>The “Great Risk Shift” – or why it may be time to re-think the developed-/emerging-markets distinction (DEUTSCHE MARKETS)

After defaulting on their external loans during the 1980s, many emerging markets (EM) experienced often severe financial crises during the second half of the 1990s and in the early 2000s. Most top-tier EM have weathered the global crisis much better in terms of public-debt sustainability and the short/medium-term growth outlook than many developed markets (DM). Following what may in the future be remembered as the “great risk shift”, it may be time to re-think old labels and traditional distinctions – and established views of economic and financial risk.

The term “emerging economies” seems to have been coined sometime during the 1980s and became part of standard vocabulary during the 1990s. The term referred to economies that were neither “developing” nor “developed”. In practice, it referred to a group of upper-middle-income countries that attracted private capital following the first oil shock. After defaulting on their external loans during the 1980s, many of the emerging markets (EM), as they were soon called by Wall Street and the City, experienced often severe financial crisis during the second half of the 1990s and in the early 2000s. To be fair, developed economies also experienced various crises during that period (e.g. ERM crises) and a handful of EM reached per income levels comparable with, or even higher than, some of the developed markets (DM), which is why the IMF moved these countries into the “newly industrialised economies” (NIE) category. But the pun about the “submerging” emerging markets, for better or worse, continued to stick.

Following the 2008 crisis, the financial fortunes of DM and EM diverged rapidly. While many DM are witnessing rapidly rising public debt, large fiscal deficits and slower growth, most toptier EM weathered the global crisis much better in terms of public-debt sustainability and the short/medium-term growth outlook. The diverging fortunes have been reflected most strikingly in the concerns about debt sustainability in the so called Eurozone PIIGS. For instance, investment-grade Greece 5Y CDSs are currently trading at 280 bp vs sub-investmentgrade Indonesia and Turkey at 160 bp.

The rating agencies rated Greece A until very recently, while both Indonesia and Turkey carry a sub-investment-grade rating. The rating agencies rationalize this in various ways. Sovereign ratings assess creditworthiness “through” the cycle. Typically, the investor base in the DM is much broader, domestically and internationally. Capital markets are much deeper, and their sovereign debt structures are often (though by no means always) less vulnerable than in the average EM. Finally, DM debt service track records are typically very strong. While some of these arguments have some merit, the rating agencies almost certainly underestimate the improvement in the creditworthiness of EM sovereigns and potentially underestimate the deterioration in DM creditworthiness.

Past (surprise) EM crises seem to have made the agencies cautious about EM upgrades. At the same time, the agencies tend to be reluctant to downgrade a country by more than 1-2 notches a year given that they claim to rate “through” the cycle. Another problem is that by downgrading a sovereign aggressively the agencies may contribute to financing difficulties and thus trigger a sort of “self-fulfilling prophecy”. The reluctance to aggressively downgrade a DM in line with the markets’ assessment of sovereign default risk is therefore understandable, but it hardly justifies the fact that until very recently Greece and China carried pretty much the same long-term foreign currency ratings. It looks odd that Greece with very limited macroeconomic flexibility due to EMU membership and a public debt burden exceeding 100% of GDP should be rated at the same level as China whose public debt amounts to a mere 25% of GDP and whose FX reserves exceed 45% of GDP.

To read the full report: TALKING POINT

>Low rates for longer - Greek impact on EUR loses momentum (DANSKE MARKETS)

■ Low rates are here to stay – at least in the G4. It is becoming increasingly clear that central banks in Europe, the US, the UK and Japan are in no hurry to normalise monetary conditions. Fiscal tightening, needed to curb the soaring budget deficits, simply crowds out monetary tightening. For most currency pairs, relative rates as the dominant driver for can therefore be delayed for longer than previously projected. And equity prices – a proxy for risky behaviour, fuelled by lower rates – and commodity prices can thereby remain significant for future exchange rate movements.

■ The Greek debt problems have not been solved – but fears of a euro collapse are fading. We believe the fiscal situation in Greece is unsustainable and think it reasonable that financial markets have been concerned and reacted by selling Greek bonds and stocks. We do however think the euro sell-off is somewhat overdone. After all, Greece only constitutes 2-3% of Euroland GDP – much less than also debt-burdened California’s 13% share of US GDP – and we think it very unlikely that the stronger Euroland countries won’t join forces if the situation escalates further. We foresee that debt problems within Euroland will continue to pop up in the media, but that the risk premium currently attached to the euro will gradually decrease and weigh less on the single currency in the quarters to come.

■ The US is set to outpace Euroland, the UK and Japan in terms of economic growth in 2010. However, as we see it, it is growth on steroids; the US economy enjoys the tailwinds from the massive fiscal and monetary stimuli but the underlying trend might not be as strong as the last GDP numbers indicated. Even though it seems like something we have seen before – the US recovers first, Euroland and the UK lag behind and Japan is stuck in the mire, and currency implications perhaps therefore should be straightforward – we keep in mind the lessons from 2003-04. At that time, the world also recovered from recession, the Fed hiked rates one year before the ECB and despite that EUR/USD climbed higher. The same thing could happen again.

■ An ‘A-team’ and a ‘B-team’ among central banks are starting to be formed: The Ateam consists of the leaders in hiking rates: RBA, Norges Bank and probably also in 2010 RBNZ, BoC, Riksbanken and perhaps also the Fed and the SNB. As we have seen with the AUD and the NOK, central bank hikes lead to currency appreciation almost no matter how anticipated they may be. The B-team consists of BoJ, ECB and BoE, from which we can expect only very moderate monetary tightening.

■ What to buy? With interest rates low, leading indicators still pointing towards economic expansion and risk appetite back in the saddle, we prefer currencies with a tendency to strengthen in good times. These include AUD, NZD and SEK. The latter we also like due to sound fiscal balances, higher interest rates to come and a good starting point from a valuation point of view. The NOK and the CAD are attractive due to several rate hikes in the pipeline and higher oil prices while the CHF is becoming interesting as the SNB is set to accept a stronger franc without intervening. The GBP has still sound potential against the EUR but patience is a virtue as the UK economy only recovers slowly and the financial sector remains under water for now. The JPY faces a losing streak as we see it.

To read the full report: FOREX UPDATE

>Bonds vs. Equities: Who’s Right? (MORGAN STANLEY)

• Key Debate: The equity and bond markets are telling us different things about the growth/inflation trade off. While the bond market is saying that the Central Bank is behind the curve and needs to raise rates quickly to quell inflation, the equity markets are much more sanguine and focused on the growth upside risks. Which market has got it right?

• Balancing Growth and Inflation: We concur that the growth risks are to the upside and to that extent, the equity markets may be getting this right but we would not be complacent about the inflation risks. We think the Central Bank will have to move firmly in its next policy meeting to assure the bond and equity markets that inflation expectations will be anchored. If it succeeds we expect, as in 2004, the market multiple and the short rates to be positively correlated. Volatility could still rise and, to that extent, the low implied volatility in the options market is an opportunity for investors to hedge portfolios at low cost against a negative surprise from the Central Bank (negative surprise = lack of rate hike by end of April).

• Policy Rate Hike – To Do or Not to Do: The flip side of accelerating growth is that capacity utilization is rising accentuated by the lack of capex over the past two years. Consequently, the output gap is closing fast leading to a buildup in core inflation (and hence higher short rates). History suggests (going back to 1998, 2000 and 2004) that the market multiple tends to decline when short rates inflect in the upward direction. While in 1998 and 2000, the rate rise happened in a slowing growth environment (compounded by negative external events) causing significant damage to market multiples, the 2004 rate change took place in an accelerating growth environment and the fall in market P/E proved temporary. Indeed short rates and market multiples were positively correlated after the initial hiccup. We believe that the current environment resembles 2004 with a rise in short rates likely to pre-empt inflation pressures in an accelerating growth environment. Indeed, the policy environment remains close to emergency levels even as the economy does not appear to be anywhere close to a crisis. The key risk is that the Central Bank falls behind the curve and rising inflation ultimately hurts growth and stock prices in 2011. We believe that the Central Bank will react to incoming data, especially on credit growth, and tighten accordingly. Of course the challenge for the Central Bank is to estimate the impact of stimulus on growth (how much of the current growth acceleration is autonomous), the next monsoons and the global growth (which in turn may depend on behavior of risk assets).

• What’s in the price?: We believe that the bond market is pricing in a 50 bps rate hike – notice how the 91-day yield has moved away from the reverse repo rate. For the equity markets, we believe a rate hike between 25 bps and 50 bps will work well. A 50 bps would generate more comfort for the medium term although there may be a negative short-term reaction. A 25 bps rate hike may leave some risks on the table though they may not be visible in the market immediately. If there is no rate hike by the end of April, the market could be at risk of multiple compression in 2H2010.

• Market Implications: 1. Buy Equities over Long Bonds: While long bonds appear interesting, especially from an ownership, supply, and valuation perspective, we believe the returns from long bonds are likely to be constrained by rising domestic short yields and our out-of-consensus
view on US long bond yields. We think equities offer better returns than bonds.

• 2. Buy Banks and Industrials: We believe the current circumstances resemble 2004, i.e., the first rate hike will confirm the Central Bank’s resolve to tackle inflation as well as recognize a sustainable recovery in growth. In our view, the sectors that are likely to outperform are banks (given their long duration liabilities) and industrials (driven by the likely start of a new capex cycle). We would avoid Technology, Telecoms and Healthcare.

To read the full report: BONDS VS. EQUITIES

>Shree Ganesh Jewellery House Ltd. (KREDENT FINANCE)

Company background
■ Shree Ganesh Jewellery House Ltd is a Rs.2,300 crores (US$ 500 million), 4 STAR export house (govt. of India recognized) company and is the largest manufacturer and exporter of hallmarked and handcrafted gold jewellery from India

■ The group is promoted and headed by Mr. Nilesh Parekh and Mr. Umesh Parekh Headquartered in Kolkata, with subsidiary offices in Hyderabad, Chennai, Bangalore, and Delhi. The group is into manufacturing of gold, diamonds and gemstone studded jewellery

■ The Company’s products have presence across different price points to cater to all customers across high-end, mid market and value market segments. They are designed by a team of creative designers which help in managing a large and diverse portfolio of designs

■ The Company’s export income has grown at a CAGR of 72.71% from FY07 to FY09. The Company’s share in the India’s gold jewellery exports has increased from 1.83% to 6.10% during the same period. During the FY07, FY08 and FY09 the company exported 86.73%, 94.13% and 99.22% of its products, respectively. The products are primarily exported to countries such as the U.A.E, Singapore and Hong Kong

■ The Company intends to open 17 outlets of which 14 are proposed to be on freehold basis and three are proposed to be on leasehold basis. The Company propose to open three large outlets, four medium outlets and 10 small outlets

■ The Company markets its product through brand store “Gaja”. It has also has a tie up with Mr. Sabyasachi Mukherjee for jewellery designing and has recently launched the collection designed by him

To read the full report: SHREE GANESH JEWELLERY

>PERSISTENT SYSTEMS LIMITED (SMC)

Company Profile
Incorporated in 1990, Persistent Systems Ltd is in the business of outsourced software product development (OPD) services for Independent Software Vendors (ISV's). The Company design, develop and maintains software systems and solutions, create new applications and enhance the functionality of existing software products. Some of the customers of the company include software manufacturers such as - Microsoft, Agilent, Intel, Openwave, IBM, i2, Critical Path, Oblix.

The company's business operations are:
■ Outsourced Product Development
■ Database and Directory Integration Products
■ Engineering and Technology Consultancy Services

Areas of expertise:
■ Database technologies
■ Identity management
■ Telecom and wireless
■ Life sciences
■ Security and provisioning
v Email and messaging

The Company has around 200 customers, of which the top 10 customers account for around 41 per cent of its revenues. As of November 30, 2009, Persistent Systems employed around 4,400 employees (including those under contractual employment with the Company and its subsidiaries as well as trainees).The Company has nine development centers in Europe, America and Asia. In India, the company operates from Pune with most of its development centers being owned by them.

The Company provides services both on time and material basis, where charges are based on the number of people dedicated and the effort invested in the project, and on a fixed price basis, where it provides services for a fixed price and agrees to complete the project in a fixed time. For 2008-09, its revenue on time and material basis dominated the revenue share with 81 per cent contribution, followed by fixed price contracts with 14 percent, while the balance revenues came from licenses and royalty.

To read the full report: PERSISTENT SYSTEMS LIMITED