Saturday, April 24, 2010

>Public finances in developed countries: what is the exit strategy?

The increase in public debt registered over the last few years is without precedent (table 1). In each of the main OECD countries, public debt is not on a sustainable path1 (chart 1). This contrasts with past periods, during which emerging markets have appeared more at risk from this perspective (chart 2). The majority of developed countries will have a public debt ratio in excess of 90% in the middle of the decade.

From 2007 to 2014, according to the IMF (2010), the debt ratio in these countries is expected to rise by an average of more than 30 points of GDP, reaching an average of 110% of GDP. Of this increase, 3 points will be related to supporting the financial system (table 2), 4 points to the increased cost of debt, 10 points to automatic stabilisers, 3.5 points to budget stimulus measures and 9 points to losses of tax revenues relating to the decline in asset prices. The widening of deficits is largely structural in nature. The deficit ratio adjusted for cyclical variations is 4.4% in the eurozone out of a total deficit of 6.7 points, with 9.8 points in the UK (out of a total of 13.3 points) and 8.8 points in the US (out of a total of 10.7 points). In the past, this structural deficit has shown a strong tendency to persist.

For the time being, surplus production capacity limits the risk of public debt having a crowding-out effect on private investment. However, the public finance situation calls for credible recovery measures. While budget stimulus measures are intended to boost demand from financially constrained consumers (in their case, the classic system of budgetary multipliers takes full effect), it may for others - the majority - result in the emergence of Ricardian behaviour, i.e. growth in savings in order to cope with the increased cost of future tax increases. While the conventional crowding-out effect does not have an impact, the budget situation - contrary to the situation before the financial crisis - now affects the assessment of risks and may inflate risk premiums (chart 3). This results in a higher cost of debt, making adjustment even more difficult.

This situation could make an end to the until now observed developments characterised by rising debt with no impact on interest payments because of falling interest rates - a kind of "free lunch" (charts 4 and 5).

A high level of debt increases the probability of an interest rate or growth shock resulting in unsustainable debt, with higher debt ratios and a widening gap between the apparent real interest rate and the rate of growth. This configuration makes adjustment even more difficult and in any case presents a number of threats (snowball effect of debt). From this viewpoint, recent data clearly call for a reaction. Furthermore, as a direct consequence of the financial crisis - with an increase in the cost of capital and structural unemployment and a decline in economic activity (Furceri et al, 2009) - the potential level of GDP in the OECD region is around 3.5 points below the pre-crisis level (chart 6).

To read the full report: PUBLIC FINANCES

>A better way to measure bank risk (MCKINSEY)

One capital ratio tops others in foreshadowing distress—and it’s not the one that’s traditionally been regulated.

In response to the global banking crisis, regulators and policy makers worldwide have united
behind efforts to increase financial institutions’ minimum capital requirements and to limit
leverage, hoping to reduce the likelihood of future bank distress.1 As of this writing, the debate over proper capital requirements continues, with major implications for the industry and the economy— yet there have been few specifics on which ratios should be targeted or at what levels.

To shed some light on the discussions, we analyzed the global banking crisis of 2007 through
20092 to identify relationships that different types of capital and capital ratios have to bank
distress.3 Our analysis is observational, based on historical data, and not a real-world experiment, which would have required randomly selected financial institutions to hold different capital levels to gauge their effects. As a result, the findings do not definitively establish how institutions might perform in the future if minimum capital ratios were changed, but we believe that the evidence we provide is a valuable input for current policy discussions.

We found that one capital ratio—the ratio of tangible common equity (TCE)4 to risk-weighted
assets—outperforms all others as a predictor of future bank distress. We also found that requiring a minimum leverage ratio would not have offered any insights that couldn’t have been found by studying the right capital ratio. And, not surprising, we found that a higher bar on capital requirements, while reducing the likelihood of bank distress, comes at an increasing cost.

To read the full report: BANK RISK

>NTPC: From trot to gallop (ICICI SECURITIES)

We maintain BUY on NTPC with Rs243/share target price owing to: i) strong 14.2% regulated book CAGR with >2.9x rise in the pace of capacity addition to 15.8GW through FY11E-15E versus 5.4GW over FY06-10, ii) foray in merchant power (500MW Korba & 500MW Farakka) to gain from the current power deficit, thus boosting earnings – this will also mark the beginning of a new era for NTPC as it prepares for a non-regulated regime, iii) FPO overhang behind and iv) attractive valuations. Key risks are: i) inability to manage imported coal and captive production and ii) slow down in project accrual pace with mandatory competitive bidding beyond FY11.

Improved execution pace to boost regulated book. We expect 14.2% regulated book CAGR through FY11E-15E owing to increased pace of execution. NTPC is likely to commercialise ~15.8GW in FY11E-15E versus 5.4GW in FY06-10 due to increased focus on meeting XI Five Year Plan (FYP) targets, resolution of disputes with suppliers, significant rise in BHEL capacity and improved gas availability.

Merchant foray of 1GW – New beginning. NTPC has planned ~1GW merchant capacity addition in FY11E-12E. This will boost FY12E earning 6.4%, which will taper-off with softening merchant rates by FY15. We believe the foray marks a new beginning for NTPC, preparing it for the transition from 100% regulated business model to competitive bidding that will likely be implemented after FY11.

Key risks – Coal, competition and condition of state electricity boards. Operational performance was impacted for some of NTPC’s plants owing to low coal availability. Given constraints from Coal India (CIL) – supply CAGR a meagre ~5% – NTPC will have to ensure smooth coal supply via imports in the interim and captive production in the medium term. Further, the project accrual pace may slow down post FY11 as competitive bidding may become mandatory for PSUs. Finally, state electricity boards’ (SEBs) deteriorating health is a cause of concern for the Power sector and NTPC is not insulated from it.

FPO pressure behind; valuations attractive. The FPO overhang had created significant pressure on the stock. The stock has significantly underperformed the Sensex in the past one year (~50.4% YoY). We believe the current stock price offers ~18% upside with 2% dividend yield, taking the overall upside to 20%. BUY.

To read the full report: NTPC


A lot at risk; urgent action needed. We believe continued tardy progress in implementation of gas development projects and new power plants may lead to the Indian gas sector performing well below its potential. We note several current and potential hurdles: Excessive government control, marathon legal cases, pricing muddle, delays in E&P and downstream development and toothless regulations. We project a steep increase in potential supply and demand by FY2015E, but both supply and demand factors will need to move in tandem to meet our projections.

Natural gas set to gain share in India's energy mix
Sharp increase in gas supply but gas development projects may get delayed
'Right' price will create enough demand; power sector to account for bulk of demand
Regulatory developments will be crucial for growth of gas market

To see the full report: NATURAL GAS


Stick with the top guns: Our analysis of the areas of poeration (print markets), print players' position with markets and advertising potential of markets validates the dominant position of top Hindi print players and widening gap over small competition. We highlight the key drivers of Indian print media over the next several years (1) rising prominence of regional print, (2)emergence of niche print, (3) diversification into new media platforms, (4) emerging advertising categories as well as (5) benign newsprint cycle and its impact.

Print leadership index validates dominant position of top Hindi players
Stick with the Top Guns as they continue to outperform smaller players
Advertising revenues: Regional print, niche print, diversification and emerging advertisers
Benign newsprint cycle and growth differential betwwen India and the world

To read the full report: MEDIA SECTOR