Saturday, October 31, 2009


Hike in provisioning for property loans from 0.4% to 1.0% could increase incremental funding cost by 60-65bps
Do not expect banks to pass on the incremental cost in the near term; move by RBI more a sign of caution
RBI measures will likely curtail run away property price growth, bringing expectations in line with our estimates

Risk weight on standard loans towards real estate sector increased from 0.4% to 1%. This move by the Reserve Bank of India (RBI) was on the back of the banking system’s increased exposure towards the real estate sector (up 42% y-o-y in Aug 2009) and the increase in restructured assets in the same sector over the past 12 months.

Impact analysis
Incremental funding cost could rise by 60-65bps. The majority of loans to borrowers (including developers) are typically linked to each bank’s Benchmark Lending Rate (BLR). Consequently if banks raise the BLR it will impact all borrowers and not specifically real estate developers. The recent move by the RBI will likely only impact incremental borrowings.

RBI policy should bring expectations in line with estimates

Do not expect banks to pass on incremental cost in the near term. Since the increase in provisioning requirement is for standard assets, it would be taxing on the borrower to pay a
higher credit cost despite meeting obligations on time. As a result we do not expect banks to
pass on the hike in the near term unless the asset/loans turn sub-standard. Our banking analyst expects the impact on banks of absorbing the higher provisioning will not be sufficiently meaningful to cause them to hike interest rates charged to large developers in near term.

Recent fund raisings have strengthened balance sheets. Most large property developers have raised fresh equity capital over the past 6 months thereby bringing down their
balance sheet leverage and leaving them in a comfortable position to fund growth over the next 2-3 years. We do not expect a 50-60bps interest rate hike to dent earnings or valuations meaningfully.

Policy move should bring expectations in line with our estimates. Property price appreciation of 15-25% in the past 6 months has been much ahead of our expectations and stock valuations have been implying further 25-40% price growth over the next 12-18 months. We believe the RBI’s attempt at increasing the cost of credit and curtailing incremental credit to the sector could lower expectations to be in line with our estimate of 10-15% over the next 12-18 months.

Stock implications: Indiabulls Real Estate and AnantRaj, with net cash positions, are relatively better placed against other coverage peers like DLF, Unitech and Housing Development and Infrastructure in the event of any rise in interest rates.

To see the full report: INDIAN PROPERTY


Why buy now? Improving fundamentals, lagging valuations
There are four reasons that trigger our more positive view on the sector:

1) Volume surprise – YTD yoy volume growth of 23% for Hero Honda, and sequential recovery for Bajaj Auto have so far been significantly above our, consensus, and managements’ stated expectations. We believe the industry is experiencing a demand growth upcycle, with double-digit growth likely to continue for the next 2-3 years, driven by rising penetration, investments in infrastructure and macroeconomic recovery.

2) Margin surprise – As shown by two consecutive quarters of significant margin surprises, we believe the market is underestimating the impact of operating leverage and companies’ ability to defend above-trend margins. As a result of these two points, we believe an earnings upgrade cycle for the sector is likely to continue for the next four quarters.

Earnings upgrade cycle to continue; U/G Hero Honda, Bajaj Auto

3) Lagging valuations – Based on our revised estimates, Indian 2-wheeler stocks are trading at mid-cycle valuations and at a steep discount to the MSCI India index. We believe this offers a compelling entry point into high cash-flow-generating businesses that have strong franchises in an oligopolistic market. We also observe that 2w stocks outperformed the index during early stage of economic recovery during 2002-04.

4) Concerns on monsoon and commodity costs – In our view, valuation case is most appealing for Hero Honda, which has underperformed the BSE Auto Index (by 30%) and BSE Sensex (by 12%) over the last three months. The stock is now trading at mid-cycle multiples and a 25% discount to MSCI India. We believe market may be overly concerned about monsoons and rising commodity costs, as we discuss in this report.

We upgrade Hero Honda (HROH.BO) to Buy from Neutral and raise our 12m target price to Rs1,912 (from Rs1,399) based on 16X FY11E EPS. We also upgrade Bajaj Auto (BAJA.BO) to Neutral from Sell, and raise our 12m target price to Rs1,566 (from Rs705), also based on 16X FY11E EPS. We raise FY10E-12E EPS for Bajaj Auto by 53%-70%, and for Hero Honda by 22%-37%.

Downside: 1) Labor unrest, 2) slowing macroeconomic growth, 3) greater than- expected success of competitors. Upside (Bajaj): 1) Continued labor unrest at Honda Motors, 2) re-entry of private banks in 2-wheeler financing business.

To see the full report: AUTOMOBILES SECTOR


Tata Steel registered lower-than-expected Q2FY10 results with PAT declining 58% YoY to Rs9.02bn. Topline dipped 17% YoY and was 7% below I-Sec estimates. This was owing to 3% QoQ degrowth in realisations, a seasonal phenomenon owing to: i) monsoons impacting demand and ii) holidays capping consumption in the North and East. Also, sales of ferro alloy fell 53% YoY. However, impressive cost performance led to sequential margin improvement (300bps). Higher fund mobilisation of ~Rs27bn in H1FY10 (net of ~Rs24bn repayment) led to increased interest outgo (15% QoQ). Maintain BUY

Impressive cost performance. Increased usage of low-priced coking coal, and reduction in power & fuel and freight costs led to 3% QoQ fall in overall costs (with flat production). Higher other expenses (up 9% QoQ) imply higher dependence on third-party rerollers and conversion agents.

Start of price war in the South does not augur well for industry. While flat products division has been able to service the robust auto market demand and is holding inventories commensurate to service level agreements, the long products division is facing structural short-term margin pressure. Our channel checks suggest that JSW Steel (aggressively marketing from SISCOL) has managed to snatch market share from RINL (with current inventory of 0.4mnte), which now offers high carbon wire rods at MS wire rod prices. Also, premium of Tata Steel to JSWS (in wire rods) has reduced to Rs500/te for some customers in the South and business has started getting relocated to the eastern markets (such as Ranchi).

Also, volume pressure led to October ’09 being hit harder than October ’08. While the price war has resurfaced, demand has been lacklustre on both B2B and B2C fronts. Floods in Andhra Pradesh and Karnataka in October led to a sharp drop in offtake. As consumer sales dip, the project segment (ex wire rods) too has come under pressure owing to lack of interest from real-estate majors. While the segment targets run rate of 75,000tpm, only 50% has been achieved for October deliveries (as on date). We continue to see high levels of dealers/end-users’ stock in eastern & western markets (Tata Steel’s long product inventory stands at 0.13-0.14mnte).

Way forward. Wire rods (17% of long product sales) are the main contributor to margins of Tata Steel’s long products division. Continuous undercutting by JSWS in the South will pressurize margins of the wire-rod segment (except WR3, which is 6ktpm). Also, with a 4-mnte market and dominance of ISPs, probability of a price war and margin erosion is high. Prices will drop even further once JSWS’ 0.6-mtpa wire rod mill is fully operational. Also, JSPL has started trial rolling of 2-3 grades of wire rods from Nalwa plant. While Tata Steel is capacity-constrained, contribution-based product mix will require expanding coverage to cater to demand from all segments; there is need for focus on strutcurals (absent at present) and TMT production.

To see the full report: TATA STEEL

>Dull is good (J P MORGAN)

Portfolio strategy –– The most important event for our strategy in coming months is that nothing happens, or better, nothing surprises and volatility and risk fade. This means a further flight out of cash into bonds and equities. We stay short cash against high-yielding assets.

Economics –– Global forecast is on track for recovery, with growth at 3.7% in H2

Fixed Income –– We are trading the range, carry and yield compression

Equities –– Banks are benefiting from asset reflation, a stabilization in housing prices and the prospect of dividend increases next year.

Credit –– A new regulatory framework is likely to alter the hybrid capital market in Europe. OW Tier I issued in 2009, UW Tier I with call after 2011.

FX –– Rising risk of dollar upward correction. Take part profit on USD shorts.

Alternatives –– Investors interest in hedge funds is increasing.

A sense of calm has started to pervade markets, with many assets now moving in narrow ranges and others just trending gently. This may not be great for active managers, but is heaven sent for the rest of us after all the fireworks of the past two years. It reduces the destructive urge to delever our finances all at the same time, and helps rebuild markets and asset values. It keeps us short cash and long assets that pay income.

The message from economic data is that a global recovery is taking hold and is spreading. Many investors still doubt it is sustainable. We believe it is, at least through next year, and find it too early to speculate about what happens afterwards. Our own growth forecasts are in stationary mode, as there is no need to upgrade projections with data tracking well. The consensus of forecasters still lags our growth numbers, but we sense that most active managers
have already bought into the recovery story. Indeed, our US surprise index is hovering around neutral now. Hence, our strategy is based less on any further upgrades of growth forecasts and more on a sense of stability.

Stability is most painful for assets that thrive on fear. That means cash. Since March, we have seen a steady and global flow out of cash into assets with a proper yield –– equities and bonds. This is not over. An informal look at the global portfolio share of cash (Chart p. 2) hints that with cash returns staying at zero, we are probably only half way into the move out of cash.

The main recipient of flows out of cash has been bonds, as the yield pick up from cash was most stark, especially to banks where demand for corporate loans is falling. But the flow into bonds should ultimately be self destructive as it steadily lowers future potential returns. The average yield on the Barcap.

To see the full report: JP MORGAN VIEW

>Oil steady in Asia; bulls seem reluctant

Singapore - Crude oil futures were little changed in Asia Friday as bulls seemed reluctant to start another run before seeing more positive macroeconomic signs.

On the New York Mercantile Exchange, light, sweet crude futures for delivery in December traded at $79.77 a barrel at 0705 GMT, down 10 cents in the Globex electronic session. December Brent crude on London's ICE Futures exchange fell 21 cents to $77.83 a barrel.

The market is generally listless, with the front-month Nymex crude contract hovering around $80 a barrel.

"There's been very little movement (today)," said David Moore, commodities strategist with Commonwealth Bank of Australia.

Oil hit $80.46 a barrel in the previous session after the U.S. Commerce Department reported a 3.5% annualized increase in third-quarter gross domestic product. But market participants appear cautious in making another run, as they doubt the soundness of the recovery.

"GDP growth this past quarter was positive only because of all the government stimulus programs," said Mike Sanders with Sander Capital Advisors.

Once the U.S. government decides to cut public spending and raise interest rates, which it will need to do inevitably in the future, the economy could dip again and bring down oil prices with it, say some analysts.

Before crude and petroleum products inventories show any signs of dwindling, the market will likely continue to take cues from macroeconomic reports and monetary policy, with U.S. employment data and a Federal Open Market Committee announcement due next week in focus.

Nymex reformulated gasoline blendstock for December--the most traded gasoline contract--gained 40 points to 202.30 cents a gallon, while December heating oil traded at 207.70 cents, 17 points lower.

ICE gasoil for November changed hands at $638.50 a metric ton, down $5.50 from the last settlement.


Friday, October 30, 2009


In November 2007 we wrote an article entitled “Surreality Check… Dead Men Walking”, in which we discussed the early warning signs of the impending credit crisis and highlighted companies that were looking particularly troubled to us at the time.

We identified General Motors with a book value of negative $74 per share that boasted a market cap of $15 billion. (Ask your friendly neighborhood Chartered Financial Analyst to explain that one to you). Two years later? Following a $50 billion government injection, GM declared bankruptcy on June 1, 2009 and reemerged on July 10, 2009 with new owners consisting of: the US Treasury (60.8%), the Crown in Right of Canada (11.7%), previous GM bondholders (10%) and the UAW Health Care Trust (17.5%). GM stock went to zero.

We identified Fannie Mae, which, at the time, had a market cap of $40 billion and owned/guaranteed $2.7 trillion of mortgages - or about a quarter of all residential mortgages in the United States at the time. Fannie’s leverage ratio was a sobering 67:1. Two years later? Fannie Mae and Freddie Mac have both been nationalized. On September 7th, 2009, the US Treasury announced the two mortgage giants were being placed into a conservatorship run by the FHFA and pledged up to $200 billion each to back their crumbling balance sheets.
We highlighted Citigroup as a candidate for collapse under the weight of its subprime portfolio. One year later? $25 billion from the TARP program, a massive US government guarantee on $306 billion in residential and commercial loans and a cash injection of $27 billion into Citigroup for preferred shares. It was a de facto nationalization.

Why the walk down memory lane? The equity market performance in November 2007 masked the underlying problems plaguing the financial system at the time, and it’s blindingly apparent that it is doing the same again today. The government has assumed most of the financial system’s liabilities in a giant game of ‘kick the can’. The calls for a new bull market are coming fast and furious. Market participants are bidding up the stocks of companies that are demonstrably bankrupt, and government balance sheets have ballooned to unforeseen levels. As respected market commentator David Rosenberg recently wrote, “the stock market is divorced from economic reality”.1 It’s time for another surreality check, but this time it isn’t the publicly traded companies that deserve attention, it’s the governments that have saved them. Make no mistake – the dead men are still walking – they’re just a lot bigger now than they were two years ago, and they don’t generate earnings – they print money and tax their citizens.


In case you failed to catch it in our previous articles this year, we thought we’d state it outright for our readers this month: the United States Government is on a trajectory to default on their obligations. In its current financial condition, it will not be able to fund its forecasted budget deficits and unfunded Social Security and Medicare promises on top of its current debt obligations. This isn’t official yet, and we don’t know when the market will react to it, but there is no longer any doubt about the extent of their trajectory. There simply isn’t enough taxing power, value creation or outside capital willing to support its egregious spending.

Stating the obvious may be construed by some as fear mongering, ‘talking up our book’ or worse, but our view is not as severe as you might think. In the Federal Reserve Bank of St. Louis’ Review from July/August 2006, Lawrence Kotlikoff stated that “partial-equilibrium analysis strongly suggests that the U.S. government is, indeed, bankrupt, insofar as it will be unable to pay its creditors, who, in this context, are current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds.” 2 He went on to suggest that the US should immediately close the Social Security program to reduce future liabilities (could you imagine?), use a voucher system for Medicare to limit costs, and replace personal, corporate, payroll and estate taxes with a single federal sales tax. All this, published in an article from 2006, well before the credit crisis and subsequent meltdown had even begun!

Three years later, the financial condition of the US government is completely untenable. The projected US deficit from 2009 to 2019 is now slated to be almost $9 trillion dollars.3 How on earth does anyone expect them to raise this capital? As we stated in a previous article, in order to satisfy US capital requirements, all existing investors would have had to increase their US bond purchases by 200% in fiscal 2009. Foreigners, however, only increased their purchases by a mere 28% from September 2008 to July 2009 - far short of what the US government required.4 The US taxpayer can’t cover the difference either. According to recent estimates, tax revenue from all sources would have to increase by 61% in order to balance the 2010 fiscal budget. Given that State government income tax revenues were down 27.5% in the second quarter, the US government will be lucky just to maintain its current level of tax revenue, let alone increase it.5

The bottom line is that there is serious cause for concern here – and don’t be fooled into thinking
this crisis will fix itself when (and if) the economy recovers. Just how bad is it? Below we outline the obligations of the US Federal Government from 2004 to 2009. We present two sets of numbers, as government accounting can vary widely depending upon the source. In column A, we outline the Total US government Obligations, using actuarial reports from the Social Security Administration and the Medicare Trustees Reports. In column B we identify Total Federal obligations according to GAAP accounting provided by Shadow Government Statistics, calculated on a US fiscal year end basis with estimates for 2009. The differences in the absolute amount of total obligations ($114.7 trillion vs. $74.6 trillion in 2009) are a function of timing, the calculation timeline for Social Security and Medicare, and other obligations included under GAAP rules. Either way we choose to calculate it, the total number is preposterously large. From 2004 to 2009, US unfunded obligations increased by an average of almost 50% over this six year period under both calculation methods, while US government revenue increased by only 12%.6 No company or government can increase its liabilities by more than four times the rate of its revenue and stay solvent for an extended period of time. And as the numbers imply, the hole that the US government is digging is getting deeper by the minute. On a GAAP basis, US government unfunded obligations increased by more than $9 trillion from last year alone! That represents ten years of projected deficits added in a mere twelve months. How can this be happening? The numbers are surreal, and we must ask ourselves how much longer the world will continue to support this spending frenzy.

The Federal Deposit Insurance Corp. is another major problem for the US. The FDIC’s Deposit
Insurance Fund, which had $10.4 billion at the end of June, has spent so much covering bank failures over the last three months that it is now completely out of money. This means there is no capital set aside to insure the $4.8 trillion of deposits and $320 billion worth of FDIC-guaranteed debt that US banks and other financial companies have issued. The real shocker that we discovered some time ago is that the FDIC ‘funds’ were never even held in a segregated bank account – the fees collected from the banks are accounted for as a part of the government’s general revenues that go towards military spending, bailouts, interest costs and other government programs. The FDIC ‘fund’ merely consisted of IOU’s from the general revenues accounts. And now that the Deposit Insurance Fund balance as of September 30, 2009 is negative13 the FDIC wants the institutions to prepay their assessments for all of 2010, 2011 and 2012. In effect, the FDIC wants to borrow money from the banks it provides insurance for. Does this not strike you as surreal? Why would anyone have any confidence in anything the FDIC guarantees?

To see the full report: UNITED STATES MARKETS

>Pause, Rewind, Replay (MORGAN STANLEY)

Key Debate: Are Indian equities set up for a significant correction?
The market is up 100% since its low in March 2009, and is now up 92% over the trailing 12-months. Reported earnings growth is still tepid and reforms are moving slower than expected by certain quarters. The central bank has been sending signals on a possible exit policy and at the same time equity supply is burgeoning. Crude oil prices are threatening to move higher with negative consequences on India’s macro whereas relative valuations do not seem attractive anymore. India is among the top 5 performing markets globally this year, and it would seem a lot of the good news and more is in the price. Does all of this mean that Indian equities are set for a significant correction?

Indian equities in a sweet spot, but…
We reckon that Indian equities are in a sweet spot with low institutional ownership (coming off five-year lows), strong liquidity (policy makers are still reticent to take away stimulus), prospects of growth (watch out for private corporate capex – the trough is likely behind us), earnings upgrade (indeed, we are at the start of earnings growth cycle), strong corporate balance sheets, and stable politics (implying steady pace of reforms).

…the pace of gains is likely to slow
Our Dec-2010 target for the Sensex (19,400) suggests upside of 19%, reflecting a slower pace of gains after a stellar performance over the past six months. Our prognosis is that Indian equities could be volatile in the near term, since a lot of the next six months’ projected growth is already
in the price. We believe that investors should use such volatility to buy Indian shares, since the growth outlook for the next 12-18 months remains firm and is still not priced into equities. Heightened volatility could make trading a less-rewarding strategy compared to “buy on dips and hold”. Our bull-case scenario takes the Sensex well past its previous high, whereas our bear case could lead it to test the post-election result close of May 18.

Key factors to watch
Key factors that could determine market behavior include government policies (watch out for infrastructure spending), global markets (correlation with SPX and China is still high), crude oil prices (a sharp spike creates problems, the risks are lower if a crude oil price rise is accompanied by strong capital flows), long bond yields (reflecting fiscal position), the RBI’s exit policy (and hence liquidity), sentiment indicators (watch market breadth and momentum, which suggests weak share prices in the offing), equity supply (the market may not tolerate more than US$20-25bn in the coming year), and valuations (relative valuations have moved above average levels).

Portfolio position: Continue to prefer cyclicals over defensives
We believe that consumer and infrastructure sectors will drive growth recovery and, hence, market performance. Accordingly, we are overweight Consumer Discretionary, Industrials, Financials, and Energy in our model portfolio. We expect the broad market to outperform the narrow market.

Key Investment Debates

Macro forecasts: Politics are in good shape, and that should allow a reasonable policy momentum. The government is already moving forward with significant tax reforms, and our belief is that infrastructure spending should pick up pace in the coming 12 months, especially in electricity and roads. We are forecasting GDP growth of 6.4% and 8% in F2010 and F2011, respectively, ahead of the consensus. More important, for the market, industrial growth is likely to accelerate over the coming 12 months. Acceleration in industrial growth will likely close the output gap faster than current expectations. The supply-side factors, including the availability of capital and its cost, favor a trough in capex and a recovery in the coming 12 months. We don’t believe this is still in the price.

Earnings growth: We have been raising our earnings growth forecasts just like the bottom-up consensus. We are now looking for 15% and 23% growth for the BSE Sensex constituents on aggregate in F2010 and F2011, respectively, compared with 5% and 20% by the consensus.
Revenue growth seems to have bottomed out given our view that industrial growth is likely to recover sharply in the coming months. The strength of the recovery could bear upside depending on execution of policy reforms. The corporate sector seems to have cut costs and thus margins have improved sharply. The macro environment (i.e., higher consumer price inflation vs. wholesale price inflation after adjusting for food prices) favors a robust rebound in margins in the coming four quarters. We think these three factors have set us up for strong earnings growth over the next 12 months. It is quite likely that broad market earnings growth will accelerate faster than the narrow market, as we saw in the previous cycle. We expect broad market earnings growth to average 20% and 25% in F2010 and F2011, respectively

Valuations: The market’s valuations do not appear attractive to us, although they are also not stretched. The prospects of earnings upgrades means that valuations could turn out to be attractive in hindsight. On our estimates, the Sensex is trading at 16.3x and 13x F2010 and F2011 earnings, respectively. The 12-month forward P/E for the MSCI Index is at a 29% premium to the emerging market multiple, making India the fourth-most expensive EM. At a 10-year bond yield of 7.4%, investors are realizing a risk premium of 6.4%, which suggests that the market is attractive for long-term returns. At the same time, the absolute P/E and P/B are 95% and 73%, respectively, off their all-time lows.

Ownership, cash levels, equity supply and liquidity: FII ownership is coming off a 5½ year low and is well off the peak. Mutual cash balances have reduced over the past three months, but still have substantial cash in their portfolios. In the meanwhile, the rising equity supply could cause
a problem for the market if it gets bunched up, as we saw recently. Excess liquidity in the system could be more than US$32 billion. Market behavior in the previous two tightening cycles has been mixed, and hence is inconclusive.

Sentiment: The market can no longer rely on depressed sentiment as a guide to better returns, in our view. Sentiment has turned up sharply over the past three months, and our market timing indicator is no longer in a buy zone. Some components of our proprietary composite sentiment indicator, notably, momentum metrics and volatility measures, suggest that the market could sell off. We think market participants should keep eye on breadth and trading turnover.

To see the full report: INDIA STRATEGY


SUBEX Ltd has offered its bondholders an exchange offer, whereby new bonds will be issued at a 30% discount to the face value. Assuming investors accept the new terms, the principal amount outstanding on the bonds would come down to $126 million. Bondholders will be compensated via an increase in the interest coupon, from 2% for the existing bonds to 5% for the new bonds. More importantly, the conversion price has been set at Rs. 80.31, a fraction of the original
conversion price. The details of the new bonds are based on announcements by the company to London Stock Exchange, where the bonds are listed. According to a LSE filing, due to the lower conversion price, “the new bonds are more likely to be converted into shares of the company, and thereby further reduce the debt obligations of the company when the new bonds fall due for redemption”. From a bondholder’s perspective, the new terms make immense sense. But from the perspective of Subex’s existing shareholders, the conversion of bonds into shares will lead to
a trebling of the company’s equity base from the current level of 34.8 million shares. If all the bonds are converted based on the new terms, 72.2 million new shares would have to be issued. For perspective, Subash Menon and his associates own 12.84% of the company currently. Upon full conversion of the new bonds, their holding will drop to around 4%. Of course, bondholders will convert the debt into equity only if the company’s performance picks up, and they have the
certainty that the share price is sustainable well above the conversion price of Rs. 80.31. Else, they’d just prefer not to convert and demand redemption instead. If that’s the outcome, Subex could be strapped for cash to pay its bondholders. Either way, the company needs to post a sharp rise in profit to avoid a debt trap.


2QFY10 performance boosted by construction earnings: During 2QFY10, GMR Infrastructure reported revenues of Rs12b (up 41% YoY), EBIDTA of Rs3.8b (up 53.8% YoY) and net profit after minority interest of Rs549m (down 50% YoY). Reported profits include several one-offs: 1) Rs95m of write-back of depreciation towards Vemagiri project, 2) Rs125m of prior period service tax charge in Hyderabad airport SPV. Adjusted for GMR's proportionate holding in SPVs, the net profit stands at Rs520m, down 41% YoY. GMR accounted for profit of Rs150m+ in 2QFY10 (v/s nil in 2QFY09) from Construction business division for executing Sabiha Gocken Airport (SGIA) at Turkey, through 50:50 JV with Limak.

Operating factors across projects improve in 2QFY10: During 2QFY10, GMR has witnessed momentum in terms of passenger traffic at both airport (DIAL: +20% YoY and HIAL: +8% YoY), most road projects under construction have entered operations phase and monthly annuity/toll collection stood at Rs305m (vs Rs116m in 2QFY09). PLF for power projects has also improved with Vemagiri operating at ~90% PLF for 2QFY10, Chennai Power at 73%.
Improvement in operating parameters is positive and could improve internal accruals in FY10 and FY11.

Business momentum picking up, growth to be equity dilutive: Over past six months, GMR Infrastructure has bagged 2 new road projects (cost of Rs33b), acquired 600MW power project from Emco, completed financial closure for 1.8GW power projects, and financial closure for ~2GW of capacity is expected in 2HFY10. DIAL has commenced re-bidding process for land monetization (15 acres) and lease is expected to be awarded by end January 2010. GMR's share of equity towards existing projects (excluding InterGen) stands at Rs47b and current cash on books stands at Rs16.6b. It has indicated plans to raise upto Rs75b in equity at SPVs/HOLDCO level over next 3 years.

Valuations and view: We expect GMR Infrastructure to report consolidated net profit of Rs4.8b in FY10E and Rs4.6b in FY11E. Our SOTP based target price stands at Rs54/sh. At the CMP of Rs67/sh, the stock trades at a PER of 51x FY10E and 53.4x FY11E and P/BV of 3.6x FY10E and 3.4x FY11E. Maintain Neutral.

To see the full report: GMR INFRASTRUCTURE

>India look for ways to strengthen climate talks hand

New Delhi - India may be preparing for long-running climate change talks that go well beyond the Copenhagen Summit in December, as it is starting to enter long term regional and bilateral pacts which will reinforce its negotiating firepower when it faces western nations.

While keeping an optimistic face on the prospect of a convincing roadmap for the future being hammered out at the U.N. Copenhagen meeting, India looks to be on a two-track journey, one path of which has emerged from the possibility no substantive multilateral deals are struck in Denmark.

Last week it signed a five-year pact with China--another country accused of paying scant respect to the environment in its pursuit of growth--under which they will among other things formalize exchanges of view on international climate change negotiations.

That agreement stresses that the U.N. framework convention on climate change and its Kyoto Protocol are the most appropriate vehicles for addressing climate change.

Also last week, China harshly criticized the EU and Japan for trying to drop the Kyoto Protocol as the basis for a climate deal, warning the Dec. 7-18 Copenhagen summit would fail if they didn't recant.

The Kyoto agreement specifically excludes developing countries for having to make binding cuts to their venting of greenhouse gases, something both India and China insist is enshrined in Copenhagen deals.

The Indian government says India's per capita greenhouse gas emissions are 1.1 tons a year, compared to 20 tons in the U.S. and 10 tons in the EU.

China, too, consistently argues that Western nations should shoulder the major burden of climate change efforts due to their higher per capita emissions and earlier industrialization.

China's latest stance is to say it will impose domestic targets for reducing its carbon intensity--the volume of carbon dioxide emissions per unit of gross domestic product--but so far it hasn't come up with any figures.

If and when a joint China-India stance on carbon intensity levels will emerge remains to be seen.

"Regional and cross regional deals to address climate and promote particular clean energy objectives will be an important aspect of a global decarbonization move," said John Topping, president of the Washington-based Climate Institute.

"The recent joint declaration between India and China leads to collaboration on clean energy development, and investment it can be a forerunner of some very important moves on the way to a greenhouse benign economy," he said.

It's not only with China that India has forged an alliance to ensure talk with one voice at Copenhagen.

India also recently said it had a united front with its neighbors in South Asia, an area particularly vulnerable to climate change, and one holding about 20% of the global population.

India environment minister Jairam Ramesh, speaking after a meeting of South Asian Association for Regional Cooperation, or SAARC, environment ministers, said that the grouping agreed it should not deviate from the Kyoto Protocol or the Bali Action Plan on climate change.

Such agreements at regional level, Topping feels, could help India go a long way.

"It is an internationally accepted norm to form various blocks to drive home your point at a global forum," a member of India's negotiating panel for Copenhagen said, on condition of not being named.


>Strong rand puts pressure on platinum producers

Johannesburg - Platinum miners' balance sheets are under strain as the South African rand strengthens, offsetting a strong recovery in metals prices from last year's lows.

Investors, however, either haven't taken notice or are betting that as the world economy recovers, demand for platinum group metals will again outstrip supply, propelling prices even higher and ultimately boosting the profitability of the companies that dig the metal out of the ground.

"If you look at the platinum price in rand terms, it has moved relatively little over the course of this year. And that is placing pressure on the industry as a whole," Ian Farmer, chief executive of Lonmin PLC (LMI.LN), the world's third-largest platinum producer, told Dow Jones Newswires.

"A large part of the industry is not making a great deal of money right now," Farmer said.

Platinum production is concentrated in South Africa, which accounts for about three-quarters of the world's supply of the metal. That means that while revenue from platinum sales is in U.S. dollars, the bulk of expenses--such as labor and power--are in rand.

A stronger rand erodes gains from platinum prices. In the year to date, platinum is up 41% to about $1,326 a troy ounce while the rand has gained about 23%.

The parallel is even more pronounced when looking at all platinum group metals--a mix that includes platinum, palladium and rhodium--compared with the rand.

Lonmin's average basket price for the group was $918/oz in the three months to Sept. 30, the last quarter of the company's financial year, a 22% increase compared with the last three months of 2008, its first quarter. At the same time, the company saw the rand strengthen 22% against the dollar.

Shares in platinum producers, meanwhile, have risen in lockstep with the dollar price of the metal, potentially setting investors up for a correction, some analysts say.

"We think the market has not yet realized that all the recent increases in dollar-denominated PGM [platinum group metals] prices have been offset by a stronger rand. We expect PGM stocks to fall, led by Anglo Platinum and Lonmin as the market realizes this," Nomura analyst Abhishek Shukla in London said.

The share prices of Anglo Platinum Ltd. (AMS.JO) and Impala Platinum Holdings Ltd. (IMP.JO), the world's largest platinum producers, are up about 30% so far this year. Lonmin is up about 74%.

"I can't see earnings justifying the share prices," said Peter Major, an analyst at fund management and broking firm Cadiz in Cape Town. "The shares are being held up on expectations of earnings far down the road."

"The majority of the rise in the platinum dollar price so far this year has been offset by the rand strength in terms of the rand basket price that we receive," said Anna Poulter, head of investor relations at Angloplat. She said the company had no comment on the direction of its share price.

Major said the revenue of many platinum producers will have hardly budged as the rand has strengthened almost in parallel, and mining companies in South Africa are faced with cost increases of at least 15%. South Africa lifted electricity prices by an average 31% this year after a similarly sharp rise last year, while recent wage settlements have pushed pay up at least 9%.

But not everyone sees an inevitable downside to share prices.

"My view is the rand can't strengthen much more. And yet the potential for demand recovery and the fact that the platinum companies are struggling so severely to me actually paints quite a rosy picture of the future," said Catherine Raw, portfolio manager for Blackrock's natural resources equity team.

That all points to a relatively good share performance for platinum miners in the next six to nine months, she says. In the longer term, though, Raw warns that the industry faces structural challenges and it will be important to invest carefully in platinum companies; Blackrock sees Impala as best positioned to benefit from an expected rise in prices. "Our exposure is to Impala really ... it's one of our largest holdings across the mining sector."

Platinum, also used in a number of industrial processes and for jewelry, is a key ingredient for the auto industry. Auto makers account for almost half of global platinum demand, using the metal in exhaust systems in order to meet increasingly stringent emissions standards.

While auto sales have tumbled, the three major producers of platinum have been focusing on slashing costs, together shedding thousands of jobs and shutting down their highest-cost production. But they are boosting output at remaining operations and supplies aren't expected to take a big hit--Investec Securities forecasts supplies at 7.5 million ounces next year, compared with 6.8 million ounces this year.

That indicates miners are holding on for higher prices--something they expect to materialize in the coming months.

"There hasn't been a sort of grand announcement about major closures," Lonmin's Farmer said. "But I think we are starting to see early signs of demand recovery. We are expecting 2010 to be a year in which supply and demand are fairly much in balance, with price recovery in 2011."


>Jewelry demand to return despite higher gold prices

Singapore - Gold is in unchartered territory for the traditional consumer in the jewelry market, but many are facing up to the reality that higher prices are here to stay, with burgeoning investment demand making up for any a dip in jewelry demand this year.

That is forcing even traditional buyers back in to the market as they reluctantly accept elevated price levels. This shift in attitude could remove the last hurdle before gold can resume a rally that appears to have hit a roadblock now.

"I would not advise anyone to short this market," said Jeffrey Rhodes, CEO of INTL Commodities in Dubai.

Since breaking higher in mid-September, gold has confounded expectations by comfortably consolidating above $1,000 an ounce and analysts say they expect a gradual march higher in 2010, regardless of periodic corrections.

Despite the strength in prices this year, a rise in investment demand on inflation expectations and for currency diversification purposes, has more than offset the weakness in the jewelry sector with overall gold demand in the first half at 1,744 tons, compared with 1,520 tons in the first half of 2008, according to Gold Fields Mineral Services data.

The most worrying statistic for bulls has been the continued decline in Indian gold bullion imports which are expected to fall below 300 tons in 2009, down from 396 tons in 2008 and more than 700 tons in 2007.

However, India's gold sales during the festival period of Oct. 12-19 actually rose 5.7% from a year earlier to 56 tons despite near-record prices in rupee terms, the World Gold Council said Friday.

This may not immediately result in higher imports as scrap supply will ensure sufficient supply for now, but any dip in gold prices is likely to lead to renewed Indian imports, traders said.

"India's will be ready to buy if gold corrects. You might not see gold below $900 again," said Rhodes. India is the biggest importer of gold bullion.

Physical traders in Singapore also expect buying to pick up strongly on dips below $1,000, a level where buying dissipated in early 2008. "Indian buyers never buy into rallies. There is always a lag time before they will be comfortable with higher prices," said a Singapore-based trader at an international bank.

The optimism is supported by historical data that suggest the jewelry market is not actually that sensitive to bullion prices.

According to GFMS data, global jewelry demand held fairly steady during the last bull run, dropping only 10% to 2,404 tons in 2007 from 2,680 tons in 2002, despite prices increasing by 200% over the same period.

Jewelry demand slumped to 2,186 tons in 2008 and looks likely to come in below 2,000 tons in 2009, with the first half down 22% on year at 765 tons, but the timing suggests this has more do with the global recession, with prices rising only 18% from the start of 2009.

"It is an exceptional year (in terms of demand weakness)," said Yunus Oguzhan Aloglu, executive vice president at the Istanbul Gold Exchange, who expects a demand recovery in 2010.

A positive pattern was evident during China's golden week holidays when jewelry demand was stronger than in previous years.

“Even with the price higher, Chinese investors continue buying gold,” said Peter Lim Fung, head of dealing at Wing Fung Precious Metals in Hong Kong.

Moreover, scrap sales won't be a major source of supply in China, said Lila Lu, the Beijing-based head of precious metals at China Minsheng Bank. “Chinese people will not trade jewelry in (to buy new designs) as in India. It’s handed down the generations.”


Thursday, October 29, 2009

>Just Deserts and Markets Being Silly Again

Just Deserts
I can’t tell you how surprised, even embarrassed I was to get the Nobel Prize in chemistry. Yes, I had passed the dreaded chemistry A-level for 18-year-olds back in England in 1958. But did they realize it was my third attempt? And, yes, I will take this honor as encouragement to do some serious thinking on the topic. I will also invest the award to help save the planet. Perhaps that was really the Nobel Committee’s sneaky motive, since there are regrettably no green awards yet. Still, all in all, it didn’t seem deserved. And then it occurred to me. Isn’t that the point these days: that rewards do not at all reflect our just deserts? Let’s review some of the more obvious examples.

1. For Missing the Unmissable
Bernanke, the most passionate cheerleader of Greenspan’s follies, is picked as his replacement,
partly, it seems, for his belief that U.S. house prices would never decline and that at their peak
in late 2005 they largely just reflected the unusual strength of the U.S. economy. As well as missing on his very own this 3-sigma (100-year) event in housing, he was completely clueless as to the potential disastrous interactions among lower house prices, new opaque fi nancial instruments, heroically increased mortgages, lower lending standards, and internationally networked distribution. For these accumulated benefits to society, he was reappointed! So, yes, after the fashion of his mentor, he was lavish with help as the bubble burst. And how can we so quickly forget the very painful consequences of the previous lavishing after the 2000 bubble? Rewarding Bernanke is like reappointing the Titanic’s captain for facilitating an orderly disembarkation of the sinking ship (let’s pretend that happened) while ignoring the fact that he had charged recklessly through dark and dangerous waters.

2. The Other Teflon Men
Larry Summers, with a Financial Times bully pulpit, had done little bullying and blown no warning whistles of impending doom back in 2006 and 2007. And, famously, in earlier years as Treasury Secretary he had encouraged (I hope inadvertently) wild and reckless financial behavior by helping to beat back attempts to regulate some of the new and most dangerous instruments. Timothy Geithner, in turn, sat in the very engine room of the USS Disaster and helped steer her onto the rocks. And there are several others (discussed in the 4Q 2008 Letter). You know who you are. All promoted!

3. Misguided, Sometimes Idiotic Mortgage Borrowers
The more misguided or reckless the borrowers, the more determined the efforts to help them out, it appears, although it must be admitted these efforts had limited effect. In comparison, those who showed restraint and either underhoused themselves or rented received not even a hint of help. Quite the reverse: the money the more prudent potential buyers held back from housing received an artifi cially low rate. In effect, the prudent are subsidizing the very same banks that insisted on dancing off the cliff into Uncle Sam’s arms or, rather, the arms of the taxpayers – many of whom rent.

4. Reckless Homebuilders
Having magnificently overbuilt for several years by any normal relationship to the population, we have decided to encourage even more homebuilding by giving new house buyers $8,000 each. This cash comes partly from the pockets of prudent renters once again. This gift is soon, perhaps, to be extended beyond first-time buyers (for whom everyone with a heart has a slight sympathy) to any buyers, which would be blatant vote-buying by Congress. So what else is new?

5. Over-spenders and Under-savers
To celebrate the overwhelming consensus among economists that U.S. individuals have been
dangerously overconsuming for the last 15 years, we have decided to encourage consumption and penalize savers by maintaining the aforementioned artifi cially low rates, which beg everyone and sundry to borrow even more. The total debt to GDP ratio, which under our heroes Greenspan and Bernanke rose from 1.25x GDP to 3.25x (without even counting our Social Security and Medicare commitments), has continued to climb as growing government debt more than offsets falling consumer debt. Where, one wonders, does this end, and with how much grief?

6. Banks Too Big to Fail
Here we have adopted a particularly simple and comprehensible policy: make them bigger! Indeed, force them to be bigger. And whatever you do, don’t have any serious Congressional conversation about breaking them up. (Leave that to a few journalists and commentators. Only pinkos read pink newspapers anyway!) This is not the fi rst time that a cliché has triumphed. This one is: “You can’t roll back the clock.” (See this quarter’s Special Topic: Lesson Not Learned: On Redesigning Our Current Financial System.)



Investor focus has shifted from earnings to valuation. We are now most often asked at what P/E should the market trade. We offer four approaches: (1) history of multiple expansions from bear market lows suggests 14.1x; (2) our top-down P/E model suggests 13.7x; (3) our DDM-derived 2009 price-target of 1060 implies 13.1x; and (4) the Fed Model implies 16.4x.

P/E multiples will likely remain below average in 2010
Our top-down regression and DDM models cannot precisely pinpoint a correct P/E multiple. However, the current weak macroeconomic backdrop as well as the historical trading pattern of bear market recoveries suggest P/E multiples will stay below average in 2010. Our forecast that multiples will remain below average represents an out-of-consensus view based on recent conversations with a wide range of portfolio managers. Many investors expect S&P 500 will reach 1200 by year-end. However, we believe it will take a higher E – not higher P/E – for the market to sustain levels above our current 1060 target.

The debate has shifted from EPS to valuation. During the past 18 months, we have focused our research primarily on the earnings power of the market and the trajectory of S&P 500 EPS. This emphasis was appropriate given forward bottom-up consensus EPS estimates for the S&P 500 plunged by 37% from $98 in September 2008 to $62 in May 2009. During the past five months, however, EPS estimates have edged up slightly, currently hovering around $68. Given the recent stability of earnings estimates, investor focus has shifted from earnings to valuation.

The Multiple Mystery: At what P/E should the market trade?

(1) History suggests 14.1x, or 34% expansion from the trough
Historical analysis reveals a consistent pattern of bear market recoveries: first multiple expansion, then earnings growth. The market multiple tends to expand by 34% during the first 10 months following a bear market trough but then remains flat during the subsequent 12 month period. Since the March low, multiples have risen by 30%, on track with historical precedent, to 13.6x currently. A further 4% rise would lead to a 14.1x P/E.

(2) Top-Down P/E Regression suggests 13.7x
Macro model of inflation and the output gap suggest multiples will remain near current levels into 2010. Both variables appear negatively correlated with P/E (output gap is positive when GDP is below potential). We acknowledge that these two variables may not have a completely linear relationship with P/E multiples. For example, a deflationary environment probably would not lead to higher P/E (despite the negative correlation between P/E and inflation). However, our 2010 headline CPI forecast equals 1.2%, a rate within our historical regression sample set. The standard error of our model is 3.4 points, indicating the regression results should not be interpreted with a false sense of accuracy.

(3) Comparison with DDM (13.1x) and Fed Model (16.4x)
Independent valuation models provide varying implications for year-end P/E multiples. Our 2009 year-end price target of 1060 stems from our Dividend Discount Model (DDM) and implies a year-end 2009 P/E multiple of 13.1x, based on our 2010 pre-provision and write-down EPS estimate of $81. This result represents the lowest implied P/E of our various approaches. The Fed Model suggests P/E multiples may expand significantly in the near term, rising to 16.4x by year-end 2009. This model suggests equities are undervalued relative to bonds. The usefulness of this methodology in the current environment is limited given the unprecedented government actions that have kept interest rates unusually low.

P/E is hard to target; using 15x long-term average is too simplistic
Most investors agree with a $75-$80 EPS estimate for 2010. Bullish investors argue for 15x P/E multiple based on long-term history, and a year-end 2009 target of 1200. Our year-end 2009 price target remains 1060. We recognize the possibility the S&P 500 could rally sharply in 4Q boosted by better than expected earnings results and increased risk appetite. However, we reject the argument of many investors that re-valuation alone will propel the market higher through multiple expansion back to the long-term average.

To see the full report: PORTFOLIO STRATEGY



India Infoline, Motilal Oswal & Geojit BNPPARIBAS, the three major brokerage under our coverage universe have come up with their Q2FY10 results

All three have delivered results which are better than the street expectations

The companies scored on top line front mainly on account of increased revenue realization from equity and commodity brokerage segments while segments such as Mutual Fund advisory and Wealth management also registered healthy increase.

The companies witnessed significant growth in margins mainly on account of an increased customer base, increased participation from the retail investor segment and an overall positive breadth on the market front also added to the cause

The recent credit policy aimed at tackling inflation will have an impact on the revenues of the companies because reduced participation on the retail front and with the markets heading back to positions which we would term as expensive considering the valuation parameters a wait and hold approach from investors could dampen revenues. However considering the fact that the companies are regularly innovating their product portfolio and with an ever increasing demand for professional money managers the industry sure has a bright future ·

Moreover we believe that with SEBI giving clearance for the extension of timings of equity market, would lead to higher revenues by the brokerage houses and thus we retain our earlier BUY call on each of the three stocks.

To see the full report: BROKING SECTOR


Numbers in line with estimates; Eduresource grew substantially: Everonn Education (Everonn) reported consolidated sales of INR 731 mn, up 70% Y-o-Y, in Q2FY10. A substantial portion of the incremental revenues was contributed by its hardware trading subsidiary Eduresource that grew 2.4 times Yo-Y. Revenues in its Vitels segment grew 67%, to INR 348 mn, while ICT segment grew by a marginal 6%, to INR 139 mn.

EBITDA up; drop in ICT margins cause for concern: EBITDA for the company was higher by 74% Y-o-Y; EBITDA margin was, however, lower by 510bps Q-o-Q, as a substantial portion of the incremental revenues originated from Eduresource – an extremely low-margin business. Also, the ICT segment, despite reporting 6% Y-o-Y growth in revenues, posted 18% drop in PBT. We believe margins in the ICT business could continue to remain under pressure as competition intensifies amongst the existing players.


Plans to move up the education value chain; execution key concern: Everonn has announced an ambitious plan of venturing into management of education institutions (schools & colleges) through its ‘Educating India’ project. Currently, the project is at the conceptual stage, with the exact timelines and business model still unclear. We believe execution will remain a key challenge in this venture, especially since Everonn has little experience in managing educational institutions.

Outlook and valuations: Risk-reward favourable; maintain ‘BUY’: We maintain our revenue and sales estimate for Everonn and expect a consolidated topline CAGR of 47% and net profit CAGR of 68%, over FY10-11E. Everonn is currently trading at P/E of 17x FY10E and 11x FY11E. Adjusting for aggressive revenue recognition (refer risk factors), the company is trading at a P/E of 13x FY11E. The Vitels segment remains key driver for the company’s valuation. We believe continued strong performance will drive a re-rating in the stock. We maintain ‘BUY’ on Everonn.

To see the full report: EVERONN EDUCATION


Disappointing performance; net profit down 11.6% Y-o-Y: Titan Industries’ (TIL) Q2FY10 revenues grew only 5.3% Y-o-Y, to INR 11.5 bn, below our expectation of INR 12.5 bn. In spite of festive season, revenues failed to show buoyancy, signaling a substantial decrease. In Q1FY10, the company changed its accounting policy (to FIFO instead of weighted average method) for valuing gold inventory.

Skyrocketing gold prices hit jewellery business yet again: As TIL’s jewellery business battled spiraling gold prices, its growth disappointed with a mere 9.4% Y-o-Y growth. Net revenues stood at INR 8.2 bn versus INR 7.5 bn in Q2FY09, driven by ~15% increase in gold prices, signaling a significant decline in volumes (~6%). This lead to 200bps erosion in EBIT margins that stood at 7% against 9% in Q2FY09.

Macro headwinds temper growth

Watches business failed to enthuse: Watches and clocks business also exhibited dismal performance with revenue decline of 2.6% Y-o-Y. Sales from the business stood at INR 2.9 bn against INR 3.0 bn in Q2FY09. EBIT margins were down 20bps Y-o-Y, at 19.7%. TIL expects the December quarter to witness a strong comeback for this business, but we stay cautious and would watch the space closely.

EBITDA margins down 218bps Y-o-Y: EBITDA margins were down 218bps Y-o-Y due to 245bps decline in gross margins. Employee costs were up 57bps, but other expenses were down 84bps; hence, the net impact on EBITDA was to the tune of 218bps. Most retailers have seen a Y-o- Y decrease in staff expenses, except for TIL.

Outlook and valuations: Cautious; maintain ‘REDUCE’: We expect the watch and eye wear divisions to see some uptick due to higher discretionary spending and improving consumer sentiment. However, lower volumes in the jewellery division, due to spiraling gold prices, will continue to be drag on the business. At CMP of INR 1,361, the stock looks expensive at P/E of 29.6x FY10E and 24.6x FY11E. We maintain our ‘REDUCE’ recommendation on the stock, and rate it ‘Sector Underperformer’ on relative return basis (refer rating page for details).

To see the full report: TITAN INDUSTRIES


We highly - very highly - recommended that you take the time to read the only article on the weekend worth reading, which was "The View Fron Inside a Depression". Have a read of the excerpts from Benjamin Roth's diary of the roller coaster ride that come to define the economy and the financial markets during the 1930s. How it was all over by 1930 - but it wasnt. How everyone was giddy from all the government stimulus in 1935 and 1936 - and the sudden and dramatic reversal in 1937 and 1938. It reasonates, especially at a time when all the mainstream economists focus so intently over the latest tick in the regional manufacturing indices or jobless claims or inventory-sales ratios.

To see the full report: THE GREAT FRAUDULATION

Wednesday, October 28, 2009

>U.S. Dollar Drowning In A Sea Of Liquidity (WELLS FARGO LIMITED)

Summary: The greenback has been especially weak in 2009, falling by 15% on a trade-weighted basis since March. However, we view the dollar’s fall as more cyclical than structural. Instead, we believe a massive injection of liquidity by central banks has supported equity and commodities markets, and related commodity and emerging currencies, at the expense of the greenback. For 2010 we expect a reversal of these trends, leading to a less favorable outlook for major currencies as well as commodity currencies against the dollar. The greenback’s trend in 2010 should be higher despite - or perhaps because of – this year’s decline, and we would still suggest formulating hedging and investment strategies around a stronger dollar outlook for 2010.

Why Is The Dollar So Weak?
From its most recent major peak in March of this year, the trade-weighted value of the greenback has fallen by 15% against other major currencies. The dollar’s decline has been accompanied by repeated calls of a terminal demise in the dollar. However, we believe that the greenback’s fall is more temporary than permanent, and that the structural factors often cited for the dollar’s decline have played only a limited role. Of particular relevance to this debate, we note:

• Although the double-digit U.S. government budget deficit is historically large, it is nonetheless
comparable to other major countries (U.K., Japan). Moreover, gross government debt levels for the overall U.S. public sector are similar to the U.K. and Germany, and well below Japan.

• We see little risk of runaway inflation undermining the dollar (or indeed any other major currency). Low capacity utilization rates and high and rising jobless rates will restrain cost pressures in the near-term, while we doubt the world’s central banks will allow inflation to become entrenched over the medium to longer-term.

• Foreigners (both the private sector and central banks) are still buying Treasury bills and bonds, albeit at reduced pace ($287B in the past six months compared to $490B in the second half of 2008 – see chart, top right). That said, the most recently available figures do point to a fall in the proportion of the world’s FX reserves held in dollars.

Instead, we believe much of the greenback’s 2009 fall is of a cyclical nature. In particular, we believe a massive injection of liquidity by global central banks, along with other economic stimulus measures by global governments, has played a large part in the dollar’s fall. The chart below shows recent liquidity trends across the OECD region, which includes all of the major developed economies. Narrow money growth across the OECD has accelerated significantly in recent months, reaching 12.9% y/y in August. In part, that acceleration reflects the very stimulative monetary and liquidity policies of central banks like the Federal Reserve, Bank of England and European Central Bank.

In contrast, growth in broader money measures has actually slowed significantly in recent months, to just 6% y/y by August 2009. These broad money aggregates reflect not only the actions of central banks, but also the actions of commercial banks and other financial institutions operating within an economy. The fact that broad money growth is slowing even as narrow money measures accelerate suggests that the cash injected by central banks into the banking system and money markets is not circulating around the economy as one might typically expect. In turn, that reflects greater caution on the part of commercial banks in the wake of the global financial crisis with lending activity still very subdued. For example, total outstanding loans and leases by U.S. commercial banks are down 4.2% from a year ago, while in the Eurozone loans to the private sector are up just 0.1% over the past year.

The contrast between accelerating growth in narrow money and slowing growth in broad money is particularly interesting and relevant for FX markets at the current juncture. The cautious approach by banks suggests that central bank actions are providing only moderate support to the broader economy, and consensus 2010 GDP growth forecasts for the major regions are subdued (around 2½% for the U.S., and just over 1% for the Eurozone and Japan). Instead, much of this ‘new’ liquidity appears to be finding its way into a range of asset markets: emerging market government bond spreads to U.S. Treasuries have narrowed to around 300bp (from around 865bp at the peak of the crisis), the CRB commodities prices are up 40% from their low, and global equities markets have surged 55% from their low point – a much stronger rebound than current or prospective global GDP growth might suggest.

Related currencies have benefited at the expense of the U.S. dollar. The commodity sensitive Australian and New Zealand dollar are both up around 30% year-todate, and have started to close in on pre-crisis peaks. Among the emerging markets, the Brazilian real (34%) and the South African rand (26%) have enjoyed particularly large year-to-date gains. 2009 has also been characterized by an especially prominent correlation between stronger equity markets and a weaker dollar as funds have been diverted towards these asset markets.

Central Bank Actions A Key 2010 FX Driver
This relationship between global liquidity, global asset markets and the U.S. dollar is likely in our opinion to remain a key theme for the foreign exchange market during 2010. As we move further away from the peak of the global financial crisis and the trough of the global economic recession, central banks (and governments) will start to remove some of the stimulative policy measures put in place over the past couple of years. This policy tightening is not necessarily designed to restrain growth or head-off inflation, but rather to remove ‘emergency’ measures that are no longer appropriate as financial markets show some stabilization, and as economies show a return to growth. The trend towards less policy accommodation has only just begun with a rate hike from Australia earlier this month and with a rate hike expected from Norway later this week. But this trend should gain momentum through 2010, with the major global central banks expected to start hiking rates from around the middle of next year.

To see the full report: U. S. DOLLAR


The rise of retail lending in emerging economies like India has been of recent origin. Asia Pacific’s vast population, combined with high savings rates, explosive economic growth, and underdeveloped retail banking services, provide the most significant growth opportunities for banks. Banks will have to serve the retail banking segment effectively in order to utilize the growth opportunity.

Banking strategies are presently undergoing various transformations, as the overall scenario has changed over the last couple of years. Till the recent past, most of the banks had adopted fierce costcutting measures to sustain their competitiveness. This strategy however has become
obsolete in the new light of immense growth opportunities for banking industry. Most bankers
are now confident about their high performance in terms of organic growth and in realising high
returns. Nowadays, the growth strategies of banks revolve around customer satisfaction.
Improved customer relationship management can only lead to fulfilment of long-term, as well as,
short-term objectives of the bankers. This requires, efficient and accurate customer database
management and development of well-trained sales force to develop and sustain long-term
profitable customer relationship.

The banking system in India is significantly different from that of the other Asian nations, because of the country’s unique geographic, social, and economic characteristics. Though the sector opened up quite late in India compared to other developed nations, like the US and the UK, the profitability of Indian banking sector is at par with that of the developed countries and at times even better on some parameters. For instance, return on equity and assets of the Indian banks are on par with Asian banks, and higher when compared to that of the US and the UK. Banks in India are mainly classified into Scheduled Banks and Non-Scheduled Banks. Scheduled Banks are the ones, which are included in the second schedule of the RBI Act 1934 and they comply with the minimum statutory requirements. Non-Scheduled Banks are joint stock banks, which are not included in the second Schedule of the RBI Act 134, on account of the failure to comply with the minimum requirements for being scheduled.

Indian banks have compared favourably on growth, asset quality and profitability with other regional banks over the last few years. The banking index has grown at a compounded annual rate of over 51 per cent since April 2001 as compared to a 27 per cent growth in the market index for the same period.Policy makers have made some notable changes in policy and regulation to help strengthen the sector. These changes include strengthening prudential norms, enhancing the payments system and integrating regulations between commercial and co-operative banks.Bank lending has been a significant driver of GDP growth and employment.

Extensive reach: the vast networking & growing number of branches & ATMs. Indian banking system has reached even to the remote corners of the country.

The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalisation of 14 major private banks of India.

In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region.India has 88 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the Government of India holding a stake)after merger of New Bank of India in Punjab National Bank in 1993, 29 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.Foreign banks will have the opportunity to own up to 74 per cent of Indian private sector banks and 20 per cent of government owned banks.

PSBs need to fundamentally strengthen institutional skill levels especially in sales and marketing, service operations, risk management and the overall organisational performance ethic & strengthen human capital.

Old private sector banks also have the need to fundamentally strengthen skill levels.

The cost of intermediation remains high and bank penetration is limited to only a few customer segments and geographies.

Structural weaknesses such as a fragmented industry structure, restrictions on capital availability and deployment, lack of institutional support infrastructure, restrictive labour laws, weak corporate governance and ineffective regulations beyond Scheduled Commercial Banks (SCBs), unless industry utilities and service bureaus.
Refusal to dilute stake in PSU banks: The government has refused to dilute its stake in PSU banks below 51% thus choking the headroom available to these banks for raining equity capital. Impediments in sectoral reforms: Opposition from Left and resultant cautious approach from the North Block in terms of approving merger of PSU banks may hamper their growth prospects in the medium term.

The market is seeing discontinuous growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in fee-based income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations.

banks will no longer enjoy windfall treasury gains that the decade-long secular decline in interest rates provided. This will expose the weaker banks.

With increased interest in India, competition from foreign banks will only intensify.

Given the demographic shifts resulting from changes in age profile and household income, consumers will increasingly demand enhanced institutional capabilities and service levels from banks.

New private banks could reach the next level of their growth in the Indian banking sector by continuing to innovate and develop differentiated business models to profitably serve segments like the rural/low income and affluent/HNI segments; actively adopting acquisitions as a means to grow and reaching the next level of performance in their service platforms. Attracting, developing and retaining more leadership capacity

Foreign banks committed to making a play in India will need to adopt alternative approaches to win the “race for the customer” and build a value-creating customer franchise in advance of regulations potentially opening up post 2009. At the same time, they should stay in the game for potential acquisition opportunities as and when they appear in the near term. Maintaining a fundamentally long-term value-creation mindset.

reach in rural India for the private sector and foreign banks.

With the growth in the Indian economy expected to be strong for quite some timeespecially in its services sector-the demand for banking services, especially retail banking, mortgages and investment services are expected to be strong.

the Reserve Bank of India (RBI) has approved a proposal from the government to amend
the Banking Regulation Act to permit banks to trade in commodities and commodity derivatives.

Liberalisation of ECB norms: The government also liberalised the ECB norms to permit financial sector entities engaged in infrastructure funding to raise ECBs. This enabled banks and financial institutions, which were earlier not permitted to raise such funds, explore this route for raising cheaper funds in the overseas markets.

Hybrid capital: In an attempt to relieve banks of their capital crunch, the RBI has allowed them to raise perpetual bonds and other hybrid capital securities to shore up their capital. If the new instruments find takers, it would help PSU banks, left with little headroom for raising equity. Significantly, FII and NRI investment limits in these securities have been fixed at 49%, compared to 20% foreign equity holding allowed in PSU banks.

Threat of stability of the system: failure of some weak banks has often threatened the stability of the system.

Rise in inflation figures which would lead to increase in interest rates.
·Increase in the number of foreign players would pose a threat to the PSB as well as the private players.