A panoramic view of eight centuries of crisis

Those wanting a detailed insight into the history of financial crises of the world spanning a period of eight centuries may refer this interesting well written paper

http://www.nber.org/papers/w13882.pdf

It covers the crisis of 14th century in England to the latest subprime financial crisis

Interesting Themes in 2008

Certain events of 2008 have fascinated me. Iam exploring all these events or "themes" (as i would like to call them) in detail. I have listed some of them below:

1. The Fall of the US dollar
2. The compounding of the subprime crisis
3. The 60,000 crore write off by the Indian govt on farm loans
4. The printing of paper currencies and excessive inventory at Fort Knox
5. The collapse of Bear Sterns
6. Inflation reaching an all time high in India
7. The forecast for crude oil at $200 per barrel
8. Financial decoupling turning out to be a myth
9. Conspiracy theory of Gold adopted by Central banks of the world
10.Various valuation theories in equity markets shown the door
11.Iam witness to a classical bear market for the first time in my life after a
grade appropriate understanding of stock markets.
12.How difficult it is to be "Ben bernanke" as the central banker of the world

U may feel free to add points that u consider to be "significant drivers" for 2008 in the financial markets.

A tribute to Field Marshal Sam Manekshaw

I am adding a few quotes of this legendary hero, one will continue to inspire billions of Indians for generations to come.

His Quotes:

Discipline is the code of conduct of decent living.

What is moral courage? It is the ability to distinguish right from wrong and having so distinguished it, be prepared to say so, irrespective of the views held by your superiors or subordinates and of consequence to yourself.

Any one who says he knows no fear, is either lying, or is a Gurkha!

To those of my commanders, who took an inordinately long time to come to a decision -I coined a Manekshawism “If you have to be a bloody fool, be one quickly.”

Officers, you have kept up the great tradition of the Indian Army... [pause] of having beautiful wives.

There are two things no honourable man should forget: His wife's birthday and the first name of the women around him

New Age in Fertilizers

World over, the issue of global warming has assumed paramount importance. Environmentalists are at loggerheads with industrialists, traffic cops are gunning at soot emitting vehicles, developed nations are in a war of words with developing and underdeveloped countries on the issue of global warming and its ill effects on the world ecosystem.

The increased concern and awareness on global warming has led to adoption of bio fuels as a viable alternative to the burgeoning energy demands of the world. With crude oil at $137 per barrel, bio fuels are slowly emerging as a viable alternative. Bio fuels emit 75% less CO2(Carbon Dioxide) when compared with the fuel variants of crude oil. As a result, the increased demand for bio fuels has over the last few years led to agricultural land being diverted towards ethanol and other bio fuels production. These bio fuels can be produced from corn. So farmers have shifted their harvesting activities from producing foodgrains to producing corn. Corn production requires increased usage of fertilisers and has led to the upshot in fertiliser prices internationally. The resultant fall in supply of foodgrains has resulted in the recent food crisis engulfing the globe with demand spiking unabated in a disproportionate manner. Food prices have hit the roof and have spearheaded the inflationery scenario prevailing all over. The global fall in foodgrain production has brought back renewed focus into agriculture. We all know that land is not a cultivable asset. We cant create more land. Therefore with its limited availability, what can be done is to increase the productivity of land, which in turn requires balanced usage of fertilisers.

In all this melee, the ones laughing all the way to the bank are the corn farmers and global companies engaged in fertiliser business. The price of corn has moved up from $3.05 per bushel to $4.28 per bushel in the space of 12 months, so have the prices of fertilisers like Urea, phosphates, DAP and MOP which have trebled in the last one year. When prices of fertilisers go up, the positive sentiment will also be echoed by fertiliser stocks listed in the capital markets. Even though, Indian fertiliser industry is still highly regulated, fertiliser stocks listed on the NSE and BSE have given returns ranging from anywhere between 60-120% in the last one year from May 2007 to May 2008 whereas the Sensex has yielded only 12%. Some standing examples are Tata chemicals, Chambal fertilisers and GNFC.

Lets analyse the reasons for investor interest in these fertiliser stocks and the issues plaguing the industry in general:

The Indian fertiliser industry has been the government's holy cow for times immemorial. It has suffered from a controlled regime with archaic regulations plaguing its growth and development. Agriculture is expected to grow in India @4% p.a and therefore fertiliser industry can also be expected to grow at a similar rate in the country. The demand -supply dynamics prevailing internationally for fertilisers will not be applicable to India due to the fact that fertiliser as a segment has not yet been decontrolled. Its still subject to government fiat and pricing. Therefore there is no proper price discovery for fertiliser products in the country. The domestic farmers are protected from the vagaries of international fertiliser prices,which to the government is more important than the bleeding fertiliser manufacturers who are forced to sell at below cost,at MRP (Max retail prices) fixed by the the former.The MRP for different categories of fertilisers are determined through a complex formula under the NEW pricing Scheme (NPS)that works proportionately to import parity pricing but ultimately forces fertiliser manufacturers to sell their produce at below cost price. As we all know vote bank politics holds sway over reforms in our democracy. The difference or underrecoveries as they are called is compensated in the form of bonds by the GOI.

Urea, DAP and MOP come under the controlled regime of the government whereas potash and phosphatic fertilisers were decontrolled a few years ago. Due to the government's subsidy schemes for Urea, farmers began deploying it excessively for their crops without regard to the soil texture leading to depletion in quality. The right targetting of subsidies and delivering the same on nutrient based needs would have gone a long way in improving agricultural output in the country. Successive governments have clearly missed the bus here.

There has virtually been no capacity addition in fertiliser production for the last fifteen years due to the unfavourable policies of the government. Export of fertilisers is also banned by the government, inspite of which we face a supply shortage which is assiduosly met through imports by government agencies like STC and FCI.The internal demand for fertilisers has pushed up the global demand and the concomitant rise in international fertiliser prices.

Major industrial players as well as existing corporates in this sector are shying away from fresh investments due to the following reasons:

1. Archaic fertiliser policies of the government
2. Non availability of feedstock for urea and phosphaic inputs
3. Cost plus pricing with huge underrecoveries for fertiliser producers resulting in
losses and thereby lack of investor attention
4. Uncertainity on receipt of government subsidy and lack of adequate compensation
through cash. Almost a significant portion of the government subsidy is granted
through bonds which are not highly liquid and have to be liquidated at a discount
to meet under-recoveries.

So after perusing through all the above points, the immediate question popping up in the reader's mind would be "How is it that the fertiliser stocks are outperforming the Sensex despite the above concerns??" Read further for your answers:

The government's fertiliser subsidy burden has risen from Rs.11,000 crore in 2003-2004 to an estimated Rs.90,000 crore as per the latest figures available. With its fiscal targets going awry, food crisis deepening and food inflation going out of control, the government has finally decided to wake up from its long slumber and has started looking at framing a new fertiliser policy by next month. Even if this gets tabled in the parliament soon, i dont think we would have concrete reforms happening in this sector until elections get over. As a first step to attract investments, this sector has been placed under priority list. The non availability of gas as a feedstock has been hampering the growth of this sector for a long time. However with gas expecting to flow from the KG basin by mid 2009, this problem gets addressed. Moreover, the government has asked all fertiliser plants to convert to gas based plants from existing naphtha based plants to reduce the cost of feedstock and make fertilisers more affordable to one and all. The advantage is that gas is cheaper than naptha by over 2.5 times.

Some of the appealing schemes proposed under the policy are :
1. Change in investment policies for Urea and phosphates, capital subsidy and fiscal
benefits for capacity expansion
2. Revival of sick public sector units engaged in fertiliser production
3. Decontrol of Urea and correcting the nutrient imbalance
4. Subsidy targetting through cash on a monthly basis instead of bonds wherever
required.

The most important issue of "pricing" has however not been touched upon so far. Most of the industry players are asking for an "import parity pricing" until domestic production comes on steam. However the sector as such being a sensitive one for any government, pricing aspects will continue to be controlled to protect the interests of farmers. The government will atmost tinker around with the pricing to the extent of reducing its subsidy burden to manageable levels.

Notwithstanding the above negativities, the fertiliser stocks are fancied upon and will continue to be fancied by investors for one or more of the following reasons:

1. Most fertiliser companies have over the years derisked their business model by
venturing into the chemicals business. Most companies derive only 50% of their
revenues from fertilisers now and the balance from chemicals. Internationally,
prices of soda ash have skyrocketed and firmed up, boosting the bottomline of
these companies.

2. Supply of gas from KG basin by 2009 which will ease out supply concerns.

3. The promising future that beholds agriculture and its allied sectors like
fertilisers

4. Stable cash flows from fertilisers and chemicals, attractive dividend yield even
if the rise in international fertiliser prices have not benefited Indian
companies .

5. Share prices have also run up based on expectations from the government on the
new fertiliser policy and the attractive schemes and measures that it may contain
to attract private investments into this sector.

6. Growth Rates in this industry are expected to outperform growth rates in
agriculture. The fact that even bio fuels would require usage of fertilisers has
almost lead to demand rising by 10% p.a globally.


All in all, fertile times ahead in the horizon for both industry players and investors.

Should our forex reserves be utilised for infrastructure developement

There have been so many vociferations from various classes of the intelligentsia over the last two to three years on utilisation of our burgeoning forex reserves for infrastructure development. Plans were also mooted to set up a government subsidiary with capital drawn from forex reserves to support infrastructure projects in India and abroad. But is it a rationale act to utilise our forex reserves for internal needs. Why is it that the government and RBI are hesitating to do the same. As on date the forex reserves stand at $316.17 billion which is more than 30% of our GDP Lets delve into the thought process of the Central banker Y.V.Reddy who remains non committal on this issue and as to what are the possible concerns he might have on releasing the forex reserves for national development :

1. Forex reserves can arise in three different ways either through FDI(Foreign Direct Investment) or FII (Foreign Institutional Investments) or RBI's currency market operations.FDI inflows are the more sustainable, permanent form of money flows which actually result in development and growth, enhancing the economic prowess of the country. Therefore inflows in the form of FDI are always encouraged by countries world over. FII inflows also known as "portfolio" flows, on the other hand, are perceived to be "hot" money whose main objective is to take advantage of arbitrage opportunities in different markets for short to medium term gains. These inflows are temporal in nature and shall be the first outflows from any country given a global/domestic crisis scenario. We have historical evidence from the 1997 east asian crisis and collapse of south east asian economies to the latest sub prime crisis that has sent stock markets across the globe into a tailspin.The experience with FII flows have never been stable in the past for any country across the globe as they are always directed towards lucrative/ speculative investment opportunities with a profit motive. The third aspect of building our forex reserves has been through the currency market operations of the RBI by purchasing dollars to keep the exchange rate pegged to the world’s largest reserve currency. Over the years the dollar has considerably declined in tune with the slowdown in the US economy and as a result currencies across the world have been appreciating against the greenback. But however since 70% of global trade is priced in dollar, RBI has been buying dollars form the open market to keep the exchange rate steady and stable to protect its exporters from the vagaries of rupee appreciation.

2. Indian economy has been growing at 7-8% p.a over the last 4-5 years and this had attracted investor attention world over. Our FDI as well as FII flows have increased over the last 4 years with our FII inflows touching $15 billion in Fiscal 2007 buttressed by commendable corporate earnings and positive economic outlook. Despite all this, the two major factors hurting the economy are fiscal deficit and trade deficit. India imports more than it exports. We don’t have a trade surplus on the current account. Our balance of payments position is negative and is expected to rise this year with spiking oil prices. India’s energy and power requirements are huge and rising by the day. Domestic capacities in the oil and gas sector are yet to fully come on steam. We are facing a crisis in agriculture with slowdown in foodgrain production. We are not self sufficient in major essential commodities. All these requirements are being met through imports. The export basket of India also needs to undergo a change in its product mix to cater to the competitive global markets. The economic growth of India has been led by the domestic consumption story. But for this growth to be sustainable its not enough if we keep consuming. We need to produce and produce innovative, value adding products for global consumption. We need to become self sufficient to rely less on imports, produce more with judicious usage of our natural resources and export the surplus for global consumption. This is the most effective way to create a trade surplus. Unlike a Singapore or a China, our forex reserves, whatever be the size, have not been created out of trade surplus. That is also one of the reasons why we have been unable to create a sovereign fund on the lines of China’s sovereign fund managed by Blackstone and Temasek of Singapore. These countries with the help of these sovereign funds have been picking up stakes in developmental projects across Africa to increase their global footprint. Both China and Singapore know that the next phase of growth will emanate from Africa. India has been missing out on this story inspite of sizeable forex reserves to the tune of 30% of our GDP for the simple fact that

a. We need to maintain adequate cushion to meet our import bills of which oil
imports form a significant component, especially in the wake of rising oil prices
b. Our external debt is pegged at 17% of GDP, which also needs to be covered for
through forex reserves
c. FII inflows might reverse any moment given the unstable global environment.
d. None of us want a repeat of the 1991 crisis when he had to pledge our gold to
meet our balance of payments deficit.

At the moment though, RBI has been supporting India Inc’s M&A deals by providing enough foreign exchange to make acquisitions abroad and pursue their ever-increasing shopping list abroad. But to provide foreign exchange to meet internal needs of the country would be possible only when we have a trade surplus and deficits get wiped out completely. The portion of forex reserves that get created out of our trade surplus can alone be utilized for infrastructure development.

The Crude Oil Paradox

As far as my knowledge of economics goes, whenever prices of a commodity goes up, the demand for that commodity start falling over a period of time. But unfortunately this economic theory doesnt seem to apply for crude oil. So does that mean all of us should retake lessons in economics. Nope, not at all. If we delve deeper into this burning crude oil problem, one would come to realise that its the faulty policies of the governments across the globe that has resulted in fuelling energy prices over the years. If we take our country as a standing example, all of us have been shielded from the impact of crude oil rise from $35 to $133 per barrel over the past 4 years. Though some amount of speculative positions have definitely found their way into boosting oil prices to the present level, the story doesnt end there. If we analyse the real reasons for the oil shock, we would come to terms with the fact that demand has been rising unabated irrespective of oil price hikes, almost to the level of becoming inelastic. In India, the consumption of diesel is more than that of petrol. Most BPL category citizens and low income groups cannot afford a LPG cylinder till date. Public welfare and social responsibility does demand that the government of a country protect its citizens from the vagaries of global economic shocks.So its pretty obvious that the entire burden cannot be passed on to consumers. Therefore the government has been following the hackneyed policy of not raising fuel prices in tune with import parity pricing of crude and subsidizing the population at large only to result in literal bankruptcy of oil marketing companies.The oil bonds that the government issues as compensation to OMC's for their underrecoveries is only a strain on the fiscal deficit of this economy and is a cost on our resources as well as a burden that is passed on to our future generation. In light of this scenario why is it that petrol prices are still subsidized? Only when petrol prices are raised to reflect international realities, will demand for oil slow down. People would either stop travelling by cars or would resort to car pool system. More and more people will start using public transport systems that run on diesel/CNG. Similar is the case with LPG. Since it is consumed by the relatively creamy layer of the population, their prices should also be increased to the maximum extent possible. The luxurious will either ways continue to pay whatever is the price. So why subsidize them. The effect of these decisions would mean CNG usage would increase in a big way given the fact that its a relatively less polluting, low cost option. Public transport systems will also get efficient with more n more people commuting through it. The teething infrastructure problems can then be handled with ease.When demand for oil from a large country like India slows down, we shall see the downward spiral in oil prices happening almost as an immediate aftermath.

But given the fact that ours is a totally warped democracy with the lack of political will to take major decisions that would be beneficial to the society in the long run, these proposals are fit to lie in my closet for the time being. See you with my next article on this subject when Oil is at $ 200 per barrel.

Avon Weighing Systems: Have you seen an IPO at face value so far??

Trust me guys, Iam not dreaming. Come June 9Th, Avon Weighing systems which assembles and sells weighing instruments in India is hitting the capital markets with its IPO priced at Rs.10 per share. The company, incorporated in 1999, is the authorised dealer of industrial electronic and digital weighing scale products of "A&D" and "Tanita" (Japan) in India. The company assembles these products after importing spare parts from these companies abroad, customising them to individual customer requirements. The company is also the authorised dealer of Excell Precision Co. Ltd., Taiwan and Ningbo Benui Electric Co. Ltd., China. A&D company is the world's third largest manufacturer of weighing machines.

The company is now venturing into manufacturing of weighing systems to address the competitive scenario and tap into the emerging opportunities in the 1000 crore market. The manufacturing would be done with the technical support of Tanita. The weighing balances distributed by the company are used in industries where precision weighing is critical eg: Gems, jewellery, pharmaceuticals, retail, healthcare, posts & couriers, oil, airports, iron and steel etc.The funds raised through the IPO will part-finance the company’s Rs 17.30 crore expenditure plan for 1. A manufacturing facility at Baddi (Himachal Pradesh) 2. Four showrooms for display and sale of its weighing systems 3. Purchase of additional office premises in Mumbai. The project is proposed to be funded through promoters’ contribution of Rs 4.36 crore, internal accruals of Rs 0.50 crore and a term loan of Rs 2.60 crore in addition to the IPO funding of Rs 9.83 crore. The fact that promoters are also making a contribution to the funding plans alone gives a lot of assurance to the issue. It also shows the confidence the promoters have in the sustainability of the business going forward, considering the fact that the company is a small scale industry (SSI) unit.

The size of the electronic weighing systems industry in India is around Rs.1000 crore and is growing at 25-30% p.a.
The biggest positive from this IPO is that it’s coming out with an IPO at a price of Rs.10 sans any premium. Retail investors can bid for a minimum of 500 shares and in multiples of 500 thereof upto a maximum of 10000 equity shares. The company plans to list its shares on the Bombay Stock Exchange (BSE). The IPO has been rated "Grade 2" by CARE indicating "below average fundamentals". Though this appears a negative from the IPO standpoint, there have been cases in the past where even a company with a moderate business profile can command superior valuations if the pricing is right and it is here where this IPO is right up your alley. Lets examine the pros and cons of this issue:

Strengths:

1. Good track record of the promoters in trading operations, excellent long
standing relationships with A&D and Tanita Corp., growing usage of digital
and electronic weighing machines compared to mechanical weighing
machines used earlier. Even a small transformation or conversion of retail
and trade establishments from mechanical to electronic weighing machines
presents a huge opportunity. Also the preference for precision and accuracy
in weights and measures will convert a significant population into potential
customers.

2. Backward integration into manufacturing will strengthen the weak margins
and lend better pricing power. The company is commencing its
manufacturing operations by November 2008 and this should ensure a
robust growth in topline going forward as well as reflect an improvement in
the PAT margins to 7-8% from the present 4%.

3. The manufacturing plant to be set up at Baddi, Himachal Pradesh is exempt
from taxes and duties. The fiscal incentives will definitely shore up the
margins of the company going forward.


4. Usage of properly serviced second hand dies for manufacturing will result in
saving on capital expenditure going forward.

5. Innovative products, better technology through internally developed
software, industry specific solutions and customised service have made the
company a preferred supplier to a number of its customers.

6. Avon has witnessed impressive growth in its topline and bottomline at a
CAGR of 43.5% and 64% respectively over the last five years. The company
has had a decent track record of paying dividends in the range of 12.5-
13.5% every year. Assuming the trend would continue, one can safely
conclude that this stock would have an excellent dividend yield given the fact
that the issue is priced at par value.

7. Legislations are being passed now by various state governments by banning the usage of
mechanical balances. Karnataka for example has already passed one such legislation.

8. Long standing relationships with companies like Novartis, Lupin, Sudarshan Chemicals lends
earnings visibility.

9. Any rupee appreciation against currencies like YEN and YUAN should result
in handsome gains for the company due to its import policy of spare parts
and raw materials.

Weakness :

1. No prior experience of promoters in the manufacture of electronic weighing
machines. The company has only been trading and distributing weighing
machines so far.

2. Excessive dependence on A&D and Tanita for business continuity. Inherent
business risk lies in highly concentrated business profile and
termination/discontinuation of dealership agreements. Also for the
manufacturing activities to commence, technical support from Tanita is
required for which no formal agreement has been entered into. The
agreement will be entered subject to inspection of the Baddi plant by
Tanita authorities. In case the agreement does not materialize, the company
plans to install an assembly plant at the proposed site.

3. Inadequate geographical reach

4. Limited investment ability of promoters

5. Significant competition from players like Essae- teraoka, Avery India, Sansui,
Phoenix, Atco, Contech and the presence of the unorganised market have
hampered the possibility of a wider geographical reach for the company.
Avery India is the only listed player that has been in existence in the
industry for more than two decades but has witnessed moderate sales growth
compared to Avon. But Avery has its own manufacturing facility in place.

6. The company has reported negative cash flows in the last three years due to
working capital constraints. The company faces a strained working capital
situation due to delay in receivables from government agencies. Government
agencies typically take 90-120 days to settle their dues. The interest burden
is expected to go up in the near to medium term.

Notes on financials:

1. With the commencement of manufacturing operations by Nov.2008, the growth momentum
is expected to continue with overall improvement in margins

2. The company has reported better earnings growth when compared to Avery India. The
margins are lower than Avery India as the former is already into manufacturing activities
that can lead to better economies of scale compared to trading activity alone.

3. At the fixed IPO price of Rs10, Avon commands a better market cap to sales ratio as well as
PEG (Price earning growth) when compared with Avery India, indicating scope for sizeable
listing gains.

4. The Enterprise value per share is also at a significant premium to the issue price


All in all, Avon India can be described as a SSI with a moderate business profile and decent financial strength with ability to deliver stable returns going forward.


Valuation:

The IPO price of Rs.10 discounts FY 08 fully diluted EPS of 1.12 by 8.92x, which is lower than the PE of Avery India, the only comparable listed peer.

The IPO is being recommended to investors for the following reasons:

·The scope for downside is very limited. The pricing of the IPO at par value discounts all the negatives associated with the company

·The company is financially sound with average fundamentals. The impressive dividend yield at the IPO price will alone attract investors to this counter.

· The weighing machines industry is growing at 25-30%p.a and players in the industry should command better valuations going forward.

· Avery India had an open offer from its promoters last year at a price of Rs.80 which indicates the sort of valuations companies in this industry should likely command.

·The market cap to sales ratio is significantly lower compared to Avery India. So valuations for Avon with better earnings growth should definitely catch up over the medium term.

·Assuming that the market conditions will stabilize by the time listing of this issue happens, investors can be reasonably sure that the scrip will get listed with a decent 30-40% premium above issue price.

It is indeed commendable that sanity has prevailed in pricing this issue. The merchant bankers have definitely left something on the table for investors. The proof of the pudding is in the eating. This “weighing balance” definitely tilts in your favour.

Anti money laundering laws strengthened

The cabinet approved the amendment to the Prevention of Money Laundering Act recently to include even credit cards, casinos, money transfer service providers like Western Union under the purview of the act. It was being noticed that "dirty money" related to crimes were being routed through these channels. So far in the past, only banks and financial institutions were required to report on suspicious transactions to the RBI. These loopholes are getting plugged now as an audit trail can be established by the regulatory authorities now to monitor transactions happening through these channels too.

Laws against Cartelisation

At present, issues concerning “cartelisation” are handled by the MRTP Commission. The MRTP Act is clearly misplaced in a growing economy like India and is anti-reform. Though the Competition Act has been enforced in 2002, to replace the draconian MRTP Act, it is non-functional to a large extent.

In a free market economy like ours, stemming the price rise through Governmental fiat is not the way forward. Having said that, to prove the existence of cartelisation and misconduct at marketplace, any government would need evidence, especially in the case of commodities, where demand exceeds supply.

It is, therefore, of utmost importance to fully empower the Competition Commission set up by the Competition Act 2002 to conduct an economic analysis of pricing patterns, market structure, business practices and consumer behaviour in the industries/sectors alleged to be involved in the practice of cartelisation