In Ahmedabad Gujarat from the beginning of new year, all HP petrol pumps have hiked CNG prices by more than 8 rupees and selling it at 50 rupees. It will be considered a strange move as nobody has expected such. Already people are struggling from high cost of living and inflation. There is not even single month relief from government authorities as every month there has been one or the another price hike announced.
It was been quite a month since the last newsletter (just as well I was on extended travel schedule!) , culminating in the events of this past week with the announcement of the Euro rescue package. These are uncertain times with markets fluctuating frenetically between the "risk-on" and "risk-off" trade, and it is important during times like these to re-evaluate (and stay with) the "big picture" view on global markets and economies. Few investment greats do that better than Bill Gross and Mohammed El-Erian , co-CEOs of the world's largest and one of the most successful bond fund managers – PIMCO. They were both interviewed recently by Counselo Mack of Wealth Track , and I have summarised below the key points:
-US growth is likely to average 0 to 1% over the next 12 to 18 months. This is because of weak consumer demand (which is 65-70% of total growth) arising from real wages being unable to keep pace with the growth of profits and other metrics.
-The struggles in the Eurozone, being the biggest economic region in the world, has serious negative implications and has brought the world to the brink of a systemic crisis.
-Europe needs two things to begin resolving this crisis – a circuit breaker to stop the crisis from spreading further and a clear vision where the Eurozone is heading over the next 3 to 5 years.
-A circuit breaker for the banking sector requires three things: ECB to provide liquidity (which is happening), equity infusion into the banks via the EFSF and improvement of the asset quality of banks.
-Europe will eventually solve the crisis and thereby prevent a downward spiral , but that does not imply that the world will return to the "old normal" as there continue to be serious structural issues facing the developed world which will take a long time to resolve.
-A key structural issue facing the US according to Bill Gross is that "long term profits cannot ultimately grow unless they are partnered with near equal benefits for labour. If main street is unemployed and under-compensated, capital can only travel so far down the prosperity road".
-These type of structural issues, and their solutions or lack thereof, have an impact on markets as they influence growth, government yields and equity prices which discount growth potential.
-Policy actions are having a huge impact on markets today and given the lack of cohesion amongst policy makers the impact is largely negative. Policy actions are also distorting fundamentals making the investing process even more difficult.
-Unfortunately the policy options are limited going forward - for example, on the monetary front with interest rates already very low, the positive impact of further declines in rates is limited.
-Therefore the focus of policy needs to shift from monetary and fiscal solutions, which have worked well in the past, to develop structural solutions to regenerate the economy.
-It is not just about stimulating demand, it is focussing on: 1) reviving housing which is critical to the health of the economy, 2) addressing structural unemployment, 3) get credit flowing again to the small and medium-sized companies, and, 4) increasing investment in infrastructure.
-The current debate between the Republicans and Democrats on whether to reduce the deficit or not is important but it needs to be dealt with later as the immediate priority is for the government's balance sheet be substituted (in a productive way) for the private balance sheet because the private sector is unwilling to take risk.
-Growth is the best way to reduce the debt problem in the developed world but we are unlikely to see growth because of the structural impediments. This has huge implications for investment portfolios.
-Portfolios should be well diversified and weighted in high quality assets in the developed world (government guaranteed bonds like US mortgages, high grade corporate bonds, equities in corporations with good balance sheets), emerging market local currency and $ bonds, diversified currencies, and "tail risk hedge" assets which provide protection against disasters like gold.
Interesting views from two investment greats and very helpful in keeping focus on the "big picture" and not getting swayed by extreme market volatility. The key lesson learnt over the last few months is the critical importance of diversity of assets – in these uncertain times it is almost impossible to predict the short to medium term movement of various asset classes and constructing a portfolio with weightings in cash, longer dated developed world government and high quality corporate bonds, EM local currency and $ bonds, developed world high quality equities, EM equities, commodities and gold should be able to withstand (to a reasonable degree!) market volatility. It is equally important not to overreact to extreme market movements, but use them to perhaps lighten or increase exposure as opposed to panic driven buying high and selling low!
On the European rescue package – it is a step in the right direction and embodies the Angela Merkel "step-by-step" approach rather than the Sarkozy/Cameron "bazooka" approach. Therefore, expect more summits in the future in response to more crises, but also realise that European leaders have shown that they have the resolve to address them (temporarily) and prevent downward market spirals (which is likely to lessen the fear factor in markets). Eventually, they will need to resort to ECB funding to support government bond markets and finally a quasi fiscal union in the form of eurobond issuance. As the above note highlights, the developed world is destined for 1% economic growth for a long while, which when combined with financing costs of 5-6% (for Italy and Spain) on a large debt burden, is not a viable scenario over the medium term.
Honda Motor withdrew its annual earnings guidance in an unusual move on Monday due to uncertainties including currency markets and Thailand's floods just as it was starting to recover from the March earthquake and tsunami.
Honda has been hit the hardest of any of Japan's automakers by both disasters this year, recovering slowly from the supply disruption in northeast Japan and suffering direct damage at its Thai car factory in the Ayutthaya industrial estate.
For the July-September second quarter, Japan's third-biggest automaker posted a 68 percent drop in operating profit to 52.51 billion yen ($693 million) due mainly to a shortage of microchip controllers from quake-hit Renesas Electronics. That was worse than the consensus estimate of 63.5 billion yen in a Reuters survey of 13 analysts.
Net profit, which includes earnings in China, fell 55.5 percent to 60.43 billion yen, also hammered by a sharp rise in the yen.
Honda, also the world's top motorcycle maker, had previously forecast operating profit of 270 billion yen for the year to March 2012, half what it made last year and far below the consensus 360 billion yen.
The maker of the popular Civic and Accord models had been preparing to ramp up overall car production to 125 percent of pre-quake plans in the October-March second half to build up inventory that had fallen after the March 11 disaster.
News Highlights - Week of 17 - 21 October 2011
The People's Republic of China's (PRC) gross domestic product (GDP) grew 9.1% year-on-year (y-o-y) in 3Q11, down from 9.5% growth in 2Q11. This is the slowest quarterly GDP growth rate since 2009. The slowdown was due largely to weaker exports. Domestic demand held up relatively well, buoyed by strong industrial production and retail sales growth.
*The Bank of Thailand decided on 19 October to leave its policy rate unchanged at 3.5%. Bangko Sentral ng Pilipinas likewise kept its overnight borrowing and lending rates steady last week at 4.5% and 6.5%, respectively.
*Hong Kong, China's consumer price inflation (CPI) accelerated slightly in September to 5.8% y-o-y from 5.7% in August, after a cooling down from a 15-year high in July. Meanwhile, Malaysia's CPI slightly increased to 3.4% y-o-y in September from 3.3% in the previous month.
*In the PRC, the industrial production growth rate rose to 13.8% y-o-y in September from 13.5% in August, while retail sales grew 17.7% y-o-y in September from 17.0% in August. Meanwhile, department store sales in Japan declined for the third consecutive month in September.
*Remittances to the Philippines from overseas workers grew 11.1% y-o-y in August to reach US$1.7 billion. From January through August, cumulative remittances rose 6.9% y-o-y to reach US$13.0 billion.
*Last week, China National Petroleum Corporation (CPNC) priced CNH3 billion of bonds, which were issued through CNPC's offshore entity CNPC Golden Autumn. The Korea National Oil Corporation issued US$1.0 billion worth of 5-year bonds at a yield of 4.137%. The proceeds from the sale will be used to finance overseas oil projects. Malaysia's Khazanah Nasional Bhd. issued its first Islamic CNH bond amounting to CNH500 million through its special purpose vehicle, Danga Capital Bhd. The issue had a tenor of 3 years and was priced at 2.90%.
*The Philippine Bureau of the Treasury issued PHP110 billion worth of Retail Treasury Bonds (RTBs). Of the total amount, PHP54.97 billion were 10-year bonds and PHP55.12 billion were 15-year bonds. The 10- and 15-year RTBs have coupon rates of 5.75% and 6.25%, respectively.
*The PRC's Baosteel was given approval last week to issue CNH bonds in Hong Kong, China. Baosteel is the first non-financial entity from the mainland given approval to issue CNH bonds. Non-financial mainland entities were previously not allowed to issue CNH bond unless they were issued via an offshore vehicle or subsidiary. Meanwhile, Hong Kong, China's property developer Wharf Holdings plans to issue at least SGD100 million worth of bonds with tenors of 7 years and yield guidance at 4.3%-4.4%.
*Government bond yields fell last week for most tenors in the PRC, Indonesia, the Philippines and Thailand, while yields rose for all tenors in the Republic of Korea and Singapore and for most tenors in Malaysia and Viet Nam. Yield movements were mixed in Hong Kong, China. Yield spreads between 2- and 10- year maturities widened in Hong Kong, China; Indonesia; the Republic of Korea; Malaysia; and Singapore, while spreads narrowed in other emerging East Asian markets.
India is set to demand a review of provisions of capital gains taxation when it meets Mauritius in December second week to renegotiate the Double Tax Avoidance Agreement (DTAA) that was signed way back in 1983.
Under the DTAA, capital gains on sale of assets in India by companies registered in Mauritius can only be taxed in Mauritius. While short-term capital gains are taxed at 10 per cent in India, they are exempt in Mauritius. So, such companies escape paying taxes in both countries.
Revenue department officials claim that the treaty is being misused for round tripping. Here, an investor exploits the tax advantages offered by a country (zero capital gains tax in Mauritius) with which India has a DTAA, takes money out of India and finally brings it back disguised as foreign investment.
The officials, however, said Mauritius "may not agree with our proposals" without a fight.
The final agenda drawn by the revenue department is being vetted by the ministry of external affairs. The move comes amidst the flak the government has been drawing from all quarters including the civil society, Opposition political parties and the Supreme Court over its alleged inaction on curbing black money generation and bringing it back from bank accounts in foreign jurisdictions.
Earlier, India and Mauritius had agreed to review the operations of a Joint Working Group set up in 2006 to strengthen the mechanism for exchange of information under the India-Mauritius tax treaty, besides putting in place adequate safeguards to prevent misuse of the DTAA.
The renegotiation will seek provisions for past information and banking information, the sources added. The tax treaty between the two nations has facilitated huge foreign investment in the country. Many venture capitalists have structured investments in India, taking advantage of the benefits provided by the treaty.
It is to be noted that Mauritius tops the list of countries brining in foreign direct investment in India. According to the Department of Industrial Policy and Promotion, bulk of the FDI inflows into the country between April, 2000 and January, 2011 has happened via Mauritius-based companies. During this period, FDI from Mauritius stood at Rs 2,69,395 crore or 41 per cent of the total FDI inflows into India.
Earlier, Finance Minister Pranab Mukherjee had said India is constructively engaged with Mauritius to update the existing DTAA convention in line with international practices.
So far, as many as 81 tax treaties with foreign countries have been amended to enable better flow of financial information and 14 tax information exchange agreements signed.
Ballooning Natural Gas Supply-Demand Deficit to Fuel LNG Imports: ICRA
India's natural gas supply has been adversely impacted in 2011-12 due to fall in KG D6 production to 46.6 MMSCMD in H1 2011-12 from 55.9 MMSCMD in 2010-11. KG D6 production is likely to remain at subdued levels over the next couple of years, especially in comparison to the earlier anticipated production of 60-80 MMSCMD.
Regarding domestic gas production in the medium term, Mr. K. Ravichandran, Senior Vice-President and Co-Head, Corporate Sector Ratings, ICRA stated, "Domestic natural gas supplies are expected to increase to around 153 MMSCMD by 2014-15 from 143 MMSCMD in 2010-11. The current estimate is about 22% lower than our previous estimates of 195 MMSCMD primarily due to lower KG-D6 production and delays anticipated in commissioning of KG satellite fields."
On the demand front, despite the significantly high potential across several sectors, the realisable demand for natural gas will be a function of gas supplies in the market at reasonable price, the price competitiveness of gas as compared to alternative fuels, timely commissioning of the proposed transmission pipeline infrastructure, and regulatory initiatives in the power sector. ICRA believes that demand will increase from new customers once the bottlenecks in the trunk pipeline are cleared in the near to medium term. Overall, ICRA expects gas demand to rise to around 410 MMSCMD by 2019-20 from the actual consumption of around 177 MMSCMD in 2010-11.
Commenting on increasing domestic supply-demand gap, Mr. Ravichandran mentioned "India needs to secure additional supply of LNG on a long-term basis, especially in view of less-than-anticipated domestic supply and possible shortage of LNG after a couple of years. India's reliance on LNG is expected to increase further, which will pose significant risks in a scenario of tight LNG supply demand scenario, leading to low availability and high prices of spot LNG."
As regards gas allocation and pooling, an inter-ministerial committee has recently recommended i) preferential allotment of available domestic natural gas to core sectors, that is, fertiliser and power sectors, along with a certain amount reserved for the CGD/CNG sector, ii) cap on domestic gas allocation to certain other sectors and iii) inferred gas price to be used as benchmark for domestic gas pricing. The committee has not suggested any form of pooling at the all-India level across industries but the objective has been assumed to be served by indirect pooling at the end of consumers, with price-sensitive sectors (fertiliser/power/CGD) getting a higher share of cheaper domestic gas. ICRA believes that the policy recommendations, if accepted, will provide more clarity to gas usage mix and pricing, which in turn would help companies across industries to formulate their capital expenditure plans (capex) and future requirements of natural gas.
As R-LNG is an expensive fuel as compared to domestic gas and domestic/imported coal, it is critical for a power producer to tie-up domestic gas for a large share of fuel requirements. ICRA believes that the additional demand from power (around 32 MMSCMD by 2012-13) along with lower KG D6 production pose significant fuel supply risk for gas-based power producers over the medium term. Commenting on this, Mr. Ravichandran stated "If the recommendations of the recent Inter-Ministerial Committee are accepted and implemented by the GoI, the fuel supply risk might be partly mitigated as the new power plants could get domestic gas allocation to the extent of 60-70%". ICRA expects that levellised tariff for a new gas based power plant would be competitive in comparison to those based on imported coal, if R-LNG share as percentage of total gas requirement remains about 30-40%.
Regarding the credit outlook for ICRA-rated companies in the Indian downstream natural gas sector, most of them are in the process of implementing large capex programmes, considering that the sector is viewed to have good long-term demand prospects. While the large capex is a credit concern, track record of executing projects of a similar nature, comfortable capital structure, regulated returns and steady cash flows are the mitigating factors from the credit perspective.
" The prospect of a potential recession in both the United States and Europe has recently increased, driving a sharp reduction in global risk appetite. Traditionally, a slowdown in developed countries - and
a decline in risk appetite - have had an adverse impact on emerging economies and their asset values. However, in the aftermath of the 2008 global financial crisis, many emerging countries were able to recover from the economic slowdown more quickly than developed economies, with the advent of counter-cyclical fiscal and monetary policies, as well as a dramatic increase in global liquidity. Can this
scenario be repeated?
Authored by Bunt Ghosh, Head of Emerging Market Strategy and Risk, Anja Hochberg, Head of Investment Strategy for the CIO Office and Adrian Zürcher, Emerging Market and Equity Strategist for the CIO Office, the paper discusses how emerging markets - while not immune from a potential global slowdown - may again have the capacity to successfully respond to the current market environment with similar counter-cyclical measures"
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