Friday, July 30, 2010

>Is Austerity the Road to Ruin? - JAMES MONTIER

Let me share with you one of my guilty secrets: I occasionally indulge in the dark art of macroeconomics. I don’t try to forecast the future (that would be truly pointless), but I do think that understanding the macro backdrop can, on occasion, help inform the investment process. For instance, those who understood the impact of a bursting credit bubble stayed well clear
of the value trap opportunities offered in financial stocks during 2008. Those who focused purely on the bottom-up tended to plow in and repent at leisure, as the deteriorating fundamentals generated a permanent loss of capital. So why share this confession now? I think we are seeing
a very worrying trend around the world: the rise of the Austerians. This breed is the latest incarnation of what used to be called the deficit hawks, a group set upon reducing what it sees as the government’s profligate spending.

The power of the paradox of thrift
The Austerians either ignore or dismiss the paradox of thrift. This paradox (which appears first in the Fable of the Bees1) was popularized by John Maynard Keynes inThe General Theory of Employment, Interest and Money. He wrote:

For although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself. It is, of course, just as impossible for the community as a whole to save less than the amount of current investment, since the attempt to do so will necessarily raise incomes to a level at which the sums which individuals choose to save add up to a figure exactly equal to the amount of investment.

In essence, the paradox of thrift is a fallacy of composition. Whilst it may be perfectly rational for one household (or section of the economy) to save more, if everyone tries to save more, total income is lowered. If you aren’t spending, then neither are the people who depend upon
you for their source of income. Firms won’t invest if there is no demand for their products, and we end up in a nasty downward spiral.

To read the full report: Is Austerity the Road to Ruin?

>New takeout financing norms - Positive for banks, NBFCs and infra companies

ECBs) after the project risks stabilize. We believe this is positive for non-bank finance companies (NBFCs) and banks as it will help them manage ALM risks better and can also earn fees on selldowns. Some investors are worried about domestic credit growth being impacted with this. We do not subscribe to that view because there is a significant requirement for bank funds to finance infra projects and with economic growth, working capital requirements will also be cyclically strong, in our view. We believe rather that it will help banks manage their ALMs better.

The Reserve Bank of India (RBI) yesterday evening released new ECB takeout financing norms. The norms allow infra companies to convert their domestic debt to ECBs only after project risks stabilize (but within three years). Such refinancing will require approval from RBI and is not automatic. Until now, infra companies were not allowed to refinance their domestic debt with foreign debt during the course of the loan. We believe this is positive for NBFCs and to banks who finance infra projects, as it will help them manage ALM risks better and can also earn fees on sell downs. Some investors are worried about domestic credit growth being impacted with such refinancing. We do not subscribe to that view because there is a significant requirement for bank funds to finance infra projects and with economic growth working capital requirements will also be cyclically strong. We believe rather that it will help banks manage their asset liabilities better because the key risk for banks in financing infra was that they did not have enough long-term funds (more than 3 yr funds) to support these projects. For NBFCs, the key advantage would be that they can improve leverage.

Key highlights:
i. The corporate developing the infrastructure project should have a tripartite agreement with domestic banks and overseas recognized lenders for either a conditional or unconditional take-out of the loan within three years of the scheduled Commercial Operation Date (COD). The scheduled date of occurrence of the take-out should be clearly mentioned in the agreement.

ii. The loan should have a minimum average maturity period of seven years.

iii. The domestic bank financing the infrastructure project should comply with the extant prudential norms relating to take-out financing.

iv. The fee payable, if any, to the overseas lender until the take-out shall not exceed 100 bps per annum.

v. On take-out, the residual loan agreed to be taken-out by the overseas lender would be considered an ECB and the loan should be designated in a convertible foreign currency and all extant norms relating to ECB should be complied with.

vi. Domestic banks / financial institutions will not be permitted to guarantee the take-out finance.

vii. The domestic bank will not be allowed to carry any obligation on its balance sheet after the occurrence of the take-out event.

viii. Reporting arrangement as prescribed under the ECB policy should be adhered to.

ix. The refinancing option will be available to sea port and airport, roads including bridges and power sectors for the development of new projects. Eligible borrowers may, accordingly, apply to the Reserve Bank for necessary approval before entering into a take-out finance arrangement.

To read the full report: FINANCING NORMS


Growth Prospects
1. The performance of the Indian economy in 2009/10 greatly exceeded expectations. The farm sector which was expected to contract showed resilience, growing by 0.2 per cent despite the weak South West monsoon. The non farm sector also did well. It is the assessment of the Council that the Indian economy would grow at 8.5 per cent in 2010/11 and 9.0 per cent in 2011/12. In the current fiscal year, agriculture will grow at 4.5 per cent, industry at 9.7 per cent and services at 8.9 per cent.

Global Prospects
2. The global economic and financial situation is recovering slowly. The large fiscal deficits and high debt ratios coupled with slow economic growth have created unsettling conditions for business and have potential for causing great volatility in financial markets. It is hard to visualize strong economic growth in the advanced economies in 2010 and to a large extent in 2011. The implications of this, for India’s strategy to return to the 9.0 per cent growth trajectory, are that public policy must promote business confidence and facilitate increased investment.

Structural Factors
3. In 2008/09 the investment rate fell on account of the drawdown of inventories. This trend has reversed and the Council expects the investment rate to be higher at 36 per cent (of GDP) in 2009/10, rising to 37 per cent in 2010/11 and 38.4 per cent in 2011/12. Similarly we expect the domestic savings rate to pick up and reach 33.4 per cent in 2009/10, 34.3 per cent in 2010/11 and 35.5 per cent in 2011/12. These rates should enable the economy to grow in a sustained manner at 9.0 per cent.

4. Private corporate investment and total investment in fixed assets is expected to recover strongly but will not reach the previous high levels. Government Final Consumption Expenditure to GDP which hit a peak of 12.3 per cent in 2009/10 is expected to fall to 10.3 per cent in 2011/12. On the contrary, Private Final Consumption Expenditure which declined in 2008/09 and 2009/10 is expected to increase in the current and next fiscal year. Since 2001-02 the progressive decline in the Private Final Consumption Expenditure has been accompanied by a matching increase in the investment expenditure component of GDP.

Sectoral Growth Projections
5. In the backdrop of a weak South West (SW) monsoon in 2009, the Council had expected the farm sector GDP to decline by 2 per cent. However, the actual loss in farm sector output was less. The strength in horticulture, animal husbandry and fisheries, as well as higher cotton output, helped farm sector GDP to ultimately register a marginally positive growth of 0.2 per cent.

6. On the basis of a normal SW monsoon forecast by the Meteorological Department, one may reasonably expect a strong rebound in crop output in Kharif and Rabi in 2010/11. The better seed and fertilizer availability and the construction of a large number of water harvesting structures through the MNREGA lend strength to these expectations. Moreover, the expansion in horticulture and animal husbandry and a low base effect should generate a farm sector GDP growth of around 4.5 per cent in the current fiscal.

7. Industrial sector recovery became evident in June 2009 and by August 2009 the General Index of Industrial Production (IIP) registered double digit growth rate driven by similar growth rates in output in the manufacturing and mining sector. The service sector has also shown strong recovery with GDP originating in the important sub-sector of “trade, hotels, restaurant, transport & communication” surging in the second half of 2009/10. The impact of the civil service pay hike and the arrears lifted growth of the “community personal services” sub-sector in the first half, but eased up in the second. Export related service activity (software and Business Process Outsourcing) was sluggish throughout 2009/10 but was more than offset by the recovery in domestic-oriented service activity. Overall, non-farm sector GDP grew by 8.8 per cent in 2009/10.

8. In 2009/10 the mining sector output grew at 10 per cent but a slowdown is expected in 2010/11 with a projected growth of 8.0 per cent in both output and GDP arising in the sector. Manufacturing output growth in 2009/10 was strong in all the quarters, especially in the case of capital goods and durable consumer goods. The only exception to this was non-durable consumer goods which were impacted by poor export growth and a lower output of sugar. Even though the manufacturing sector has recorded strong growth rate in April and May 2010, we expect this to ease as the base effect wears off. The projected growth rate in the manufacturing sector and the general index (IIP) is expected at 10 per cent in 2010/11.

9. The expected expansion of investment in physical infrastructure, including housing will drive the construction sector. Accordingly, the GDP arising in the construction sub-sector would rise by 10 per cent in 2010/11, which is likely to inch up to 11 per cent in 2011/12. In the “trade, hotel, restaurants, transport & communication” sub sector, growth picked up in the last two quarters of the year. We expect this trend to be reinforced with 10 per cent growth in both 2010/11 as well as 2011/12. There will be no contribution to expansion from civil service pay in the current year but the private sector component of the sub-sector “community and personnel services” will continue to register strong expansion in line with the rest of the economy. Software and BPO activity is expected to expand significantly in 2010/11, both in the domestic and export sectors. Alongwith steady expansion in the financial industry we expect this sub-sector to record growth of 9.5 per cent in 2010/11 which will rise further in 2011/12.

10. Overall, we expect GDP arising in the industrial sector to expand 9.6 per cent in 2010/11, rising to 10.3 per cent in 2011/12. The expansion in the services sector is expected to approach 9 per cent in 2010/11 and inch up to 9.6 per cent in 2011/12. Over all, the non-farm sector is expected to grow by 9.2 per cent in 2010/11 and 9.8 per cent in 2011/12.

Trade & External Sector
11. According to the DGCI&S report the merchandise trade exports touched $176.6 billion in 2009/10 which was 4.7 per cent less than 2008/09. Engineering and electronic goods were the hardest hit declining by more than 20 per cent. Because of currency fluctuations, the rupee value of exports showed practically no decline in 2009/10. The value of merchandise imports in 2009/10 in dollar terms was 8.2 per cent lower at $278.7 billion and 4 per cent lower in rupee terms.

To read the full report; ECONOMIC OUTLOOK

WIPRO: Result Update 1Q FY11

WIpro’s IT services volume growth was in-line with our expectation but way lowerthan peers; however we expect it to catch up peers (in terms of volume growth) from 2Q FY11 onwards. Further, our view of the company gaining ground is corroborated by double-digit onsite volume growth indicating strong momentum in new projects and 6.1% QoQ revenue growth guidance for 2Q FY11 (in US$). Moreover we are impressed by the company’s ability to maintain margins despite decline in billing rate, dip in utilization rate, cross currency headwinds and impact of wage hike (it was effective from February 2010). Considering, strong momentum in new projects, 6% QoQ revenue growth guidance (in US$) for 2Q FY11 and the company’s ability to manage cost despite many headwinds, we upgrade our recommendation on the stock to “BUY” from “HOLD” and assign P/E of 19x to FY12E EPS of INR24.6.

• Consolidated revenue recorded modest growth: Wipro’s consolidated revenue in 1Q FY11 increased 3.7% to INR72.4 billion, from INR69.8 billion in 4Q FY10, primarily led by IT services and consumer care and lighting segment. The IT products business continues to be under pressure for the third consecutive quarter.

• Growth in IT led by double-digit onsite volume increase: Global IT services’ revenue was US$1218 million (in constant currency) in the quarter, marginally higher than the management’s guidance of US$1215 million.

To read the full report: WIPRO