Tuesday, March 6, 2012


What’s New? The Congress has won just one of the five state elections. It is also not in a position to play a role in government formation in Uttar Pradesh – something the market widely hoped for as a key trigger for policy action at the Center. What does this mean for the market? Here are our key conclusions:

The continuing structural change of Indian politics: There has been a subtle change in Indian politics over the past five years. Throughout the 1990s and the first part of the previous decade, being an incumbent government seemed to be almost a guarantee of losing elections. However, since end-2007, 2 out of 3 incumbent governments - which are arguably those that have delivered a development agenda - have won elections. The other change of the past five years is that the electorate has delivered absolute majority for several newly elected governments which allows the incoming government to execute its agenda without the stress of engaging in coalition politics. This theme recurs in the ongoing state elections with clear mandates in four out of five states though two out of the five incumbents did lose (possibly a reflection of poor performance).

Policy reform – is the glass half full or half empty? The immediate consensus reaction is that these results will trigger a wave of populism from the Congress government at the center. However, that would be a hasty conclusion given the country’s fiscal balance and that general elections are another 24 months away. In fact, we think that these results could trigger a concerted effort to consolidate the fiscal deficit and raise growth through development so that social spending becomes more viable in 2013 ahead of the 2014 general elections. Of course, there is a busy state election calendar but it is unlikely that the Congress may spend resources at the center to win these elections – it is not effective, in our view. For one, most of these state elections are likely only at the end of 2013. Two, state election results have a different dynamic – the political agendas are local and the constituencies are smaller and their results cannot be extrapolated to the center.

To read full report: MARKET STRATEGY

>INDIAN CAPITAL GOODS: Power Grid orders: A slow start to 4Q

  • Power Grid orders showed lumpiness, slowing to INR8.4bn in January (down 32% y-o-y); YTD orders are up 82% y-o-y
  • Competition remained stable in most segments, except substations, where we saw an increase in players
  • Maintain preference for EPC players; reiterate OW on KPP and KEC, UW on SIEM and ABB, and UW(V) on CRG

Slow start to 4Q: Power Grid orders came to INR8.4bn in January, down 32% y-o-y and 64% m-o-m. The total number of awarded contracts rose to 16 versus 12 last year, underpinning continued order momentum. Orders in the first 10 months of 2011 came to INR121bn, up 82% y-o-y. We expect heavy ordering of INR80-100bn in February-March, given that historically, Power Grid has awarded at least 50% of its yearly orders in 4Q. We also note that so far c43% of orders have been awarded in the tower segment, while only 29% are in the transformer and substation segment. Given that historically order distribution has been more equitable, we believe that ordering in February-March could be slightly skewed towards substations and equipment. As such, we expect Power Grid’s strong order inflow will continue, acting as a catalyst for a sector re-rating. We believe this will benefit small-cap stocks, e.g. KPP and KEC,
which trade significantly below historical averages.

Competition intensifying in substations: Competition has clearly intensified in the substation segment; there are now nine players in the 765kV space and 13 in the 400kV space. Interestingly, competition is mostly from domestic players, with only three active foreign players in the segment. As such, we believe the increase in players may put further pressure on pricing. Competition in the transformer segment remains broadly stable and the companies under our coverage retain 39% of orders in the 765kV space and 81% in the 400kV space. Competition in the tower segment is also stable, with KPP, KEC and JYS winning 19% of orders YTD versus c24% last year.

Order momentum to drive re-rating: Strength in Power Grid orders should raise confidence in the transmission capex outlook, in our view. Also, competition suggests that pricing is rationalising in the EPC segment, but may remain under pressure for substation vendors. Hence, we continue to prefer EPC players. Reiterate OW on KPP and KEC, UW on SIEM and ABB, and UW(V) on CRG.


>US: A Quick Take on Energy Prices (OSK GROUP)

■ The debate on the likely impact of energy prices on economic growth has once again received some limelight recently. Unlike prior episodes, however, the divergence between the price of gasoline and the price of natural gas adds additional wrinkles to the complex determination of the net effect on the US economy. Broadly, our casual analysis implies that the bulk of the negative imprint from higher gasoline prices, all else equal, might be offset by the subdued price of natural gas at this juncture.

 In general, a simple breakdown of the different sources of US energy consumption (based on BTU) indicates that petroleum products still dominate natural gas as of 2010. In terms of overall energy consumption shares (% of total BTU), the former has fallen to slightly less than 37% in 2010 from just over 40% in 2005, while the latter has increased to roughly 25% from slightly more than 22% in 2006. Indeed, the dominance of petroleum products over natural gas has dwindled almost to the slimmest level on record (since 1949, the narrowest difference between petroleum products and natural gas shares was 11.4%-point).

 The foregoing shift in energy consumption shares in recent years implies that the likely impact of natural gas prices on the macro economy, while generally less than the effect of gasoline prices at this juncture, must be taken into account and analyzed more closely. For example, simple rule-of-thumb estimates (without incorporating the effects of price volatility and price asymmetries) suggest that a tax on households of roughly $30bn to $40bn annual rate from higher gasoline prices recently might be offset by a lift of around $15bn to $30bn annual rate from much lower natural gas prices of late. Therefore, the net effect on the US economy due to the dissimilar change in energy prices, all else equal, might be marginal at this time, perhaps shaving off a tenth of one percent from GDP growth at most.


>OBEROI REALTY: Cash rich in debt-trapped industry; initiate with a BUY

■ Premium developer with a strong track record: Oberoi Realty (ORL) is a premium real estate developer in Mumbai. Till date the group has developed 35 projects with a saleable area of 6.6msf. The company’s high focus on quality has earned goodwill from the buyers and hence it earns itself a premium over its peers. The company has a land bank of 124 acres with a saleable area of 13msf.

 Focus on Mumbai, the strongest real estate market in India: Among all macro markets in India, Mumbai has been the strongest where the impact of property price correction came later and revival is faster and steeper compared to others cities. Demand in the region has also remained high between Nov 2008 and Nov 2010, when absorption grew by more than three-and-half times. Though, due to unaffordable prices pushed absorption down considerably following the slump in new launches, we expect increase in the pace of approvals from the government and new launches by the developers.

■ Balanced portfolio provides smooth cash flow: ORL has created a strong product mix, which includes development properties and investment properties (rental earning). The mix helps the company to enjoy smooth cash flows and places it in advantageous situation in every business cycle.

■ Land acquisition is a strategic game, ORL played it well till date: Unlike its peers in listed space, ORL has not increased its land bank aggressively. The management does not want to own land bank that has longer than 5-6 years of construction visibility. This strategy has helped the company in creating a healthy financial position, which is a rare case in listed space of Indian real estate industry.

■ Premium to cash is warranted: The strong net cash position places ORL in a good bargaining position against its peers who are desperate to monetise their land assets. This helps the company in buying assets at a significant discount either by paying upfront cash or by entering into joint development with the land owner. Thus, the company can buy assets with a value of 140x-150x by paying only100x.

Mumbai - one of the strongest real estate markets in India
Macro markets in India have witnessed sharp corrections and saw strong recoveries in the past few years. However, among all, Mumbai is the strongest and most-resilient real estate market. This was evident during the downturn in 2008-09; Mumbai (excluding Navi Mumbai and Thane) was the last to see property price corrections and was amongst the first to recovery. Considering July 2007 levels as a base of 100, Mumbai property prices came down to 83 and within less than 6 months, it rose back to the original levels. Currently, it is at 121. This, when compared to other active markets, is the fastest and strongest recovery.

■ Valuation and recommendation: We have valued ORL using NAV approach. We value the company’s net asset at Rs138bn, including a 30% premium to its cash balance. We initiate our coverage on ORL with a BUY rating at a target price of Rs336 (20% discount to NAV), providing 26% upside.

>EQUITY STRATEGY: Mixed earnings scorecard by biggies

Second rung stocks continue to outperform
For the second month in a row the markets closed on a positive note. February witnessed a secular rally, however, unlike January profit booking in the fag end of February clipped gains. The BSE Sensex closed with a gain of 3.3% while S&P CNX Nifty closed with a gain of 186 points at 5,385. Small and midcap stocks continued to outperform their large cap peers. The BSE Midcap and BSE Smallcap indices closed with gains of 8.8% and 6.1% respectively. Delisting candidates Oracle Financial Services, Alfa Laval and Goodyear India attracted buying interest.

Secular uptrend; realty leads rally
Most sector‐oriented indices on the BSE closed on a positive note, the BSE Healthcare index bucked the trend to close on a flat note. The Realty and Consumer Durables indices closed with double digit gains. The S&P CNX 500 gained 4.7%. Markets were skewed in favour of gainers with the advances‐declines ratio at 4:1. This was particularly strong in finance, industrials and utilities. Second rung stocks in the banking, NBFC and realty spaces played catch up with larger peers. Bargain hunting continued to be at play in the realty space; however, a slowdown in momentum was noted.

Global Markets
Major stock indices across the globe closed in the green, Asian indices were amongst the top gainers. In the commodity space bullion prices gold on a mixed note, while energy prices moved upwards. Steady HSBC PMI numbers from China augured well for industrial metals in the non‐ferrous space that closed on a mixed pack. European debt markets closed on a mixed note with yields on Italian paper dropping lower while that of Greece moved up.

Growth continues to falter, core inflation eases
GDP growth (on a quarterly basis) slipped to its lowest point in 11 quarters. For the December quarter of FY 2012, growth was reported at 6.1% YoY. As depicted by the sluggish IIP, the industrial sector was flat with utilities being the only silver lining. Services sector continued to be resilient at 8.7%YoY while the growth in the agriculture sector was reported at 2.7% (despite a high base in grain production). Output figures of the eight core industries for the month
of January were flat; IIP for the month of December was flat with electricity continuing to drive growth. Inflation continued to slide; for the month of January it was reported at 6.6% YoY. This was largely driven by a moderation in both the food and core‐inflation pack. The fuel component, however, continued to wreak havoc at 14% YoY.

 Fiscal pressure leads to novelty
Just as with necessity being the mother of all innovation; pressure on fiscal finances has led the government down the path of novelty. As a first of sorts the Government launched an offer for sale in ONGC through the secondary market. Central PSUs are estimated to have declared a 40% increase in dividend doll out for the year till date. The Government has also cleared a buyback policy for Central PSUs to shore up its fiscal position. The government has yet another weapon its armor via SUUTI’s (Special Undertaking of UTI) stake in Axis Bank, Larsen & Toubro

Chorus for a rate cut on the rise
The CRR cut that was carried out in January did not have much of an impact in the financial system. Liquidity continues to remain tight with the net reverse repo in the negative zone at Rs 1,920 bn (way beyond the RBI’s comfort zone). A further cut in the CRR is unlikely to trickle down into lower corporate borrowing costs; at best it could ease some of the pressure on liquidity. With the advance tax date (March 15th) approaching pressure on liquidity is set to get even tighter. Public debt has crowded out private sector debt; the banking system is sitting on excess SLR (appears to be rising with every passing fortnight). The down tick in GDP growth and sliding core inflation provides more room for a rate cut. The chorus for a rate cut appears to be getting louder.

Fuel likely to lay pressure on inflation
For quite awhile crude oil has been ruling at elevated levels; a further a rise in crude oil prices could throw a spanner in the works; however, such a move appears unlikely in the near term. However, we need to brace ourselves for higher fuel prices as suppressed prices have taken a toll on finances of oil marketing companies. Hike in prices of petrol and diesel would trim benefits of moderating food and core inflation.

To read full report: EQUITY STRATEGY

>CHALLENGES FACING VIETNAM: Taking Vietnam’s economy to the next level

To continue on a strong GDP growth trajectory, the country should work to raise its labor productivity.

During the past quarter century, Vietnam has emerged as one of Asia’s great success
stories. In a nation once ravaged by war, the economy has posted annual per capita growth
of 5.3 percent since 1986—faster than any other Asian economy apart from China. Vietnam
has benefited from a program of internal restructuring, a transition from the agricultural
base toward manufacturing and services, and a demographic dividend powered by a
youthful population. The country has also prospered since joining the World Trade
Organization, in 2007, normalizing trade relations with the United States and ensuring
that the economy is consistently ranked as one of Asia’s most attractive destinations for
foreign investors.

The challenges facing Vietnam
In the near term, Vietnam must cope with a highly uncertain global environment. The
economy faces a state of heightened risk because of macroeconomic pressures, including inflation that has built up as a by-product of the government’s efforts to maintain robust
growth despite the global economic crisis. In early 2009, Vietnam’s global trade and
foreign direct investment declined dramatically, and while exports have recovered, the
future of these two sources of economic activity is quite uncertain. The slow recovery of
the United States and Europe, together with the nuclear disaster in Japan, has created
additional near-term uncertainty. In response to the global economic downturn, the
Vietnamese government relied on expansive macroeconomic policies that have led not
only to inflationary pressures but also to budget and trade deficits and unstable exchange
rates. Some signs suggest that the financial sector is under stress, and international creditratings agencies have lowered their ratings on Vietnam’s debt.

In the longer term, Vietnam has a larger challenge. Since the key drivers that powered
its robust growth in the past—a young, growing labor force and the transition from
agriculture to manufacturing and services—are beginning to run out of steam, Vietnam
now needs new sources of growth to replace them. The demographic tailwind responsible
for driving a third of Vietnam’s past growth is slackening. Some companies already
report labor shortages in major cities. By 2020, the share of the population aged 5 to 19 is
projected to drop to 22 percent, from 27 percent in 2010 and 34 percent in 1999. Although
Vietnam’s median age, 27.4 years, is still relatively young compared with that of countries
such as China (35.2), its population is also aging.

An agenda for sustaining growth
Six percent–plus annual growth in economy-wide productivity is a challenging but not unprecedented goal. The successes and failures of other countries that had to raise their productivity offer a road map for broadening the bases of its growth.

The priority for officials is to restore calm in the economy and ensure that Vietnam retains the trust and enthusiasm of national and international investors. Surging inflation, repeated currency devaluations, a deteriorating trade balance, and rising interest rates have undermined investor confidence. And Vietnam’s financial sector does appear to have a degree of fragility.

Three long-term systemic risks loom—a rising volume of nonperforming loans, squeezed liquidity, and a drying up of foreign-exchange reserves. Many of the issues Vietnam faces come down to limited governance and transparency. Today, for example, the financial-reporting standards and risk management techniques of Vietnamese banks are a long way from Basel II or Basel III standards. Laying out a clear road map for their adoption would help improve the sector’s long-term stability and viability and bolster confidence among investors.

To read full report: VIETNAM'S ECONOMY

>The Ice Age only ends when the market loses hope: there is still too much hope

■ One key lesson from Japan is that an essential ingredient to the end of a long valuation bear market is revulsion. It is when ‘buyers-on-dips’ become ‘sellers-on-rallies’. It is when volume dries up to almost nothing. It is the loss of hope. In Japan we saw huge rallies in the Nikkei on the back of short-lived cyclical recoveries. Each cyclical failure and further new lows in the equity market saw hope being progressively crushed. Previous US valuation bear markets typically take 4 or 5 recessions to fully play out. We have only had two.

 The market is once again in a hope phase – hoping that the US is now in a self-sustaining recovery; hoping that China might be soft-landing; hoping that the Greece bailout and the ECB liquidity polices have settled things down in the eurozone. These bursts of hope are essential in long bear markets. Essential in the sense that hope must be crushed. It will be crushed. Hope still beats in the breasts of equity investors. The market will rip out that hope and consume it in front of investors’ eyes. Only then can the bull market begin.

 Talking about pain, having previously shared my experience of an anaesthetic-free vasectomy, I feel I know what sudden unexpected pain is - link. Standing outside Daphne’s on my recent sun-seeking hols enjoying my happy-hour rum punch, this plucky crab proceeded to attempt to remove one of my toes. It hurt far more than I expected but provided much amusement for my wife. Upon finding he was not large enough to remove my toe he scuttled under the decking to get his bigger mates out to help him. Cue my exit.

To read full report: GLOBAL STRATEGY

CHART OF THE DAY: The food glut charts

What it means
One of the enduring reader requests among our daily charts is for an update of the annual Food Glut series. As a reminder, once a year we show capital expenditure in the agricultural sector as a share of total agricultural value-added – i.e., the sectoral investment/GDP ratio – for India, China and Russia, the three major EM countries that have data available (unfortunately, the Brazilian authorities don’t report fixed investment from the national accounts, otherwise we could show “BRIC-wide” figures).

Those data are reported with roughly a 12-month lag, and so here are the updated numbers through the 2010 calendar year. In Chart 1 we show the average for all three economies, and in Chart 2 below we show the individual country trends.

As you can see,
• EM agricultural investment spending has never been higher, and indeed is orders of magnitude larger than during the previous food price boom in the mid-1970s, and

• The aggregate investment ratio continued to accelerate right through the crisis and the post-crisis period. (This is particularly true for India and China, while Russian investment was clearly impacted by the dramatic financing recession in 2009-10).

To read full report: FOOD GLUT CHARTS

>INDIA BUDGET PREVIEW 2012: A year of mild consolidation

■ The FY12/13 Union Budget, to be presented on 16th March, comes at a time when economic growth has slowed and inflation, while declining, is facing headwind from a renewed rise in global commodity prices. Additionally, with the FY11/12 fiscal outturn likely to exceed the budgeted target by close to 1% of GDP, there is considerable pressure to get back on the path of fiscal consolidation.

 Unfortunately, building on the slippages of FY11/12, it is difficult to see much scope for substantial fiscal consolidation in FY12/13. The expenditure side of the budget will likely remain sticky owing to welfare programs such as NREGA and rising subsidy bill on account of food, fertilizer and oil. The revenue side of the budget is likely to be weak despite the slated implementation of the Direct Tax Code, given likely persistence of weak growth in the next few quarters. To support the revenue base, excise duties could be raised on certain items while the services tax net could be broadened, but this could affect economic growth adversely on the margin. We don’t expect major progress toward the implementation of the Goods and
Services Tax (GST), due to opposition from a few states.

 We think that the government will factor in INR250-300bn proceeds from disinvestment, with an intention of bringing fiscal deficit down to slightly below 5% GDP in FY12/13, from a likely 5¼% of GDP outturn in FY11/12 (as against the budget estimate of 4.6% of GDP). Consistent with past trend, the fiscal deficit will be financed primarily through sizable market borrowings, which will continue to weigh on bond market sentiments.

Focus on fiscal consolidation
The FY12/13 Union Budget is scheduled to be presented on 16th March. Most stakeholders would want to see a strong commitment from the government to return to the path of fiscal consolidation, after having likely breached the current fiscal year’s target by a wide margin. The RBI has repeatedly underscored the importance of fiscal consolidation in making monetary policy transmission more effective; a budget that reverts to fiscal consolidation would give the central bank some flexibility in its monetary policy actions.

Apart from monetary policy considerations, fiscal consolidation is also necessary to prevent crowding out of private investment and reduce the current account deficit. Running high twin deficits not only exposes the economy to macro imbalances but also makes it vulnerable to any possible external shocks. Fiscal consolidation is an imperative to achieve a stable noninflationary rate of growth in the coming years.

We particularly look forward to the government’s plan of action with respect to two key tax reform initiatives—the Direct Tax Code (DTC) and the Goods and Services Tax (GST). The third, equally important area, but perhaps with less suspense, is expenditure management related to various subsidy programs including petroleum, fertilizer and food. There will be some movement toward cash transfers over broad-based price controls, which will be welcome but substantively far from best practice.

Could the government deliver yet another populist budget keeping its electoral considerations in mind? We are cautiously optimistic that this is not going to be a year of fiscal expansion, given that state elections will be behind and the fiscal’s role in fueling inflation is being recognized in Delhi. Of course, there is a risk that like last year, the government would announce an optimistic fiscal deficit target, allowing the RBI to embark on its rate cutting cycle, only to recognize by the middle of the year that the fiscal targets are unlikely to be met. But generally speaking, we expect the FY12/13 budget to aim for less than 5% of GDP in central government deficit. This would constitute about a ½% of GDP improvement in the fiscal position over the previous year.

To read full report: BUDGET PREVIEW


■ India's growing defense expenditure presents a huge opportunity: Given the ~USD200b expected allocation to defense capital expenditure for the period 2012-2017, India is set to ramp up its naval capabilities meaningfully. With its 'Buy Indian, Make Indian' initiative, the Ministry of Defense (MOD) is increasing stress on indigenization. The Ministry also envisages a greater role for the private sector, which should benefit established players like PIPV.

■ PIPV is suitably positioned - has first mover advantage, strong international tieups: PIPV enjoys first mover advantage and best-in-class infrastructure in the shipbuilding segment. It operates the second largest shipbuilding capacity in the world. PIPV uses modular construction technology, with two 600MT Goliath cranes, which enables it to reduce the construction and delivery time of vessels. Further, it enjoys strong strategic partnerships with several international players, which should aid robust warship order booking in the near future. MOD's growing stress on indigenization and its Mazgaon JV should boost order intake.

■ Capacity utilization increasing; expect revenue CAGR of 40% over FY12-14: PIPV's current capacity, which is currently USD1.7b (in terms of revenue potential), is likely to shoot up to USD2.5b once the second dry dock becomes operational by 2014. In FY11, capacity utilization stood at USD170m (10% of total capacity). We now expect capacity utilization of USD360m (22% of total capacity) in FY12. We expect revenue to grow at a CAGR of 40% over FY12-14. Our earnings estimates largely factor in execution of the existing order book of USD1.3b. We have not factored in possibilities of increased defense orders.

 Initiating coverage with a Buy rating: We believe that PIPV is well placed to exploit the massive opportunity that India's defense sector offers in the next few years. It has global-sized assets and best-in-class tie-ups. Also, PIPV offers the only credible large-size exposure for investors to India's defense business. We estimate net profit at INR532m for FY12 and INR809m for FY13, translating into an EPS of INR0.8 for FY12 and INR1.2 for FY13. We value PIPV based on replacement cost method at INR67b (INR100/sh). Initiate coverage with a Buy.

To read full report: PIPAVAV DEFENCE

>CURRENCY UPDATE(March 2012): Dollar, Yen rise as risk appetite abates

“This low growth target with relatively high inflation suggests monetary policy will be relatively relaxed. This in turn will help increase bank lending and boost investment.”

Liu Li-Gang, head of Greater China economics at Australia & New Zealand Banking Group Ltd. in Hong Kong, on China’s revised growth target, 05/03/2012

“Discipline is necessary on a European level; each state needs to make an effort to improve its accounts. But it will be impossible to meet these goals if there isn’t growth and jobs and activity.”

Francois Hollande, the Socialist candidate in France’s presidential election, 04/03/2012

Currencies – Dollar, Yen rise as risk appetite abates
• China Lowers GDP Growth Target to 7.5% as Export Gains Slow
• China’s February Non-manufacturing PMI Fell to 48.4 in February
• Asia Stocks Fall Most in Two Weeks on China as Yen Strengthens
• China Car Sales Seen Having Worst Start Since 2005 on Growth
• Asia Currencies Drop on Concern Global Slowdown to Hurt Exports
• India Rupee Touches 1-Month Low as Costly Oil Deters Risk-Taking
• Osborne Must Boost Business Aid as Recovery Weakens, BCC Says
• Hollande Repeats EU Treaty Change Call; Rival Doubts Credibility
• Greek Private Investors Are Slow to Commit to Debt Swap, FT Says
• Greece Debt-Swap Deadline This Week to Show If Europe Moving Past Crisis
• EC PMI services at 48.8 from the exp of 49.4
• Euro-Zone Jan Composite PMI Was 50.4, Forecast 49.70 • Utsumi Says ‘Quicksand’ of BOJ Bond Purchases Adds to Japan Fiscal Risks
• Intervention Sought on Strong Asia Currencies
• Hollande Repeats EU Treaty Change Call; Rival Doubts

Risk appetite has taken a hit today with China cutting its growth target forecast to the slowest pace since 2004. Markets are jittery ahead of the Greece bond swap deadline. The success of the 106 billion-euro ($140 billion) debt swap, confirmed on the eve of last week’s European Union summit, depends on how many investors agree to the write down by the March 8 deadline. Euro-area finance ministers will hold
a teleconference on March 9 to review the deal’s outcome. Anecdotal evidence suggests participation might fall short of expectations. Such a development would be very bearish for the Euro and risk assets.

European PMI services data released today has been disappointing, though European Composite PMI data came in better than forecast. European Zone Sentix investors’ confidence data trailed the forecast too.

Markets are concerned with the upcoming elections in Greece and France. Francois Hollande, the Socialist
candidate in France’s presidential election, repeated his promise to renegotiate Europe’s latest fiscal treaty, saying it puts undue emphasis on austerity and offers little about the need for growth measures.

India’s GDP data released Friday showed that India’s economy grew at the slowest pace in more than two years last quarter. Gross domestic product rose 6.1 percent in the three months through December following the previous quarter’s 6.9 percent climb. The data was lower than the median of 29 estimates in a Bloomberg News survey was for a 6.3 percent advance.

Elsewhere, China’s car sales are having the worst start in last seven years on slowing economy and record gasoline price.

Thus we see that the headlines are not very encouraging today. Some profit booking has always been expected before the Greece debt swap deadline and the coming FOMC meeting on 13th of this month.

We think the correction has got more to do with the headlines pouring out of Europe rather China. The US Dollar and Japanese Yen should do well on their safe haven appeal, however we look for limited upside in both the currencies.

While the risk assets are likely to correct lower, the downside is likely to be limited ahead of the US Fed meeting.

Asia Watch - China Targets GDP Growth at 7.5% in 2012, Premier Wen Jiabao Says

China pared the nation’s economic growth target to 7.5 percent from an 8 percent goal in place since 2005, a signal that leaders are determined to reduce reliance on exports and capital spending in favor of consumption.

China will also aim for inflation of about 4 percent this year, unchanged from the 2011 goal, according to a state of- the-nation speech that Premier Wen Jiabao delivered at the annual meeting of the National People’s Congress in Beijing today. China’s GDP grew 8.9% in 2011.

Officials are targeting money-supply growth of 14 percent, according to the report, in line with the median forecast of 15 analysts for the rise in M2, the broadest measure. China has a goal of increasing fixed-asset investment by 16 percent this year, the National Development and Reform Commission said in a report. That’s below the 18 percent median estimate of 12 economists.

The growth target matched the median forecast of 15 economists surveyed by Bloomberg News last month.
Twelve of 15 economists forecast a 4 percent inflation goal, while the median estimate of 13 respondents was for a budget deficit of 1 trillion Yuan.

China’s lower growth targeting is not necessarily a negative development as this strives at improving domestic consumption while making the growth more sustainable. Moreover, markets have been expecting this for quite sometime.

China Car Sales Seen Having Worst Start Since 2005 on Growth - Deliveries of passenger autos, including sportutility vehicles and light-goods vans, in the first two months of 2012 fell 3 percent from a year earlier, based on the median estimate of five analysts surveyed by Bloomberg. That would be the biggest drop since 2005, when they fell 8.9 percent, according to the China Association of Automobile Manufacturers, which will release industry data later this month.

Utsumi Says ‘Quicksand’ of BOJ Bond Purchases Adds to Japan Fiscal Risks - The Bank of Japan is locked into purchasing more government bonds and may contribute to a loosening of fiscal discipline in the world’s largest public debt market, a former top Japanese currency official said. “Since they have come this far, if the BOJ stops purchasing bonds, there will be a fall in bond prices and huge valuation losses” for banks, said Makoto Utsumi, former vice finance minister for international affairs and now president of Japan
Credit Rating Agency Ltd. “They’re damned if they do and they’re damned if they don’t,” he said in an interview in Tokyo on March 1.

The central bank last month boosted bond purchases through its asset fund by 10 trillion yen ($123 billion) as part of easing measures to counter deflation and spur growth. That means the BOJ is poised to buy a record 25 percent of bonds sold by the government in the fiscal year starting in April. In the long term, the nation risks a loss of fiscal discipline, said Utsumi, 77, who led the nation’s currency policy from 1989 to 1991. “It looks to me like the BOJ is increasingly stepping into quicksand.”

Europe WatchECB Says Greece May Not Get Enough PSI Participation, Der Spiegel Reports Greece may fail to garner enough investors to participate in a voluntary writedown of its debt, Der Spiegel magazine reported, citing unnamed officials at the European Central Bank.

Private holders of Greek debt are being slow to take up the government’s planned debt swap offer, and even Greek creditors aren’t committing promptly to the deal, the Financial Times reported, citing unidentified people familiar with the situation.

The Institute of International Finance, representing private bondholders in the negotiations over the debt swap, said yesterday that it endorsed the final terms of the deal, while leaving it up to individual investors to decide whether or not to participate in the deal.

A second Greek bailout is partly tied to investors’ agreeing to the writedown by a March 8 deadline.

Hollande Repeats EU Treaty Change Call; Rival Doubts Credibility - Francois Hollande, the Socialist candidate in France’s presidential election, yesterday repeated his promise to renegotiate Europe’s latest fiscal treaty, saying it puts undue emphasis on austerity and offers little about the need for growth measures.

“If tomorrow I’m president, I’ll say there are parts of this treaty we can accept, but we won’t accept sanctions that are against countries’ interests and, second, we’ll add growth, activity, big industrial projects, Eurobonds to pull the economy ahead.”

Pound Declines Versus Dollar as Business Lobby Cuts Growth U.K. Forecast - The pound weakened for a second day against the dollar after the British Chambers of Commerce cut its growth forecast for the U.K. economy. Sterling declined for the first time in five days versus the yen after the London-based business lobby lowered its 2012 growth projection to 0.6 percent from 0.8 percent in
December. The group also pushed back its forecast for a Bank of England interest-rate increase to the end of 2013, from the first quarter of that year. U.K. 10-year gilts were little changed.

US Watch - Obama Assures Israel of Resolve on Iran
President Barack Obama and Israeli Prime Minister Benjamin Netanyahu, heading into their meeting today at the White House, are emphasizing agreement over how to confront Iran’s nuclear program, even as Obama asked Israel to help dial back “too much loose talk of war.” Addressing the American Israel Public Affairs Committee, the biggest pro-Israel organization in the U.S., Obama said yesterday that he takes “no options off the table” including a “military effort” to stop Iran from having a nuclear weapon.

Israel has a “sovereign right to make its own decisions,” Mr Obama also said, and “I will not hesitate to use force when it is necessary to defend the United States and its interests.”

Market watch – US Treasuries Snap Advance Before Data
Reports on U.S. Service Industry, Jobs US Treasuries snapped a gain before a private report that analysts said will show the U.S. services industry, which makes up almost 90 percent of the economy, grew at almost
the fastest pace in a year.

Treasuries have “considerable risk,” a report by Charles Schwab Corp. said. Analysts raised their year-end forecast for 10-year rates by four basis points last week to 2.52 percent, according to responses from banks and securities companies surveyed by Bloomberg, with the most recent forecasts given the heaviest weightings. It was the largest increase since Bloomberg began compiling the predictions in July 2011.

USD-INR – Up on week
The USD-INR pair closed with a gain of 0.48% at Rs 49.78. The pair was up 0.90% on the week.
The pair can rise to Rs 51 level this month. Immediate resistance is seen at Rs 50.29. Support is at Rs 49.78.

Euro-INR – Slightly lower
The Euro closed with a minor loss of 7 Paise at Rs 65.94. The single currency was down 0.15% last week. The US Dollar Index surged 1.34% last week as the Euro dropped 1.87%.

The Euro-USD pair has a strong support at 1.3150 that is likely to hold in short-term.

LTRO impact has been taken as mostly positive by the markets, however the operation is being considered negative for the Euro on increased liquidity.

Euro-USD pair faces a strong resistance at 1.3290. GBP-INR – Up 0.35%
The GBP closed with a gain of Rs 0.35% at 79.22. The pair was up 1.71% last week. The GBP-INR pair could test the resistance around Rs 80.35 should the BoE refrains from signaling possibility of further easing at its upcoming meeting this week.

Support is at Rs 78.50.
JPY-INR – Slightly down
The JPY closed with a loss of 0.09% at Rs 61.0925. The Pair was down 0.20% last week. The USD-JPY pair was up 0.76% last week as the USD hit a new cycle high at 81.87 Friday. The pair is highly volatile. We look for USD-JPY rising to 82.20-82.50 level in near term. Support is at 81/ 80.60.


>CAPTURING DOMESTIC DEMAND IN EMERGING MARKETS: Neither Small Caps Nor Multinationals Are a Good Proxy

We believe one of the most compelling investment opportunities over the next few years is likely to be in companies that serve domestic demand within emerging markets. Our case rests on two underlying and interconnected forces – one economic and the other demographic. As poor countries get richer, they save as much as they can. Savings rates usually rise until countries reach a range of $3,000 to $10,000 per capita GDP. Once in that range, savings rates begin to decline and consumption becomes a larger part of GDP growth as society starts to provide a social safety net. At this level of wealth, per capita consumption of all goods and services rises in a highly non-linear fashion. For example, while Chinese per capita
GDP quadrupled from $1,000 to $4,000 during the past decade, auto sales rose from one million vehicles per year to over 17 million. Markets rarely anticipate this kind of non-linear growth.

Fifty percent of all emerging markets (by market capitalization) are now in this sweet spot of shifting from savings to consumption.

Further strengthening the economic case is a shift in demographics: a record number of people are coming into their earning years in emerging markets at the same time that baby boomers are starting to retire in the developed world. As a result, we believe that the world is in the midst of a massive shift in demand from the developed world to emerging markets.

As this domestic demand play gains momentum, we hear increasingly that the best way to capture this theme is to buy small cap emerging stocks. We believe, however, that this is a mistake and that focusing on companies that specifi cally serve domestic demand is a more effective way to exploit the opportunity. Besides, why buy a proxy when you can buy the real thing?

First, let’s look at the core of this argument. Favoring small cap stocks rests on the presumption that large cap emerging market stocks represent export and globally-oriented businesses. As a result, removing these large cap names from the investable universe would leave a collection of companies that are focused primarily on domestic demand. The fi rst part of this contention is true, the second is not. Large caps are geared highly to global demand. However, the small cap universe alone does not represent a pure play on domestic demand and, in fact, is as exposed to globally-sensitive sectors as the large cap universe.

If one divides all emerging market companies into those that are domestically-oriented (Financials, Consumer Discretionary, Consumer Staples, Health Care, Telecoms, and Utilities) and those that are globally-sensitive (Energy, Materials, Technology, and most Industrials), globally-sensitive sectors are almost as highly represented in aggregate in the small cap universe as they are in the broad emerging markets universe.

The sector weights of the Emerging Broad and Emerging Small Cap universes are shown in Exhibit 1. In fact, globally sensitive sectors represent 45% of the small cap universe vs. 47% for the broad universe as of September, 2011.

If one were to construct a universe of domestic companies (handpicked on a company-by-company basis based on who their ultimate customers are rather than market capitalization), one would see that it is nothing like the small cap universe. Exhibit 2 shows sector weights of this true domestic demand universe alongside those of the small cap universe. We
can see that the domestic demand universe has a far lower exposure to globally-sensitive sectors than does the small cap universe. In fact, even the companies represented within globally-sensitive sectors of the domestic demand universe are those that specifi cally serve domestic demand (e.g., technology companies whose business is primarily within emerging
markets) rather than those that export to developed countries. An example of such a company is Kingdee International, which provides Chinese language ERP software and services and competes with the likes of SAP for small- and medium size businesses in China.

One might raise an eyebrow when noting that fi nancials are such a large part of this domestic demand universe. This concern, however, is somewhat misplaced. Most emerging market fi nancials are an extremely good play on demand growth because they provide the credit that is essential to the rapid growth of these economies. Second, most emerging market financials sectors are underleveraged and have extremely strong balance sheets. The average Tier 1 capital ratio for banks in emerging markets is north of 15% versus 8-10% for developed banks. The one exception is Chinese fi nancials: there are serious concerns about their health in any housing/ infrastructure downturn. Any actively managed strategy would most likely take this into account.

One other problem with using small caps as a proxy for domestic demand is that they tend to have low profi tability and higher volatility of earnings, given the high proportion of materials and industrial companies. Exhibit 3 shows the average return on equity (smoothed over 36 months) for small caps and the domestic demand universe. Clearly, small caps have been less profi table historically than true domestic demand companies.

Last, but not least, not all domestic demand is served by companies domiciled within emerging markets. Global multinationals also serve this rising demand and, in some cases, are dominant players. A complete domestic demand universe should include multinationals that receive a substantial part of their earnings/revenues from emerging markets or will within a few years.

While very few multinationals currently meet this test of being driven largely by emerging demand, they will inevitably become a larger part of this theme. While some commentators make the argument that investing in multinationals alone is the best way to access domestic demand in emerging markets, we believe that domicile is irrelevant. What matters is whom they serve. 

The winning companies could be domiciled in either developed or emerging markets. The primary advantage that domestic companies have over multinationals is home fi eld advantage in the form of having well-established local brands, supply chains, products adapted to local conditions, and barriers to entry in the form of government xenophobia and anti-competitive rules. The biggest advantages that multinationals have over domestic companies are global brands, management expertise, and access to cheaper capital and supply chains. In the early stages of penetration to a market, the locals have economies of scale in their favor, which switches to an advantage for multinationals as their market share grows and they are able to source globally.

To conclude, the best way to access demand from the burgeoning middle class in the emerging markets is to invest in companies globally that directly serve that demand, rather than using emerging market small caps or global multinationals as a proxy.

In short, if you want to buy domestic demand, buy the real thing, not a poor proxy.