Wednesday, May 24, 2006
Market consensus has acknowledged that the Indian equity market was in need of a "healthy correction". While the macro problems of running both a deteriorating current account deficit and a fiscal deficit have yet to be adequately addressed, private sector credit has become increasingly dependent on fund flows. With a negative basic balance of payments, the credit system appears much more susceptible to an external shock. At the same time and apparently unbeknown to investors, the degree of financial leverage (open interest of derivatives) relative to equity market capitalisation has risen from five times to 20 times over the past 20 months, creating considerable systemic risk for investors in an economy with an open capital account. We feel investors are being betrayed by high earnings growth projections and macro risks are being ignored. Equally, the large issuance of equity by companies looks set to dampen ROE — normally a good indicator of a peaking in equity markets. We believe Indian equities have far further to correct compared to regional peers, and thus remain Bearish, with a lean towards Taiwan as an alternative.
Sunday, May 28, 2006 : This appeal is made to all Indians who feel betrayed by the Union Govt's decision to enforce reservations for OBCs.
This protest will be completely peaceful. JOSH MEIN HOSH MAT KHO BHETHO. Remember, we are NON-VIOLENT - NON-POLITICAL - UNITED
For details please keep visiting this site
Morgan Stanley - Suzlon
CMP - 1227
Target - 865
Valuations: At Rs 1,228, SEL trades at P/E of 26.6 and 21.2 times our F2007 and F2008 estimates. We retain our earnings estimates over F2006-08. While the growth momentum is strong, we believe that that's captured in the current valuations and hence retain our Equal-weight
rating. For F2006, SEL would be paying dividend of Rs 5 per share to its equity shareholders and Rs10 per share to its preference shareholders
The Morgan Stanley Emerging Market Index has been declining since May 10, when the US Fed raised the interest rate and signalled further rise.
The current market crisis could be handled better if it is viewed against developments in global markets. First, the world commodity and bond markets were impacted and then the bourses.
What has happened since May 18 is nothing short of butchery at the bourses. In three trading sessions — on May 18, 19 and 22 — the Sensex dropped by 1300 points. It was galling that the Sensex, which dazzled market analysts when it hit the peak of 12,612 on May 10, has been winding down since. When it hit the peak, they assumed that the market was defying gravity and there would be no roll back. They also seemed unaware of the developments in other markets of the world.
Fear of inflation and anxiety over the policies of the US Federal Reserve (Fed) began to stalk the markets. Though the Fed chief, Prof Ben S. Bernanke, raised the rate to 5 per cent on May 10, financial markets remained sceptical about his commitment to fighting inflation even as the dollar was depreciating. As Buttonwood (The Economist, May 16) analysed: "The fear rippling through Asia... was that the Federal Reserve might find itself with a classic inflation scare: faced with a tumbling dollar and rising bond yields, it might have to raise rates higher than it would otherwise have done."
Worm in the apple
Higher rates would exacerbate the global financial imbalances by reversing flows, driving Asian surpluses away from dollar assets, upsetting balance-sheets, pricking the housing bubble, lowering US consumption levels and slowing its growth, hurting Asian exports. To many, these concerns may appear irrational, but the worm had entered the apple.
Indeed, faith in the value of the dollar was critical to the current global financial balance. Asian surpluses could finance the US' twin deficits and, as some economists describe, sustain a new Bretton Woods II.
Many others wondered whether faith in the dollar would endure long. Unfortunately, at some point, especially since April, that faith has been shaken.
On May 12, the dollar slumped to its lowest level since October 1997 against the euro, the pound sterling, the Swiss franc and the Japanese yen, losing 6-8 per cent since April. In turn, they brought down the value of the currencies of Brazil, South Africa, Turkey and Hungary. Iceland and Australia were wrecked too. As reported by financial papers, carry trade investors such as hedge funds began to cut their exposures to "emerging markets amid rising volatility in the leading currencies in which they borrow and mounting risk aversion as concerns over inflation increase" (Financial Times, May 13).
Carry trade contagion
Carry traders borrow at, or near, the 1 per cent overnight rate set by the Fed and invest in multi-year notes and bonds that yield high profits. The former Fed chief, Mr Alan Greenspan, lowered the Fed rate 13 times since 2001 to mid-2003 from 6.75 per cent to 1 per cent.
In 2002, it was negative when adjusted against the inflation rate. The carry traders were awash with liquidity provided by the Fed at historically low rates. Carry trade spread to all markets such as currency, commodity, equity and bonds.
Much of the equity to emerging markets was through carry trade. In India, the equity was provided through the portfolio route operated by foreign institutional investors (FIIs) and Participatory Notes (PNs). It was no coincidence that capital flows surged after 2002-03. Apart from the interest differential, the tax exemption given to investors attracted further inflows.
FII flows reached $10.70 billion in 2005 and were expected to scale higher levels in 2006. In tandem, the Sensex rose from 6,000 points in January 2004 to 12,612 on May 10, 2006. Financial prudence should have suggested circumspection and concern whether the trend would hold. Sadly, it was taken as a badge of honour or testimony to India rising as an emerging giant.
To get back to the fears of other markets. On May 15, Bloomberg reported that the Morgan Stanley Capital International Emerging Market Index, which tracks shares in 26 developing markets, plunged to 759.26 on Monday. The index, in fact, had started declining since May 10, when the Fed raised the interest rate and signalled further rise. This gave rise to fears that if the Fed kept hiking the rate, money would start flowing back to Treasuries.
The Latin America index also fell by 2.8 per cent on top of an earlier drop of 3.6 per cent. The commodity market began to tumble. There were also jitters in the bond market. Running through all these were the withdrawal symptoms of the carry traders.
Impact across markets
If the Fed has raised the rate to 5 per cent and threatened to hike it further, it took the bottom out of the carry trade. In the Greenspan years of cheap money, they had over-reached themselves and taken excessive or indiscriminate risks.
In the changed context, they would have to unwind and rebalance their positions. The reverberations of such unwinding were felt across all the markets and segments, beginning with currency and extending to commodities and equity. It was just a question of days before it hit Indian shores.
Their honeymoon with emerging markets is over as developments there are now seen to be volatile and unpredictable. As Landon Thomas Jr. explains, though the earlier crises in Mexico, Asia and Russia might have been due to faulty government policies, "the pandemic nature of these blow-ups was deepened by the panicked selling of unsophisticated investors" (The New York Times, May 18).
Perhaps, what was witnessed in the Indian bourses was an extension of this frenzy. Referring specifically to India, he adds that "... a market that has shot up 141 per cent over the last two years... some of the largest shareholders of top Indian companies are American mutual fund companies like Janus, known more for its momentum style of investing than for its emerging markets expertise... " The current crisis in our bourses may be handled better if it is viewed in the context of developments taking place in other global markets.
Though the Finance Minister blamed `rumour-mongers' and explained how the draft circular of the Central Board of Direct Taxes (CBDT) did not envisage any change in the status of the FIIs or propose additional taxes, all investors are aware of the tax implications of their operations and have safeguarded against them through suitable tax shelters.
Indeed, a lot was said about the global factors but not wholly convincingly. Recent developments must not be seen through the narrow prism of the stock market requiring correction.
It is a major economic issue with implications for sustaining the rupee rate, management of foreign exchange reserves, etc. In particular, the government needs to clarify whether it will continue to keep faith in the FIIs, a la Lahiri Committee, or if there will be a rethink to bring about financial stability in the coming years.
(The author, a former Finance Ministry official, has experience in international, financial and trade issues.)