>The Dubai Debt crisis: What really happened?

Dubai’s debt woes are a lot older and deeper than Friday’s announcement by Dubai World (a
conglomerate of the government of Dubai) might indicate. The announcement-asking for a
standstill on the repayment of USD 60 bn worth of debt till May, 2010-appears to be a culmination of the stress that Dubai has been witnessing over the last year. It is just a visible symptom of the woes of an economy long reeling under the weight of a real estate crash that hit the economy over a year ago. Since their peak in 2008, real-estate prices have plummeted to 60% of their precrisis levels thus exposing highly leveraged real-estate developers to the risk of default. In fact, major credit rating agencies such as Standard and Poor’s and Moody’s had placed several government related entities (GREs) and local banks on negative rating watch as far back as May, 2009 indicating that the prospect of rising credit risk and debt default had become real much earlier than Friday’s announcement.

In an effort to ride over repayments falling due over the year (including USD 327.5 mn to British
contractors and USD 9 bn of international debt falling due over the next four months), Dubai
sought to draw down support from Abu Dhabi- UAE’s wealthiest member and unlike Dubai, an oil producer. On the face of it, this was not such a difficult task with Abu Dhabi having a history of providing big ticket financing to Dubai. Abu Dhabi and Dubai appeared to tie up financing
arrangements. However the negotiations soon turned fractious and acquired a political hue with
Dubai asking for “unconditional” support and Abu Dhabi intent on following through any support
only under the condition of an asset transfer (market rumours suggest that Abu Dhabi was keen on taking over Emirates Airlines, Emistalat, DP World and others) in return for funding. Talks
between the two countries subsequently broke down prompting Dubai to issue a 5-yr USD 20 bn
loan programme in February, 2009. USD 10 bn of this amount was subscribed by the UAE central bank. However, with foreign exchange reserves totaling only USD 25 bn at its disposal and the rest of the reserves parked in sovereign wealth funds of member nations, the central bank could not subscribe to the residual USD 10 bn. The residual amount was originally supposed to be subscribed by Abu Dhabi Investment Authority (ADIA), which handles UAE’s largest forex reserves totaling USD 627 bn. However, it failed to come through and a last minute deal was worked out with two Abu Dhabi banks (Al Hilal Bank and NBAD) subscribing to USD 5 bn of the residual USD 10 bn amount.

Despite securing sizeable financing to meet its debt needs, events snowballed to a crisis last Friday when Dubai announced its willingness to a standstill on the liabilities of Dubai World and declared that the USD 5 bn raised from Abu Dhabi banks would be used for purposes other than the immediate needs of Dubai World. This statement came in the backdrop of a USD 3.5 bn Nakheel (subsidiary of Dubai World) bond falling due on December 14, 2009 thus prompting fears of an imminent default on the note. It also underscored the fact that while investors had expected an ‘implicit’ guarantee on debt raised by GREs like Dubai world (there was no explicit guarantee) the Dubai government was unwilling to play ball.

The status of the repayment falling due remains uncertain as of now. While Dubai World is looking to restructure USD 26 bn of its obligations (including the USD 3.5 bn Nakheel bond falling due in December,2009 and USD 5.7 bn of debt falling due before May,2010) whether banks and creditors will agree to Dubai World’s terms remains to be seen. The fate of the remaining USD 13-14 bn is less uncertain with bulk of the amount held by units such as DP World that have enough cash flow to service impending obligations.

Dubai World’s financial mess is as much a reflection of the real-estate market as it is of the
complexities of UAE politics. With the lion’s share of foreign assets (over 95% on last count) being held by Abu Dhabi, the ability of both the central bank of UAE and the Dubai government to help out in times of crisis is limited. Total foreign exchange reserves of the UAE sum up to USD 700 bn (including Abu Dhabi’s foreign assets) and the USD 60 bn of debt owed by Dubai World or the USD 100 bn of debt held by Dubai is easily manageable if Abu Dhabi co-operates. Would Abu Dhabi not have engaged in a power struggle over Dubai’s assets, chances are that Dubai’s debt problems would not have been as exposed as they were last week. However, with both Abu Dhabi and the government of Dubai now explicitly backing away from Dubai World’s obligations one thing appears clear. Dubai’s GREs (government related entities) and private debtors will have to bear the brunt of bad investment decisions alone.

To read the full report: DUBAI DEBT CRISIS

>GDP Growth in QE Sept 2009 - Much Stronger Than Expected (MORGAN STANLEY)

• GDP growth accelerated to 7.9% in QE Sept 2009: The Central Statistical Organization (CSO) announced that GDP growth in the quarter ended September 2009 (QE Sept 2009) was 7.9%, the highest since QE June 2008. This compares with 6.1% registered in QE June 2009 and 5.8% registered in QE March 2009. The growth was much higher than our expectation of 6.4% and consensus expectation (as per Bloomberg survey) of 6.3%.

• Positive growth in agriculture segment was a surprise: Growth in the agriculture sector decelerated to 0.9% in QE Sept 2009 (vs. 2.4% earlier). The deviation in actual GDP growth numbers in QE Sept 2009 from our forecasts is largely on account of positive growth in the agriculture segment vs. our expectation of a decline due to poor monsoons. Growth in mining and quarrying, on the other hand, accelerated further to 9.5% in QE Sept 2009 (vs. 7.9% earlier).

• Industry segment growth largely in line with our expectations: The industry segment growth accelerated to 8.2% in QE Sept 2009 compared to 4.8% in the previous quarter. Within industry, the manufacturing segment growth picked up sharply to 9.2% (vs. 3.4% earlier). While growth in the electricity, gas & water supply segment accelerated to 7.4% (vs. 6.2% earlier), the construction segment growth decelerated to 6.5% (vs. 7.1% earlier).

• Services segment growth higher than expected due to higher-than-expected growth in government revenue expenditure: Growth in the services sector accelerated to 9.3% in QE Sept 2009, compared with 7.8% in the previous quarter. Within services, the growth in the community, social & personal services segment accelerated sharply to 12.7% vs. 6.8% earlier due to higher government spending in this quarter. While growth in the trade, hotels, transport &
communication segment accelerated to 8.5% (vs. 8.1% earlier), the financing, insurance, real estate & business services segment growth decelerated to 7.7% (vs. 8.1% earlier).

• Growth in consumption and fixed investment accelerated: In QE Sept 2009, consumption expenditure growth accelerated to 8.4% from 2.8% in the previous quarter, driven by acceleration in both private and government consumption expenditure growth to 5.6% and 26.9%, respectively (vs. 1.6% and 10.2% in the previous quarter). Fixed investment growth accelerated to 7.3%, compared with 4.2% in the previous quarter. Net export contribution to growth was 6.1%, compared with 3% in the previous quarter, as the contraction in imports more than offset the decline in exports.

• Upside risks to our F2010 GDP growth forecasts: We believe the headline GDP growth for QE Sept 2009 has been overstated by accounting for poor agriculture growth being pushed to the next quarter. However, even adjusting for this, the non agriculture GDP growth has accelerated sharply to 9% in QE-Sept 2009 (vs. 6.9% in the previous quarter) confirming that the pace of recovery is stronger than expected. We see upside risks to our full year F2010 GDP growth forecast of 6.4%.

• Normalization of interest rates under way: We maintain our view that the RBI will lift policy rates by 25bp in January 2010. By then, the RBI should have had adequate comfort on the pace of recovery. Indeed, we expect a cumulative increase of 150bp in the repo rate in 2010. However, note this potential rate hike is unlikely to derail the recovery as we see this increase in policy rates as a move toward normalization rather than tightening that hurts growth.

To read the full report: GDP

>Heidelberg Cement India (ICICI DIRECT)

Value play…
Heidelberg Cement, formerly known as Mysore Cement, is a mid-sized cement player with an installed capacity of 3 million tonnes (MT). The company’s plants are located in UP, MP, Maharashtra and Karnataka. Out of the total installed capacity, 50% is in the central region, where prices were up 15% YoY in October 2009. The company has a healthy balance sheet and cash per share of Rs 14 (one-third of CMP).

■ Strong balance sheet
The company has a strong balance sheet with gross debt equity ratio of 0.02. At the end of CY08, the company had total cash & cash equivalents of Rs 338 crore (Rs 14 per share, i.e. one-third of CMP)

■ Presence in central region
Out of the total installed capacity of 3 MT, 50% of the capacity is in the central region. Prices in the central region were up 15% YoY in October 2009 as compared to the all-India average of 3.5%. In April- October 2009, the central region has grown at 16% YoY as compared to the all-India growth of 11%.

■ Capex plan
The company has received an environmental clearance for increasing its capacity by 1.9 MT in UP and by 1 MT in MP. However, on account of the recent global economic slowdown, the company has not been pursuing aggressive expansion plans.

Valuation
At the CMP of Rs 41.1, the stock is trading at 5.3x and 1.3x its TTM earnings and book value, respectively. On CY08 capacity, the company is trading at $42 per tonne. Despite having healthy return ratios (RoE of 21% and RoCE of 17%), the stock is trading at more than 60% discount to its replacement cost. Thus, investment can be considered in this counter with a short-term target of Rs 45.2, offering an upside of 10%.

To read the full report: HEIDELBERG CEMENT

>India: RBI’s stance on capital controls (DBS)

Summary: The Reserve Bank of India (RBI) and the government recently revealed India is working on plans to auction rights to corporates to borrow via external commercial borrowings (ECBs). The policy makers’ thinking is aimed at better management of capital inflows and is in line with our expectations for India as well as broadly for Asia [1]. Here we elaborate on the central bank’s and government’s thinking on capital inflows and controls and implications for future policy direction. In brief, we think the RBI’s long-standing view that restricting the volume of capital inflows to manageable levels, preventing extended periods of currency overvaluation and using macro-prudential norms to prevent buildup of asset price bubbles, is only strengthened by the current global crisis. At the same time, given the government’s burgeoning borrowing program, both the RBI and the government are cognizant of the need to attract productive foreign capital. Taken together, we expect the authorities to contemplate only targeted controls on inflows, rather than sweeping controls that would damage investor sentiment. Measures would likely be targeted at debt capital inflows and may be in the nature of controls on volume rather than outright taxes that alter net returns. Furthermore, we rule out controls on capital outflows, as the RBI’s key concern is not excessive currency depreciation, but rather, prolonged currency overvaluation as a result of large capital inflows.

The rationale behind contemplating controls when ECB flows are still low
There are many reasons why the RBI has begun contemplating controls on ECBs again. First, while ECB flows have not recovered yet, foreign exchange reserves have surged by USD 20bn since February and the rupee has appreciated by 10% against the dollar. As such, total capital flows have seen a turnaround and it is only a matter of time before overall inflows may become difficult to manage. Second, in the backdrop of the global meltdown post-Lehman, the RBI eased regulations on ECBs, specifically lifting restrictions on rupee capital expenditure from USD 50mn per entity per year to USD 500mn per year. With financial markets and economies recovering, the RBI has to consider the impact of the relatively liberal ECB regime. Third and importantly, given prospects for early rate hikes in India, and the probable future increase in demand for foreign borrowing as the recovery takes hold and capacity utilisation rates rise, it is only natural that the central bank contemplates ways to manage the likely future increase in ECB inflows.

Where the RBI stands on the controls debate and FX management styles
We think it is clear which side of the ‘capital controls’ debate the Indian central bank sits on. We believe the RBI has long been of the view that capital flows can be temporary and can flow into unproductive assets and investments if not properly regulated. Also, the RBI doesn’t believe capital flows would necessarily stay in line with the fundamentals of the real sector or as it noted recently, the ‘absorptive capacity’ of the economy. The policymaker probably views this long-standing stance as vindicated by the recent global crisis in addition to the many emerging market crises of the 1990’s. Therefore, the approach it takes is to regulate the quantum of inflows as well as the degree of appreciation of the currency.

Sweeping controls unlikely; targeted measures probable
At the same time, the central bank and the government are cognizant of the need to ensure adequate availability of capital for the private sector and is concerned that high government borrowing would crowd-out private investment. For this reason, we believe the policymakers are themselves wary of hasty or ill-designed controls that might send the wrong signal and drive foreign investors away. For example, India is unlikely to follow in the footsteps of Brazil that imposed a 2% tax on short-term flows and a 1.5% tax on ADRs. While the reaction to the Brazilian measure was muted and short-lived (Brazilian real is broadly unchanged from Oct 20 when tax was first imposed and also from Nov 19 when taxes were imposed on ADRs), if India did the same, the reaction could be very different – after all, the policy action doesn’t take place in a vacuum and is interpreted in the context of the existing policy and rhetoric. Such (low) taxes on flows also do not materially alter quantum of flows as they are small relative to overall expected returns.

To read the full report: CAPITAL CONTROL

>MAHINDRA UGINE STEEL COMPANY (AASPL)

KEY INVESTMENT ARGUMENTS

• Rising Automobile demand- to boost revenue
• Capacity Expansion - "to help capture the potential demand".
• Operating Profit grow at a CAGR of 38% p. a.
• Valuations- "Value not yet valued"

To read the full report: MAHINDRA UGINE

>Have the central banks saved us from the crisis, or caused it?

The behaviour of the central banks of major OECD countries since the start of the crisis has led to opposing comments: for some, thanks to them the global economy has avoided a deflationary collapse; for others, they have put in place the conditions for the next financial crisis through the adoption of incredibly expansionary monetary policies, exacerbated by the reaction of emerging countries to the dollar weakness this has caused.

So, have the central banks saved the planet, or have they condemned it to another crisis? We believe that both theories are true, on different time horizons, and that, as in the past, central banks are unable to exit quickly enough from the excessively stimulating policies justified by the crisis.

To read the full report: BEHAVIOUR OF CENTRAL BANKS