Wednesday, February 29, 2012

>ECONOMIC PROSPECTS: PM’s Economic Advisory Council (PMEAC) has made certain projections for the economy for financial 2012 & 2013

The PM’s Economic Advisory Council (PMEAC) has made certain projections for the economy for the current financial year as well as indicated prospects for the next one.

■ The rate of growth in FY12 is estimated at 7.1%, which is marginally higher than the projection of 6.9% of CSO due to better growth in agriculture and construction.

  • Capital formation is to slip to 29.3%, which is a decline of almost 4 percentage points over the last four years. It had reached a peak of 32.9% in FY08 and dropped to 32.3% FY09 and then to 31.6% FY10 and 30.4% in FY11.
  • Farm sector growth to average 3% on record output for rice, wheat and strong trend growth in horticulture and animal husbandry.
  • Mining and quarrying sector likely to report negative growth on account of weak coal output growth, restrictions imposed on iron ore production, decline in natural gas production and negative growth in crude oil output.
  • Electricity sector to grow at 8.3%.
  • Manufacturing and construction to grow by 3.9% and 6.2% respectively.
  • Strong growth in the services sector at 9.4%.

■ Balance of Payments (BoP) position will be tight and current account deficit to end at 3.6% for the year. The pressure both in regard to a larger than expected CAD and lower than expected net capital inflows resulted in a very sizeable depreciation of the rupee. In the fiscal year to date, the nominal terms of trade weighted 6-currency index fell by 14%, while in terms of the inflation adjusted effective exchange rate (REER) the decline was 11%. The decline of the rupee vis-à-vis the USD was 19% in April–December 2011. However, there has been some recovery in the course of January and February 2012, with the rupee recovering about 7.5%.

 WPI inflation projected to be around 6.5% and this has been enabled by both monetary and other public policies.

 Expansion of the fiscal deficit beyond its budgeted estimate of 4.6% of GDP is an area of concern. Government must strive to contain and improve the efficacy of subsidies.

To read full report: ECONOMIC PROSPECTS

>INDIA STRATEGY: Identifying Over-Owned/ Under-Owned Stocks

FII portfolio: U/W on IT & Consumer and O/W on Industrial fall; U/W on energy & O/W on telecom rise

 During the quarter while FIIs were net sellers, domestic MFs & LIC were net
buyers. FII holding in Sensex has come down marginally.

 FIIs were positive on defensives like Consumers & Telecom whereas they sold across most of the other sectors like Financials, Metals and Industrials. FII ownership in SBI is at all time low whereas Industrials has become an U/W sector for the first time due to this selling.

 Financials, the favorite sector for FII, saw significant selling during the quarter bringing down the O/W marginally. Industrials was another sector sold by the FIIs resulting in reduction in its O/W. The Software sector was the biggest sector bought by the FIIs, followed by Consumers, resulting in change in their respective O/W and U/W.

 In terms of long term trends, while the underweight of energy continues to come down, Industrials has become an underweight sector. On the other hand, consumers are no longer an underweight sector due to consistent buying done every quarter. Also Financials has seen its weight come down. Within Banks while FIIs have sold names like SBI, ICICI, Axis, they have increased exposure in Kotak. Any surprise in these names can reverse the trend.

 Key buys in this quarter were: Infy, ITC, TCS, HDFC, HUL and Wipro . Key sells were: ICICI Bk, L&T, Coal India, Axis Bank and RIL.. 

Domestic MF Portfolio: U/W on metals fall; O/W on Industrials rise
 Domestic MF portfolio is in stark contrast with that of FIIs, with Industrials being major O/W sector, sector where FIIs are marginally positive. Consumer is another sector where domestic MFs are heavily O/W in contrast to FIIs who are not. They are also U/W Financials where FIIs are O/W. However, on the similar lines of FIIs, domestic MFs are also U/W commodities.

 In contrast to FIIs, MFs bought Metals and sold consumer & telecom names. On the similar lines of FIIs, MFs also bought software and cement names.

 During the quarter mutual funds bought Software, Industrials, Metals & Energy and sold consumers &Telecom.

LIC net buyer
On the similar lines of MFs who were buyers, LIC was also a net buyer. LIC bought Financials (SBI, HDFC Bank), Utilities (Tata Power) and Energy (RIL). LIC sold Cement (Ultratech, ACC), Software (Infy) and Telecom (Bharti).

To read full report: INDIA STRATEGY

>RBI's draft PSL guidelines - negative for asset financiers. 22 February 2012

RBI today released the draft guidelines on re-classification and updates for priority sector lending (PSL) and related issues under the chairmanship of Mr. M. V. Nair. While most of the original PSL guidelines remain unchanged, a sub-target of 9% of Adjusted Net Banking Credit (ANBC) for small and marginal farmers (SFMF) within agriculture and allied activities has been recommended (negative for private banks). At the same time, the distinction between direct and indirect agriculture has been done away with (positive for banks in general and private banks in particular). RBI has also revised the guidelines for on-lending to/securitisation by NBFCs, which we believe could be negative for MMFS and SHTF.

■ No major impact on listed banks: PSL has been increased for foreign banks to 40% of ANBC (from 32%), in line with public and private banks. The sub-target of 10% for exports and 15% each for agriculture and MSE has been recommended as PSL for foreign banks. A sub-category of weaker and marginal farmers has been introduced, which should be 9% of the total ANBC and can be negative for private banks given their lower rural reach. However, the RBI has also done away with the distinction between direct and indirect agriculture for the 18% PSL target requirement (4% + 14% earlier), which we believe is positive for private banks.

 Guidelines for asset financiers like SHTF and MMFS: The draft recommends that NBFCs should maintain a minimum threshold requirement of 65% of their total Assets Under Management (AUM) on their balance sheets (of the last financial year), as also on an average throughout the financial year. However, pre-existing assets on book may be excluded for the purpose of priority sector classification. Moreover, spreads for asset financing companies under on-lending, securitisation and buyouts under direct assignments have been capped at 6% and for HFCs at 3.5%.

 Impact on asset financiers like SHTF and MMFS, and HFCs: Shriram Transport Finance (SHTF): As on 31 Dec’11, securitised assets comprised 39.6% of the company’s AUM. On an incremental basis, given that 65% of AUM will have to be held on the balance sheet, securitisation levels should likely come down at the margin. However, as per the draft guidelines on-lending to SHTF would also be eligible for PSL classification, though, we also believe that overall loan portfolio eligible for PSL classification could be lower than 35% due to interest spread cap of 6% put up by RBI (spread on securitisation is significantly higher than 6%). Moreover, we note that a cap on spreads at 6% of securitised assets could be a negative, as we estimate the securitised portfolio spreads at 10%+ since spreads on old CV portfolio are higher (as of 31 Dec’11, old CV constituted 76% of AUM). Mahindra and Mahindra Financial Services (MMFS): As on 31 Dec’11, MMFS’ securitised portfolio would have comprised ~10% of its total AUM. As per our interaction with the management, the securitisation portfolio primarily comprises tractors, for which spreads would have been significantly higher than 6%; these could come under pressure if the draft guidelines were to be implemented. Housing Financiers: We do not foresee much impact on housing financiers as we estimate their spreads on the mortgage book to be lower than that the stipulated 3.5% as per the draft guidelines.

To read full report: FINANCIALS

>BHARAT ELECTRONICS LIMITED: A Solid Play on Indian Defense Modernization

Initiate coverage with Overweight rating, Sept-12 PT of Rs2000 based on 16x Sep13E P/E. BHE, a leading Indian manufacturer of defense electronics, is a play on rising government expenditure on modernization of Indian defense forces. This is supported by a favorable policy framework that seeks a higher share of domestically-produced equipment. With its strong R&D capability, solid execution track record, and long-standing relationship with the Indian defense establishment, we think BHE is well positioned to benefit. It currently has an order book of Rs270B providing revenue visibility for 4-5 years. Valuations have de-rated over the past few quarters on account of margin pressure owing to oneoff lower-margin non-defense orders. We expect a rebound in margins to drive 18% EPS CAGR over FY12-FY14E, which should drive valuations higher. We estimate BHE has Rs55B of cash (Rs685 per share, 45% of market cap) as at 3Q FY12; with the govt. looking at sources of cash to fund its fiscal deficit, we see a case for higher/special dividend payout (the govt. has a 75.9% stake in Bharat).

 Well positioned to benefit from rising defense expenditure. Indian govt. spending on defense equipment is expected to rise at a 10% CAGR to USD19B by 2015 (source CII-Deloitte). While most defense equipment procurement is from foreign vendors, govt. wants to increase domestic share. Defense Procurement Policy mandates minimum 30% offset against any foreign capital acquisition over Rs3B. BEL is well positioned to benefit, given its strong R&D capabilities and longstanding relationships with Indian defense establishment. Its current order book of Rs270B is largely skewed towards defense related orders (80%+) providing steady revenue visibility over next 4-5 years.

 Margins set to recover, solid cash profile. We forecast EPS CAGR of 18% over FY12-FY14E, driven by 8% revenue CAGR and margin recovery. We estimate BHE has cash balance of Rs55B (Rs685 per share) on its books, which will increase to Rs63.6B (Rs795 per share) by FY14E.

 Price target, valuations and key risks. Our Sep-12 PT of Rs2000 is based on 16x Sep13E P/E, towards the middle of BHE's historical trading range. BHE is trading at 13xFY13E P/E, which we believe is attractive given its order-book, earnings growth and cash profile. We expect margin recovery to drive stock rerating. Key risks to our thesis are increasing competition, delay in execution, changes to payment terms and slowdown in defense expenditure.

To read full report: BHARAT ELECTRONICS

>STERLITE INDUSTRIES: Restructuring Version 2.0e

 2nd Attempt at restructuring: After an aborted attempt in 2008, Sterlite Industries seems to be getting close to attempting another restructuring. Management had highlighted its intent to resolve the equity holding of VAL by March’12. Instead of separate business verticals, this time management appears to be considering merging everything into one holding company, virtually creating a dual listing structure. Based on our scenario analysis, even in a worst case, Sterlite could have 25-30% upside. Maintain Outperform.

 Dual listing structure in offing: It is not difficult to see the rationale for this restructuring. Investors have been looking for a simpler structure, while Vedanta has been grappling with the mis-match of cash flows among its various businesses. This means Vedanta is likely looking to merge everything into one holding company, almost mirroring Vedanta PLC, except for perhaps Konkola Copper Mines (where it has a minority partner).

 Vedanta Aluminium (VAL) – expected structure reduces risk for Sterlite: VAL appears to be the prime trigger of this restructuring exercise as it is lossmaking and has no near term solution. Investors have been concerned that the entire VAL stake would be passed on to Sterlite shareholders. However, under the proposed merger structure, if the liability is not assumed by Vedanta PLC, it will be distributed across all the merged entities.

 Merger ratios – scenario analysis indicates Sterlite well below worst case: We have assumed 3 scenarios, based on current stock prices, consensus target prices and the worst case for Sterlite. Assuming the market cap of the merged entity remains the same as the current sum of parts market cap of the entities to be merged (at US$19bn, see Figure 12), even under our worst case assumption Sterlite’s implied stock price comes to Rs157.

 Proforma estimates of the merged co: The merged company would have a consolidated Net Profit of US$2.5bn and trade at around 9.5x PER based on the peer group valuation. This implies market cap of US$24bn as compared to the current sum of parts market cap of US$19bn. Some of this would be driven by reducing the holding company discount as minorities reduce.

Earnings and target price revision
■ No change.

Price catalyst
 12-month price target: Rs149.00 based on a Sum of Parts methodology.
 Catalyst: Clarity on merger ratios, streamlining the holdings

Action and recommendation
 Maintain Outperform: Given past experience, investors may find it tough to believe that the restructuring would not hurt minority shareholders. But our analysis does indicate undervaluation for Sterlite. In particular we would buy on any dips.

To read the full report: STERLITE INDUSTRIES

>REAL ESTATE(FEBRUARY 2012): 50 bps cut = 3-4% price cut; not enough to attract demand

 50 bps cut = 3-4% price cut only
Our economist expects a 50 bps rate cut in 2QCY12. Developers are holding prices primarily hinged on this rate cycle turn for demand to return. However, our analysis shows a 50 bps rate cut equates to mere 3-4% reduction in cost of acquisition; which we believe will not be enough to attract demand.

■ Waiting for 100bps cut in FY13 might be too late
We believe, with poor cash flows, developers will disappoint the market on volume and cash flows in FY13 also if they decide to wait out for demand to return once a total of 100 bps is cut in FY13.

■ Time correction versus price correction
There seems a consensus opinion built-up around possibility of real estate prices under-going time correction rather than price correction. We believe the same is possible for affordable cities of Bangalore and Noida as prices remain stable in FY13 and 100 bps rate cut reduces cost by 7-8%. Developers in both cities are offering 3-4% discount to close deals. However, we believe the city of Mumbai will have to witness a double digit correction beyond the 7-8% reduction due to rate cuts. Anecdotal data shows discounts of 6-8% available depending on the project.

■ History says only price correction can do the trick
We believe the market will be disappointed with operational performance of real estate firms, if prices stay sticky leading to poor volumes. Past cycles show stock prices lag price correction but lead volume recovery by a quarter to two.

■ Volumes with sound realization remains critical
3QFY12 witnessed volume recovery but at lowered realization as developers continued their focus on affordable housing to weather tough market conditions. We believe new launches (mid-end to high-end) in core markets (at discounted prices) will help improve cash flows.

 Current rally does not corroborate with physical market
We believe the current rally in real estate stocks could be overdone and recommend caution as the current rally led by global liquidity does not corroborate with the physical market trends wherein 1) sales volume continue to wilt, 2) unsold inventory remains high 3) balance sheets remain stretched 4) asset sale progress
slow 5) capital availability still tight and 6) execution has slowed.

■ Can buy fundamentals at dips
We like firms with sound balance sheet, annuity income and launch visibility; thus recommend BUY on Oberoi (C-1-7, Rs287.45) and Underperform: HDIL (C-3-9 Rs120), IBREL (C-3-8, RsV-3-8).

To read full report: REAL ESTATE

Tuesday, February 28, 2012

>Indian Telecom Sector : GSM Operators (Circle wise wireless (GSM) subscriber numbers as at the end of Jan 2012)

Key Highlights
 The GSM operators added 8.44 mn new subscribers in January 2012, taking the total GSM user base to 648.08 mn in the country, according to the COAI data. During the previous month the subscriber addition was 7.55 mn.

 Uninor added the most 2.49 mn subscribers in January 2012 taking its total subscriber base to 38.80 mn; on the other hand Idea Cellular added 1.75 mn new subscribers during the month to take its total subscriber base to 108.13 mn.

 Bharti added 1.3 mn subscribers, taking its total subscriber base to 176.95 mn users. The GSM subscriber market share of the company dropped marginally to 27.30% in January 2012
compared to 27.46% in December 2011.

 Vodafone Essar added 8.6 lakh users in January 2011 against 9.1 lakh addition in December 2011 to take the company's total subscriber base to 148.60 mn. The market share of the company dropped to 22.93% in January 2012 from 23.10% in the previous month.

 Aircel added 8.2 lakh new customers during January 2012 compared to 6.9 lakh in December 2011 while Videocon added 4.1 lakh customers taking its subscriber base to 5.85 mn.

 The subscribers from the 'B' and 'C' circle constituted 54% of the total GSM subscriber base in India. Both these category circles put together witnessed 4.69 mn subscriber additions during the month of January 2012 as compared to the previous month.

 The 'Metro' and 'A' circles added 3.76 mn subscribers during the month constituting 44% of the total subscriber net addition.

■ Idea Cellular, Uninor and Videocon gained subscriber market share by 5 bps, 31 bps and 5 bps respectively during January 2012 to take their respective GSM subscriber market share to 16.68%, 5.99% and 0.9% respectively.

 The industry is set to witness significant change in the months ahead following the recent license cancellation order by the Supreme Court. The Supreme Court recently cancelled 122 2G licenses of many operators granted during 2008 by the former telecom minister A Raja.

 Incumbents continue to face huge regulatory uncertainty pertaining to the one time excess spectrum charges that the incumbents have to pay for spectrum they hold in excess of 6.2 MHz in each circles, legal validity of the 3G roaming agreement that the incumbents have entered among themselves for offering 3G services in circles where they do not have the required license and spectrum (issue is pending with TDSAT for final hearing) and various other issue. 

 Despite such extreme regulatory uncertainty and flip-flop we are positive on the operational performance of the mobile operators under our coverage (Bharti Airtel and Idea Cellular). Maintain our 'Buy' rating on both Bharti Airtel and Idea Cellular with the target price of Rs 495 and Rs 133 respectively.

Circle wise wireless (GSM) subscriber numbers as at the end of Jan 2012


The Union Budget for 2012-13 (FY13) is to be presented in the Parliament on 16th March. This will be a critical Budget as it sets the tone for policy stance relating to not just fiscal issues but also monetary policy and economic reforms. Also, it is being announced at a time when the economy has shown distinct signs of a slowdown and is looking for a boost from the government through appropriate policy announcements. Global as well as the domestic investors would also be looking for signals.

The theme of the FY13 budget would be on:
■ Striking a balance between fiscal consolidation and public spending while maintaining sustainable inclusive growth
■ Focusing on growth in rural areas and provision of more education and health facilities through centralized sponsored schemes
■ Focusing on increasing infrastructure investment
■ Moving towards implementing GST and DTC

  •          Revision of tax slabs, rates and so on

Projections made in the Union Budget for 2011-12:

India’s fiscal deficit was targeted at 4.6% of the Gross Domestic Product (GDP) for FY12 at the beginning of the year. However, on account of a sharp increase in expenditures and fall in revenues as a result of higher spending on oil subsidies and other social spending programs, as well as lower tax collections due to the slowdown in the economy, fiscal deficit is likely to slip to 5.5-5.7% of GDP.

India’s fiscal deficit has already reached 92.3% of the targeted budget in the first nine months of FY12. As of December 2011, the amount of fiscal deficit reached Rs. 3,81,012 crore, an increase of 122% from the same period last year.

Total expenditures amounted to Rs. 8,96,361 crore during the Apr-Dec 2011 period, 71.3% of the FY12 budget estimate. Meanwhile, revenue is falling short of the target. This amount includes Rs. 4,20,414 crore of taxes collected, which was merely 63.3% of targeted tax revenues.

Further, the Government is set to borrow beyond its target for FY12. At the beginning of the year the Government estimated gross borrowings to the extent of Rs. 4,17,128 crore. However, on account of the developments in revenue collection and expenditure, the Government increased its borrowings programme by about Rs. 90,000 crore. Borrowings for the period of 1st Apr- 17th Feb FY12 stood at Rs. 4,75,000 crore. While it is not clear whether the additional borrowing of Rs 90,000 crore includes the slippage on account of disinvestment, it may be assumed that this amount could go up in case this programme does not fully fructify.

Macro-economic environment:
The economic conditions in India during FY12 have been challenging with the development of a sharp trade-off between inflation and growth being the driving factor. Policy formulation has been difficult on account of the persistently high inflation and slowing industrial growth clubbed with sluggish investment climate in the country. Further, volatility in the foreign exchange market has added to the difficulties of the policy markers.

Based on CSO’s projections for the year, industrial sector growth is expected to be subdued this year with manufacturing growing at 3.9% as against 7.6%, construction at 4.8% compared with the 8.0% growth in FY11 and the growth in mining and quarrying is likely to be negative 2.2% as against the 5% growth in the previous year. Service sector has acknowledged robust growth of around 9% throughout the year while electricity, gas and water supply segment is to register 8.3% growth this year. GDP growth would be 6.9% as against 8.4% last year.

Inflation has been persistently high around 9% throughout 2011 and it is only from December onwards that there has been a decline in the prices of primary articles, taking the headline inflation down to 6.6% for January compared to 9.1% for November. The declining trend in the food inflation is likely to help bring down Wholesale Price Index (WPI) though admittedly the base year effect has moderated such increases. However, though core inflation has started to come down since January, it needs to be tracked for some more time before we are confident that it will remain at lower levels. Therefore, RBI will lower interest rates only after it is convinced that inflation has come down permanently.

Monetary Policy Outlook:
So far in the current financial year, the major driving factor for the RBI’s monetary policy had been the growth-inflation trade-off. However, in recent times the persistent deficit in liquidity conditions and the volatility in the exchange rate have also called for the Central Bank’s attention.

RBI in its recent monetary policy review cut cash reserve ratio (CRR) by 50 bps in order to ease the prolonged tight liquidity conditions prevailing since November. The 50 bps cut in the CRR (to 5.5%) would infuse approximately Rs. 32,000 crore into the banking system. The RBI has also infused liquidity into the system through Open Market Operations (OMOs) to the extent of Rs. 95,190 crore so far in the financial year (as on 10th February 2012). Further, the RBI has indicated that it would conduct more rounds of OMO auctions as and when the need arises.

Budget expectations:
Expectations from the Budget should be looked at against the overall macro economic background. Further, while the two major tax reforms, i.e. direct and indirect taxes have been defined broadly by the DTC and GST, modifications in the present system have to be consistent with this overall framework.

The Government’s objective in the budget should be regaining the growth momentum. It is expected that recovery in economic growth would be possible by the second half of FY13 if the global economy starts mending from the slump and monetary easing by India’s central bank starts early next fiscal. Growth target for this year would be around 7.5% with inflation of around 6-6.5%, thus implying a nominal GDP growth of 13.5-14% for the year. This will be lower than that in FY12 which is 16.1%.

Fiscal Consolidation
It is important to understand that the deterioration in fiscal health cannot be repaired in a single year. The Government is expected to bring fiscal deficit under control over a period of time and provide a realistic roadmap rather than ambitious, unattainable target. Therefore, transition to the FRBM will be in a phased manner. Overtime, not only the ratio of Fiscal Deficit to GDP should be reduced, but the composition also needs to be changed and without expenditure restructuring, fiscal consolidation cannot be successful. The fiscal deficit ratio would be targeted at around 5% of GDP, which will be an improvement over the revised estimate of 5.5-5.7% for FY12.

Given that there is a possibility of slippages in the fiscal targets of the Government for FY12 and the fall in tax collections during the first nine months of FY12, one can expect that the Finance Ministry would try and increase revenue collections by increasing excise duty and service tax from 10% to 12%, therefore also laying ground for a GST at 12%. The other sources of increasing tax collections would be as follows:
  • Increasing taxes on cigarettes, etc in order to improve human and fiscal health
  • Increase import duty on crude oil from 0% to 5%
  • Abolishment of Kerosene subsidy
  • A reduction in the overall Cenvat rate may be considered. The revenue risk could be compensated by a non-refundable cess on polluting goods and services.
  • Rationalization and simplification in terms of reduction in surcharges for corporates, withdrawal of some tax exemptions and increase in the rate of Minimum Alternate Tax (MAT).
Personal taxation
Deduction under section 80C may be revised to Rs. 1,50,000 from the existing limit of Rs. 1,00,000 to provide enhanced options of investment to the assessee. There could also be some concessions given to interest on bank deposits to encourage savings. The limit of deduction on interest paid against self-occupied property may be revised up to Rs. 3,50,000.

Capital markets
Presently Securities Transaction Tax (STT) paid on purchase or sale of equity shares, derivatives, equity oriented funds and equity oriented mutual funds, etc is not allowed as deduction under the head capital gains, and allowed only under profit and gains from business or profession only if the assessee is engaged in the trading of shares. The STT paid may be included in the cost of acquisition and selling expenses under Capital Gains. This will help the capital market.

In order to sustain a healthy GDP growth rate, equivalent investment in infrastructure is required. The Government can undertake several measures in order to encourage investment in infrastructure sector. A few have been noted below:
■ Focus on fiscal incentives, which help in increasing the infrastructure spending in the country. For e.g.: 80 CCF tax benefit/rebate up to Rs. 20,000 on investment in infrastructure bonds need to be increased to Rs. 1,00,000.
 Increase in outlay to Jawaharlal Nehru National Urban Renewal Mission (JNNURM). This will not just lead to higher investments but also bring about improvements in the quality of urban infrastructure.
 Specialized institutions should be allowed to fund infrastructure projects as most banks are ill-equipped as it creates inherent Asset –Liability Mismatch (ALM) issues.

It has been observed that most banks are not well equipped for project financing as it creates ALM. In other words, bank deposits are of shorter duration while project financing is longer term. Therefore, the budget could provide an incentive to lengthen bank deposit maturity structure by offering fiscal concessions to bank deposits of maturity of 3 yrs and above instead of the 5 yrs and above currently.

The Agriculture Ministry has demanded lowering of interest rates on crop loans to 3% from 4% for those farmers who pay in time. Ministry has also suggested that the target of credit flow to agriculture sector by banks and FIs be retained at Rs. 4,75,000 crore in FY13 as well. Further, strong emphasis is laid on rural infrastructure to provide impetus to rural demand.

Food Security Bill
The Finance ministry should roll out the Food Security Bill in the Budget FY13. It is believed that the implementation of the bill would take place in the later part of FY13. However the allotment of around Rs. 5,000 crore could be made in the Budget itself. Currently the food subsidy stands at Rs. 63,000 crore and the Ministry expects that the subsidies provided under this Bill would increase the expenditure to the extent of 2% of the current expenditure.

Small and Medium Enterprises (SMEs)
Access to finance can be enhanced by making NBFCs a vital intermediary financial institution for micro and small enterprises. These enterprises need to be actively promoted through supportive policies. Support through venture capital and private equity funds, SME dedicated banks, securitization of trade receivables and SME exchanges/ platforms would help this sector.

Health care
The Budget should raise the healthcare expenditure to a sizeable portion of the Gross Domestic Product (GDP) from 1.9% to 3.5% and target 5% in the budget of FY14. The Government should also reduce import duty on sophisticated medical equipment for India to be at par with the rest of the world and provide incentives for doctors who work in rural areas.

Real Estate
The Union Budget could target increasing business friendliness of the Indian tax administration and relax norms for repatriation of FDI in real estate. In case of SEZs clarity should be provided on its status in the light of the Direct Tax Code (DTC). For residential housing, scope of the1% subsidy announced last year should be amplified and broadened to include a wider price band to benefit home buyers, especially in lower income groups.

The power sector would be expected to get some relief especially in terms of assistance on the interest to be paid on borrowed capital. The sector is under pressure of high bank debt which is difficult to service given the cost and pricing structures presently in the country. Restructuring of State Electricity Boards (SEBs) would be high on the agenda of the Budget given their tenuous state of financial health.

In order to modernize and strengthen the armed forces, India’s defence budget for FY13 is likely to touch Rs. 2,00,000 crore as against Rs. 1,64,415 crore, which was 2.5% of the GDP for FY12. The defence budget for FY12 had seen a 11.6% hike and if the trends and the need of the Armed Forces is to continue in FY13, as there is need to modernise against the background of political developments across our borders.

Excisable goods used for R&D purposes could be exempted from Central Excise Duty besides import of all capital goods, raw materials, consumables. Even reference standards for R&D purposes to be fully exempted from customs duty and other related duties. This will definitely boost R&D activities significantly. The Budget can provide a new drug delivery system by extending weighted deduction for R&D activity beyond 2012, giving incentives for core R&D activity players as well as incentives for expenditure incurred overseas.

This would once again be important for the government and the decision on the 2G spectrum could also lead to some action on further auctions in this field. Disinvestment targets could be pegged to the last year’s level of Rs. 40,000 crore on the back of an assumption of a recovery in the economy and the markets recovering.

Bringing down subsidies would be a challenge, and while the Budget will plug it at a level lower than the revised number for FY12, there will be a move to open up prices of petro products, which will result in higher prices of diesel and petroleum to begin with.


>INDIA STRATEGY: Uttar Pradesh State Elections(February 2012): Too Close to Call

We hosted Dorab Sopariwala, India's leading psephologist, on a call with investors: The topics were the ongoing state elections, the likely results, and their implications for national politics. Here is a synopsis of the discussion.

UP elections – by the far the most crucial: Of the five states going to poll, Uttar Pradesh is the most important one given its sheer size. However, the results may be too close to call. No doubt the turnout has increased but seasonally adjusted (given the shift in timing to the winter months), the increase is about 5%. That said, it is hard to tell who has come to vote and hence which party may benefit. Tight fights seem to be of the order given how small vote swings seem to be affecting seat count.

A complex election and difficult result to predict:

• The Bahujan Samajwadi Party (BSP) suffers from incumbency, but Chief Minister Mayawati has tried to overcome it by aggressively churning her candidates. She has also has seemingly delivered by doubling the state's domestic product in nominal terms over the past five years (real growth of around 7%, which is not necessarily a strong relative performance). Still, there could be voter fatigue due to corruption allegations.

• The Samajwadi Party (SP) has a fresh tailwind with Akhilesh Yadav and does not have the headwind of being an incumbent as it did in 2007. If the results are close, Ajit Singh's party (currently a Congress ally) could play a prominent role in government formation.

• Both the Congress and the BJP suffer from lack of local leadership and grassroots presence in the state. The reason UP elections get complicated is that it is a four-way fight, unlike most other states which are straight fights and hence easier to predict.

To read the full report: INDIA STRATEGY

>GREED & FEAR: Bullet dodged (CLSA)


The Greek bullet has been dodged for now though the scheduled April elections in Greece remain an obvious stumbling block. Accordingly, GREED & fear’s base case remains with the “risk on” trade which means that any pullback in equities should be bought. A potential moderate disappointment for the markets may be that the LTRO-2 is not quite as large as previously expected because of the apparent reluctance of the big German and French banks to be seen taking up the carrot of generous ECB funding. For this reason the amount raised may be less than the €500bn-1tn previously guesstimated.

Still this will not be enough to end the “risk on” rally since those banks that really need the funding, or the profits from the carry trade like the Italian and Spanish banks, seem likely to participate again. Meanwhile, it is a telling sign of improving market conditions that Italian bank Intesa Sanpaolo was able this week to issue an €1bn unsecured bond with a five-year maturity, following its successful issuance of €1.5bn in unsecured 18-month bond at the end of January. Such longer term funding would have been impossible prior to the LTRO.

It also continues to be clear that Flexible Mario would like all the major European banks to take advantage of the LTRO. Indeed the ECB stance towards the banks is increasingly likely to be either take funding from the LTRO or raise equity, rather than the other option of pursuing deleveraging and balance sheet contraction. While, as previously noted here, it is also likely that the European Banking Authority (EBA) will come under growing pressure to relax its capital requirements even if nothing specific appears to have been announced yet.

To read the full report: GREED & FEAR

>BANKING SECTOR: Recommendations on Priority Sector lending by Nair Committee

The Reserve Bank of India (RBI) on 21 February 2012 released the report of the Committee headed by Mr. M V Nair which was constituted to re-examine the existing classification and suggest revised guidelines with regard to priority sector lending and related issues. The RBI has sought recommendations from various stakeholders by March 31, 2012.

We believe that the recommendations are broadly towards directing the credit flow to the economically weaker sections of the society and can be fairly achievable in a phased manner on overall basis given the timeline for implementation. The overall targets for PSL have been retained with certain new sub-segment targets introduced, which intend to improve the lending towards agriculture segment, ensure appropriate monitoring mechanism and change of methodology for calculation of shortfall to make it more effective and transparent. We believe that the recommendations are neutral for public sector banks and more on the negative side for private banks since they may fall short in meeting many new sub-targets given that the current lending towards such segments is already at the lower end. While the introduction of the guarantee scheme for SFMF, removal of DRI scheme, increasing housing and educational limits under PSL, change in calculation of shortfall and loans to NBFC’s for on-lending, buy-out & securitization classified as priority sector are positives amongst the recommendations, cap of 5% of ANBC for NBFC lending and introduction of sub-segments for meeting PSL targets are some of the negatives.

To read full report: BANKING SECTOR

>GLOBUS SPIRITS LIMITED: GSL continues to remain the leader in the Country Liquor (CL) segment in North India

In our Q2FY11 update dated November 26, 2011, (CMP Rs.100.55) we had recommended buying/adding the stock to dips of Rs. 87 for a target of Rs. 120. The stock achieved our target of Rs. 120 on February 6, 2012 and made a high of Rs.129.40 on Feb 10, 2012. It is currently trading at Rs. 121.00.

GSL recently declared its Q3FY12 results and reported net sales of Rs. 152.6 cr. - up 38.0% Y-o-Y and up 15.6% Q-o-Q. The Operating Profit for the quarter was Rs. 19.7 cr in Q3FY12 vis-à-vis Rs. 19.4 cr in Q3FY11 and Rs. 17.3 cr in Q2FY12. OPM for the quarter was 12.8%, 450 bps down YoY and 10 bps down QoQ. The fall in OPM can be attributed to the 81.2% increase in “other expenses” YoY and marginal increase in raw material expense QoQ. The Net Profit for the quarter was reported at Rs. 11.7 cr vis-à-vis Rs. 11.4 cr in Q3FY11 and Rs. 9.7 cr in Q2FY12. Interest expense has risen largely due to capitalization of new capacity and an increase in working capital loans due to higher sales volumes. Increase in depreciation costs YoY is due to capitalization of new capacity since Q3FY11.

• Government regulation is a major concern in the industry. In FY11 the Maharashtra government raised taxes on liquor sales, increasing prices significantly. While this currently has no effect on GSL’s sales, the possibility of a domino effect in the other states is a concern. The increase in excise duty for franchise bottling in Haryana has had a direct negative impact on GSL as Jagatjit has suspended franchise bottling operations till the law is changed in the ensuing Budget.

• The liquor industry is very seasonal. Q3 is the best quarter while Q4 is traditionally a poor quarter due to depletion of stock due to the allocation of liquor sale licenses to retailers in the fresh fiscal year.

• “Other expenses” increased significantly in the quarter to Rs. 46.6 cr from Rs. 25.7 cr in Q3FY11, an 81.2% rise. Other expenses increased significantly in all 3 quarters due to added power and fuel costs during the stabilization period of the company’s newplants. Stabilization is now complete at both the locations and these expenses could come back down in the coming quarters. “Other expenses” also increased as GSL wrote-off ~Rs. 0.5 cr worth of old inventory in Q3FY12.

• Country Liquor (CL) realization has fallen 6.7% in Q3FY12 over that in Q3FY11 because of a change in product mix / packaging mix. However, the 9MFY12 realization remains in line with that last year. GSL is seeking increase in selling price of Country liquor in Rajasthan, Delhi and Haryana and is confident of getting it effective Apr/May 2012.

• While IMFL sales are growing, they are not growing rapidly. IMFL realization fell in the quarter to Rs. 669.6/case from Rs.1118.2/case in Q3FY12 and Rs. 804.2 in Q2FY12. This fall in realization is almost entirely attributable to a change in duty structure in new locations entered in Q2FY12 and product mix.

• GSL’s capacities have risen from 288 lakh BL (bulk litres) to 700+ lakh BL from FY10 to FY12. So far the demand scenario for RS/ENA has been robust. In case there is a slowdown in offtake going forward, GSL could get hit due to higher fixed costs, which may not be fully recovered. Further the plan of GSL to get higher value add for its production by converting more of industrial alcohol into IMFL/Franchisee bottling/Country liquor has been progressing at a slow pace resulting in OPM getting hit and rerating of the stock getting postponed.

• Realization on exports is lower (~10% lower) than that of domestic sales. GSL exports ~2 lakh litres every month. OPM for a quarter could get impacted by the proportion of exports in total sales.

• GSL has suffered a setback in its OPM during 9MFY12 due to stabilization issues of expanded capacity at both the locations. This results in higher power and fuel costs due to frequent boiler shutdowns and restarts, low capacity utilization resulting in higher fixed costs, some quantity of lower quality production resulting in overall realizations getting impacted. While the Haryana expansion was stabilized in H1FY12, the Rajasthan expansion was stabilized only in Q3FY12. In case these issues recur, GSL could get impacted in terms of production and margins.

To read the full report: GSL

>RAIN COMMODITIES LIMITED: Expansion plans on track

RCL came out with better than expected set of numbers for Q4CY11 on the back of superlative performance by Carbon Products segment. While the topline was in line with our estimates at INR 1608 mn (up 38% YoY & 24% QoQ) led by 18% YoY increase in CPC volumes, net profit exceeded our estimates to INR 1802 mn in Q4CY11 (despite a forex loss of INR 294 mn due to USD denominated forex loan). Its plans of setting up 35 MW waste heat recovery plant by CY12 remains on track. The company has completed 85% of the buyback program at an average price of INR 31/share till date. We introduce CY13 estimates and maintain a BUY rating on the stock with a target price of INR 71/share.

■ CPC segment on the boil
RCL reported a revenue growth of 38% YoY & 25% QoQ to INR 16079 mn on the back of 41% YoY increase in Carbon Products revenues to INR 13995 mn. This superlative performance was aided by 18% growth in CPC volumes to 533000 tonnes & 24% growth in CPC realisations to $ 512/tn. In CY11, revenue of Carbon Product segment grew by 56% to INR 48292 mn aided by 4% increase in CPC volumes & 43% surge in realisations to $ 468/tn. Demand for CPC is healthy and RCL continues to identify new long-term sources for its GPC supplies worldwide due to its limited availability.

■ CPC EBIDTA/tn to remain between USD$90-100
EBIDTA of CPC segment improved significantly aided by 17% YoY & 11% QoQ increase in CPC EBIDTA margin to $123/tn. Currently CPC prices are hovering ~ $ 500/tn and management expects to negotiate the CPC pricing for H1CY12 in next few days. Although we are expecting some softness in CPC pricing, we expect CPC EBITDA margin to remain in the range of $90-100/tn going forward.

■ Cost pressure continue to dent Cement segment
Cement turnover improved by 20% YoY to INR 2081 mn aided by volume growth of 11% YoY to 523000 tonne & 8% increase in realisations to INR 3978/tn. Cost pressure continues to dent this segment as EBIDTA margin declined by 3% YoY & 22% QoQ to INR 682/tn. Volume is likely to remain muted due to political agitations in the state of Andhra Pradesh.

To read full report: RCL

>Dr. Reddy's Laboratories Limited: Entered into an agreement with Teva Pharmaceuticals Inc. (“Teva”) under which the company would supply olanzapine 20 mg tablets to Teva.

 Q3 FY12 Results Update
Dr. Reddy’s Lab. has reported consolidated net profit of Rs 5129.60 million for the quarter ended on December 31, 2011 as against Rs. 2731.40 million in the same quarter last year, an increase of 87.80%. It has reported net sales of Rs 27691.90 million for the quarter ended on December 31, 2011 as against Rs 18985.10 million in the same quarter last year, a rise of 45.86%. Total income grew by 45.22% to Rs. 27856.70 million from Rs.19183.00 million in the same quarter last year. During the quarter, it reported earnings of Rs 30.26 a share.

■ Net Sales & PAT growth
During the quarter, Net sales rose by 45.86% to Rs.27691.90 million from Rs.18985.10 in the same the quarter last year and the Total Profit for quarter ended December 2011 was Rs. 5129.60 million grew by 87.80% from Rs. 2731.40 million compared to same quarter last year.

Due to increase in equity capital the basic EPS of the company stood at Rs. 30.26 for the quarter ended December 2011 from Rs. 16.14 for the quarter ended December 2010.

 ■ Launched during the quarter
During the quarter, the Company received an approval and was awarded a 180-day period of marketing exclusivity from the U.S. FDA for olanzapine 20 mg tablets (generic version of Eli Lilly’s Zyprexa®20 mg) for sale in the United States. The Company had entered into an agreement with Teva Pharmaceuticals Inc. (“Teva”) under which the company would supply olanzapine 20 mg tablets to Teva.

To read the full report: DR REDDY

Saturday, February 25, 2012

>CONSTRUCTION QUARTER 3 REVIEW: Macro headwinds changing, impact to be limited

■ Order inflows scenario improved: Engineering & Construction (E&C) companies which had seen a gradual downward shift in the order inflows since the last two quarters, have seen a healthy revival this quarter. Mining, Water and Road orders contributed majorly to the revival. Total orders announced in Q3FY12E for PL Universe are close to Rs309bn (Overall: Rs400bn) which was up by 39% QoQ and 19% YoY. However, if one excludes NCC’s internal power order of Rs52bn then the growth would be 15% QoQ and flat YoY. Orders from the Gulf countries in the petrochemical segment have cooled off in Q3FY12 to Rs15-16bn from close to Rs67bn in Q2FY12. The total order inflow till now has been close to Rs115bn in Q4FY12.

 Earnings in Q3, though, have not shown improvement: Sales growth stood at 17% YoY and higher by 20% QoQ (as Q2 is seasonally weak). However the ‘C’ segment was down by 9.1% YoY, where IVRCL’s sales were down by 15.3% YoY, whereas the ‘E’ segment stole the show by a 24% growth YoY and 20.9% QoQ. Sales growth for ‘C’ segment was mainly arrested by working capital constraints faced by mid-sized players. EBITDA grew by 2.8% YoY and flat QoQ, where barring L&T & EIL, all the players were in the negative territory. EBITDA margins (down by 120bps YoY) were down for all the companies which clearly shows the competitiveness and lower execution/higher fixed overheads is taking toll on the margins. Interest continues to haunt the companies growing by 30-40% YoY and 5-10% QoQ. Interest as a % to sales (excl. L&T & EIL) stood marginally lower QoQ at 5.2%. Overall, PAT grew by 8.1% YoY, mainly arrested by losses in Punj Llyod, NCC and HCC.

 Risk reward ratio still not predictable: Markets have risen since the last quarter, particularly the Infrastructure sector, where the jump has been substantial, mainly in the last 30 days. However, the balance sheet profile, ROEs and moreover corporate governance issues still continue to haunt the prospects, which don’t make our view any positive on the fundamental side. With the run up to the 2014 elections and fresh orders from the 12th Plan, we expect a sharp revival in order inflows. Investment opportunities pegged at 9-10% of the GDP could bring out new projects worth US$1trn over 2012-2017, doubling the 11th plan estimates. However, we think that the onus will again fall on the private sector and with stretched balance sheets and liquidity crunch, only few players will be able to cash in on the opportunities. Only a potential dilution at the parent level and SPVs will bring some hope to ease the debt trap and working capital deadlock. However, due to overall improvement in the macro economic environment, there has been a re-rating in the sector. Our sector stance remains ‘Neutral’.


>ABB INDIA: Growth in base orders remains healthy but revival in project capex, particularly in the Industrial segment, may take some time

UW: Recovery remains elusive; valuation premium unjustified

  • Q4 earnings miss but orders surprise positively; beat driven largely by the booking of old HVDC order 
  • Margin recovery remains elusive; negative surprises likely to continue as restructuring benefits appear backend loaded
  • With further downside risk to earnings, valuation premium unjustified; reiterate UW with a TP of INR510
Earnings miss but orders surprise positively: ABB reported another set of weak results missing our Q4 EPS estimate by c8% but consensus by c50%. Sales growth of c6% came in line with our expectations and was driven primarily by the Power business, which grew c13%. Industry growth disappointed, as large automation projects failed to materialise. While the total order intake of INR22bn surprised positively, the beat was largely driven by the booking of the 9-month old HVDC order worth INR5.6bn. Management noted that growth in base orders remains healthy but revival in project capex, particularly in the Industrial segment, may take some time. The order backlog was largely in line with our expectations and stood at INR91bn, on the back of which management expects strong (double-digit) sales growth in the next couple of quarters.

Visibility on margin recovery remains low: While margins improved somewhat q-o-q, they once again fell short of expectations. Management attributed weak profitability to lower volumes, high input costs, project delays and poor project mix. We note that ABB India’s margins have remained depressed for two years now, more so than any of its competitors, and this may indicate poor project selection. In addition, restructuring benefits seem to be more backend-loaded as they have hardly provided the necessary impetus to the margins in last two years. Hence, while on a long term basis, ABB India may appear to be well placed to benefit from India’s growth story, in the near term the outlook certainly remains weak, particularly as expectations of recovery remain too high in spite of estimate downgrades in the last 8 quarters. We currently forecast EBITDA margins to improve to c7.7% in CY12 and c9.1% in CY13; however, if the project mix remains suboptimal, future results may warrant further downgrades.

We trim our CY12/13e EPS by c3%/5%; maintain UW with TP of INR510: As Q4 results came only c8% below our forecasts and the order intake was ahead of our estimates, we are only marginally reducing our CY12/13e earnings. Consequently, we keep our TP of INR510 unchanged and reiterate UW on the stock as we believe ABB will most likely continue to miss expectations in the near term. In addition, the stock remains priced for perfection, trading at c51x CY12e (Dec YE) PE and c35x CY13e PE, factoring in a solid beat to our numbers, which appears unlikely. Hence, we would take profits at current levels. Our target price is derived from our preferred EVA valuation methodology and implies a 12 month forward target PE multiple of c21x on 24 month forward estimated EPS of INR24.5.


Friday, February 24, 2012

>Talwalkars Better Value Fitness

We spoke to Talwalkars’ CFO to gauge the near term outlook for the company. TALW has rolled out 19 gyms in nine months so far and expects to open another 16 gyms in the current quarter. Management also stated that a plan for roll out of clubs has been put on hold and it would retain focus on gym expansion. Mgmt targets FCF +ve in FY14 as a large chunk of gym base would then be operating in the mature state and expansion through franchisees would gather pace. Roll out of HiFi gyms through franchisee route will ensure deeper penetration without concurrent capex needs. Company expects benefits of operating leverage to kick in considering the large share of fixed costs which would help improve margins. We revise lower our estimates and now expect a 33% EPS cagr over FY12-14; retain BUY with revised 9-mth tgt of Rs190.

■ Club roll out plan put on hold; to focus on gym expansion
Talwalkars Better Value Fitness (TBVF) mgmt stated that plans to roll out clubs - a different format compared to gym requiring much larger investments and longer gestation periods - has been put on hold. It would continue to focus on gym expansion where it remains bullish on the opportunity in the market given the low penetration rates for organized players.

■ To end FY12 with total gym base of 126
TBVF has rolled out 19 gyms in 9M FY12 and it is slated to launch another 16 gyms in Q4, a traditionally strong quarter for the fitness business. This would take its total gym base to 126 of which about 90 would be owned and rest would be through a combination of subsidiaries, franchisees/JVs and HiFi gyms. Company plans to add 8 HiFi gyms in the current year through franchisee route which would not entail any capex for the company. We also revise lower our owned gym addition count to 18 in each of next 2 years.

■ Cut earnings on reduced owned gym count but retain BUY
We cut earnings forecasts for FY12/13 as we reduce owned gym additions and now expect ~18 gyms to be added in FY13/14. Expansion in HiFi gyms through the franchisee route would gather momentum over next 2 years which would lower overall capex intensity and generate free cash flow in FY14. Retain BUY rating with revised 9-mth tgt of Rs190.

To read full report: TBVF

>Is The Eurozone At Risk of Turning Into The Rouble Zone?

On February 9, 2012, the ECB’s Governing Council (GC) approved, for seven national central banks (NCBs) (of Ireland, Spain, France, Italy, Cyprus, Austria and Portugal) “… specific national eligibility criteria and risk control measures for the temporary acceptance of additional credit claims as collateral in Eurosystem credit operations”.3 NCBs can choose the eligibility criteria freely, subject to minimum requirements set by the ECB GC.

We consider this to be a dangerous and potentially disastrous decision. Either, this decision could plausibly imply a loss of central control over the Euro Area’s Monetary, Credit and Liquidity (MCL) policy. The amounts of ECB credit and liquidity provided are demand-determined once the eligibility criteria for collateral are set. Delegating the setting of these criteria to the NCBs therefore opens up the possibility of uncontrolled, and therefore accelerated, balance sheet growth for the Eurosystem, if the NCBs in the soft euro area (EA) member states are not restrained by the absence of Eurosystem-wide loss sharing associated with the new, more relaxed national collateral standards. Such a failure to respond ‘responsibly’ to the ‘you break it, you own it’ loss sharing arrangements for the new NCB collateral regimes may be individually rational if both the NCB in question and the sovereign backing it are close to insolvency.

Alternatively, if the absence of a Eurosystem-wide loss pooling regime is recognized (and enforced), the 17 Eurosystem NCBs could become counterparties with very different degrees of default risk. Normally, central bank solvency would not be threatened by increased exposure to high-risk assets, as long as that central bank’s liabilities are denominated in domestic currency — as is the case for the EA NCBs. A central bank’s ability to issue monetary liabilities (to use current seigniorage) or its capacity to borrow by issuing non-monetary liabilities (effectively secured against its future ability to issue seigniorage) should permit it to meet any payment obligations. This is not the case, however, if the ECB GC does succeed in putting a cap on the ability of the national NCBs to increase their balance sheet size despite the widening of the collateral eligibility, and if that cap is tight enough to prevent an individual NCB from saving itself from default through the use of seigniorage, but not tight enough to stop it from getting into trouble in the first place. Such a combination of a loosening of some NCBs’ collateral standards, the absence of loss pooling and effective constraints on these NCBs’ ability to use seigniorage would pose a different danger from that of ‘Roublezoneification’: it implies further differentiation between NCBs and their counterparties along national lines and the segmentation of the Eurosystem into NCBs characterized by possibly significant differences in default risk.

The decision of February 9 introduces a relaxation of collateral requirements in only part of the EA — the ‘soft’ part, consisting of 5 of the 6 EA periphery countries (only Greece is missing) and 2 of the 3 ‘soft core’ EA member states (only Belgium is missing). This selective relaxation creates an uneven playing field for central banks and their counterparties that could easily be destabilizing. And it could further accelerate the bifurcation of the EA into a soft EA and a hard EA.

If it is indeed true that there will be no loss pooling for these additional credit claims (as ECB President Draghi suggested in the Q&A of the press conference, although no formal decision of the ECB’s Governing Council to that effect has been communicated), the solvency of the NCBs in fiscally weak EA countries would be called into question even more. And counterparties in the euro area and elsewhere would start to differentiate more strongly between different Eurosystem NCBs. That would be a further nail in the coffin of a single money, credit and liquidity policy (MCL policy) for the EA and a further step towards the re-emergence of national MCL policies and, eventually, national currencies.

To read the full report: EUROZONE

>MACRO STRATEGY: Draghi-ng the market back from the edge

 Macroeconomic data YTD has beaten expectations, but growth outlook for the full year remains weak
 The rally in asset prices has been supported by the liquidity front-stop and should be sustained by this month’s LTRO
 Tail risks from Greece suggest very near-term caution, but long liquid risk over the next month is still preferred

Less bad...
Developed-economy macroeconomic data has remained broadly better than expected. The same could be said for Asia, but the impact of an early Lunar New Year makes the data far harder to read.

Globally, PMIs have surprised to the upside, with both manufacturing and services PMIs rising in January in aggregate (Chart 1). Both the US new orders and German IFO survey have shown not only resilience but upside. This indicates further improvements in confidence, adding to stronger employment figures from both countries.

The composition of US growth has, however, been materially different to our expectations and signals significant risks ahead. Q4 data showed a weaker contribution from investment (we had expected the investment incentive act to bring forward spending), but an offsetting larger contribution from inventories.

Consumer activity increased, but this was driven by a reduction in savings rather than a rise in incomes. Recent US labour-market reports have painted a more optimistic picture, although the labour overhang is significant. High gasoline prices are also likely to act as a drag on household consumption, with prices at their highest ever level for this time of year (Chart 2).
We still see significant headwinds to US growth. Credit availability remains tight (the NFIB small business optimism index disappointed earlier this week), while the government‟s fiscal policy will also have a negative impact on growth.

To read the full report: MACRO STRATEGY