Global Capital Markets: Not There Yet

For me the current Euro crisis and the spike in gold prices reflects the investors’ inability to grasp the slow yet sweeping, rebalancing of global trade and growth. Cash surplus western investors are catching up slowly to the fact that their domestic fishing grounds are no longer viable and that their catch is falling. But, in my opinion, what they lack is knowledge and foresight to explore and enter the developing markets, where resources are abundant (and where fish are fishes). Thomas Friedman pointed out in his book ‘The World is Flat’ that the world is witnessing a globalization revolution, bringing down barriers of knowledge, information and intellect. I completely agree with his observations, but I feel finance is still not flat, although it has always been on that track.

One should now get used to increased speculation and volatility in domestic markets, as they are domestic no more; international is their new citizenship.

We are still to break down all barriers of information sharing and thus leading to an admirable state which economists call “perfect competition”. Many books have been written on the fact that globalization essentially is based on free market philosophy and has its roots in perfect competition. And so when people look at global finance, I feel they miss out on the basic assumptions of perfect completion or free markets or globalization. First, that information on prices, transactions and products are well known to all market participants.

Even George Soros, the man who made global hedge funds a symbol of global finance, questions this in his revolutionary theory of reflexivity. He also further goes on to write about how decisions of market participants have personal biases and thus enter the Keynesian animal spirits. Today there is no level playing field in global finance. From profligate and covert governments like Greece to unethical market leaders like Goldman Sachs, where is free information? With so much uncertainty the average, or better put majority, of investors will be nervous and jump on to gold.

The second assumption is that there are no transaction costs. But, in reality, today transaction costs are very high, eating into the investor’s margin. Ranging from consultancy fees, to trading fees, incoherent tax laws and legal charges; costs are higher for attracting foreign investors. Thus I reiterate that there is no level playing field.

The point I am trying to make here is that foreign investors have little (if not more) confidence and expertise while investing in developing markets. For instance, some stock analysts in India say that their foreign counterparts rely on broad macro economic data to analyze stock markets and so that explains their unpredictability when sudden macro events happen. Even I am witness to how FIIs in the last decade, even though have pumped up markets have made Indian markets even more volatile and inclined with global markets.

I feel we have a long way to go to see the full effects of a truly ‘free and flat’ global finance. One should now get used to increased speculation and volatility in domestic markets, as they are domestic no more; international is their new citizenship. Till the time we see some global regulations and standards in capital markets, like we have seen in the banking sector, investors should be worried.

Analysis of Indian Union Budget 2010-11

The Union Budget 2010-11 was another remarkable landmark in the long political history of Finance Minister Pranab Mukherjee. He has maintained many of the union government’s large fiscal policies and has further provided relief to the rising earning middle class of India. Thus, in a broader sense, a totally consumption-based model for growth has been pursued. In other words, the budget allows both rural and urban populace to have more money to spend and continue this remarkable economic boom we have seen in the last decade.

The Finance Minister is looking to close this economically historical decade, by targeting the high growth rates we have been looking to get from the start of the millennium. The target looks "refractionally" even higher thanks to global recession. But, India has done well to decouple itself from the profligate West and its government’s prudent and somewhat conservative outlook has paid off enormously.

India’s amazing recovery growth story is not just another milestone, but has many signs to read.

The first is how India has strong domestic consumption and its economy may not be as dependent on exports, as it first appeared. Second, it places India at the centre of the global economic rebalancing along with China, taking in favour of Asia. Third, it sets a precedent of kinds to other political bigheads who are yet write economic policies, to maintain populist fiscal measures.

The annual budget announcement has become a major part of an ordinary citizen’s life today, with due credit to the Indian press, who seem to forget every other news happening for a week or so. But, why not! People’s budget expectations are so necessary in the spirit of the democracy and are what I believe to be the biggest ‘RTI’ of all. Can you think of any other occasion in a year which allows people to make the government to be more accountable to them? Perhaps not, and so I wish to support the further cause by breaking the budget and to even cover issues not usually spoken about in the media as well. So let us begin this, by having a look at the government’s bottom line first.

Taming the Fiscal Deficit

The most important announcement which was eagerly awaited by all was the call to restraint the growing fiscal deficit. The fiscal deficit was being chiefly blamed for the high levels of inflation India has witnessed over the last 6-8 months. However, I am of the opinion that there were many other serious administrative problems which were major aggravators.

So as expected the finance ministry has simply cut, copied and pasted the 13^th Finance Commission’s recommendations and targets. (See the chart for more clarity). The finance minister has committed to bringing down the fiscal deficit 2009-10 level of 6.7 % of GDP to 5.5% of 2010-11 GDP. Also the government has remembered to realign itself with requirement of the Fiscal Responsibility and Budget Management Act of 2003. The government has announced to bring down the deficit to 3% level by the end of next 4 years. 3% target is under the rules of the Act. Although, I think the Act will give more leeway to the FM to dictate his sudden austerity mood swings!

The Union government was well on track to achieve its FRBM targets till the global financial crisis came about. The government had to quickly change gears and announce huge expansive fiscal policies to maintain growth.

For the year 2007-2008 the budget deficit was just 2.6% of the GDP. However, going back to such levels will take much longer than what it took to go up.

The foremost reason being, that a calibrated and planned approach will steer clear of the uncertainties over crowding out private investment. Furthermore, the danger of Japanese like bust on pre-mature withdrawal of government support. Second, being the political will required to renounce the populist policies. After all they all stand for re-election.

The budget has done well to quell fears of high fiscal deficit led inflation. We will see the results over the next 2 quarters. I still have my doubts on its inflation tackling effects. Nevertheless, words must be converted into action. Or like Obama says,” Words must mean something!”.

Sensex Crosses 20,000: Irrational Exuberance?

BSE Sensex : 32 months ago and today (Source: Google Finance)

The Sensex on Tuesday just barely crossed the 20,000 mark to close at 20001.55 and its fellow benchmark index Nifty closed at 6009.05. There is something very different about the 20,000 mark. It is a limiting psychological barrier, especially since the last time the Sensex crossed it was followed by its worst fall in history (see chart). The stock markets have become a prominent discussion; especially with some people who become over enthusiastic and share anecdotes of their previous heroic encounters of riding the Bull Run. Some are still recovering from the last of the bear claws, and there are most importantly others who are confused and yet obdurate of investing in the markets. For they know if they can pull this one off, it will be remembered by one and all.

The whole dilemma surrounds the principle notion of “this time is different”. But is it really so? Can we be sure that the crash from the peak of 20,000 in 2008, about 32 months ago will not happen again. Can the market pundits on the TV quell our fears about the market, and encourage us to make a quick buck before Diwali? Well nobody can predict the right answers, but we at least have to acknowledge that time is not constant, and whatever the present conditions, this time will never be different.

Source : NSE

The first question, then, is to ask who paid for this ride? FIIs have put in record amounts of money in the stock market this year. The above chart I have assembled shows how currently FII have been strong resilient net buyers and domestic investors are selling their investments. The domestic investors are probably not confident of the market so much and definitely when the Sensex is in the 18,500+ range.

Indian markets are a good bet for foreign investors for whom the lack of good investment opportunities in the West is making them look East. There are still some worries about the debt-laden Euro nations. The recovery in America has been very pale as the Fed prepares for another round of Quantitative Easing. Gold a negative barometer of economic expectations has been touching all time highs in recent weeks.

This leads to my second question, so how long will the Sensex hover above the 20,000 level? Well there is a slight idea that it could be as long as the foreign investors want to stay put in the Indian markets, which implies as long as no other attractive investment opportunities emerge elsewhere outside India. But it leaves us thinking that would the FII continue the bull rally in coming months and achieve record heights, or simply book profits and correct.

Again all this depends on the markets perception of the fundamentals of the stocks. India’s P/E ratios remain higher compared to the P/E ratios across the rest of the world. While some analysts have said that the coming quarterly results might be rather dull, others are expecting a stable market till Diwali followed by a market correction.

Source: Stockezy.com

Coming to the last and most important question that is this the right time to invest in the markets? If you were till now expecting a clear answer from me, I am sorry to disappoint you. I am still not convinced about the reasons to be bullish or bearish, and I am not the only one. Well that’s also what the market has been thinking in the last couple of weeks. Have look at the NSE VIX, which measures on the basis of existing options contracts, the market’s expectations in the coming days or months. High volatility in recent weeks shows how investors are currently viewing the market’s situation.

To sum it up, the market can be judged to thriving on exuberance and optimism, whether it is rational or irrational, only time will tell. I think it will be prudent and wise for me to sit out of this fight and leave it for the biggies to clean up. Will you too?

Indian Stock Exchanges Going Global?

I have written previously about how global markets are getting more integrated and showing signs of high correlation. Regarding this, I had also highlighted the point of imperfect information dissemination and how domestic markets have changed. The previous article talked about how exchanges and other capital markets, which were earlier domestic in nature, especially of emerging economies such as India have now gone global or have initiated the process of doing so.

A valid concern then arises whether any of our stock exchanges have the ability and necessity to become truly global. Ability? Of course yes. India enjoys a strong technological advantage, thanks to its IT sector. Supplemented with the appropriate investor friendly policy environment, India has better chances in comparison to its competitors. Furthermore, necessity, as economics teaches us, arises from a near inelastic demand curve. And presently, I would say that this inelastic demand is present in the form of the huge investor interest in the growing returns of the securities of Indian capital markets.

As I write, the US short term interest rates are close to zero, and the US long term rates are around 2-3 %. The interest rate prevailing in India is currently around the 6-7 % range. Thus, this vast interest rate differential makes a compelling case for carry trade. But cash- laden investors in the West are looking for even higher returns in the form of equities.

The question we should be asking to ourselves is that, can Indian stock exchanges make it big on the international stage in the next 10-20 years? I say yes.

India is among the many emerging economies that they consider and competing for the same factors of production and markets for its production. The race to fight for these economic resources and markets for sale has only intensified since the economic crisis begun.

The race for other factors of production shall continue, but I would like to focus on capital as the most necessary factor for the coming years. Capital is a very important input for growing economies and if India needs to sustain existing growth levels of 9%, it has to tap external savings and investments. In simple economic terms, investments in an economy are equal to the domestic savings, budget surplus and net imports. Hence increasing capital inflows in the form of foreign investments on the NSE traded stocks will be a great boost to the Indian economy.

Just recently in May, when the government announced plans for compulsory 25% stake sale in all listed public companies, there was a lot of hue and cry over whether the market would have enough liquidity to absorb so much of stake sale. The estimated amount of equity issuances over the next 3 years is around $30 billion. This amount is trivial in comparison to what large corporations in the US issue. For instance, HP is planning to come out with a $33 billion bond issue in the coming weeks.

Another important factor is competitiveness among the national exchanges itself. NSE is closely followed by BSE and another MCX-SX is waiting in the docks If not NSE then there will be some other exchange. But in my opinion, with its current position in terms of the market position, management and technology advantage, NSE is the most amenable to such expansion.

NSE has recently signed a cross listing agreement for futures of flagship indices with CME and earlier with SGX, but these listings are just to give foreign investors a feel of Indian markets and assist in portfolio diversification. The real deal will be when the NSE can convert the volumes and listing numbers the large foreign bourses boast about.

My last argument for having such high hopes of seeing an Indian stock exchange reach the heights of a global exchange is the comparative advantage Indian capital markets have over other emerging economies markets. In the recent World Economic Forum’s Global Competitiveness Index, although India fell two places to 51st rank, its financial markets were rated 17th across the world. This shows how the existing level of competitiveness in the Indian exchanges and the future can be built on this grounding.

The IMF or EMF

We rise in glory as we sink in pride. This is what I have to say to the EU leaders and ECB officials, as they quickly dismiss any talks of an IMF rescue for Greece. The IMF seems to me the best way out for Greece with all its fiscal mess and politics involved in the matter. Let’s face it, that today no eurozone country is audacious or willing enough to get into this ‘delicate’ issue of sovereign default and debt assurance, specially after grinding through such terrible economic times. What Greece is looking right now is for some generous donor to grant an easy loan with low interest rates and in return it will promise to cut down its fiscal deficit by adopting real disciplinary measures.

Here are a few reasons in a nutshell as to why I feel Greece’s bailout is a ‘delicate’ issue:

ü Any loan or bailout money provided to Greece would be along with a number of constraints attached to it. Nobody would be willing to give a ‘no-frills’ loan to Greece considering its past record of conceited accounting practices and inexperienced policy makers. It is obvious common sense that any entity would like to protect its investment and make sure it oversees its utilisation.

ü Secondly, there is an inevitable political angle as well which needs to be looked into. There already massive protests across Greece by its unhappy citizens over the government’s resolute commitment to cut public spending and public sector pay freezes. Already unions have endured enough, and one feels that the tipping point is not far away. Thus, in such a heated political environment, having foreign country or interests dictate control and supervision over its policymaking will further add to the fire.

ü Thirdly, all hopes of the Euro’s future are hinged on a quick, transparent and stable Greek recovery, as the fear of contagion spreading to Portugal, Italy and Spain is high. As a consequence, any hiccups in the bailout may cause sharp reactions from bond markets. Which leads to my argument that what is required is a patient and calibrated approach, but not many would be looking at long term scenario, except the IMF.

Who will take out the chequebook?

Setting aside the IMF as one major contender for this job, let us examine who are the possible contenders. First on the list is the EU, which cannot explicitly bail Greece out as per the treaty clause which governs its functioning. Second, would be unilateral loans form the rich and prosperous European states, which in its current circumstances narrow down to Germany. Germany is the real powerhouse of Europe, also being one of the main beneficiaries of the introduction of Euro currency. Thus, more than an obligation, the last thing Germans want is a euro collapse in a fragile recovery period of today.

But, the German public is outraged by the idea of bailing out the profligate Greeks with their hard earned savings. To me a German bailout looks less probable than a German supervision. This leaves us with only 2 remaining choices. One is a real institution with more than 60 years experience of handling such cases, none other than the IMF. The other is EMF, which is fictitious and is a yet to be started fund. And so one feels the idea of EMF is promoted purely on pride and less logic.

It drives me nuts to read how EU policy makers are so blindly hopeful on setting up the European Monetary Fund as it is currently named. The IMF is clearly a better alternative even though the setting up of EMF is great for future crises but not the present Greece concern at hand. In simple terms, on having met with an accident does a person go to a experienced and reputed hospital, or does one choose go to a new, inexperienced and a politically correct clinic. Of course one chooses the former over the later. Then why make a distinction here for Greece.

Greece certainly needs help, and IMF for me looks like the safest bet. Disillusioned European leaders and policymakers need to shun their pride and also look at another positive from it. An IMF rescue will set a good example for the rest of the eurozone nations. An EMF rescue even if possible will imply a ‘too big-to fail’ guarantee, which will make future defaults even more dangerous.

Right To Banking??

Yes you read it right, coming shortly to a political theatre near you! After the super successful populist agenda on the Right to Education and the work in progress i.e. Right to Food, here comes the much awaited sequel ‘Right to Banking’!! If you thought two additional rights were enough to send you back to your Civics class in school, well here is another one.

Well I am not this hyper always, but the way the government is selling this in the newspapers does deserve such enthusiasm. Almost every other morning, there are articles by civil servants and the who’s who in the govt. pledging their allegiance to the cause of financial inclusion. The day is not far when ‘financial inclusion’ moves to the more populist and sympathetic name of ‘right to banking’.

The hype surrounding financial inclusion has been influenced our minds so much that we cannot even think beyond what is being presented to us. In a classroom discussion, when I raised my hand to put forward objections to the government’s drive to push and force commercial banks to open up more branches and extend services to rural India, I was told to keep quiet. It was as if I had committed a sin and even the slightest leaning towards capitalism in my speech would be enough for them to brand me an arrogant elitist. It came as a rude shock to me, has the issue become totally one sided? And if yes, what happened to our democratic moral of free speech and opposition.

One has to give some credit to the government for making financial inclusion a buzzword in pink papers. The RBI has tried moral suasion to ask banks to extend their services to the unbanked rural population. But now with the fresh issue of banking licenses to be issued by end of this year, the RBI is going to indirectly force more rural coverage by the prospective bidders as an important prerequisite for the license. This should be a source of worry for the existing commercial banks, especially the foreign banks which already having drawn big plans for urban expansion, might have to rework their strategy.

As a part of Manmohan Singh’s government’s pledge towards inclusive growth, financial inclusion is being seen as a separate issue altogether. Financial inclusion is really just one of the many a component of the overall inclusive growth strategy. Other things such as social inclusion, education, healthcare, infrastructure and energy requirements etc. must go hand in hand to make financial inclusion happen. By just simply opening bank branches will not help the cause.

Account Opened, Now What?

Infrastructure is needed in the form of roads connecting bank branches, security and law& order to protect deposits, communication to connect the banks computer networks and housing for the banks staff. Opening an account is not the last step; the average rural illiterate has to be taught how to operate the account, the details of interest and deposits, rules and nomination policies as well as the procedure for consumer grievance redressal.

Just handing out the money to the farmer is not the end of the story. The farmer also has to be supported and encouraged to improve productivity, has to be given access to electricity and meet his other energy needs, has to be part of holistic community development and most importantly, he has to be feel social included. Only then can the bank expect to receive back the principal with interest. Otherwise it would have to wait a few decades for another populist government to come and waiver off its loans.

Greece Faces a Tough Year Ahead

For those of you who have just joined us and asking what in the world is happening. Here’s the situation: We’ve got in our hands the possibility of the first sovereign debt default by a Euro currency member. Greece has an external debt of 170% of its GDP and is currently running a 13% fiscal deficit. The nation’s problems are increasing day by day. Productivity and employment are at very low and painful levels, for the country to even think of self sufficient recovery.

Much of the panic subsided on Feb 3^rd, as the government’s plan to reduce substantially it’s budget deficit to 3% by 2012, was supported by the EU. The plan proposes up taking very unpopular measures to control spending, like slashing public sector spending, pay freezes and wage cuts and increasing taxes. This hasn’t gone down well with public at all. They have already absorbed the 4% pay cut and are expecting the worst is yet to come. However, fear is again creeping into the minds of investors.

There is no doubt that this year's plan to cut deficit from 12.9% to 8.7% will be very difficult and regaining confidence even more.

The bond markets are increasingly skeptical about the government’s plan as the spreads on Greek bonds are rising. What Greece needs foremost is quick cash to refinance it debt which becomes due in a few months. The debt is estimated to the tune of €20 billion. It has been successful to raise €8 billion on Jan 25^th through the sale of 5 year bonds. However the rate of interest was very high at 6.2%. With more speculation on Greece’s future going rounds, picking up further debt from markets will become next to impossible for the government at prevailing interest rates.

The government has tried to blame the speculators who have bought credit default swaps (CDS) to insure themselves against a Greek refusal to oblige on the debt. They have alleged that buyers of CDSs are driving up the spreads on bonds and have made borrowing more difficult. That in turn has made the Greek government helpless and led to its current state of affairs. While there have been some officials and economists in Europe who have sympathised on these grounds. But I have two words for them.

Shut up!

The Greeks have no one to blame than themselves. Markets don't show sympathy, they respect discipline and trust. Years of profligacy and dodgy accounting practices in an attempt to fool the EU and the investors, has left them in a terrible position. There is increasing furore in France and Germany on why it should bail out a cheater. Their displeasure is completely understandable and rightly so.

Its time Greece did the right thing and took some excruciating steps to control the budget and announce some real cuts and meaningful trust-building measures. Passing the buck around, will neither impress the EU nor the investors holding Greek bonds. Its time it pressed the button of urgency and did things swiftly and not smirk around looking for easy deals with the EU or the big members. The more it waits. The more the threat grows, specially for the other European economies, which also have high debts to service, namely Portugal, Spain and Italy. Its time it pleaded guilty.