Thursday, July 1, 2010

>Regional Implications of Renminbi (RMB) appreciation

The economic impact of nominal RMB appreciation likely very limited… — There are three major reasons why: 1) Expected pace of RMB appreciation will be very gradual; 2) Other Asian currencies are expected to appreciate alongside it; and, 3) Intra-Asia production linkages would mitigate the impact on China’s export prices, and reduce substitution gains on Asia’s exports.

…but medium term RMB real appreciation may be increasingly important — Real appreciation can be realized via combination of nominal appreciation and higher inflation. China’s faster wage growth vis-à-vis productivity is expected to lift China’s trend inflation to above 4% in the coming decade vs. 2% in the previous decade, with further upside inflation risk from future price reforms.

Export substitution gains may be highest in India, Pakistan & Thailand — While net export similarity with China is highest for Taiwan and Philippines, this likely exaggerates substitution gains from RMB appreciation given concentration of similarity in electronics where disproportionate amount are exported to China for processing/re-export. Meanwhile, exports of India, Pakistan and Thailand overlap with China across a broader set of export items that are less likely to be vertically integrated, and could thus marginally benefit more from substitution
gains from third party markets via RMB appreciation.

Import gains highest for Australia, Indonesia and Vietnam — Relatively stronger RMB vis-à-vis the region would boost China’s purchasing power of imports. We think the impact will be stronger for Chinese imports that are for final demand than for processing/re-exporting, benefiting commodity exporters and low cost manufacturers.

Inflation impact to Asia Hong Kong looks relatively more vulnerable — Rising imported costs on a REER appreciation of RMB is likely to impact inflation of HK more than others in Asia given the HKD peg and sizeable amount of goods comprising HK’s CPI basket that are imported from China.

Capital flow impact– Exacerbating inflows? China’s overseas investment — A gradual appreciation of RMB could exacerbate capital inflows to China and rest of Asia, making liquidity management increasingly complicated. We think RMB’s REER appreciation over the longer term will support China’s increased overseas investment, including to Asia, for two reasons: 1) Makes overseas assets cheaper; and 2) Re-configuration of manufacturing production and ancillary investment flows, with lower end manufacturing potentially relocating to South and parts of Southeast Asia (ex-Singapore, Malaysia) – capital deficient countries like Vietnam, India, Pakistan, Sri Lanka and Indonesia should increasingly welcome capital inflows.

To read the full report: RENMINBI APPRECIATION


■ Mobile segment adds 20.3 million subscribers in March 2010.

■ Fixed wireline segment remained stable at 36.96 million in March 2010.

■ 3G spectrum auction is still underway

■ RCOM unveils new voice packs for CDMA subscribers

■ Videocon Telecom launches GSM mobile services in Gujarat, Punjab and Kerela.

To read the full report: TELECOM SECTOR


The media sector reported better-than-expected results in FY10. Robust revenue growth and strong margin expansion resulted in the profitability of some companies almost doubling. Others consolidated their operations in the financial year. We maintain our Overweight stance on the sector, and prefer broadcasters to print media.

FMCG advertisers to drive broadcasters’ revenue: Sustained high advertising and promotion expenses by FMCG companies would mainly benefit broadcasting companies. FMCG accounts for more than 55% of spending on television.

Consolidation – the mantra in FY10: FY10 was the year of consolidation for the media industry. For instance, the Zee group consolidated its general entertainment channels (GECs) under Zee Entertainment. TV Today and DB Corp consolidated their radio businesses and HT Media de-merged its Hindi daily for an IPO.

High dividend payout: Companies paid higher-than expected or in-line dividends through special or interim dividends during the year. Broadcasting companies have increased the dividend payout ratio, while print companies have slightly reduced the same.

Prefer broadcasters to print players: We prefer broadcasters to print companies, considering that ad revenue growth for broadcasters is expected to be over 15%. DTH subscription revenues are expected to increase. With carriage and placement costs
remaining flat and programming expenses under control, we expect margins to expand.

Top picks and top sells: We maintain our Overweight rating on the sector. We have a Buy on Sun TV Network, Zee Entertainment and Jagran Prakashan; Hold on ENIL, HT Media and Info Edge; and Sell on Balaji Telefilms.

To read the full report: MEDIA SECTOR

>Credit derivatives: under the bonnet (CREDIT DEFAULT SWAP)

A primer on CDS, indices and tranches

■ CDS contracts, volumes and conventions

■ Building credit curves and pricing CDS

■ MTM and quotation conventions

■ Exotic variants including recovery swaps, quantos, CLNs and FTDs

■ Index tranche volumes and rationale

■ Index tranche conventions

■ Pricing, base correlation and risk analysis

To read the full report: CREDIT DEFAULT SWAP

>Are we building the foundations for the next crisis already? The case of central

1. Introduction
Counterparty credit risk has played a pivotal role in the credit crisis due to the insolvency of large prestigious financial institutions such as AIG, Bear Sterns, Lehman Brothers, Fannie Mae and Freddie Mac. The size of over-the-counter (OTC) derivatives markets means that counterparty risk is a key concern for financial institutions and many corporate users of derivatives. OTC derivatives are widely seen as having the natural ability to create systemic risk. Due to the increased focus on
counterparty risk in OTC derivatives, especially credit derivatives, there has been a significant interest in central clearing. A central counterparty (CCP) is an entity that stands between parties with respect to some or all contracts traded between them.

Because a CCP intervenes between buyers and sellers, it bears no net market risk but does take the counterparty risk. An institution trading through a CCP no longer needs to worry about the credit quality of its counterparty. Effectively, the CCP is the counterparty to all trades.

A CCP may reduce systemic episodes that were so highlighted within the financial markets during the 2007-2009 period. If an institution becomes insolvent then the CCP will guarantee all the contracts of that counterparty executed through them. This will mitigate concerns faced by institutions and may prevent any extreme actions that could worsen the situation, behaviour characterising the domino effect that is so associated with a severe systemic risk episode. The CCP will have initial margin and reserves to absorb losses due to the insolvency of a member. It may also require that excess losses caused by the failure of one or more counterparties be at least partially shared amongst all members of the CCP.

Whilst the presence of one or more CCPs might seem like a “silver bullet” with respect to counterparty risk, it is not all good news. A CCP must have a fine tuned structure with respect to margining, settlement and risk management and ultimately should be extremely unlikely to fail. The bigger a CCP becomes, the more catastrophic its failure would be. Furthermore, the homogenisation of counterparty risk and removal of the need for institutions to assess their counterparty’s credit quality may cause problems. The aim of this article is to discuss the strengths and weaknesses of CCPs and assess their viability in reducing counterparty risk.

2. The drive towards central clearing
The housing crisis, credit crunch and financial and economic downturns during 2007- 2009 led policymakers to propose laws that would require most standard OTC derivatives to be centrally cleared. This was largely driven by fears surrounding the credit default swap (CDS) market. A CDS is a derivative instrument whereby the credit quality of one of more underlying assets is traded. Due to their nature, CDS contracts can lead to large exposures being built up in rather small periods. The failure of American International Group (AIG) and some monoline insurers was
linked to CDS contracts and so surely having all such contract derivatives cleared will be a big step forward in terms of limiting counterparty risk?

To read the full report: CENTRAL COUNTERPARTY

>Emerging Opportunities in Infrastructure (ANANGRAM)

After announcing last year about awarding mega highways projects, the Ministry of roads transport and highways has started the process of site selection for the same. The Mega roads projects are the ones which are approximately of 500 kilometers and are of around Rs 5000 Cr.
Though not of the same size, but one such project was bagged by IVRCL Infra recently valued at around Rs 3100 Cr. Over the last one year (i.e. June 2009 – May 2010) the NHAI has awarded projects with a combined length of 7478 km and plans to award a further 12000 km in FY11. After showing significant improvements during the 1 year of charge, in terms of formulating / modifying policies favorably to faster awarding, the ministry now takes a step ahead.

The government has set a target for constructing 35,000 km of highways in the next five years under the National Highways Development Programme (NHDP), which will require an estimated investment of about USD 60 billion. Out of this, USD 40 billion will come from the private sector.

The National Highways Authority of India (NHAI) has estimated its annual borrowings from the domestic and international market to be more than Rs 4.3 billion for the next 15 years.

While not many construction companies will pre-qualify for such mega projects, we believe that many small construction companies too will be benefitted from these as we expect the actual developers to sub-contract quite a lot of the work to smaller players.

Funding remains challenging – at least as of now
The gross borrowings would be in the region of Rs1,92,000 crore, with a peak at around Rs. 71,500 crore. This is where the major challenge lies.

The RBI has recently rejected priority status to road projects as the priority status is for the borrower like farmers and small and medium industries. The planning commission has recently proposed to set up a $ 11 billion fund to finance infrastructure projects in order to secure ample investments to implement the development plans. The fund will be under a special company which will be owned by banks and financial institutions. The main objective will be to raise long term funds from domestic as well as overseas markets by issuing bonds.

Thus while the government is working on this, it is still on an early stage and may take a while before it materializes.

To read the full report: INDIAN INFRASTRUCTURE