Deja vu

What prompted me to write this post is that suddenly all the talks about the use and production of alternative sources of fuel and conservation of energy have disappeared because Oil although not in the 2-digit territory but is well below $ 147 a barrel. As usual the talks of alternative fuel , electric car , nuclear energy all started with a wham and ended in a whimper.We all know that the oil crisis is not new to the world we had seen it in 70's and times earlier than that . So why are we faltering again and again and stumbling due to high oil prices,what has prevented a radical shift to the alternative source of energy and a radical shift in the demand for crude oil?

This time its no different , now since oil price is easing off we are back to the square one.No wonder ,the day crude oil came down by $5 from its high of $ 147 , the coal stocks came down too , indicating the market is discounting the potential of coal stocks , although I agree it is just indicative but it does suggest the historical behavior.So if the history is anything to go by then this easing crude oil prices is neither due to the result of radical shift in the demand nor due to the surfacing of new alternative source of energy.This is just the temporary suppression in the demand which will surface again once the crude oil is back to the normal and stops visiting the high price territory. Why this happens ? Let us take a simple example:electric car came into existence but never was improvised or its not even seen frequently . The reason , the car is appealing till the time , oil prices are obscenely high but once prices go down we switch back to the conventional form of energy , this is not radical shift,but this is a temporary suppression of demand.Hence it is also difficult for the auto companies to rely on the temporary demand of electric car to invest in some serious technology to build a more efficient electric engine.

The demand suppression that I mentioned above is the short run effect of increase in prices but in the long run either the supply needs to get adjusted or the demand needs to take a permanent shift. When we zero in the long term supply situation , first if we consider the supply of oil , no new incremental refinery has been invested in although we had oil crisis before numerous times and second , investment in new sources of energy , has not caught required consistent attention so as to become a substitute for the oil. Demand has also refused to take a leftward shift . So we have seen several oil spikes and their evil effects on economies.

This whole thought was running in my mind for not to make a prediction of crude oil prices but to ponder over the thought that what will push the serious and the real efforts to improvise, produce the alternative sources of energy and reduce the dependency on oil or on second thought does it mean that once again the currently easing of oil price does not bode well or to be more precise does not bode something different in the long run ??

Ergo I have question to the reader that do you think that this time the high oil prices , rattled economy would bring about a significant and long lasting shift in the demand or a shift to the alternative sources of energy ?????

Should India have a Sovereign Wealth Fund (SWF)?

Before going on to the topic that whether India needs a SWF or not let’s first try to understand what is a SWF. A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial assets. These funds are run by professionals and buy assets in other countries on behalf of the parent country. Most of the SWF owns financial assets like stocks and bonds, one of the well known, sovereign fund having its strong hold in India is Temasek owned by the government of Singapore. In fact recently SWF’s have proved to be a big saviour to the cash starved global markets. The ongoing financial and subprime crisis eroded networth of giants like Citibank and UBS to name few. These banks were in dire need to raise funds and were bailed out by SWF.

So now since we have got a brief idea of SWF’s the question is in the world of globalisation does India require a SWF? I put this question to you’ll my readers what do you think? Do we require a SWF? Do we have enough money to have a SWF. Average size of a good SWF at the start would be atleast $20-30$ billion. Can we use nearly 10% of our forex reserve for SWF.

The above question was recently raised in the Lok Sabha by a MP and as usual there was a uproar. Taking cue from this couple of months ago Iasked this question in front of a close friend, who also happens to be in the financial market. He is of the view that India should not have a SWF as we don’t have enough money for ourselves and our development so it would not make sense to waste 10% of our reserves in SWF. Instead he suggested that part of the forex reserves should be deployed in infrastructural development. Something Chidambaram has mentioned in his book a compilation of his articles between 2002/2004. But alas he himself has not followed what he preached. I think the point made by my friend is valid and is something that most of the economists are suggesting.

But I have a different perspective on this topic. I think India requires a SWF. I know if Mr.Karat or Mr.Yechury would read this they would be fuming with anger but the fact is that we are in need of a SWF. Lot of you would ask me why and what would be this SWF be of use. Well my idea of SWF is a bit different from the one that the government of Singapore or Kuwait has. I guess the government of India needs to have an investment management company of its own u can name it as a SWF or Special Purpose Vehicle (SPV). The way this Investment Company would be different from others would be the nature of the company. India doesn’t need a SWF to buy stocks and bonds of companies abroad I think we have enough world class companies in the country itself. But India needs a SWF to buy assets abroad. Now what do you have to say do we need it or not?

Well let’s look it this way India is growing at 8% requires energy to fuel this demand, needs food to meet the ever increasing appetite of its people, requires industrial metals for infrastructure, needs more coal than what we use today to fulfil the dream of power for all. If I summarise all these things one thing that comes out is the demand for commodities from India is bound northwards. So if we need more oil we need to import it which means higher deficit for the government, if we need more coal we have bottlenecks in our country so will have to import, more food grains imports. Over all the import burden would rise.

What would this $20 bn (size of SWF is always debatable) do is that it will give us good opportunity to buy assets overseas. For eg: I have read lot of times that ONGC bids for oil blocks in Sudan but looses out to Sinopec. If we are able to use out forex reserves in a concrete way it will make a difference. Buying oil blocks internationally would reduce our import bills. So is for any other metal India would require more Iron ore for steel there are enough iron ore mines in other countries which can be bought. I could give ample amount of examples to support my stance but the fact is that we need more commodities to meet our growing needs and this is likely to increase the conundrum. This can only be solved either by importing more which means higher deficit and large subsidy bill or by increasing supply something which is not in India’s hand at least for some of the important commodities. Which means the only way India could solve the problem is by assets internationally and this can be solved by a SWF.

I leave you my readers with this question that should India have a SWF? I would like to read your views on it. We could have diverse views but this is a topic of debate and something that needs to be taken up in corridors of power.

Revenge of the old economy

Today, as I sit down to write this article, someone (preferably a Central Banker) somewhere would be worried and thinking about the strategies to combat an evil called inflation. Inflation has today become a global phenomenon and has stopped the wheel of growth in many emerging economies like China and India. It has also managed to send developed economies into the recessionary phases. To me, this is the revenge of the old economy. Inflation is today fuelled by commodities like energy, food and primary articles sectors which were neglected for nearly two decades. The old economy was neglected due to the resurgence of the new economy sectors like retail, IT & ITES. Commodities like metals and energy have been reeling under the pressure of underinvestment for nearly two decades.

This decade definitely belongs to commodities, which has witnessed one of its best bull run in the recent times. It was their time to take revenge, it was their time to get noticed and the revenge has not been sudden but gradual. Early part of the decade saw interest developing in commodities when the demand started to pick up as the wheel of economic growth started to move and countries like India and China started to demand more to meet their consumption needs. The second phase came during the middle part of the decade when demand from the industries grew and we saw investments growing in the manufacturing sector pushing the prices further up. The third phase has left the policy makers worried and have led them to make certain policy changes which has hampered growth.

Commodity prices cannot go up forever and breaks will have to be applied either for good or for worse. There has to be a conclusive policy to stop commodities prices from rising to levels which can threaten world economy. So far, central banks have just been mere spectators and their steps to curb inflation and control prices have failed miserably. The solution is not so easy and we will not be able to achieve it if we take short term steps. The solution to this problem lies in the cause of the problem. Cause: a) Underinvestment & b) Food prices have risen due to usage of food products for fuel.

Also the issue with regards to global commodity crisis is such that it requires efforts from the global community to combat the current situation. Lone efforts from India, China or US won’t work. It will have to be a conclusive plan and something that all of them needs to work together. There has to be an UN backed policy on food and food products. Usage of Agricultural products for energy purpose would solve our short term energy crisis but it would spiral into a food crisis for our coming generations. This would then make us more dependent on GM foods and that is not a good sign. Farming has been neglected for a while and most of the farm land is been used for SEZ in various countries this is something that is calling for a dooms day scenario. Our current hunger to grow at any cost is going to affect our coming generations.

The second problem is that of underinvestment for nearly decades commodities have been under the phase of lack on investment. We haven’t heard of any big investment done in any oil field or we did not hear of any big ticket investment in the mining of metals. It is only now that we are hearing mining and oil companies doing investment in natural resources. These investments would bear fruits only after 4-5 years till then it would be too late by then. Just to put it into perspective crude oil one of the most important commodity on the planet earth is in a demand supply conundrum. Right now oil demand is around 87-88 million barrels per day. Total production capacity available is at 90 mbpd. Which means currently we have a spare capacity of 2 mbpd all of it been in Saudi Arabia. By 2013 it is estimated that oil demand shall cross 95 mbpd and in the next 5 years additional capacities of 6 mbpd would likely to be on track. This means that the spare capacities would be reduced by 50%. This situation is not only in oil but in other natural resources also. What we need today is a spate of public and private investments in the natural resources sector. There are other concerns grappling this sector it is capacity concerns with allied industries like rail and port. There are capacity issues which lead to artificial shortages just like what we are facing in coal market. These also have to be addressed by one and all.

Sometimes these price movements’ leads to countries taking extreme policy measures like curbing exports and this leads to shortage in another country. Since this is now becoming a global phenomenon it actually requires policy measure that incorporates interest of all countries. I think the UN has to be more proactive and involve World Bank to undertake projects in countries where there is dearth of investment but ample resources.

If we don’t take notice of it today than it would be too late for us. The “Revenge of the old economy” would lead to disaster.

ECB needs to put Inflation on back burner:

The US Fed has kept the rates unchanged ,as expected ,and let it on the markets to put up with weak dollars.The logic behind raising the interest rates would have been to the strengthen the dollar and to rectify the oil path.But as the Fed didn't raise the interest rate , the oil reached to another life-time high and also it is quite clear that Fed is not going to increase interest rates any time soon so the funds are channelized into the oil and gold.

Fed has reservations regarding the growth prospects of US , which is known to the universe now and although the dollars has been weak for quite sometime ,the weakness in dollar has been a boon in the form of export surge that has given a boost to the US GDP(which is expected to be ,thank gosh!!,at least around 1% , thanks to the Emerging economies)but this is not due to the internal growth (mentioned in my last post that US is expected to slow down or shrink ) but due to the growth in emerging economies ,which has led to the exports from US to the Emerging Economies.US is some how though not markedly sustaining in the wake of the weak dollars.

The other giant central bank to be watched is the ECB meeting coming up this week. The ECB has couple of stark differences when compared with US Fed in ways that ECB 's the main motto is to contain inflation while US fed mandate is not only to control inflation but to have sustained economic growth as well and also ECB is working as the umbrella for more than dozens of countries unlike US Fed that stands only for one country.All these traits are important to be considered when the gambit of the ECB is predicted.So far,ECB has tried to contain inflation and and hence increased interest rates , reducing the attractiveness of European goods as a result the market expects western europe to slow down.Needless to say ECB has not been able to keep up with the various demands of the countries under its purview.The whole region has undergone a not-so-uniform growth.

In the background of above mentiomed scenario any further increase in the euro 's strength will further mar the performance of the euro region.So we have two scenarios to ponder on . Firstly,In case if ECB's Mr.Trichet and its co members increases the interest rates then it will unleash more problems for the macro economics. Euro region will be further pushed into slow down , weakening dollar will further boost oil prices and rest is history to all of us.
In case if the ECB ,the second scenario, does not increase the interest rates , the thing I m betting on, that might give a boost to the exports and may cool down the fired up crude oil and that would give boost to the stock markets across the board.Hence I feel that the remedy has to begin somewhere and Mr.Trichet can play a pivitol role.

I think that ECB although should remain cautious about inflation but it should keep the interest rates unchanged and now should focus on the growth prospects of the euro region.

Inflation more monstrous for the Emerging Economies:

Inflation is the new monster that every country is dreading. But there is a difference in the potential damage that inflation can do to the US and other emerging countries.Why ? That is because now the emerging countries are undergoing some fundamental changes that put the emerging countries in different perspective calls for individual actions on the part of each such economies as far as their monetary policies are concerned and how can this can be done..?By not pegging against the US dollar.

US endured the credit crunch, credit crunch affected the economic growth and consequently to relieve the situation ,the monetary policies were eased off in US. At that time the concern was growth and not inflation but now concern has shifted to inflation but still at this stage, in US, it seems like the easing would be stopped i.e.no more rate cuts but it does not make it apparent that the interest rates would be increased.There are two reasons for it ;firstly ,the imminent election and secondly the expectation of the shrinking of the US economy which will help in offsetting the inflationary pressure .As emerging economies like India and China have pegged their currency with US dollar ,this has led to the brewing of high inflationary situation in these countries too.

But ,this time around , Emerging Economies(EE) should react and behave in the manner suitable to their current economic situation.To be more precise-as i mentioned earlier that EE economies are undergoing sea change and so this change should be incorporated in their monetary policies. The internal demand curve in the countries like India and China has shifted rightwards and hence the equilibrium is expected to change and also it implies that the economic development of emerging countries is not only depended on the US and other developed countries but also on their own internal growth and so any measures that affect this growth should take into consideration both the factors. Logically it follows that the countries need to de-peg its currencies to US dollars to have more independence regarding its own interest rate policies.

To elaborate with example - If we take look at the investment in infrastructure , India is expected to invest 500 billion$ through its five year plan (data from Economist) and China along with other oil producing countries are expected to invest in fixed asset majorly .Investments in infrastructure translates into prosperity and lays path for the sustained economic development and the growth does not seem to be slowing down in the EE.While in US there is no major contribution to the infrastructure any time soon in other words it is expected to be flat .Hence, in India the RBI should start tightening the monetary policy regardless of how long US takes to tighten its own and India should smoothen the path of its own economic development.

It will take more than traditional method of pegging currencies to US dollar ,to combat the inflation, by the emerging economies as they have much more to loose by following the US dollar this time.

COAL-It doesn’t glitter but its gold

Another commodity which has caught my imagination over the past couple of months since the time I have started to track it. I have been fairly fortunate enough by sheer coincidence. My foray in the commodities research concurred with the Bull Run in global commodity markets. Over the last 4 years that I have been in this market each year have been exciting and every year there has been a new commodity which has become darling of the market। . 2008 is the year for Coal and Natural Gas. I will take up natural gas in my subsequent articles in the current one let’s look at coal. After crude oil by far one of the most important commodity in this world when you look at the energy composition.

Introduction

Coal can be classified in two categories broadly thermal and coking coal (hard and semi soft). Thermal coal is used for electric generation purpose where as coking coal is used for crude steel production. The demand for both these categories is fairly high. We would be focussing on thermal coal in this article. Over the years despite the fact that coal is of strategic importance it has never really been talk of the town or coal prices never flew of the roof just the way crude or some of the other commodities did. Unlike Crude oil coal is easily available and is also in abundance. Recently coal has become the talk of the town and just like other commodities coal is also witnessing supply side issues. These days’ supply side issues are something that every commodity is going through but hold you horses the supply issues in coal are a bit different from other commodities. Unlike Crude oil coal story is not about lack to reserves and new capacities to meet demand. According to estimates current coal reserves are around 908 billion metric tonnes with current supply been at 5.9 billion metric tonnes coal reserves can last for nearly 153 yrs.

Supply

On the supply side there are two big issues lingering a) mine damages and b) infrastructural issues. Coal is produced across the globe but nearly 70% of coal comes for 4-5 countries US, Russia, China, India and Australia. Other important producers are Indonesia and South Africa. There have been supply side issues with some of these big producers. Flooding in Queensland has significantly caused damage in the Australian mining area and has constrained coal supply. The mines in Queensland were flooded during the early part of the year and it would take couple of years to restore the mines to its full capacity. In the case of South Africa wet weather had struck the first blow to the coal mining industry. Due to the wet weather in South Africa coal could not be delivered to the power plants and there were brown outs (brown outs is a phenomenon of low voltage) in South Africa. The power utilities company could not produce required amount of power as they don’t have enough stocks of coal with them. Due to this the mines are receiving just 90% of its required power and they are running below capacity. It’s sort of a vicious circle in South Africa. China was another country where weather issues have hampered the deliveries of coal to power plants. Another big coal exporting country is Indonesia the central government is Indonesia has decided to reduce the exports as they themselves require coal to meet their indigenous requirement; this is likely to create tightness in the market.

The other issue on the supply side is infrastructure bottlenecks in some of the major coal producing countries. For example in India itself there are logistics issues apart from quality issues. There are significant rail and port capacity constraints in big exporting market where the capacities have not increased in line with demand for coal. In one of the recent instance, Newcastle one of the biggest coal exporting ports ships were lying for nearly 3 weeks and coal could not be exported. It’s much more severe issue than the weather concerns hampering supplies as the latter is a short term factor but the infrastructural bottlenecks stays for long time. My guess is if the governments of exporting nations take a stock of the situation today and start working on it would take at least 2-3 years to ramp up capacities till then every now and then the supply issues will crop up.

China and India driving demand

According to the IEA, developing countries, should contribute 74% of the increase in global primary energy use between 2005 and 2030. China and India alone will account for 45% of the increase mainly due to the robust demand in China and India where most of electricity is produced by coal. Until recently, China was able to meet its domestic coal needs from its own production. In 2007 however, China became a net importer of coal while traditionally it has been one of the major exporters in the coal market into a net importer. In order to meet its energy demands, India is increasingly dependent on imports. This has also affected the coal sector as India’s economy relies heavily on coal, which accounted for around 39% of total primary energy demand. The Indian Government now plans to build a number of huge or so called “ultra mega” coal-fired power stations, each with a capacity of 4,000 megawatts (MW). Each of these 4,000 MW power stations is expected to consume about 15 million tons of coal a year. India has large coal reserves, they typically comprise high ash content and thus imported coal is needed to reduce pollutants.

Rising Cost

Rising costs should support thermal coal prices over the longer term driven by higher personnel and maintenance costs. Also, the declining quality of coal deposits and less favourable geographic locations of coal mines will support costs. Having said that coal is an efficient source of energy than crude or gas.

Coal vs. Crude

As mentioned above Coal is far more efficient as a source of energy than crude oil. With crude oil prices expected to remain high it is likely to help coal demand where we could see demand substitution setting in. If we try to compare coal and crude, 1 tonne of coal produces 7,100 kilo watts of electricity where as 1 tonne of crude oil produces nearly 6,500 kilo watts of electricity. Which means in volume terms it produces 600 kw more. Even in cost terms coal is cheaper 1 tonne of coal costs USD 120-160 depending on the place from where one imports. Where as in terms of crude oil assuming that crude consolidates and remains at USD 100. 1 tonnes of crude oil would cost roughly USD 600. Which means crude oil is 3-4 times more expensive than coal. Even if coal prices increase by 100% over the next 2-3 years coal would continue to remain cheaper than oil.

Looking at the long term Coal to me looks like a lucrative investment. Over the next couple of years I expect coal prices to increase anywhere between 50% - 75%. Though coal prices have increased by nearly 30% this year but I believe and my conviction in the market makes a case of further more upside. Coal continues to remain a cheap source of energy and the power of the commodity has not been factored in the price.

Crude USD120- A bit too early

At the outset I would like to apologies for not updating the blog. Over the last couple of months there has been something that has been worrying me and it is the sporadic rise in the price of crude oil. By any stretch of imagination the recent rally looks out of place. I would not argue to the fact that yes crude oil market is in a secular bull run and the Bull Run in crude has always had its own share of hysteria but to me it has gone a bit too far this time. I have had an uneasy feeling since the time prices crossed USD90 and it has been growing since then. When I look at the fundamental situation at present in the market doesn't justify such a rally. It has been the financial flows which have been the largest culprit maybe a study of behavioral finance can put some light on the rally. The rally started with a free fall of the USD and as usually geo political tensions in the Middle East. These two have been the biggest driver and have also been supported by the tightness in the distillate markets, slowing imports and huge financial flows into the market.

According to me somewhere near 20-30% of the crude price is purely speculation and nothing else and I believe that it is largely driven today by large banks and hedge funds. I am not really a great exponent of the theory that weakness in the USD should strengthen the crude oil price. I tried to run regression on the time series of USD and Oil and even by historical standards it looks 10% over stretched. Going by the dollar weakness theory with the recent strength in dollar crude oil prices should be coming down but it continues to go up. Which means that is not a full proof theory to trade crude oil with.

Another thing that worries me is the excessive geopolitical premium in the price of crude which never seems to go off even when the geopolitical tension has subsided. Over the last 6 months or so there were events in Middle East and Africa and currently there is peace in both these places but the premium has not shaved off from the price of oil. When you look at both these factors alone there is nearly 20-25% excessive premium in the price of oil. Which means that oil price should have been around 100$ when I remove excessive premium out of the price. Still I haven’t really analysed speculative premium in the market though there has been a brief consensus amongst lot of participants off the record that there is some speculation which has led to the price rise. This trend is pretty evident with the CFTC data released every week.

When I look at the fundamentals of the market it surely gives me a sense of tightness in demand and supply but not as tight as the prices are showing them to be. The price rise in oil is a function of what is going to happen to supply and demand in future. When I look at the data available from various oil producing countries there is nearly 11-12 million barrels of oil is likely to come on track. In 2008 alone it is estimated that nearly 5 million barrels of oil would be on track. So honestly its not as tight as it has been shown to be. Yes there is peak supply on the cards but things are moving too fast in terms of prices. Even with the estimate that 25% of the projects are behind schedule at least 3.5 million barrels would be on track and that is likely to take the spare capacities above 3 million barrels. Also to some extent there has been artificial demand supply tightness created by some parties. There is a catch when you look closely at the demand supply and refinery throughputs figures. The overall crude supply in the market is 87 million barrels per day whereas the demand is at 86.6 mbpd and only 74 mbpd goes into refineries for refining into products which means that nearly 12 mbpd of oil is going into various coffers as inventories. We have already seen oil been stocked by US and China into their strategic petroleum reserves (SPR). The question is that why does US who has increased their SPR from 500 mb to 700 mb in 2-3 years needs to be buying oil above USD 100 for their SPR. Also the economics of business is playing an important role since the refineries are not making profits as it was making earlier due to high crude prices they r not refining enough products and creating shortage of products which has led to rise in price of crude and products. Also with prices consistently above USD 80 it gives lot of space for the non traditional oil producers to come out with the new kind of oil where the cost of production is roughly 40-50$ and an IRR of 17% it would still give them handsome profits. One more point is worth looking at is when crude was at USD 70 there was a huge cry about alternate source of energy and ethanol now when crude is above USD 100 I haven’t heard anything about them.

When I look at all these factors it surely feels that there is more to demand and supply in this market that is driving prices. I feel it’s the financial flow and the need for an alternate investment avenue for investors in wake of global financial turmoil is pushing prices. I feel the the realistic price of oil should be between $85-$90

India’s Robin Hood arrives – Chidambaram rolls out goodies for all (Score: 8/10)

By far one of the best budget that I have seen in last 7 years that I have been following budgets and Indian economy more closely. Panniapan Chidambaram had goodies for everybody; be it the people of India or the farmers of Bharat. With an eye on the election and continuity of the robust economic growth this is the best thing that Finance Minister could deliver. Though there were few misses but the hits were more than the misses.

In my last blog I had written that we should not be concerned that the GDP growth has come down from 9% and above to sub 9% but what is more important is that how inclusive the growth is and is it touching the poor people of rural India and whether agriculture can grow at 4%. I have been for long saying that the important thing for rural growth is not only irrigation and fertilisers but it is rural infrastructure and good seeds. And this budget has both an increased outlay for rural infrastructure. I would like to go into a bit detail of the budget and analyse each section.

When I first saw the budget I felt what a lousy one Finance Minister had come out and reacted the same way as capital markets did but when I sat to analyse the budget I felt he has done a great job. Let’s look at details if the budget:

HITS

1) Economic Growth: The good part is that despite the blip in GDP growth the FM has been able to maintain the GDP growth above 8.7%. Though agriculture continues to be a laggard the FM is taking some great step towards providing a fillip to the sector. One of them is increasing the investment in agriculture to 16% of GDP from current 12%. The government is talking about inclusive growth in the economy and for the first time we are looking at some great concrete steps. Lot of governments have come and reduced the interest rates or have given soft loans but waiver of such big amount will go a long way in helping the farmers bettering their living standards and reducing farmer suicides. If the standard of living of rural India improves it will only do a world of good for the economic growth.

2) Education Programmes: Today’s India story is about outsourcing, is about knowledge and it’s about “Young India”. For long NASCOM has been talking about the dearth of manpower we are going to face in next half decade or so and I think it is great step that government has taken by setting up new IIT’s, IIMs and some other Scientific research institutes.

3) Agriculture: One of those sectors which has been a big laggard for a long time but which continues to touch more than 70% of the population. There has been some revolutionary steps take for half decade or so. The NDA government first came out with the Kisan Credit Card which helped in getting easy access to credit which was followed by the thrust given by UPA on agricuktural credit and we have achieved more than Rs.280,000 crore of rural credit. Also according to the 11^th Five year plan we will see investment going up to 16% which is a great step. The big step that government has taken is waiving off RS.60, 000 crores as debt form marginal farmers and this is likely to have a great impact. This would mean that farmers have more money with them and this is likely to drive consumption in the country. This is also likely to clean balance sheets of PSU banks that have got huge exposure to rural loans. Though the big issue is that how is the government going to fund it will it be through bonds or will the government take the hit itself. The increase of RS.14, 000 crore in rural infrastructure is also likely to boost the agriculture sector.

4) Natural Resources: According to me what lot of people have missed out is that nobody has looked at the steps that government has taken is setting up of the coal regulator and coal distribution policy and also mulling that private participation should be allowed more in coal exploration. This would help the power generation units and it would also ease the coal shortage in the country.

5) FRBM: Over the last eight years governments have been working fairly hard on achieving fiscal prudence. The FM has in fact beaten hi own target and achieved FD 3.1% of the GDP. He has also set a bold target of 2.5% next year. Whether he will be able to achieve it or not is a big question. I will take it up later.

6) Direct Tax: The decision taken by FM in this section is a way of saying thank you to the working population of the country for the contribution given to the tax kitty of GOI. The increase of exemption limit form Rs.110, 000 to Rs.150, 000. This is likely to drive more consumption in the economy and help the GDP of the country.

7) 6^th Pay Commission: The sixth pay commission has recommended an increase of 25% for all government employees. This is going to increase the money in the hands of the individuals. Now here is the big work for the government that this incremental money does not go only into savings but also increases the consumption in the country so that it keeps the wheel in the economy moving fast. Since the Indian story is all about domestic consumption if it keeps on moving India will be able to overcome the global slowdown.

Misses

1) Infrastructure: This is one front I am utterly disappointed, the government had no mention of infrastructure in this budget. We are talking about higher consumption and higher income in the hands of people and cheaper cars but do we have enough infrastructures to support these rising demands. I would like to see more corridors and more rural infrastructure.

2) Capital Gains and Transaction tax: I guess this was something which was not required. We could argue that how much % of the population invests in the capital markets but increasing the tax by nearly 50% was uncalled for. Also another big step was that the GOI introduced Commodity Transaction Tax; the commodity market is still grappling with and trying to overcome the effects of ban on various commodities and now they have another issue at hand. He also did not comment anything on the Abhijit Sen committee report.

3) Education: The budgets for years and years have mentioned about spending on education but nobody has ever spoken about the teachers who impart education. The problem today is not only about enough schools and colleges but it is also about quality teachers. Today nobody wants to join government schools and colleges as there isn’t enough pay. I still remember in School my teachers used to tell me they used to get Rs.2 for checking one SSC paper. Today a professor who teaches in university colleges gets Rs.200 for one hour. IS this the way we going to treat our teachers and is this the way we gonna thank them for imparting quality education. If we donot increase the emoluments of professors and teachers then they would shift to private jobs in the corporate world.

4) FRBM: When one closely looks at the fiscal deficit figures given by the government for 2008-2009 it paints a different picture. The FM aims to achieve 2.5% of GDP as FD next year beating the 11^th Five Year Plan target of 3%. What the Fiscal Deficit figures do not include is Rs.20,000 crore of farm loan waiver (Rs.60,000 crore written off in 3 year tranches), it also doesn’t take into account the 6^th Pay commissions extra disbursements. This means that the government may not be able to achieve 2.5% but could be very well achieving the target of 3%. Though when you add up these two figures it pushes fiscal deficit above 3% but with revenues for last few years beating governments estimates which I expect to happen this year also I guess 3% is easily achievable.

Overall to me this is a consumption driving budget this will keep the wheel of the Indian economy driving. What we have to look at closely is that how surplus cash in the hands of individuals is used. Do we have enough resources to fulfil the demand and also the excess cash should drive consumption and not runaway inflation. One last thing I would like to see from the FM which he has not touched upon in this budget is some sops for the exporters who have been hard hit by the rupee. Overall it’s a great budget by the FM and his team ahead of the crucial state and general elections. It is good that the FM has now shifted his focus from inflation to economic growth.

(The views mentioned in this write up are purely of mine and not that of my company)

Indian economic growth down but not out

As per expectations the Indian economic growth has moderated for the first time after clocking above 9% growth for two consecutive years. Indian economy is currently facing the problem of plenty. Global turmoil, high interest rates, low per capita incomes, slowing exports and above all the strong rupee are creating problems. I think the problem is more internal than external one. The Indian economy is more insulated today from global slowdown than it was in 2000 or in earlier periods of global slowdown.

High interest rates have started doing their trick and in my last write up I had said that how long can RBI continue with high rates now the question gains more importance than ever and I feel in the current scenario if RBI continues to give more importance to inflation than economic growth we would in for some tough times. I am not saying that inflation is not important but since the headline inflation is in control and already below the RBI comfort level RBI can now start looking at effects of higher rates on economic growth more closely than inflation.

CSO last week released Indian economic numbers and as per expectation the Indian growth moderated to 8.7% but the big surprise to me was agricultural growth which plummeted to 2.6%. Industrial growth was down to 9% and Services 10.2%. I think the agricultural growth could be revised upwards during the course of the year and most probably we could see the figure more closer to the 3% mark when the economic survey gets released in another two weeks. The monsoons this year was good apart from the north east monsoon. Also apart from wheat we have seen improved crop scenario in major crops. I still maintain that agricultural growth could be near 3% which would roughly add 6bps to the GDP growth.

According to me the big issue with India is not whether India can continue to grow at 8% or 9% but what is more important is that how inclusive is the growth. I have no doubt about the fact that we are into a secular growth trajectory and India largely insulated from the slowdown in G3. The reason I feel we are in a strong growth region is because of the strong domestic consumption in the economy. Indian domestic story is strong amongst the most of the developing economies. Domestic consumption account for nearly 70% of the overall figure. Also we are today a service oriented economy which means if there is a significant slowdown across the globe we would be less hit as the investment in the service industry is lesser than in manufacturing sector. Whereas China is more of a manufacturing story if we are going to face a global slowdown or a significant recession in US or EU it would be hit really badly as first there is huge investment and second it would lead to huge inventories for companies as China story has been about mass production.

My concern about Indian economy is about sluggish trend shown by the agricultural sector which has more than 74% of Indians dependent on it and also the growing rift between Bharat and India. If the growth has to be conclusive India it not only has to continue to grow above 7% but the agricultural sector has to grow above 4-5% and the big one been which I feel would make a big impact is India’s per capita income has to continue growing more than 15% per year. India’s per capita income is one of the lowest amongst all Asian economies the only ones below India been Bangladesh and Pakistan.

The other problem Indian government has is that 70% of the population is just contributing 18% of the GDP. The government has to reduce the burden if it wants to see inclusive growth otherwise there is very much likely hood of an unrest if the rift between the haves and the have not’s keeps on increasing. I don’t want to sound politically biased but for the first time I agree with the leftist that rise of the stock markets is not everything. Sensex at 20,000 doesn’t really mean anything for the aam aadmi because only 5% of the total savings flows into the Indian market. The aam aadmi is concerned about agriculture, about food, about better living. If there is a 100 bps increase in agricultural growth it adds nearly 18 bps to overall GDP but the long term implication to the GDP is more as it reaches far more people.

To me there are few big issues that Indian agricultural sector is facing and something government has to address. There is a serious need for the government to improve the quality of rural infrastructure. The government is already working on providing irrigation facilities but by just announcing either Rajiv Gandhi yojna doesn’t work. Firstly the roads have to proper so that we don’t lose goods in transit. Second the value chain has to be reduced and that is only possible by strong spot market with lesser middle men. Also the government has to work more aggressively on water conservation that will reduce the burden on irrigation.

To me there current blip in the GDP growth looks temporary as India grapples with the problem of plenty but with the deadly trio of PM, FM and Montek Singh working round the clock we have some aam aadmi friendly spos at hand before the election. The biggest problem that the trio faces are inflation and interest rates with the former in control interest rates should come down to acceptable levels. But I continue to reiterate that if we want the growth to be inclusive and if we want it to be sustainable we require agriculture to continue to grow at 4% for a sustainable period of time.

(The views expressed above are purely that of mine and my company has nothing to do with it.)

Rebalancing of Power

Rebalancing of Power:

In my last article I mentioned about the relative strength of the US dollar and also expanded that the US dollar shine is there but for short time of one year or so .Although US dollar won t loose its sheen against all currencies so easily the way it appears but in the long run I think there would be reshuffling of power which will lead to the shift in power from US to other economies and this reshuffling of power can be attributed to the phenomena of globalization.
Globalization with it has brought a lot of impact which does not seem to be conspicuous. The rage of globalization has brought about a rebalancing act; rebalancing of the power and dilution in the world economic concentration.
Globalization has increased the money in the hands of the developing countries and now the middle class of the developing countries is catalyzing the economic development of the countries by creating demand by leaps and bounds , making the countries like China and India , a fundamentally attractive places for investments and seek alpha.
With globalization, began the continuous circle of the fueling the economies. India growing at a pace of around 7% while China continues to post double digits growth of around 10% p.a. creating voracious demand for commodities , industrial products , manufactured goods et al.Hence, it has enabled new equations of the trade creating more significant trade partners other than US. With more options to invest and earn, the flow of capital seems to be changing course very swiftly, resulting in volatility in the world around, with change in the environment of a country making it more vulnerable in event of some economic or political blow-out. Hence a small mistake or oversight may prove to be expensive for any economy. Like in US the sub-prime melt down has led to the flight of capital away from US and the structural weakness in the US dollar.
I think with globalization, any faltering by any economy will lead to shake-up and further redistribution of power, creating more trade and investments avenues .Hence redistribution of the power among the various developed and developing world is going to be the course of the capital in the coming decade. The edge would be to gauge where the money is flowing and from where it is flowing, not just among the various sectors but also among countries. Hence for US to maintain its supremacy, it needs to gather its acts. For the biggest proponent of globalization, the effects seem to be far reaching; the latest fiasco of the sub-prime mortgage has cost US loose its dollar supremacy which is quite a lesson not to err again. So what globalization has done for US is: firstly, it has made US more vulnerable to its own mistakes. Secondly, it calls for more discipline in the markets .Thirdly, in future, it will lead to sharing of its economic leadership with other countries may be Euro region, China, India and others.
Finally, this game of rebalancing of power will surface in the form of currencies. In other words, the gainers and losers of power will be reflected in the strength and weakness of their respective currencies. Eventually I think the various currencies would be pegged not just to the US dollar but may be to a basket of currencies or just Euro. But this process is very long one, this transition period will take time but it seems to be imminent. World is indeed getting rebalanced.

Reddy does a Trichet; leaves rates unchanged

It was one of the most anticipated RBI meetings over the last few months and Y.V.Reddy disappointed the street with leaving Indian benchmark rates; repo rate at 7.75, reverse report rate 6% and CRR at 7.5% something which did not go well with the markets. If you look at the history of Indian monetary and economic policies they have never been devised for markets. Indian policies have always been formulated keeping in mind the aam aadmi (politics of aam aadmi) and his well being. So it was not surprising to see Reddy keeping the lending rate unchanged at this high level since past 10-month. May be that is the biggest difference between Indian economic managers and the ones in US.

RBI has for long been saying now may be close to 2 years that inflation and liquidity is their biggest concern and it will do all possible thing in its armoury to curb the inflationary devil. The question then remains that how long this can continue in India, will we go the same path the US went. Well the answer lies more on the structural differences of two economies. They both are completely different in their own ways. RBI has been deeply concerned about the rising commodity prices especially oil and other food items, money supply is still growing and the rate hikes seems to have minimal impact if any on it also the liquidity remains fairly strong.

My point is that it would be interesting to see that when growth risks would over take inflationary risk and RBI goes ahead and cuts its benchmark rates. Well looking at the figures released by RBI it seems that growth is starting to moderate. This can be clearly seen in the credit numbers and industrial production numbers released the RBI and Finance Ministry respectively. Bank Credit has moderated to 22% (below RBI target of 24%) in 2007 from 28% and 32% in 2006 and 2005 respectively. Personal loans are down to 20% from 35% in 2006.

Since M3 growth, inflation and liquidity overhang are RBI concerns it should have at least announced a CRR hike and should have laid some more stringent guidelines on Capital flows into the country or else opt for MSS rather. The reason I feel so is that if Fed would go ahead and cut interest rates today by at least 25 bps the differential rate between India and the US would increase to 450 bps this would further lead to foreign exchange flowing into the country and excess liquidity and then RBI would have another issue at hand and that would be the soaring rupee, which already damage our export performance. The high rate differential would also induce Indian corporate to raise money through the ECB route. I guess it would not be wrong to say that RBI is today facing problem of plenty. It wouldn’t be a bad option if RBI can roll out a few infrastructure bonds and it would play a duel role one suck liquidity and the other been would also help in fulfilling infrastructure requirement (the greatest bottleneck in the economic growth story) of the country. I think RBI is too much concerened about inflation but it is missing one point that even if the government passes the rise in crude prices to the public inflation would still be under 5% comfort level of RBI. I completely agree with the concern about money supply and liquitdity and as mentioned above there are enough weapons in RBI’s armoury to suck liquidity.
A lot has been written about the slowdown in India and how insulated it is. But what is interesting to see is that India’s growth story is about domestic consumption and strong capital expenditure and sound balance sheets of Indian banks when you look in context of subprime fracas. I think somewhere the whole rate hike is starting to hurt the Indian consumer and his confidence. If that happens it would be difficult for the economic managers to get things back on track. Obviously it would be not as severe as it has been in the US. The rates have very likely peaked and a cut is very much on the cards in its next RBI meeting. According to me we are likely to see some rise in NPA’s especially the small loans segment where it is always risky and the risk of NPA’s is quiet high.

Indian economy despite all this could spring surprise by just managing to grow at 9% in 2007 and the big driver would be agriculture. I feel this year has been good for agriculture in the country. The sowing was on time coupled with good monsoon and increase in acreage levels in few important crops. Agriculture would grow above 3% and to me the agriculture scenario is likely to improve going forward. May be this time Bharat is likely to be the saviour of India. I would be keenly awaiting the CSO numbers on the GDP to be released next week and may be then we could revisit the numbers and economic scenario again.


(The views expressed in this blog is personal and not necessarily of my company)

Middle East – Natural Resources fueling growth

The rise of the Middle East has been a fairy tale story. The desert nations have shown fantastic growth over the past decade and this growth has been fairly inclusive and the governments have been able to sustain it over the period of time. But the question remains that whether the politically turmoil region will be able to sustain such high growth rate. May be yes?

If ever we wanted to see the impact of the commodities boom on a particular region Middle East is the best example. The region has been witnessing high growth rate due to oil and non oil sectors but it is crude and natural gas that has helped the desert nations reach where they are today. According to me Middle East has a strong case to become an economic powerhouse. This is something their governments also understand and thus we have seen the formation of Gulf Cooperation Council (GCC) which includes Saudi Arabia, UAE, Kuwait, Qatar, Oman and Bahrain.

The economic growth in Middle East is likely to remain fairly robust in coming few years in the wake of positive outlook on oil and natural gas prices. The region been an export oriented economy and a net oil exporter is best poised to utilise the price rise of black gold. Oil accounts for more 90% of Kuwait, Saudi and Iraq’s oil export and more than 70% of their fiscal revenues. On average oil accounts for roughly more than 50% of regions exports.

Been a net oil exporter which traditionally forms a huge chunk of any country’s trade balance most of the Middle East countries have a positive current account balance. One of the strongest attribute of economies in this region. The average current account surplus in the region is more than 20%. Large amount of earnings through oil exports also keeps the fiscal situation of the region in check with most of the countries having a Fiscal balance of 11%. With another year of high oil prices the current account and fiscal balance is likely to remain positive and both are expected to witness marginal growth in 2008. The economy will not only benefit from high oil prices but also from increase in production of oil from OPEC countries. The benefit of investments made in the exploration sector is likely to be seen in the way of rise in production. High oil prices are also likely to reduce the debt burden of the region. According to a recently released paper by a economic governing body current account situation in the region will not reverse unless oil prices come below USD 30 which is a far cry and at current demand supply situation looks nearly distant possibility.

The growth witnessed due to the oil price rise has also had its spill over effect on the non oil sectors like real estate. We have recently witnessed fantastic growth in the real estate both commercially as well as residentially as rich and famous people across the globe want Middle Eastern countries to be their holiday homes. Tourism has also flourished in the region over the last decade thus bringing in foreign capital for the region. The country is also likely to benefit from the investments made by sovereign funds of governments of these countries in markets like India, China and other mature markets.

I expect the region to continue with its robust growth scenario as according to my estimation of oil demand till 2015 I see demand rising by 2.5% p.a. Also the astonishing growth witnessed in the BRIC (Brazil Russia India and China) will be the big drivers of growth in the desert region. Today GCC has 40% of proven oil reserve and 20% of natural gas reserves it is the only region that can truly utilise the boom in energy prices to its use.

My big concern for the economy is its political scenario and rigidness in government policies. More than these two there is another impending threat on the desert are and that is the regional instability which is not allowing the region to grow to its fullest capability, to me this is something which can very well derail the drive of becoming economic superpower.

Some of the things that the economy has to do to achieve further growth and maintain it are as follows:

1) Better Education standards and quality human resource: Among the country in its league the Middle East has got some of the lowest educational standards. If we look at India and Japan the growth in these two countries have been attributed to the quality of human resource available especially due to robust primary and secondary education institutions. Today most of the region gets its working population imported. Hoards of Indians, Pakistanis and Bangladeshis working in Middle East either in lower or higher level jobs. India’s outsourcing boom was only due to the exceptional talented young minds in the country.

2) Transparent and more flexible economic policies.

3) Low Investment rate: One of the big drivers of growth in the country is the kind of investments made. The Investment rate in the region is close to 15%. Some of the developed and developing economies in the world boast of an investment to GDP ratio of 25-30%. According to me this is likely to change in coming couple of years. With Islamic banking picking up and more and more companies becoming sharia compliant we would see slew of money coming from Middle Eastern countries.

There are few risks the economy faces:

1) Slowdown in the US: Frankly to me this doesn’t look like a big risk to the economies of the region. I feel the region is largely insulated from the slowdown in the region. As the largest export partner for the region is Asia. Also today US is no longer the only driver of oil prices; this mantle has now been taken by china which is still very much on high growth trajectory.

2) Global slowdown: Because of its export oriented nature it is highly affected by global economic activity especially Asia and Europe. With picture looking grim for Europe as well as Asia ex China and India it is likely to marginally affect the oil kingdoms.

3) Commodity Shock: According to me probably the biggest risk that the economy faces. With oil prices near the three figure mark there could be contraction of demand if prices remains at such high level. Fiscal situation in lot of oil importing countries is moving from bad to worse and if this continues they would be forced to pass on the price hike to the consumer thus straining demand. Also an oil shock has got all the power to derail the world economy. Oil at USD 150 could very well decelerate the world growth form 4.5 – 5% to 2 – 2.5%.

4) Political Instability: This is something that the oil kingdoms have to overcome. The region for quiet some while has been affected by war, by terrorism and I again reiterate the if the region is able to overcome this it has the full potential to be the third strongest block after G7 and BRICS.

According to me Middle East is a pot of gold which is still waiting to reap benefits. This is just the start of fantastic era of growth in the region. The best way to invest in the region would be either buying the currencies or stocks of companies listed in some of the Middle Eastern exchanges. The risk of buying stocks for a large investor is lack of liquidity. Most probably that is the reason why real estate is booming in the country as investor’s money is flowing into land in the area.

Middle East is also a good play for some of those investors who want to benefit from commodities boom but either has burned their hands in volatile market or a too scared to enter at these levels.

Written by: Chirag Sheth

(This is my first article on Middle East and this would be followed by an analysis of some of the economies of this region)

The realtive strength of the US Dollar

The sub-prime melt-down resulted in the downward journey of the US Dollar. But the journey that appears to have fathomless bottom does not seem to be so apparent to me. It all started when the sub-prime melt down sparked a credit crunch battering the US market (read US $) from every direction.

US has tried and maintain strength in its currency since long time even Secretary Paulson believes that a strong dollar is in the nation's interest. Strong US currency enables the major exporting countries like China, Japan, Sweden and the likes to enjoy the favorable exporting environment and maintain the demand of their product internationally, given everything else equal and also with strong currency it is favorable for US to import. But contrary to what the US and the other economies have tried to maintain so far, the dollar has been weakening Vis a Vis Euro, Yen, Rupee, Canadian dollar et al.This structural weakness in US dollar disturbs the long followed equation relating to the trade between the major exporting countries like China, Japan etc and their main destination –US

I agree that the further weakness in the US dollar is imminent but it is not the phenomena that will take place during this year, it’s a long term process and I feel so because the relative weakness of the US dollar is not so simple and straight forward as it appears.
I have numerous reasons to attribute to my belief. Firstly the major export-oriented economies like China, India, which are the few countries forming the backbone of thriving emerging markets, are mighty sensitive to the market conditions due to which the Government intervention in their currency is very likely, which will aim to keep the competitiveness of their exports intact to continue to enjoy overseas market. Case in point is India which is trying hard to maintain the weakness of the Rupee against the US Dollar.

Secondly, if the government does not intervene like in case of Japan (elaborated shortly) then it will mar its economy making it less desirable destination for investment. Japan being the fourth largest exporter of the world is obviously affected by the weakness in US dollar against Yen but Japan has so far not intervened but it might once the US dollar and Yen exchange rate falls below a certain level or it will hurt the economy. Either case the , it will lead to a weaker Yen. Take for another example, Canada, which, few weeks back was mulling over the idea of pegging their currency with the US dollar and hence prevent Loonie to soar against the US currency and also they might try to adjust their interest rate in lock step with that of US to maintain the competitiveness of their exports. Canada might not peg its currency but these ideas from their direction gives an indication that glory of US dollar is not yet over. Last but not the least, Euro region is giving signals about the weakness or slow down in their economies, which might further lead them to decrease their interest rates, which makes me to believe in the relative strength in US dollars.

Now, I am sure many of you have questions that what about the strong internal demand and momentum of emerging economies like India and China? But having mentioned the reasons for testifying the relative strength of the US Dollar, I think US dollar will remain more or less flat for this year and it does not mean that US dollar is invincible but it will resist the weakness as of now. Infact the world economies as a whole are undergoing a structural change, which is not so much in favor of US dollars. This transitory period is a very long term process and that process that has already set out.Hence, I think that US dollar is expected to get weaker but for the year, I expect it to stay more or less resistant to a steep weakness.
(This analysis of the transitional period of the economies and its winners and losers would be the focus of my next blog which will be posted soon.)