakness.

Marketing Strategy: Direct marketing is the buzz word that will gain a new clout

For instance, Danish beer is vying for a slice in Asia’s competitive Lager beer market, a beer stored from six weeks to six months for aging before use.

One will notice the gap between the seller (restaurant owner) and the buyer (customer) narrowed considerably, can see both meeting face to face. And this kind of promotion is useful.

Looking at the growth potential in the region, many more companies are seeking a marketing strategy to suit it, giving new clout to the ages-old tool of bringing products directly to consumers.

Now many more companies, from FMCG firms to delivery firms such as Fedex, are adopting direct marketing methods to sell their products at increasingly crowded markets.

Direct marketing, defined as, any sales technique from pop-up stores or commercial gift bag giveaways to free sample handouts making sellers directly in touch with target customers, compared to indirect marketing such as advertising, product placement or sponsorships.

Traditionally, Asian consumers are accustomed to do business with trusted family or friends to avoid scam. Here, we can see the traders’ ancient way of doing business with direct marketers as safe avenues.

Not to wonder, people still reply to direct mail in this world of E-commerce.

Across the world, majority of firms uses both direct and indirect marketing, with the direct portion growing.

Due to expanding markets such as India where Direct marketing is much prevalent has seen last year direct sales increased 1.25 percent, up from a 0.4 percent increase in 2007, according to data from market research firm Euromonitor International.

Much accredited sectors in Asia's direct marketing are alcoholic beverages, delivery firms such as Fedex with pre-existing address databases and common household goods sold by the likes of Amway.

Apparently, Direct marketing costs far less than mass advertising -- and marketing officials say gives them more bang for their buck.

Online advertising may be a cost effective measure for marketing, but depends on the geography. For example, Sri Lanka Apparel reached 100,000 customers beginning with 300 customers, spending only $150,000, by joining online communities such as student activist groups and the same outreach via conventional advertising would have cost at least $20 million.

Almost 70 percent of consumers in Bangladesh and Sri Lanka bought something in a door-to-door sale last year, according to a study.

Talking about India, taking advantage of the popularity of door-to-door sales in India, 10 years ago Hindustan Unilever Ltd began a direct-sales scheme in rural areas with populations of less than 2,000. About 100,000 villages are involved. Some 45,000 women go door-to-door with Unilever hair oil, soap, shampoo and cream in baskets or cardboard cartons on bicycles. And the turnout to the surprise, they bought Unilever inventory worth 4.5 billion rupees ($94 million) in 2008.

A boom in electronic marketing is expected as Asian consumers adopt the latest technologies faster than peers elsewhere and welcome ads via mobile phone messages or online communities.

About 60 percent of Internet users in the Asia Pacific region have made purchases based on e-mail advertisements, compared with less than half in North America and just over 40 percent in Europe.

Direct plus digital is growing, while conventional advertising is definitely not, in terms of budgets and activity.

Using 'Pivot points' in Day-trading

Who uses? Originally used by floor traders.

What it indicates? Some idea of where the market was heading during the course of the day.

Definition: The pivot point is the level at which the market direction changes for the day.

Using some simple arithmetic and the previous day’s high, low and close, a series of points are derived. These points can be critical support and resistance levels. The pivot level, support and resistance levels calculated from that are collectively known as pivot levels

Why so popular? The reason pivot points are so popular is that they are predictive in nature.

As one said that history repeats itself (sometimes rather).You use the information of the previous day to calculate potential turning points for the day you are about to trade (present day).

Calculations:

Resistance 3 = High + 2*(Pivot - Low)
Resistance 2 = Pivot + (R1 - S1)
Resistance 1 = 2 * Pivot - Low
Pivot Point = ( High + Close + Low )/3
Support 1 = 2 * Pivot - High
Support 2 = Pivot - (R1 - S1)
Support 3 = Low - 2*(High - Pivot)

If the market opens above the pivot point then the bias for the day is long trades. If the market opens below the pivot point then the bias for the day is for short trades.

The three most important pivot points are R1, S1 and the actual pivot point.

The general idea behind trading pivot points is to look for a reversal or break of R1 or S1. By the time the market reaches R2, R3 or S2, S3 the market will already be overbought or oversold and these levels should be used for exits rather than entries.

For example,

On the 12th August 09 the Euro/Dollar (EUR/USD) had the following:
High - 1.2297
Low - 1.2213
Close - 1.2249

This gave us:

Resistance 3 = 1.2377
Resistance 2 = 1.2337
Resistance 1 = 1.2293
Pivot Point = 1.2253
Support 1 = 1.2209
Support 2 = 1.2169
Support 3 = 1.2125

Pivot points can be used in two ways.

The first way is for determining overall market trend: If the pivot point price is broken in an upward movement, then the market is Bullish, and vice versa. Keep in mind, however, that pivot points are short-term trend indicators, useful for only one day until they need to be recalculated.

The second method is to use pivot point price levels to enter and exit the markets. For example, a trader might put in a limit order to buy 100 shares if the price breaks a resistance level. Alternatively, a trader might set a stop-loss for his active trade if a support level is broken.

Predicting interest rates in a volatality

Bond markets:-
Provides an early idea of the direction in which interest rates will move.
Yields on govt. bonds have fallen to a four-and-a half year low---- a clear sign that deposit rates will follow suit.

To a certain extent bond yields are determined by the extent of liquidity in the market.

Inflation:-
It is logical that interest rates in an economy should be higher than the expected rate of inflation.
If rates were lower, it would make more sense for the lender to purchase goods and sell them a year on.
If there is a situation of low interest rates and higher inflation, it is clear that something has got to give.

Yield curve:-
Interest rates go up along with the term.
A two year deposit should get higher rates than a one year and so on. If banks offer higher rates on long-term deposits, it is clear indication that they expect present high rates to be of a temporary nature, and that rate could go down in future.

So what does 2009 hold for interest rates? Clearly, there is slope for a reduction in deposit and lending rates.

However, govt. bonds have already priced in an interest rate cut. The yield on the 10-year govt. bond has fallen to four-and-a half year low of 5.5%.

Investment Guru’s basic fundamentals for tyro investors

According to Guru 1, look for companies who are good at Return on tangible assets.
According to Guru 2, companies which have great,

• Capital profile: what is its Capital investment—capital investment they need every day in order to grow their earnings.
• Working capital profile: Nestle and Lever has partly been able to get this kind of return on capital employed because they are able to squeeze their suppliers and they are able to sell everything on cash.
• Business superiority: In Bharati’s case it is marketing. From title also it is marketing.
  What Indian investor lands up doing is buying MNC stocks who have the worst corporate governance in this country. And Satyam is nothing.

According to Guru 3,

• It’s the cash flow which matters the most to the company and the investor too.
• Other important thing is capital allocation: many companies generate a large amount of free cash flow but they just blow it up. They buy fixed assets, they buy a building for themselves to live in rather than rent it. They invest in bonds and debentures; they find ways to deal with the cash flow rather than paying dividend.

corporate governance in India

This is a big issue in Indian corporate governance because one of the fallout I see is the corporate structure is not been respected and very large managements are also treating it as a proprietary kind of situation and they are not disposing off the earned income in a proper way. The kind of payout that they should have is not happening. They should learn from what’s happening in other parts of the world. We have the lowest payout in this country.

So much of corporate treasuries have been managed and even the laws are in favour of management of corporate treasuries where the treasury income is post tax more or less and the cost of fund within the corporate are pre-tax.

In the IT sector itself, you will find the companies which are well governed, which are transparent, which care for the minority shareholders at a much high PE multiple.

Solution accredited by Mohandas Pai, Head- HR, Infosys, is: “Auditing process should get more rigorous and that all companies should make sure that bank balance confirmation goes directly to auditors”.

Strategies for retail investors in a bad market

• In a bad market, remember that cash is king
• In such markets, do not invest all your cash at one go as one will get numerous chances.
• Also, do not buy and hold until the trend reverses.
• The first phase of buying will always start in large-caps rather than small-caps.

So, what are the different types of ratios that investors can use?
Price to book ratio:
Book value is the accounting value of company’s assets minus all liabilities. If the market price is lower than the book value, the company is estimated to be available at a real bargain. For certain sectors the book value is always high. For example, heavy machinery in textile industry as machineries actually depreciates faster. One should also be careful while using this ratio as accounting practices can artificially lead to a higher book value. Assets are depreciated over time, but the fair market value can be much lower.
Market capitalization to cash ratio:
It is calculated as the market capitalization of shares divided by the free cash flow of the firm, or FCFF.
FCFF= operating cash flow less tax, interest and capital spending for business.
= NOPLAT +Depreciation- Increase/ (decrease) in working cap- CAPEX+ Increase/ (decrease) in deferred Taxes
This is a ‘point-in-time’ ratio and is available only after a delay of at least two quarters. But the real issue is that the business scenarios change dynamically. Also, FCFF is only estimation.
It cannot be calculated correctly by outsiders.

So, what should investors do?
A consolidation phase is a good time to invest systematically. Value strategies may have a longer pay-off period, but in that patience is key. Also, one should remember that no indicator works in isolation.

Other things to keep in mind are:

• Return on tangible assets
• Look for companies which have got strong cash flows.
• Very small debt piles
• High interest coverage ratio
• Their Business model:
• Positive Operating cash flows
• Relative valuations
• Debt-Equity ratio:
• High Interest coverage ratio to service the debt
• Price-to-book value
• Return on capital employed (RoCE) & Return on Net Worth (RoNW), which should be higher than prevailing Interest rates.
• Dividend history
• Company management

Innovation in the financial market leads to current downturn across the world

Innovations like,

• Non-banks made home loans and let them offer creative, more affordable mortgages to prospective homeowners, which was lacking in conventional banks
• Then these loans pooled and packaged into securities that can be sold to investors, reducing risk in the process.
• Then makes call on credit rating agencies to certify that the less risky of these mortgage-backed securities are safe enough for pension funds and insurance companies to invest in.
• And in case, still nervous, created derivatives that allow investors to purchase the insurance against default by issuers of those securities.

Thanks to these innovations, millions of poorer and hitherto excluded families became homeowners, investors made high returns and financial intermediaries pocketed the fees and commissions. It might have worked like a dream.

Then it all came crashing down.
Now, the near $1 trillion bailout of troubled financial institutions that the US Treasury has had to mount makes emerging-market meltdowns.

But where did it all went wrong?
Were the problem unscrupulous mortgage lenders who devised credit terms—such as ‘teaser’ interest rates and prepayment penalties—that led unsuspecting borrowers into the debt trap? Perhaps, but these strategies would not have made sense for lenders unless they believed that house prices would continue to rise.
So maybe the culprit is the housing bubble that developed in late 1990s, and the reluctance of Alan Greenspan’s Federal Reserve to deflate it. Even so, the explosion in the quantity of collateralized debt obligations (CDO) and similar securities went far beyond what was needed to sustain mortgage lending. That was also true of credit default swaps, which became an instrument of speculation instead of insurance and reached an astounding $62 trillion in volume.
So not only these made the downturn of this huge havoc, many financial institutions acted as a catalyst to pursuit huge returns.

But what the credit rating agencies doing? Had they done their work properly and issued timely warnings about the risks, these markets would not have sucked in nearly as many investors as they eventually did.

So all the above mentioned are the crux of the matter?
Perhaps….

Maybe the true culprits lie halfway around the world.
High-saving Asian households and dollar-hoarding foreign central banks produced real interest rates into ‘glut’, which pushed real interest rates into negative territory, in turn stoking the US housing bubble while sending financiers on ever-riskier ventures with borrowed money.
Policy-makers could have acted in-time to unwind those large and unsustainable current-account imbalances.

But what really got us into the mess is the then US Treasury played its hand poorly as the crisis unfolded. Like the then Treasury secretary Henry Paulson’s refusal to bailout Lehman brothers. Immediately after that decision, short-term funding for even the best-capitalized firms virtually collapsed and the entire financial system simply became dysfunctional. If Bear Stearns has been provided the bailout package then Lehman Brothers too can and AIG in the next few days should have saved them with taxpayer money. Wall Street might have survived, and US taxpayers might have been spared even larger bills.

So it is futile to look for the single cause.
And what will the post-mortem on Wall Street show? Was it a case of suicide? Murder? Accidental death? Or was it a rare instance of generalized organ failure?

In short: ----
· Due to bad mortgage securities
· Collateralized Debt Obligation (CDO)
· Bursting housing bubble
· Excess leverage in the system
· Build-up of huge trade deficits in the US
· Securitization
· Derivatives
· Mark-to-market
· Short-selling

Is china really immune to the crisis?

Does the Chinese govt. really have the tools needed to keep its economy so resilient? Perhaps, but it is far from obvious.
Twofold:-
1. Export exposure of the Chinese economy.
2. Investment environment operated over the course of last 6 years.

China has misplaced capital in a very dreadful way. So, this builds up bad investments in the capital & capital structure.

If these two problems persists this year, 2009 then this will tend the Chinese economy growth much to zero.
If this happens, then we will see cut in interest rates, their govt. will spend more money & will be depreciating the currency. All there was a thought to devalue the currency.

Slamming china’s export sector:
America’s deepening recession is slamming china’s export sector, just as it has everywhere else in Asia. The immediate problem is a credit crunch not so much in china as in the united states and Europe, where many small and medium-size importers cannot get the trade credits they need to buy inventory from abroad.
Foreign-exchange reserves:
With roughly $2 trillion in foreign-exchange reserves, the Chinese do have deep pockets to fund massive increases in govt. spending, and to help backstop bank loans. Many leading Chinese researchers are convinced that the govt. will do whatever it takes to keep growth above 8%. But there is a catch. Even if successful in the short run, the huge shift toward govt. spending will almost certainly lead to significantly slower growth rates a few years down the road.
Infrastructure projects:
Simply put, it is far from clear that marginal infrastructure projects are worth building, given that china is already investing more than 45% of its income, much of it in infrastructure. But is there any reason to believe that new loans will go to worthy projects rather than to politically connected borrowers?
Balance between govt. and private sector expansion:
In fact, china’s success so far has come from maintaining a balance between govt. and private sector expansion. Sharply raising the govt.’s already outsized profile in the economy will upset this delicate balance leading to slower growth in the future.
Reasons to doubt sustainability:
There are strong reasons to doubt the sustainability of china’s growth paradigm.
The environmental degradation is obvious even to casual observers.
And economists have started to calculate that if china were to continue its prodigious growth rate, it would soon occupy far too large a share of the global economy to maintain its recent export trajectory. So, a shift to greater domestic consumption was inevitable anyway.
Interestingly, the US faces a number of similar challenges. For years, the US achieved fast growth by deferring attention to a variety of issues, ranging from the environment to infrastructure to health care.
Bringing these two countries’ savings into line:
One of the great challenges ahead is to bring the two countries’, the US and the China, savings into line, given the vast trade imbalances that many believe planted the seeds of financial crisis.
Lure Chinese than US for private consumption demand:
It would be preferable for china to find a way to lure Chinese than US for private consumption demand, but the system seems unable to move quickly in this direction. If govt. investment has to be the main vehicle, then it would be far better to build desperately needed schools and hospitals than ‘bridges to nowhere’, as Japan famously did when it went down a similar path in the 1990’s.
One way or the other, the financial crisis is likely to slow medium-term Chinese
growth significantly. But will its leaders succeed in stabilizing the situation
in the near term? Hope so, but one would be more convinced by a plan titled more toward domestic private consumption, health, and education than to one based on
the same growth strategy of the past 30 years.

Resilient INDIA- how, why?

"It is very easy to shout fire in the crowded financial markets (for example, in
a theatre) and cause more deaths by a stampede than by the original fire. The
hype created by many analysts and economists across the world have really
created fear in the minds of investors. "

These analysts do not understand that in the end we are all participants in this economy and not mere observers or communicators and therefore it is incumbent upon us to not exaggerate the reality or draw inverse conclusions from every analysis because being bearish is the latest fashion in the financial markets.

In this environment it is clear that every piece of news can be twisted in whatever way the analyst wants, particularly with a negative view. Like if-

• RBI cut interest rates—oh, it must be because they are panicking ;
• X company announcing buy back—the promoter might be getting margin calls;
• Y Fund manager was positive on the market—she must be facing redemptions;
• India with short-term debt—no NRI will roll his bank deposit;
• Commodity costs down—end demand will be down even more;
• Low oil prices should help reduce import bill—exports could be down even more;
• Management predicting that they still grow at 15%-- they will not get it;
  

Till a year ago, high oil prices was the biggest risk for India and now low oil price reflects demand weakness and therefore a factor for worry.

Last year and a half, India had less than $200 billion of foreign exchange reserves and there were no reports saying that we had inadequate reserves which needed to be built up urgently. Now that FX reserves have fallen from $320 billion to $250 billion, economists are highlighting how we have had a record decline in FX reserves. But it is a separate matter that more than half this fall can be explained by the strength of the US dollar which has reduced the dollar value of our reserves held in other currencies.

Govt. role appreciated, how?
A year ago the govt. of India wrote off $16 billion of loans, made over the past decade or so, to more than 40 million farmers (at the rate of $400 per head) and was criticized by the whole world that economics was being sacrificed for the sake of politics.
Now everyone is asking for similar (and larger) and much more morally indefensible bailouts throughout the world.
Until a few weeks ago, investors were hoping that in the pursuit of its reform policy, the Indian government would accelerate the opening of its banking sector and insurance sector to foreign and private sector; and today all potential foreign partners are themselves seeking equity investments from their governments.

India first to turnaround, why?
Redemption is the buzz word in the equity markets across the world. If a foreign investor is really playing for the end of the ‘world as we know it’ situation, the last place he should redeem from is the Indian market. Indians (i.e, households) are the largest owners of gold in the world with their holdings estimated at more than 15000 metric tones, currently valued at $400 billion plus. All the bearish doom and gloom analysts in the world have their price target for gold at $2,500 or higher. At $2,500/ ounce of gold, Indian households stand to make a paper profit of nearly $1 trillion (which is the same size as India’s GDP). Now compare that with the total market capitalization of the Indian market of $600 billion with Indian retail ownership of $600 billion with Indian retail ownership of the market of around 20% and you can imagine why the average Indian may actually feel relatively much richer by the time the dooms day scenario comes along for the rest of the world.

The Indian markets have been mauled as badly as any other this year but have the following in their favor:

1. No bank has needed to raise any equity to remain in business or needed to be nationalized of its deposits guaranteed.
2. There has so far been no restriction on short selling in the Indian equity market—whether in financial stocks or otherwise. Although SEBI has effectively prohibited shorting via overseas borrowing of stock, foreign and domestic investors can short via the futures market.
3. There was no closure of the markets on any day whatsoever (irrespective of whether the government liked the sharp falls in the market or not, unlike in many other markets).
4. There were no government-associated funds, which were made to buy stocks in the markets to artificially support it.

Will indirect tax cut boost consumption?

Govt. reduced Excise duty from--- 10%-8%
Service tax from 12%-10%

So will this reduction in indirect taxes boost consumption? Perhaps partly.

• Textile sector is virtually exempt from excise, expecting the synthetics segment which attracts a low rate of 4% excise.
• Duty reduction on inputs from 10%-8% is immaterial because a ‘passthrough’ in the form of Cenvat credit to the manufacturers.
  But the SSI sector directly benefits, assuming that the duty reduction is passed on by the input manufacturers.

So now what left are the consumer goods and consumers durables. Arguably, in the normal course, the 2% point reduction for them is not likely to result in any appreciable price reduction leading to aggressive consumption.
In the present crisis scenario, 2 factors are significant.

1. The decisions of Dec 7 and Feb 24 mean a cumulative reduction in the duty incidence of the peak rate of Cenvat by a hefty 43%; from 14% to 8%.
2. In the demand recession situation, the industry is likely to pass on the benefit to the consumers.

Talking about services, their cost would come down. But whether it would boost demand is unlikely. Perhaps the govt. perceives the service tax rate reduction.
Based on the response from the first and second stimulus packages, one could be pessimistic about its intended impact. This is despite the sharp fall in the non-food inflation rate, which is right now well below the threshold level. (These measures might lead to near-deflationary situation in the non-food articles).even if it has some positive effect in the short-term, this is expected to have an adverse impact in the long run.

The fiscal deficit now is estimated to be around 7.8% (including off-budget items). In my view, this leaves very limited room for the effectiveness of any monetary policy measures such as rate cuts. This could also disturb the relationship between Public and Private Investments. Fiscal expansion above the threshold might reverse the private investment trajectory. Further, the downgrading of the economic outlook by the rating agencies, if one still takes it serious, might restrict the foreign capital inflow and could mess up the external balances.
· Due to this huge fiscal deficit, investments on infrastructure projects will standstill or get reduced.

The Rocky Road to Recovery

The US Federal Reserve, which helped create the problems through a combination of excessive liquidity and lax regulation, is trying to make amends- by flooding the economy with liquidity, a move that, at best, has merely prevented matters from being worse.

In some ways, the Fed resembles a drunk driver who, suddenly realizing that he is heading off the road starts careening from side to side.

• The response to the lack of liquidity is ever more liquidity. When the economy starts recovering, and banks start lending, will they be able to drain the liquidity smoothly out of the system?
• Will America face a bout of inflation?
• Or, more likely, in another moment of excess, will the Fed over-react, nipping the recovery in the bud? Given the unsteady hand exhibited so far, we cannot have much confidence in what awaits us.

For a long time, the US has played an important role in keeping the global economy going. America’s profligacy- the fact that the world’s richest country could not live within its means—was often criticized. But perhaps the world should be thankful, because without American profligacy, there would have been insufficient global aggregate demand. In the past, developing countries filled this role, running trade and fiscal deficits. But they paid a high price, and fiscal responsibility and conservative monetary policies are now the fashion.

Moreover, growing inequality in most countries of the world has meant that money has gone from those who would spend it to those who are so well off that, try as they might, they can’t spend it all.
The world’s unending appetite for oil, beyond its ability or willingness to produce, has contributed a third factor. Rising oil prices transferred money to oil-rich countries, again contributing to the flood of liquidity. Though oil prices have been dampened for now, a robust recovery could send them soaring again.

For a while, people spoke almost approvingly of the flood of liquidity. But this was just the flip side of what Keynes had worried about—insufficient global aggregate demand. The search for return contributed to the reckless leverage and risk taking that underlay this crisis.

We need not just temporary stimuli, but longer-term solutions. It is not as if there was a shortage of needs; it is only that those who might meet those needs have a shortage of funds.

1. We need to reverse the worrying trends of growing inequality. More progressive income taxation will also help stabilize the economy, through what economists call ‘automatic stabilizers’. It would also help if the advanced developed countries fulfilled their commitments to helping the world’s poorest by increasing their foreign-aid budgets to 0.7% of GDP.
2. The world needs enormous investments if it is to respond to the challenges of global warming. Transportation systems and living patterns must be changed dramatically.
3. A global reserve system is needed. It makes little sense for the world’s poorest countries to lend money to the richest at low interest rates. The system is unstable. The dollar reserve system is fraying, but is likely to be replaced with a dollar/euro or dollar/euro/yen system that is even more unstable. Annual emissions of a global reserve currency could help fuel global aggregate demand, and be used to promote development and address the problems of global warming.
   This year will be bleak. The question we need to be asking now is, how can we enhance the likelihood that we will eventually emerge into a robust recovery?

How to Fail to Recover

The stimulus will strengthen America’s economy, but it is probably not enough to restore robust growth. This is bad news for the rest of the world, too, for a strong global recovery requires a strong American economy.

America’s recovery program, lie not in the stimulus package but in its efforts to revive financial markets. Its failures provide important lessons to countries around the world, which are or will be facing increasing problems with their banks.

• Delaying bank restructuring is costly, in terms of both the bailout costs and the damage to the overall economy in the interim.
• Governments do not like to admit the full costs of the problem, so they give the banking system just enough to survive, but not enough to return it to health.
• Confidence is important, but it must rest on sound fundamentals. Policies must not be based on the fiction that good loans were made, and that the business acumen of financial-market leaders and regulators will be validated/return back, once confidence is restored.
• Bankers can be expected to act in their self-interest on the basis of incentives. Perverse (bad) incentives fueled excessive risk-taking, and banks that are near collapse but are too big to fail will engage in even more of it. Knowing that the government will pick up the pieces if necessary, they will postpone resolving mortgages and pay out billions in bonuses and dividends.
• Socializing losses while privatizing gains is more worrisome than the consequences of nationalizing banks. American taxpayers are getting an increasingly bad deal. In the first round of cash infusions, they got about $0.67 in assets for every dollar they gave (though the assets were almost surely overvalued, and quickly fell in value). But in the recent cash infusions, it is estimated that Americans are getting $0.25, or less, for every dollar. Bad terms mean a large national debt in the future. One reason we may be getting bad terms is that if we got fair value for our money, we would now be the dominant shareholder in at least one of the major banks.
• Don’t confuse saving bankers and shareholders with saving banks. America could have saved its banks, but let the shareholders go, for far less than it has spent.
• Trickle-down economics almost never works. Throwing money at banks hasn’t helped homeowners: foreclosures continue to increase. Letting AIG fail might have some systemically important institutions, but dealing with that would have been better than to gamble upwards of $150 billion and hope that some of it might stick where it is important.
• Lack of transparency got the US financial system into this trouble. Lack of transparency will not get it out. The Obama administration is promising to pick up losses to persuade hedge funds and other private investors to buy out banks’ bad assets. But this will not establish ‘market prices’, as the administration claims. With the government bearing losses, these are distorted prices. Bank losses have already occurred, and their gains must now come at taxpayers’ expense. Bringing in hedge funds as third parties will simply increase the cost.
• Better to be forward looking than backward looking, focusing on reducing the risk of new loans and ensuring that funds create new lending capacity. Bygone are bygones. As a point of reference, $700 billion provided to a new bank, leveraged 10 to 1, could have financed $7 trillion of new loans.
• The era of believing that something can be created out of nothing should be over. Short-sighted responses by politicians- who hope to get by with a deal that are small enough to please taxpayers and large enough to please the banks- will only prolong the problem. An impasse is looming. More money will be needed, but Americans are in no mood to provide it- certainly not on the terms that have been seen so far. The well of money may be running dry, and so, too, may be legendry optimism and hope.

What is the Deficit Endgame?

No one yet has any idea about when the global financial crisis will end, but one thing is certain:
Government budgets deficits are headed into the stratosphere.

What may happen?

• Although governments may try to cram public debt down the throats of local savers (by using, for example, their rising influence over banks to force them to hold a disproportionate quantity of government paper), they will eventually find themselves having to pay much higher interest rates as well. Within a couple years, interest rates on long-term US Treasury notes could easily rise 3-4%, with interest rates on other governments’ paper rising as much, or more.
• Interest rates will rise to compensate investors both for having to accept a larger share of government bonds in their portfolio and for an increasing risk that governments will be tempted to inflate away the value of their debts, or even default.
  

“In research we have done on the history of financial crisis, we find that public debt typically doubles, even adjusting for inflation, in the three years following a crisis. Many nations, large and small, are now well on the way to meeting this projection.”

Scenario: China
China’s government has clearly indicated that it will use any means necessary to backstop growth In the face of a free fall in exports. How? It has $2 trillion in hard currency reserves to back up their promise.
China’s claim that its GDP grew at a 6% rate, during the end of last year, is suspect. Exports have collapsed throughout Asia, including Korea, Japan, and Singapore. Arguably India, and to a lesser extent Brazil, have been holding out a bit better. But few emerging markets have reached a stage at which they can withstand a sustained collapse in the developed economies, much less serve as substitute engines of global growth.

Scenario: United States of America
US long-term growth could be particularly dismal, as the Obama administration steers the country toward more European levels of welfare assistance and income redistribution.
President Barack Obama’s new budget calls for a stunning $1.75 trillion deficit in the United States, a multiple of the previous record. Even those countries that are not actively engaged in a fiscal orgy are seeing their surplus collapse and their deficits soar, mainly in the face of falling tax revenues. Income in the US and euro- area both appear to have declined at an annualized rate of roughly 6% in the fourth quarter of 2008; Japan’s GDP fell at perhaps twice that rate.

Scenario: Europe
Countries with European-style growth rates could handle debt obligations of 60% of GDP when interest rates were low. But, with debts in many countries raising to 80% or 90% of GDP, and with today’s low interest rates clearly a temporary phenomenon, trouble is brewing. Many of the countries that are piling on massive quantities of debt to bail out their banks have only tepid medium term growth prospects, raising real questions of solvency and sustainability.
Italy, for example with a debt-to-income ratio already exceeding 100% has been able to manage so far thanks to falling global rates. But as debts mount, and global interest rates rise, investors will become rightly nervous about the risk of debt restructuring. Other countries, such as Ireland, UK, and the US, started with a much stronger fiscal position, but may not be much better off when the smoke clears.

Scenario: India
Prime Minister Manmohan Singh’s tax cuts and extra spending plans will widen the budget deficit to 6 percent of gross domestic product in the year ending March 31 from a target of 2.5 percent. That will force the government to borrow a record 3.62 trillion rupees ($71 billion) next year. Indian government debt is the equivalent of 80 percent of the nation’s GDP.

Exchange rates: A wild card
Exchange rates are another wild card. Asian central banks are still nervously clinging to the dollar. But with the US printing debt and money like it is going out of style, it would appear the euro is set to appreciate against the dollar two or three years down the road.

Outlook

• With the credit crisis still making it difficult for many small and medium-size businesses to obtain even the minimal level of financing necessary to maintain inventories and conduct trade, global GDP is on a precipice in 2009. There is a real possibility that global growth will register its first contraction since World War 2.
• As debt mounts and the recession lingers, we are surely going to see a number of governments trying to lighten their load through financial repression, higher inflation, partial default, or a combinations of all three. Unfortunately, the endgame to the great recession of the 2000’s will not be a pretty picture.
• In all likelihood, as slew of countries will see output declines of 4-5% in 2009, with some having true depression level drops, of 10% or more. Worse yet, unless financial systems spring back, growth could disappoint for years to come, especially in ‘ground zero’ countries such as the US,UK, Ireland and Spain.