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.

To read other reports on  SWOT ANALYSIS ON BANKING INDUSTRY 


The Reserve Bank of India announced its second quarter review of monetary policy. Despite the
fact that most of the key rates policy rates remained unchanged as expect, the benchmark indices corrected by around 2% with the banking and real estate sectors plummeting the most. This is mainly because of the fact that the policy sets a tone for the beginning of the reversal of Monetary Easing.

Some of the key highlights form the policy documents are:
· The share of agriculture in GDP has been declining over time, and as of 2008-09 it was 17.0 per cent. However, experience shows that a deficient rainfall can have a disproportionate impact on overall economic prospects and on the sense of well-being. Poor output will push up prices and depress rural labor incomes. Given the inter-sectoral supply-demand linkages, the knock-on impact on the industrial and services sectors can also be significant.

· Continuing the trend witnessed since Q2 of 2008-09, the two major components of demand, viz., private final consumption expenditure and gross fixed capital formation (with a combined weight of around 88 per cent) decelerated further in Q1 of 2009-10. Government consumption, which had increased sharply in Q3 and Q4 of 2008-09 due to the fiscal stimulus measures and the Sixth Pay Commission payouts, also decelerated in Q1 of 2009-10. While the direct impact of fiscal stimulus is waning, its indirect impact on private consumption and investment will persist for some more time

· The GDP projection for 2009-10 for policy purposes remains unaltered at 6%, made in the First Quarter Review of July 2009.

· Keeping in view the global trend in commodity prices and the domestic demand-supply balance, the baseline projection for WPI inflation at end-March 2010 is placed at 6.5 per cent with an upside bias. This is higher than the 5.0 per cent WPI inflation projected in the First Quarter Review of July 2009 as the upside risks have materialized

· The policy dilemma for India is different in some important respects from that of advanced
economies as also other emerging market economies. First, most of these countries do not face an
immediate risk of inflation. Indeed, in several advanced economies, the concerns were about a
possible deflation, which are just about waning. On the other hand, India is actively confronted
with an upturn in inflation – a rising WPI inflation and stubbornly elevated CPI inflation

· An issue of some immediate relevance is the critical need to downsize the government
borrowing programme so as to help sustain a moderate interest rate regime. This is crucial
for investment demand to pick up on which hinge our long-term economic prospects

· Reversing monetary policy easing stems from the concern about inflation. WPI inflation has
turned positive, the base effect which has kept WPI low so far is now gone and CPI inflation has
remained stubbornly elevated. On a financial year basis, WPI has already increased by 5.95 per
cent. In as much as monetary policy acts with a lag, there is need to act now

· The Reserve Bank’s inflation expectations survey shows that households expect inflation to
increase over the next three months as also one year. The lag with which monetary policy
operates suggests that there is a case for tightening sooner rather than late

· The balance of judgment at the current juncture is that it may be appropriate to sequence the
‘exit’ in a calibrated way so that while the recovery process is not hampered, inflation
expectations remain anchored.

To read the full report: CREDIT POLICY

>Emerging As One of the Top Destinations for FDI (MORGAN STANLEY)

In this week’s EcoView, our spotlight focuses on the recent trend and outlook for FDI inflows into India. With the revival in global business confidence and risk appetite, FDI inflows into India have rebounded sharply over the last six months. Indeed, if the current trend is maintained, we expect FDI inflows in 2009 to reach the high of US$41.2 billion received in 2008. Read the detailed note to see the analysis on trend in India’s rank relative to other emerging markets, which sectors are attracting FDI inflows, and the outlook for FDI inflows.

Elsewhere in this week’s EcoView, we summarize the key macro developments including:
(a) Road infrastructure development – taking stock of progress: According to the monthly data released by NHAI, there has been some pickup in project awards since February 2009 compared to the prior period when not a single project was awarded between August 2008 and January 2009.

(b) What does the rise in oil prices mean? With oil prices trending higher again, we have updated our analysis on the sensitivity to increasing oil prices on three fronts: subsidy burden, external balance and inflation.

(c) Assembly elections – good news for Congress Party: Congress leads in the assembly elections in all three states – Maharashtra, Haryana and Arunachal Pradesh. The Congress and its alliance parties were the incumbents in these states.

(d) New monthly WPI series to be launched: This will replace the current practice of releasing the index on a weekly basis. The proposed new monthly series will include a wider and more updated basket compared with the current WPI weekly series.

• Quick revival in FDI inflows into India: After a brief period of slowdown post the emergence of
global credit crisis in 2H08, FDI inflows have increased sharply – though they remain far away
from peak levels seen in 1Q08. If the current trend is maintained, we expect FDI inflows in 2009 to reach close to the high of US$41 billion received in 2008.

• India is steadily improving its rank compared to other EMs: India’s share in global FDI flows
improved significantly to 2.4% in 2008 from 1.3% in 2007 and 0.3% in 2000. From being ranked 36th in the world on FDI inflows in 2000, India has improved its rank to 20th in 2007. Indeed, if we measure FDI inflows in terms of percentage of GDP, India is already receiving more inflows than Brazil, China and the US.

• Can FDI into India be higher than that into China? Over the last three years, India considerably bridged the gap with China. Yet in 1H2009, India received less than half of the FDI inflows into China. Indeed, with India gradually catching up to China on GDP growth, it would not be surprising to see India reach very close to China on FDI inflows over the next 4-5 years.

To see the full report: INDIA ECOVIEW


E&P valuation factors meaningful premium to NAV — The D9 dry well is not significant per se but assumes importance given a) E&P value roughly factors Rs350-400 premium from potential exploration upsides over and above the NAV of known reserves, which largely comprise 21tcf of recoverable reserves from D6, and b) there are high expectations from D9 as it is adjacent to D6 (see Figure 1) and c) it brings to fore risks due to the probabilistic nature of the E&P business.

D9 Dry Well – Part of Life but Valuations Leave Little Room for Error

E&P being valued as a going concern — Our valuation of E&P in the SOTP is based on PER of 12x FY11E earnings from D6 and therefore indirectly factors reserve upsides from D6 and new blocks (primarily D3, D9, KG-D4 and MND4). This in fact translates to over 60% premium to NAV of D6 (21tcf), NEC and CBM. Incremental news flow from D9, D3 (which has had 2 discoveries so far), Cauvery and later on from the potentially huge MN-D4 (in 3Q2010) is critical to sustain this valuation approach.

It’s not over for D9 by any means — RIL will drill 3 more wells in the block after incorporating the data from the first well. The first well encountered sands but with some background gas.

Refining recovery need not be V-shaped — While present levels of refining margins are unsustainable, we see a weak case for a very sharp rebound in FY10. We build in a moderate recovery over the next 2 years - $8.6 and $9.5 in FY11 and FY12 from $7.5 this year.

To read the full report: RIL