Thursday, September 17, 2009


SDLs to flood the system in H2; spread over G-sec to soar 120bps+

Twelfth Finance Commission recommendations on state finances
  • The Twelfth Finance Commission (TFC) and Fiscal Responsibility Legislation (FRL) were enacted in 2002 and 2003, respectively, to guide various states achieve fiscal prudence.
  • The TFC recommended reduction of state fiscal deficit to 3% by March 31, 2009 along with the complete elimination of revenue deficit. State governments were also advised to borrow directly from the market without the central government being an intermediary.

Budgeted state expenditure management hit by crisis
  • The onset of the global housing crisis that rendered a serious blow to industries world wide tainted the pretty picture painted by FY09 budgeted estimates.
  • As per RBI’s release of revised FY09 estimates of state deficits, the consolidated fiscal deficit soared to 2.7%, with interest payments (budgeted at 14.6% of the revenue receipts for FY10) growing at 15% Y-o-Y in FY10; the interest cost of SDLs in FY10 is expected to inch up 40-50bps to 8.20-8.40% from the FY09 levels.

Budget analysis of top SDL issuers in FY09
  • Over the past two years, some of the biggest borrowers witnessed an absolute jump of over 2-3x in their fiscal deficit; Tamil Nadu’s fiscal deficit soared from INR 36 bn in FY08 to INR 118 bn in FY10.
  • Maharashtra, Tamil Nadu, and West Bengal witnessed the maximum fiscal slippage among the states under study. West Bengal is expected to post revenue deficit of 42% of its revenue receipts for FY10.
  • We anticipate the overall deficit to soar further as GSDP growth rate estimates for some states under study fail to post the budgeted performance; three out of the five states anticipate 10% annual growth in their respective GDP for FY10.

Expectations for state finances (FY10)
  • The gross fiscal deficit of state governments is expected to rise from FY09 levels by 70bps to 3.4%. The growing burden of interest payments, expected to sustain at 2% of GSDP, is budgeted to double the primary deficit to 1.4% in FY10 from the FY09RE levels.
  • The debt-GDP ratio (which had dipped from 32.7% in 2004-05 to 27.5% as per BE of 2008-09) is expected to witness a U-shaped trajectory with higher reliance on debt financing, offsetting the deleveraging (reduction in outstanding liabilites) carried out for state balance sheets since FY05.

FY10: Flurry of SDL supplies and cut-off expectations

  • Relaxation of the FRBM target for states by 0.5% of GSDP is expected to supply the market with an additional INR 210 bn worth of SDL; cumulative SDL issuance is expected at INR 1.56 tn for FY10.
  • With INR 1-1.1 tn of SDL supplies scheduled in H2FY10, we expect the spread over equivalent maturing G-sec to balloon from present levels to 125bps by December, and have further upside bias in final quarter of the FY10. In case of bear widening, with corporate bonds expected to exhibit stickiness as present levels, SDLcorporate bond spreads are also expected to shrink to 10-20bps as existing corporate spreads over G-secs remain around current levels.

Twelfth Finance Commission recommendations on state finances
  • The finance framework of states has come a long way from being only an additional limb of the complex central government finance machinery. While the Twelfth Finance Commission has been instrumental in building a budgetary balance for both the Centre and states by laying out a devolution mechanism for the shareable portion of revenue proceeds, the gradual adoption of state-specific fiscal responsibility legislations has called for larger significance of the study of state government budgets.
  • In 1997, during the maiden conference of state finance secretaries, Dr. Rangarajan, the then RBI governor, brought to light various issues that needed to be addressed for the management of state finances.
  • In an effort to provide guidance to various states to attain fiscal prudence, the TFC and FRL were enacted in 2002 and 2003, respectively. The latter is similar to Centre’s FRBM Act, catering to the expenditure management policies at the state level.

To see full report: STATE FINANCES


Analyzing why people play golf is like exploring the intricacies of string theory – there are so many permutations lacking scientific observation that physicists or golfers can pretty darn well say anything they like and the explanation might stick. When it comes to whacking that little white ball, the possibilities are nearly endless: People play to relax, to be with friends, to get close to Mother Nature, to enhance business connections, to compete and excel. Gosh, I don’t know, the Zen explanation for why we play golf could even resemble the old saw about climbing a mountain: People golf because it’s there. Whatever the reason, it is the most frustrating, damnable game ever conceived – alternately elevating and depressing you within the span of mere minutes. I love golf. No, I hate it.

Personally, the reason that golf draws me to its intricate web of psychological entrapment is epitomized by a simple six-inch trophy: a chartreuse ball resting on top of its ebony base, preening on a bookshelf in the family room at our desert home. Its inscription reads, “Hole in one, March 15th, 1990, 14th hole Desert Course, 155 yards.” Well and good, I suppose – the ace of my life – except it wasn’t. It was the ace of my wife. Above the inscription rests the name Sue – not Bill – Gross. It was a great shot but it wasn’t my shot, and I guess therein lies the explanation for why I continue to tee it up.

Actually, two years ago I did tee it up in the sweltering 105° June heat of the Palm Springs desert. No one, of course, was crazy enough to be with me including my “ace” role model wife who was sipping a cool lemonade in the comfort of our air-conditioned home. Now, there is an “unwritten” rule in golf that in order to be official, a hole-in-one has to be witnessed, and that you have to play a full 18 holes. Otherwise, I suppose, you could stand on the tee with a bucket of balls and hit hundreds or thousands until one of the little guys went in – whatever. The fact is, on this particular day, I was playing only one ball, but I was alone, and – good God! – it went in! The trophy with ebony base and spanking white Titleist ball would read: “Hole in one, June 7th, 2007, 17th hole, Mountain Course, 139 yards.” Or was it? Does a falling tree make a sound in the middle of a forest if no one’s there? Is a hole-in-one a hole-in-one if no one else saw it? I say emphatically – yes! That damn ball went in and later that day Sue agreed with me (although she had a funny look in her eye – especially since she didn’t know a thing about the rules of golf). No one else though. No one else agrees with me. Not a soul. I suspect they’re jealous and, in fact, I’ve seen a few of them hitting buckets of balls at dusk from that very same tee when they think nobody’s looking. I’m watching, though, which brings up a funny question. If they sunk one, would theirs be a hole-in-one because I was a witness? Like I said – a damnable game.

Well, the surprise is that there’s been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.

This focus on the DDRs – delevering, deglobalization, and reregulation – may be conceptually understandable, but nevertheless still a little hard to get one’s arms around. Why would they necessarily lead to a new, slower growth normal? A little easier to grasp might be the following approach, which feeds off the same concept, but which extends it a little further by suggesting
that DD and R lead to a number of broken business or economic models that may forever change the world we once knew and make even Barton Biggs a chastened adult.

They are as follows:
1) American-style capitalism and the making of paper instead of things. Inherent in the “great moderation” of the past 25 years was the acceptance of a sort of reverse mercantilism. America would consume, then print paper assets and debt in order to pay for it. Developing (and many developed) countries would make things, and accept America’s securities in return. This game is over, and unless developing countries (China, Brazil) step up and generate a consumer ethic of their own, the world will grow at a slower pace.

2) Private vs. public-driven growth. The invisible hand of free enterprise is being replaced by the visible fist of government, a temporarily necessary, but (if permanent) damnable condition
itself in terms of future growth and profits. The once successful “shadow banking system” is being regulated and delivered. Perhaps a fabled “110-pound weakling” may be an exaggeration
of where our financial system is headed, but rest assured it will not be looking like Charles Atlas anytime soon. Prepare to have sand kicked in your face, if you believe you are a “child of the bull market!”

To read full report: INVESTMENT OUTLOOK

>Can growth surprise further on the upside? (HSBC)

How fast is global growth recovering?

The depth of the drop – and misleading y-o-y changes – make that a hard question to answer

But growth will probably continue to surprise on the upside

Nobody doubts that growth in the world economy has begun to recover. But, with global stock markets having risen 61% from the bottom (and some much more than that, notably China up 122%) the key for the next few months will be how fast growth rebounds and how sustainable the rebound is. Growth, then – much more than monetary policy (major central banks will be on hold for the foreseeable future) or valuations (reasonable as long as earnings recover) – will be what drives equities over the next couple of quarters.

But the path of growth is particularly hard to predict at the moment. First, because the global economy fell off a cliff at the end of 2008, the y-o-y change in almost any data series you look at is going to swing from a big negative to a big positive over the next few months. Chart 1, for example, shows the likely path of Asian exports in y-o-y terms (assuming a moderate recovery continues). By next February, they will be growing over 60% y-o-y. Markets are likely to react positively to such a strong number, even if it is misleading. But it is even harder to judge how far the underlying data might rebound. Many data series at the moment look like Chart 2, which shows monthly Japanese exports. These fell 50% from peak to trough. But how fast and far will they recover?

This note looks at indicators of growth (IP, earnings, economists’ forecasts) and concludes that growth is likely to continue to accelerate for a more few months, beating current forecasts. But that is more so for developed or highly cyclical economies than for Asia, especially China, where output and earnings are already back close to peak levels.

To see the full report: EQUITY INSIGHTS


Fund raising to spur future growth.....

INR 3.67 bn raised through QIP issue
Nagarjuna Construction (NCC) has raised INR 3.67 bn through a QIP issue. It issued 27.7 mn shares at a price of INR 132.46 per share, resulting in a post issue dilution of 10.8%. The funds raised will primarily be used to meet working capital requirements for its contracting business as well as the equity commitment for NCC’s infrastructure development portfolio. The company’s debt: equity ratio was comfortable at 0.7x at FY09 end.

Funds raised to be utilised to boost future growth
The funds raised will aid growth in the contracting as well as asset ownership businesses. NCC has performed well on the order intake front in the current year; order intake stood at INR 27 bn in Q1FY10 and has surpassed INR 40 bn YTD (against INR 66 bn in FY09). We expect the company to overshoot its order intake guidance of INR 65 bn for FY10. This is likely to improve revenue visibility going forward. NCC has a portfolio of 11 BOT projects—five road, two hydropower, two airports, one port, and one convention center (apart from the Gautami power plant where the company has decided to sell its stake). Of these 11 projects, one is operational, five are in the development phase, and five have yet to achieve financial closure. The company is also bidding for the upcoming NHAI BOT project. It has been already shortlisted among the bidders for a couple of road BOT projects. The funds raised will help meet equity commitment for current as well as future projects.

Outlook and valuations: Growth prospects improve; upgrade to ‘BUY’
While the fund raising exercise will be EPS dilutive in FY10, it will be EPS neutral in FY11 with likely increase in execution (due to strong order intake) and savings on interest cost. We are revising our EPS estimates downwards by 5.3% and 0.3% for FY10 and FY11, respectively. At CMP of INR 134, the stock is trading at a P/E of 18.3x and 13.9x for FY10E and FY11E, respectively. Our sum-of-the-parts-based target price for the stock is INR 175, with BOT projects contributing INR 17 to valuations. We have valued real estate investments at book value.

We believe fund raising will help the company log a faster growth trajectory. Also,
improvement in the pace of road BOT project awards and improving economic outlook with government’s thrust on infra projects is likely to aid NCC, going forward. Hence, we are upgrading the stock to ‘BUY’ from ‘HOLD’ and rate it ‘Sector Performer’ on a relative return basis (refer rating page for details).



To see the report: MRF