As corporate-politician nexus wanes, investors move away from 'well-connected' cos, which indicates a paradigm shift.
The Hyderabad Connection
In August, 2008, I found myself on a flight to Hyderabad with our infrastructure analyst. On the flight, we went through the financial statements of the said infra company, but could not make any sense of the
balance sheet. Why was the infra company making loans equivalent to almost its entire shareholders' equity? And why did the annual report say that the infra company only had minority stakes in its power plants when the investor presentations clearly suggested otherwise?
On being asked these questions, the infra CFO said, "Look, this is the way things are in India. You need to get used to it." In effect, he was trying to circumvent Accounting Standard 21 by using a clever structure, which allowed him to use his own balance sheet to flatter his own P&L. When we published our 'Sell' note on the said infra company, we were threatened by the same CFO in Bollywood-style language. And next came the investors' reaction. While some clients heeded our warnings and stayed away from the infra company, others said, "You have to accept these political connections… This company is a prime play on the 'power deficit' story in India."
These investors were right. Throughout CY09 and the first quarter of CY10, the company's stock trebled as it won more contracts and was given water and fuel linkages. And then came the scandals.
These were the defining national scandals of CY09 – CWG, Adarsh, 2G, etc. and they have had two salutary effects across a range of sectors. Firstly, they have deterred politicians from helping companies win contracts or access natural resources. Secondly, they have deterred investors from investing in companies, which are fronts for certain political godfathers. These findings are from two studies, performed over the past quarter by my colleagues.
Our Research
The first study hinges our forensic accounting model, which ranks the BSE 500 companies according to the quality of their financial statements. I remember trying to use this forensic model to make stock calls in CY08, CY09 and CY10. But it was a fruitless exercise because investors would back companies, like the infra company highlighted above, which had hopeless accounting but strong political connections. These companies would, in turn, go on to outperform the broader market. However, as the corporate-politician nexus has sought cover over the past year or so, investors have swiftly gravitated towards companies, which have strong accounting quality. So, if I break the BSE 500 into four quartiles, where quartile A has the strongest accounting quality (as per our forensic accounting model) and quartile D has the weakest, our analysis shows that over 1, 3 and 5 years, quartile A has outperformed B; this, in turn, has outperformed C, which has outperformed D. Whatever return metric is used – average returns from each quartile, median returns from each quartile, % of companies in a quartile reporting positive shareholder returns over 1/3/5 years – this pattern holds, suggesting that finally, share prices in India are being driven by fundamentals, rather than political connections.
Our second hinges around explicitly analysing the impact of political connections on shareholder returns. Within our universe of BSE500 stocks (excluding financial services stocks), we have classified the companies into 'Strong/Medium/Low,' based on the strength of their connectivity to political establishments over the past few years. Out of this universe of 360 firms, our sector leads have classified 25 (7 per cent) of these firms as having 'strong' connectivity and another 50 (14 per cent) as having 'medium' connectivity. By default, therefore, the remaining 285 (79 per cent) firms are deemed to have 'low' connectivity.
The 75 stocks with 'strong' or 'medium' connectivity came from the following sectors: Power (13 per cent), Capital Goods, Infrastructure and Construction (44 per cent), Real Estate (17 per cent), Technology (16 per cent), Metals and Mining (5 per cent), Telecom (3 per cent) and Media (1 per cent).
In the previous bull run (the period ending 2008), the 'strong connect' stocks outperformed the market substantially. However, around 2008, this outperformance peaked. Then this outperformance gave way to underperformance, which has become especially meaningful during the past one year. Over the past one year, the cumulative outperformance since 2006 has not only waned and disappeared, but has now moved into negative territory.
In particular, the 'strong connect' group has underperformed the market by 14 per cent in the past one year.
Investment Implications
It is debatable whether the pattern which has been established over the past year – of investors avoiding well-connected firms in favour of fundamentally high quality firms – is here to stay or is it a temporary reaction to the fear created by the intensity of the 2G investigation. I believe that this pattern is a positive paradigm shift and marks a watershed in the evolution of the Indian stock market. Several investment implications arise from this positive paradigm shift:
Fundamentals will become a bigger focus in sectors such as Power, Realty, Construction, Technology, Mining, Real Estate, etc., as the market forces these companies to either shape up or ship out. It won't be enough for these companies to have one or two powerful people sitting on their Boards and expect a premium valuation from investors due to the presence of these luminaries.
When the Indian market finally goes into a secular bull run, the kind of stocks which will deliver market-beating returns will be very different from the stocks which did well in the two previous bull runs (the one ending January, 2008, and the other brief blast from March, 2009-July, 2009). In particular, the high beta stocks, to the extent that they are 'strong or medium connect' companies with weak fundamentals, might not be able to outperform. In contrast, companies with clean accounting and solid franchises should be in high demand.
Investors' ability to generate market-beating performance should now become more closely aligned to their skills of spotting fundamentally high quality companies (as opposed to their skill in knowing which company is connected to which grandee).
Dear All
1 of 1 File(s)3 new metrics get added to the already 5 covered (some of which also see a
change in methodology) in the previous note and the 8 have been classified
into 3 categories with weights assigned to try and arrive at a better
picture on the banking sector. Dena Bank, United Bank & Allahabad Bank see
a big fall whereas City Union, IOB and Kotak Mahindra Bank see a quantum
jump in the ranks.
I believe the 3 new metrics are pertinent in the current scenario where
risk on asset quality & balance sheet could have a greater bearing then the
operational performance of the banking sector.
New metrics added
a. stressed sector exposure - funded { i believe pertinent
in taking a view on the asset quality risk that may evolve in b.
stressed sector exposure - non-funded { the near future given the
uncertain times of slowing growth & high interest rates
c. quality of pension assumptions
Interestingly, as per our calculations SBI has about Rs.170bn towards
underfunded pension liab (Exhibit 13) and Andhra Bank, UCO Bank stand-out
for their exposure to the infrastructure sector (exhibit 7 & 12).
Category Weightage Metrics
1. on-Balance Sheet risk 40% NPA volatility,
stressed asset classification, stressed sector exposure
2. off-Balance Sheet risk 40% Fee
income cost index, stressed sector exposure (non-funded), quality of
pension assumptions
3. P&L Discretion 20% Treasury income
volatility, discretionary provisioning
Some of the spectacular movements in rankings seen are:
Bank New ranking Earlier ranking
Dena Bank 4 33
United Bank of India 7 30
Allahabad Bank 8 26
Karur Vysya Bank 10 36
Axis Bank 3 15
Canara Bank 8 13
Idbi Bank 1 8
City Union Bank 25 3
Bank of Baroda 36 24
Bank of India 31 17
IOB 20 5
Kotak Mahindra Bank 34 20
SBI 32 19
Some of the banks with a high exposure to our defined stressed sector are
Bank Funded exposure as % of networth
Non-fund based exposure as % of networth
Andhra Bank 35 130
UCO Bank 32 80
Canara Bank 30 170
KVB 28
United Bank 22 20
Axis Bank 15 130
Yes Bank 180
Banks that stake up well/poor based on overall forensic scores and
valuations.
Strong candidates Bank of Baroda, Central Bank, Federal Bank and
City Union Bank
Weak candidates Yes Bank and Axis Bank
Can I request for some of your time to briefly discuss our findings and
thoughts on the changing landscape of the banking sector.
We rank Indian banks based on their & off Balance Sheet risks and the
extent of P&L discretion that they are exercising. We find that amongst:
(a) The new private sector banks, Axis Bank and Yes Bank look exposed; (b)
The major public sector banks, Bank of Baroda stands out as being the least
risky; (c) The old private sector banks, Federal Bank appears to be running
a well-balanced operation.
The modus operandi
Our 11th July note highlighted the tendency of Indian banks (particularly
public sector banks) to use evergreening and restructuring to flatter their
reported NPAs. We also highlighted the extent to which Indian banks
(particularly the new private sector banks) take considerable amounts of
off-Balance Sheet risk to earn fee income which flatters their ROEs. The
note went on to highlight the use of Treasury Income as a "balancing
figure" on the P&L of banks and the note also discussed the inadequacies in
the pension assumptions of the banks.
Quantifying the risks being taken by Indian banks
In this note, using the standalone financials for the last five years, we
quantify the risks being taken by 37 listed Indian banks under three
different categories: On Balance Sheet risk, Off Balance Sheet risk and P&L
discretion.
On Balance Sheet risk (40% weight): The new private sector banks are
clear winners on this front with all 7 new private sector banks
featuring in the top half of our analysis. While 7 of the 9 old
private sector banks figure in cluster C (clusters C and D are the
weakest in our ranking matrix), the state-owned banks fare the
poorest on this metric with 11 (of 21) state-owned banks in cluster
D, the weakest bucket.
Off Balance Sheet risk (40% weight): The state-owned banks bring up
the rear in this parameter as well with only 5 (of 21) in the top
half. A majority of the new private sector banks also figure in the
bottom half. Hence, the old private sector banks are clear winners on
this metric with 7 (of 9) in the top half of our scores for this
metric.
P&L discretion (20% weight): This metric measures the extent to which
banks use Treasury income and provisioning to control their reported
earnings. This is the only parameter on which state-owned banks fare
well compared to the private sector banks with a majority of the
state-owned banks featuring in the top half. Two-thirds of the
private sector banks (old as well as new) figure in the bottom half.
Investment implications (see pages 15-26 for details)
Whilst the overall forensic scores of the banks (see table on the right),
highlight the accounting weaknesses of the state-owned banks, the market
has already factored this in for the most part (although we emphasise that
BOB and Central Bank score well in our model and look undervalued). In
contrast, Yes Bank and Axis Bank, which are trading at 3.3x and 3.4x FY11
book value respectively at present, have low forensic scores and look
overvalued. Lastly, the better quality old private sector banks, Federal
Bank (at 1.4x FY11 book value) and City Union Bank (at 2.0x FY11 book
value), appears to be worth investigating as long term outperformers.
Consolidated ranks based on the three categories of risk metrics
(On-Balance Sheet risk, Off-Balance Sheet risk and P&L Discretion)
(Embedded image moved to file: pic24626.gif)
*: We assign 40% weight each to "On balance sheet risk" and "Off balance
sheet risk" and the residual 20% weight to "P&L discretion"
Source: Ambit Capital research
2 of 2 Photo(s)
change in methodology) in the previous note and the 8 have been classified
into 3 categories with weights assigned to try and arrive at a better
picture on the banking sector. Dena Bank, United Bank & Allahabad Bank see
a big fall whereas City Union, IOB and Kotak Mahindra Bank see a quantum
jump in the ranks.
I believe the 3 new metrics are pertinent in the current scenario where
risk on asset quality & balance sheet could have a greater bearing then the
operational performance of the banking sector.
New metrics added
a. stressed sector exposure - funded { i believe pertinent
in taking a view on the asset quality risk that may evolve in b.
stressed sector exposure - non-funded { the near future given the
uncertain times of slowing growth & high interest rates
c. quality of pension assumptions
Interestingly, as per our calculations SBI has about Rs.170bn towards
underfunded pension liab (Exhibit 13) and Andhra Bank, UCO Bank stand-out
for their exposure to the infrastructure sector (exhibit 7 & 12).
Category Weightage Metrics
1. on-Balance Sheet risk 40% NPA volatility,
stressed asset classification, stressed sector exposure
2. off-Balance Sheet risk 40% Fee
income cost index, stressed sector exposure (non-funded), quality of
pension assumptions
3. P&L Discretion 20% Treasury income
volatility, discretionary provisioning
Some of the spectacular movements in rankings seen are:
Bank New ranking Earlier ranking
Dena Bank 4 33
United Bank of India 7 30
Allahabad Bank 8 26
Karur Vysya Bank 10 36
Axis Bank 3 15
Canara Bank 8 13
Idbi Bank 1 8
City Union Bank 25 3
Bank of Baroda 36 24
Bank of India 31 17
IOB 20 5
Kotak Mahindra Bank 34 20
SBI 32 19
Some of the banks with a high exposure to our defined stressed sector are
Bank Funded exposure as % of networth
Non-fund based exposure as % of networth
Andhra Bank 35 130
UCO Bank 32 80
Canara Bank 30 170
KVB 28
United Bank 22 20
Axis Bank 15 130
Yes Bank 180
Banks that stake up well/poor based on overall forensic scores and
valuations.
Strong candidates Bank of Baroda, Central Bank, Federal Bank and
City Union Bank
Weak candidates Yes Bank and Axis Bank
Can I request for some of your time to briefly discuss our findings and
thoughts on the changing landscape of the banking sector.
We rank Indian banks based on their & off Balance Sheet risks and the
extent of P&L discretion that they are exercising. We find that amongst:
(a) The new private sector banks, Axis Bank and Yes Bank look exposed; (b)
The major public sector banks, Bank of Baroda stands out as being the least
risky; (c) The old private sector banks, Federal Bank appears to be running
a well-balanced operation.
The modus operandi
Our 11th July note highlighted the tendency of Indian banks (particularly
public sector banks) to use evergreening and restructuring to flatter their
reported NPAs. We also highlighted the extent to which Indian banks
(particularly the new private sector banks) take considerable amounts of
off-Balance Sheet risk to earn fee income which flatters their ROEs. The
note went on to highlight the use of Treasury Income as a "balancing
figure" on the P&L of banks and the note also discussed the inadequacies in
the pension assumptions of the banks.
Quantifying the risks being taken by Indian banks
In this note, using the standalone financials for the last five years, we
quantify the risks being taken by 37 listed Indian banks under three
different categories: On Balance Sheet risk, Off Balance Sheet risk and P&L
discretion.
On Balance Sheet risk (40% weight): The new private sector banks are
clear winners on this front with all 7 new private sector banks
featuring in the top half of our analysis. While 7 of the 9 old
private sector banks figure in cluster C (clusters C and D are the
weakest in our ranking matrix), the state-owned banks fare the
poorest on this metric with 11 (of 21) state-owned banks in cluster
D, the weakest bucket.
Off Balance Sheet risk (40% weight): The state-owned banks bring up
the rear in this parameter as well with only 5 (of 21) in the top
half. A majority of the new private sector banks also figure in the
bottom half. Hence, the old private sector banks are clear winners on
this metric with 7 (of 9) in the top half of our scores for this
metric.
P&L discretion (20% weight): This metric measures the extent to which
banks use Treasury income and provisioning to control their reported
earnings. This is the only parameter on which state-owned banks fare
well compared to the private sector banks with a majority of the
state-owned banks featuring in the top half. Two-thirds of the
private sector banks (old as well as new) figure in the bottom half.
Investment implications (see pages 15-26 for details)
Whilst the overall forensic scores of the banks (see table on the right),
highlight the accounting weaknesses of the state-owned banks, the market
has already factored this in for the most part (although we emphasise that
BOB and Central Bank score well in our model and look undervalued). In
contrast, Yes Bank and Axis Bank, which are trading at 3.3x and 3.4x FY11
book value respectively at present, have low forensic scores and look
overvalued. Lastly, the better quality old private sector banks, Federal
Bank (at 1.4x FY11 book value) and City Union Bank (at 2.0x FY11 book
value), appears to be worth investigating as long term outperformers.
Consolidated ranks based on the three categories of risk metrics
(On-Balance Sheet risk, Off-Balance Sheet risk and P&L Discretion)
(Embedded image moved to file: pic24626.gif)
*: We assign 40% weight each to "On balance sheet risk" and "Off balance
sheet risk" and the residual 20% weight to "P&L discretion"
Source: Ambit Capital research
2 of 2 Photo(s)
Eurobonds could cost Germany up to €47bn per year in additional interest, according to the Ifo institute for economic research at the University of Munich, in a presentation to a press conference in Berlin on Wednesday
Eurobonds which would be issued across the 17-member-country common currency area, are the subject of an intense debate in Europe, with struggling economies in favour while the prudently run economies would see a hike in the cost of servicing sovereign debt.
Last weekend, Giulio Tremonti, Italian finance minister, again called for the introduction of such bonds, saying, "We wouldn't be where we are now if we had had eurobonds."
It's an interesting comment from the top official of a country that could only manage average annual growth of 1% over the past decade. In the context of the latest crackdown on tax evasion, in recent weeks a court deposition has disclosed that Tremonti paid a former aide €1,000 in cash weekly, for the rent of an apartment in Rome.
Jean-Claude Juncker, prime minister of Luxembourg and the chairman of the Eurogroup of Eurozone finance ministers has also advocated the launch of eurobonds as has Olli Rehn, the EU Economic and Monetary Affairs commissioner, claiming that that they would restore stability by stopping speculative attacks on the debt of individual Eurozone member countries
Following the two-hour meeting in Paris on Tuesday this week between Nicolas Sarkozy, the French president and Angela Merkel, the German chancellor, Merkel reaffirmed that eurobonds were not part of the solution. Rather, the goal is to solve the debt crisis in a step-by-step fashion: "I do not believe that eurobonds would help in that regard," she said.
The French president however said eurobonds could be a possibility in the future: "Perhaps one could imagine such bonds at some point in the future at the end of a process of European integration. But not at the beginning" of it, he said in reference to a proposed 'economic government' for the Eurozone.
Eurobonds will not be on the agenda until agreement is reached on new Eurozone governance rules.
Der Spiegel, the German news magazine, says that the pro-business Free Democratic Party (FDP), junior partner to Merkel's Christian Democrats, has ruled out the creation of euro bonds. Their leader, Economy Minister Philipp Rösler, reiterated his opposition to them in an interview in the Die Welt newspaper on Monday, saying they "lead to equal interest rates in the whole euro zone and thereby undermine the incentives for a solid budget and economic policy in the member states."
Germany's opposition Social Democrats and Greens have both said they would support the introduction of eurobonds provided that certain conditions were attached to them, including a tighter control of nations' fiscal policies. Green Party leader Cem Özdemir said the volume of eurobonds should be limited to 60% of a nation's gross domestic product.
The Ifo institute said on Wednesday that at the end of July, the yield of 10-year German government bonds was 2.0 percentage points below the Eurozone average. For 5-year bonds the yield spread was 2.6 percentage points; for two-year bonds it was 3.0 percentage points. The average yield spread therefore depends on the term structure of German government debt. Assuming an average maturity of 7.5 years, this results in a yield spread of 2.3 percentage points. Based on the overall current level of gross debt of the Federal Republic of Germany of €2,080 billion (as of the end of 2010), additional interest expenses of €47 billion per year would result.
Ten-year bund yields fell nine basis points to 2.23% on Wednesday.
Germany is not the only country that opposes eurobonds.
Finland and Greece on Tuesday reached an agreement on collateral for Finland's participation in the latest Greek bailout, Jutta Urpilainen, Finnish finance minister, said Tuesday.
"I am very pleased with the result of the negotiations," Urpilainen told a news conference in Helsinki, without disclosing details.
Urpilainen said Greece will deposit a still-to-be-decided sum of money with the Finnish state for Finland to invest.
"When Greece has managed all its obligations with the European Financial Stability Facility, Greece will receive the original installment and all of the accrued profit," Finland's finance ministry said in a statement.
Last month, European leaders agreed a new €109bn bailout package for Greece,
Presentation by Prof Kai Carstensen at the Ifo press conference "Eurobonds – What they will cost the taxpayer – After the meeting between Merkel and Sarkozy" on 17 August 2011 in Berlin – - Download (in German)
Given the current debate over the introduction of eurobonds, the Ifo Institute has updated its estimate of the costs for the German government. The calculation is based on the assumption that eurobonds will lead in the long run to the communitarisation of the sovereign debts of all countries in the euro area, guaranteed according to the ECB's capital shares of the individual countries.
The nominal interest rate differences between government bonds, as have been determined by the markets, reflect the different default probabilities of the countries and cause the effective interest rates of the countries (in terms of mathematical expectation values of the interest rates) to be similar.
Eurobonds give all states the ability to finance themselves regardless of their default probability at the same nominal interest rate. In so doing they push the effective interest rates of countries, to the extent of the annual default probabilities, under the common nominal interest rate, implying a subsidy of the financing costs of the unsound countries.
The nominal interest rate convergence (and effective interest rate divergence) that is a part of the eurobonds has the effect its proponents desire that the interest rates of unsound countries falls significantly. Since the creditworthiness of the euro countries is communitarised, the creditworthiness of the eurobonds also reflects only the average credit quality of the participating countries. The interest rate of the eurobonds will thus likely settle in the vicinity of the value that would otherwise have resulted in the average of all countries. The effective interest rates of the unsound countries will in some cases even be negative.
At the end of July, the nominal interest rate on ten-year government bonds in the euro area averaged 4.6%, according to the European Central Bank, while for Germany it was only 2.6%. Italy had to pay interest of 5.9%, Spain 6.1%. Portuguese and Irish government bonds were traded with a yield of around 11%, and Greek bonds were traded at almost 15%.
The nominal interest rate differences moved in the same order of magnitude as in 1995, one year before the start of nominal interest rate convergence that went along with the announcement of final fixed exchange rates in the euro area. At that time, nominal interest rates on ten-year government bonds in Italy, Portugal and Spain were, on average, as much as 5 percentage points higher than German interest rates, whereas at the end of July 2011, they were only 3.7 percentage points higher.
Even France had to cope with a slightly larger interest rate spread of 0.69 points than at the end of July 2011, when it amounted to 0.65 points. However, Greece's interest rate premium at the time was 10.1 percentage points, which is slightly below the 12.4-point level reported in July this year.
For Germany, a pooling of liability by means of an artificially induced nominal interest rate convergence (and effective interest rate divergence) would in the long term result in substantial additional costs. These additional costs can be calculated for the period after the expiration of all conventional German government bonds under the assumption that the nominal interest rates of the eurobonds would potition themselves at the average interest rates in a regime without such bonds and that interest rate spreads without the eurobonds would remain where they have been as of late.
At the end of July, the yield of 10-year German government bonds was 2.0 percentage points below the euro area average. For 5-year bonds the yield spread was 2.6 percentage points; for two-year bonds it was 3.0 percentage points. The average yield spread therefore depends on the term structure of German government debt. Assuming an average maturity of 7.5 years, this results in a yield spread of 2.3 percentage points. Based on the overall current level of gross debt of the Federal Republic of Germany of €2080 billion (as of the end of 2010), additional interest expenses of €47 billion per year would result.
The calculation is lower if instead of the interest at the end of July the average values of the first seven months of 2011 are used as the basis for comparison. Average German interest rates in this period were not 2.3 percentage points lower, as at the end of July, but 1.6 percentage points below the euro area average. Consequently, using this as a basis, additional interest expenses of €33 billion per year result.
The calculation shows that the expected additional annual expenses depend on a number of assumptions. The additional costs would be lower if debt in the euro countries is reduced, that is, if austerity programmes are implemented in the euro area that go beyond the requirements of the German statutory debt-reduction requirement. This, however, is extremely unlikely. On the contrary, it is to be feared that eurobonds will reduce the incentive for consolidation in the euro area since the disciplining effect of interest rate spreads would be eliminated. Whatever country is more indebted than the average drives up the interest rates for eurobonds slightly, but this disadvantage mostly affects the other eurozone countries and not the country itself. The smaller the country, the smaller is the share of the negative consequences of additional debt that affect this country and the stronger the incentive to carelessly take on additional debt. And the debt incentive as such exists for all countries, including the larger ones. The debt of the euro area is thus likely to grow even faster than in the past, which will increase the interest rates for Eurobonds that the capital markets will require.
It is above all to be feared that investors will doubt that the more solid countries will actually be able to shoulder the risks that come along with the liability union. After all, even Germany with a debt ratio of 83% is far above the limit of 60% permitted by the Maastricht Treaty. This would result in a loss of confidence and renewed turmoil in the financial markets, which would then also affect Germany directly.
Some may be inclined to counter the negative incentive effects by limiting the eurobonds to a certain proportion of GDP, for example 50% or 60%; debt that goes beyond this would be the responsibility of the respective countries. But this proposal sounds better than it is. What would happen under this system is that the debtor countries would first refinance their debt with eurobonds alone until the debt limit is reached. For the first few years the debt limit would thus only be on paper and would have no real meaning. And when in time more and more countries come close to the debt limit and fear having to pay higher interest rates for new debt, they will exert political pressure to set a higher debt limit. Past experience with political debt limits in the euro area unfortunately leave little doubt as to what will happen.
Some proponents of eurobonds argue that they would have a high recognition value and for the investors of the world would thus suggest greater liquidity than the individual government bonds in the euro area. This feeds hopes that they can be placed at lower interest rates than the current average of euro interest rates. The liquidity effect is conceivable but likely to be of lesser importance. Surely it will not match the importance of the credit rating effect on which the above calculations are based. The liquidity of the eurobonds will likely not come close to that of German government bonds, and even if it did, their creditworthiness would not even remotely match that of current German government bonds since the liability is offered by countries whose ability to pay is increasingly being doubted by the markets. Thus Germany will certainly have to pay much higher interest rates as would be the case if it did not join the liability union.
One might conclude from this that in contrast to the above calculation the eurobonds would have to carry the joint and several liability of all participating countries. In fact, there is a fictitious scenario in which lower interest rates than the average for the euro countries would come about because the eurobonds would be serviced completely even if only one single euro country survived and assumed the debts of everyone else. But this scenario is completely unrealistic because even Germany as the largest country with the best rating so far would be driven to default in such a case. After all, the GIPS countries alone and together with Italy have more debt than Germany by half, and Germany today with a debt ratio of 83% is far beyond the 60% limit of the Maastricht Treaty. Those who maintain that with eurobonds interest savings could be achieved over the present average assume unrealistically that Germany, although jointly and severally liable, is not exposed to a greater default risk than is the case today.
Even in the case of the proportionate liability for the eurobonds on which we based our calculations, the Ifo Institute strongly advises against the introduction of eurobonds. Even if Europe had the strength to form a federal state, it would make no sense to communitarise the liability for government debt that has been taken on. Even in the United States of America, which exists as one country, one state is not liable for the other. The principle of liability is the basic principle of any rational economic activity and one of the cornerstones of a market economy. Whoever abandons this places Europe's future in jeopardy.
A sharp global slowdown would weaken exports of both goods and services, but the larger impact on India would be through the secondary channels of net capital outflows, tighter financing conditions, falling confidence and negative wealth effects. With the domestic economy already in a cyclical downturn, worsening global growth will slow real GDP growth to 7.0% y-o-y in 2011, instead of 7.7% in our base case. Meanwhile, a 15% correction in global commodity prices will lower WPI inflation to around 7% y-o-y by December 2011, in line with the RBI‟s March 2012 projection.
India‟s consolidated public debt at close to 70% of GDP does not leave much scope for additional fiscal stimulus, as a slowdown can hurt revenues more than the benefit from lower subsidies. However, there is substantial room for a monetary policy response. With repo rates at 8%, the highest since May 2008, the RBI will likely keep the repo rate on hold in September and could cut policy rates thereafter. With FX reserves at USD286bn, the RBI has enough of a cushion to defend INR, but FX intervention would likely drain INR liquidity. We believe that cutting the cash reserve ratio (CRR) would be the RBI‟s first course of action, followed by open market operations in order to inject INR liquidity.
Amid volatile swings, sectoral institutional ownership levels remained constant even as positive flows failed to prop up Nifty, which was down 3.2% in Q1FY12. From the portfolio perspective, the stake of BFSI in the overall FII portfolio declined whereas the consumer sector surged. A similar trend was seen within the DII portfolio where consumer sector soared while capital goods sustained its place. FIIs added positions in Infosys and L&T while slashing SBI, RIL and Axis Bank. A conspicuous trend in the Q1FY12 institutional flows was the growing appetite for defensive sectors (read consumer) as well as bottom up ideas.
Sectoral ownership: FIIs hold more BFSI, IT, DIIs stick to cap goods
Reasonable stability was apparent in the sectoral ownership level on a Q-o-Q basis though divergences, between FII and DII ownerships, within sectors continue. For example, FIIs continued to hold substantially more within BFSI, software, auto, telecom and real estate sectors whereas DIIs hold more in capital goods.
Portfolio: FIIs up weight on FMCG, sustain overweight on BFSI
Within the FII portfolio, share of FMCG sector saw a sharp jump (120bps) while the share of BFSI slipped ~100bps, Q-o-Q. Despite this, BFSI continues to be a key overweight while FMCG is an underweight. One of the reasons for the under-representation of the FMCG sector is the underweight position of ITC within the FMCG portfolio. The representation of other sectors within the FII portfolio stayed largely unchanged, Q-o-Q.
DIIs hike FMCG share, overweight on cap goods
FMCG sector also found favour within the DII portfolio, its share shooting up 150bps Q-o-Q. The share of energy and materials, however, saw a decline of 50bps. DIIs remained overweight on the consumer and capital goods sector even as underweight position in BFSI and software was maintained.
FIIs shed SBI, RIL, but lap up L&T, Infosys
On an average price basis, we estimate that the highest FII selling within the BSE-100 universe in Q1FY12 took place within BFSI and energy sectors while the highest buying was seen within consumers and software. Our estimates suggest that SBI and Axis Bank within BFSI and RIL and Cairn India within energy sector were among stocks in which FIIs reduced their positions while adding onto benchmark heavyweights such as L&T and Infosys.
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We are observing selling in US banks after imposition of Financial Transaction Tax. One more reason could also be the ban on short selling in Europe. As Global Investors cannot benefit from shorting their banking positions in Europe, they might be hedging their global risk by shorting Banks in US.
Is the impact percolating down to India as well? It seems so. The last two trading sessions have seen huge additions of Open Interest in Bank Nifty, as also in almost all Banking Stock futures combined with sharp erosion in price.
Banks have also suffered due to incessant rate hikes by the Reserve Bank of India. Rising Non Performing Assets and slowing credit growth are also hurting the balance sheets of domestic lenders.
SCRIPT | C/P | OI Addition in last two days | HIGH/LOW of Settlement | |
Bank Nifty | 9954 | 17 % | 10967/9954 | |
AXIS BANK | 1173 | 14 % ( 17% yesterday) | 1256/1173 | |
BOB | 792 | 20 % | 873/792 | |
CANBANK | 431 | 17 % | 476/429 | |
BHANBANK | 83.1 | 5 % | 98/83 | |
ICICIBANK | 912 | 6 % (8% yesterday) | 1047/912 | |
INDUSINDBANK | 247.2 | 18 % | 274/247 | |
OBC | 315 | 7 % | 354/315 | |
SBIN | 2175 | 25 % in last 4 days | 2356/2175 | |
PNB | 1028 | 18 % | 1123/1028 |
These stocks may give some bounce back if global market conditions are good. That should be good opportunity to go short again with stop loss or an options hedge.
Do You Know?
Traditionally "equity investments" have been considered as long term investments. However, most of us are hard-wired to think short term and "instant gratification" is the norm in the world we live in.
Every investor we come across asks us the question how long is "Long Term"? Though there is no definite answer, we can highlight the benefits of long term investment through the following synopsis. Analyzing the Rolling Returns of BSE Sensex over the last 15 years, following have been the observations:
Traditionally "equity investments" have been considered as long term investments. However, most of us are hard-wired to think short term and "instant gratification" is the norm in the world we live in.
Every investor we come across asks us the question how long is "Long Term"? Though there is no definite answer, we can highlight the benefits of long term investment through the following synopsis. Analyzing the Rolling Returns of BSE Sensex over the last 15 years, following have been the observations:
We trim SBI's FY12e and FY13e net profit forecasts on higher NPA provision assumptions. We retain a Sell as SBI's likely high credit costs would keep RoE lower than that of peers.
NIM expands, though further gains unlikely. NII rose 32.8% yoy, led by a 183bps rise in domestic credit-to-deposit to 76.7%.CASA share improved 38bps yoy to 47.9%, and grew 18.8% yoy. Due to a 44bps yoy rise in NIM to 3.62%, we raise our NII for FY12e and FY13e by 6.5% and 7.7%, respectively. Yet, given SBI's rising liability costs, particularly short-tenure deposits and a stretched credit-to-deposit, NIM has little scope for further gains.
Asset quality suffers, high slippages persist. Fresh slippages of `61.8bn (~3.4% of loans) indicate that asset quality is still suspect; ~20% of restructured loans (`37.3bn) are NPAs. We raise credit cost estimates by 12.2% and 9.9% in FY12e and 13e, respectively, due to likely high defaults. SBI's management estimates net NPAs of 1.5% by end-FY12. We expect this to be attained through higher NPA provisions, rather than lower incremental slippages.
Low capital adequacy necessitates infusion. Tier-1 capital is now a low 7.6%, making capital infusion paramount for business growth. Management expects the government to infuse capital via a rights issue in FY12, but the quantum is still not finalized.
