Sunday, February 14, 2010

>Is there reason to be concerned about the tightening of China's monetary policy? (NATIXIS)

The financial markets have reacted very negatively to the announcement that China will tighten its monetary policy (increase in the mandatory reserve ratios, increase in the interest rates on central bank notes via open-market operations, demands made to the banks to curb lending).

We believe that this reaction by the financial markets is totally excessive:
• the key objective of the Chinese government is to create jobs, and it will therefore not take the risk of an excessive slowdown in growth;

• interest rates still remain extraordinarily low in relation to the growth rate, therefore the monetary policy is highly expansionary;

• private companies self-finance their investments, and use little credit; credit has been used extensively to finance speculative investments: real estate, commodities.

The monetary policy is starting to become more restrictive in China:
• increase in the mandatory reserve ratio (Chart 1A);
• increase in interest rates on central bank notes in open-market operations (Chart 1B);
• demands to the banks to curb lending, which slowed during 2009, but became very strong again at the beginning of January 2010 (Charts 1C and D).

The financial markets have reacted very badly to these announcements: decline in stock market indices (Chart 2A), rise in CDS for emerging countries (Chart 2B); rise in risk aversion (Chart 2C), halt in the appreciation of emerging countries' currencies against the dollar (Chart 2D).

To read the full report: MONETARY POLICY

>Introducing five structural themes (BNP PARIBAS)

We identify five structural themes to generate significant alpha in the years ahead.

The five themes are: Alternative Energy, Rural Asia, Demographic Challenges,

Economic Rebalancing and New Emerging Markets.

The report drills down to the drivers behind the themes from a macro perspective.

We suggest a list of stocks offering direct exposure to each theme.

We identify five structural themes that should critically influence Asia’s economic growth and should have potential to generate signficant alpha in the years ahead. The five themes are: Alternative Energy, Rural Asia, Demographic Challenges, Economic Rebalancing, and New Emerging Markets. This report analyses the drivers behind the themes from a top-down perspective, and includes a list of stocks offering direct exposure to them (page 4). We plan to revisit these themes over the course of the year when there are new developments.

Theme #1: Alternative Energy: Investing for a greener Asia – We believe environmental change, accelerating investment, government support and strong demand from EM will drive the increased use of alternative energy. We suggest investors select low-cost and efficient Asian producers with reasonable valuation that may offer exposure to the theme.

Theme #2: Rural Asia: Policy support to last – The urban consumption theme is well recognised, but the spending power in rural China and India, driven by supportive policies and rising income, is less analysed. We focus on under-penetrated consumer products and select beneficiaries, including farming equipment and agricultural-related industries.

Theme #3: Demographics: Aging challenge – Asia’s elderly population is expected to increase at a 4.0% CAGR over the next decade, far exceeding the 0.6% CAGR for the rest of population. The challenge is most pressing for Singapore, Hong Kong and China. We suggest a list of healthcare stocks for exposure to the theme.

Theme #4: Economic Rebalancing: Producers moving up the value chain – It’s not only about consumption! Our analysis reveals a different angle to this theme: China’s manufacturers need to move up the value chain as the economy rebalances away from low value-added industries. We suggest stocks that fit into this theme.

Theme #5: New Emerging Markets – Korea will likely graduate from the MSCI emerging market to developed market this year; and this may have positive liquidity repercussion among large caps in Korea. UAE and Qatar are most likely to achieve emerging market status in 2010, while Nigeria could be placed on review for upgrade to emerging market.

To read the full report: THEMATIC STRATEGY


Event: RBI introduces Base rate to replace BPLR
The RBI has decided to replace the prevailing BPLR (Benchmark Prime Lending Rate) system with a new Base rate for all scheduled commercial banks. This base rate system would be effective from 1st April, 2010.

As per the draft circular by RBI, all lending rates would be determined with reference to the base rate which shall be common across all categories of borrowers. The actual lending rates charged to borrowers would be the base rate plus borrower-specific charges – which will include product-specific operating costs, credit risk premium and tenor premium.

Each bank is free to decide its own base rate; though following criteria could be used:

  1. cost of deposits
  2. adjustment for the negative carry in respect of CRR and SLR
  3. unallocable overhead cost for banks
  4. average return on networth

Banks would not be allowed to resort to any lending below base rate.
The base rate system would be applicable for all new loans and for those old loans that come up for renewal. However, if the existing borrowers want to switch to the new system before the expiry of the existing contracts, in such cases the revised rate structure should be mutually agreed upon by the bank and the borrower.

Banks are required to provide information on the actual minimum and maximum lending rates charged to major categories of borrowers to the RBI on a quarterly basis.

Earlier, RBI had constituted a Working Group on BPLR to review the BPLR system and suggest modifications to increase transparency in credit pricing. The committee had suggested replacing the BPLR system with a new Base Rate system. Going ahead with the committee’s recommendations, the RBI has come out with the present policy moves.

Short-term rates for large corporates might inch up
Ample liquidity and relatively subdued credit demand over FY10 had led to many large corporates borrowing at significantly low rates. Application of the illustrative formula (as provided by the RBI) to most banks reveals that base rates could vary between 8% to 9.5% (see Annexure). With most banks setting their base rates around these levels, we believe that shortterm rates for large corporates could inch up.

Teaser rates would come under pressure
RBI has taken a negative view of the recent “teaser rate” schemes launched by major banks. RBI expects banks to be more prudent in pricing the risk and do not lose sight of asset quality while chasing market share (in wake of subdued credit demand). We believe that such “teaser rate” schemes would come under pressure as base rates are expected to higher than the rates offered on such schemes.

Our view
Increased transparency on lending rates
Over Oct-08 to Dec-09, while banks’ cost of deposits declined significantly, the movement in BPLR’s was relatively less and did not adequately reflect the effective lending rates in the economy. Moreover, ample liquidity in the system and the subdued demand for bank credit had increased the competitive pressure on banks to lend at sub-BPLR rates. As a consequence, the BPLRs of banks have turned out to be the maximum lending rates in most cases, distorting the information content.

Faster transmission of policy rate changes
We believe the base rate system has directly linked headline lending rates in the economy to banks’ cost of deposits. The RBI, over the past 3-4 quarters, had repeatedly sounded concern that while transmission of policy rate changes (over Sep-08 to Apr-09) had been faster in the money and government securities markets, it had been slow to the banks’ lending rates.

The RBI’s present action is to encourage faster transmission of policy rate changes to banks’ lending rates as the base rate would be directly linked to banks’ cost of deposits.

To read the full report: INDIAN FINANCIALS

>INDIA TECHNOLOGY: More evidence of a solid FY11 (BNP PARIBAS)

CTSH outlook a likely pre-cursor to strong Infosys guidance
Cognizant’s (CTSH) CY2009 results provided the latest data point supporting an improving demand environment for Indian IT services players. The revenue (USD903m) and non-GAAP EPS (USD0.50) topped the consensus view of USD889m/ USD0.47. More significantly, the CY2010 revenue growth guidance of “at least” 20% matches current consensus estimates, and leaves scope for upgrades as the revenue visibility improves. Using this and NASSCOM’s recent industry exports growth estimate of 13-15%, we believe the upper end of Infosys’ initial FY11 (March 2011) growth guidance could be 16-17%. We expect this to be raised through the year (as is typical with Infosys) to eventually meet or exceed our 21% projection. Healthy US corporate free cash flows (because of reduced investments last year) driving increased tech spending through FY11 has been the theme driving our positive sector view; barring unexpected adverse macro events, we see little risk to that outlook.

More evidence supporting corporate spending recovery theme
Over the past few weeks, further evidence points to improving pipelines and faster deal closures: 1) Positive commentary from Cisco, Oracle and SAP – all call for a recovery in enterprise spending in 2010; 2) Our recent industry checks suggest an unusually high RFP activity carrying forward from the December holiday season into 2010 so far; 3) Genpact, the US-listed BPO services provider, guided for 14- 17% CY2010 revenue growth, which implies mid-high 20s growth from its non-GE accounts (60% of revenue) to offset flat revenue from GE; 4)Industry hiring is picking up significantly. Our checks with local recruitment agencies suggest significantly increased business for them, while gross hiring is likely to exceed CY08 levels, which would put companies on course to achieve our estimates.

Recent correction provides buying opportunity
Frontline Indian IT stocks have corrected 9-13% from their recent highs, in line with the overall market, on heightened concerns of debt default from countries such as Greece, Spain, Portugal and Ireland. We point out that this should not be an immediate concern for Indian players, unless this cascades into another global crisis as: 1) they generate insignificant revenue from the above countries, and 2) the cross-currency impact since December (beyond what we are modelling) from a falling EUR and GBP has been more than offset by a depreciating USD/INR. We reiterate BUY on Infosys and TCS among the large caps, and HCL Tech, Tech Mahindra, Satyam and Rolta among the smaller names. We have a near term bias towards the larger caps, which we see as less volatile stocks.

To read the full report: INDIA TECHNOLOGY

>CEMENT SECTOR: Price hikes across regions (RELIGARE SECURITIES)

Cement prices across India have increased in the range of Rs 5–20/bag in February. The northern (New Delhi) and southern (Bangalore) markets registered an increase of Rs 10/bag, while in the west (Mumbai), rates moved up by Rs 5. The eastern and central regions logged the steepest price hikes of Rs 15–20. Dealers anticipate a further uptick in pricing, particularly in the central and western regions. We expect a buoyant fourth quarter for the sector on the back of strong volumes and pricing, despite a likely roll-back of the excise-duty cut in the forthcoming Budget. We maintain Grasim Industries, Shree Cement and Birla Corp as our top picks.

Price hikes of Rs 10/bag in Bangalore and Delhi: Our dealer checks indicate that cement prices in the southern market of Bangalore have increased by Rs 10/bag in February. However, in Andhra Pradesh and Tamil Nadu, prices have remained stable at Rs 145–170/bag and Rs 215–220/bag (Chennai) respectively. New Delhi in the north has seen a price rise of Rs 10/bag in February.

Western region sees price increase of Rs 5/bag: Mumbai has logged an increase of Rs 5/bag in February and dealers opine that prices in this market could rise further. Rates in Gujarat too are expected to increase by Rs 5/bag in the next 5–10 days. Our channel checks suggest that Gujarat is no longer facing a situation of short supply and hence the likelihood of price hikes after 15 February is low.

Sharpest hikes in central and eastern regions: Rates in the eastern market of Patna have increased by Rs 20/bag. The central region, particularly Uttar Pradesh, has seen a similar hike of Rs 15–20/bag with a further increase of Rs 10–15 expected. We reiterate that prices will continue to rise in the short term as demand remains strong, particularly in these regions.

Expect excise duty increase in Budget: We expect the excise duty on cement to be rolled back to 10% from 8% in the current budget, which could be marginally negative. This apart, the industry expects the government to reduce the duty on imported coal.

Cost inflation a major concern: Over the last two months, imported coal prices have risen by 25% to US$ 90–93/tonne. This steep inflation is a major concern for all large cement companies in general and India Cements in particular (55–60% of requirements met via imported coal). The price escalation is estimated to increase production costs for cement companies by Rs 30–100/ tonne.

Sector to outperform in the short term: Although we are currently Neutral on the sector, we believe that cement stocks could outperform in Q4FY10 as demand remains buoyant. Also, with price increases across the country, sequential EBITDA margin expansion is likely.

To read the full report: CEMENT SECTOR