ULIPs under the lens of IRDA

It is good news for investors. Close on the heels of Mutual Fund regulator SEBI scrapping the entry load on all MF schemes w.e.f. 1st August 2009, it is the turn of the Insurance regulator IRDA announcing a cap on charges levied on ULIPs. ULIPs are very popular amongst investors, accounting for over 80% of the new business premium collected by private insurance companies and around 65% new business premium for LIC.

According to IRDA, the difference between gross and net yields to a policyholder should not exceed 300 basis points (3%) for policies maturing within 10 years (fund management charges capped at 1.5%), and 225 basis points (2.25%) for policies maturing in more than 10 years (cap on fund management charges at 1.25%). Gross yield is the yield generated by the ULIP before all charges are deducted, and Net yield is the yield generated by the ULIP after all charges are deducted. To make the ULIPs more transparent the insurer at the time of maturity will have to issue a certificate showing details of year wise contributions, charges deducted and fund value. Experts are of the view that these measures would establish ULIPs as long term insurance plans. It makes the ULIP products more attractive than similar products available in the market.

The new regulations will become effective from 1st October 2009, for all products approved by the regulator after this date and all the existing products that do not meet the requirements are required to be withdrawn or modified by 31st December 2009.

Disinvestment demystified

Disinvestment (sometimes referred to as divestment or deivestiture) refers to the action of an organization or government to sell or liquidate, wholly or partially, an asset or subsidiary. It is the opposite of an investment. There could be several motives for disinvestment:

• A firm may divest (sell) businesses that are not part of its core operations so that it can focus on its core operations. For example, selling of cement business by L&T.
• Another motive for divestitures is to obtain funds by selling one of its businesses in exchange for cash. For example, Unitech selling its Hotel properties to generate cash.
• A third motive for divesting is that a firm's "break-up" value is sometimes believed to be greater than the value of the firm as a whole. This process is sometimes referred to as 'Spin off'.

The term 'Disinvestment' is seen in the Indian context from the point of view of divestment of Govt. stake in state run enterprises. The markets were visibly upset when there was no concrete announcement on divestment in the FM's budget speech. The history of disinvestment goes back to the liberalisation of the Indian economy in 1991. The Department of Disinvestment was set up as a separate department on 10th December,1999 and was later renamed as Ministry of Disinvestment from 6th September,2001. From 27th May, 2004, the Department of Disinvestment is one of the Departments under the Ministry of Finance. Total proceeds from stake sale in state run enterprises till 2007-08 is Rs.51,600 crores. There are diverse views on the use of funds generated from divestment.

The major advantages perceived are:

• Public investment in PSU's would make them more accountable, thereby increasing profitabilty and resource mobilisation.
• The proceeds of divestment could be used to improve urban/ rural infrastructure.
• Govt. protection for its labour force is a hindrance in improving productivity of labour.

On the other hand, the disadvantages of Divestment are:

• The proceeds may be used to fund fiscal deficit, leading to overspending by Govt. on unproductive purposes.
• Profit making PSU's are the highest dividend payers to the Govt., thus a stake sale in them could dent Govt.'s ability to generate huge cash flows in the future.

The endless debate continues. It would be in the interest of the nation if disinvestment is pursued selectively, with the objective of improving productivity of PSU's, to bring them at par with the Private sector enterprises thus creating a healthy competitive environment.

Budget Analysis IV: Impact on Markets

The presentation of the Union Budget is a widely anticipated event for the markets. The markets seem to have given a thumbs down to the FM.

Equity Markets: Both BSE Sensex and the Nifty have shed 9.5% each in the first week after presentation of the Union Budget. In fact the Sensex recorded its largest ever loss in terms of points on the budget day. A deeper analysis reveals that the budget is not bad for the markets overall, but as the traders and speculators had built large positions ahead of the presentation of budget, the knee jerk reaction resulted in unwinding of those positions. Negative global cues also did not help matters in any way. It may be outrageous to put the blame on the Budget for the downfall. In fact the budget seems to be very positive for the long term growth of company profits by stimulating demand for their products. The high fiscal deficit of 6.8% of GDP is definitely a matter of concern for the FII's, as it has the potential to put pressure on the Rupee and the Interest rate scenario.

Bond Markets: Yields on bonds have moved up in the backdrop of huge Govt. borrowing programme to fund the expenditure of the Govt. The yield on benchmark 10 year Gilt bond ended the week higher at 6.97% as compared to 6.83% at the beginning of the week. Yields on corporate bonds have also witnessed an upward bias.

Future of Stock Market: The equity indices are close to the levels expected by me 13000 on the Sensex and 3900 on the Nifty. One cannot rule out a further decline of 5% or so from these levels, but equity investments have turned fairly attractive at these levels from the long term bull market point of view. I have a gut feeling that some new sectors will lead the next bull run. These sectors could be:

• Hospitality & Tourism: Considering the huge shortage of rooms in view of the forthcoming Commonwealth games 2010, and India gaining its rightful place in World tourism, this sector could be a fruntrunner in case of an early turnaround in the global economy.
• Media & Entertainment: This beaten down sector has all the portents of a spectacular bounce back, in the second half of FY 2009-10, when the world economy recovers from recession.
• Power & Energy (Specially non-conventional energy): Non-conventional energy such as Solar Power & Wind energy, as also Bio-diesel will be much sought after once Crude oil resumes its upward march.
• Domestic Retail: With real estate prices/rentals falling to reasonable levels, organised retail and consumer durable companies are in for good times. We are likely to see huge investments in organised retail in the coming months.

One can selectively invest into companies from the above sectors to ride the next bull run.

Budget Analysis III: Taxation Measures

Goverments the World over have to raise resources to fund various social security schemes such as poverty allieviation schemes and provision of social infrastructure, and to fund the cost of running the Govt. This purpose can be accomplished through Govt. borrowing or through the measures of Taxation. Taxation is also aimed at equitable distribution of wealth, by taking money from the priviledged class for distribution amongst the less priviledged. India's Gross tax revenue is slated to grow at a slower pace this year, leading to a decline in the Tax/ GDP ratio from 11.5% in 2008-09 t0 10.9% in 2009-10.

Sources of Government's tax revenue can be broadly classified into Direct taxes (Income tax, Wealth tax, Corporate tax etc.) and Indirect taxes (Customs and Excise duties, Service tax). The share of direct taxes is steadily on the increase, budget 2009-10 projects the share of direct taxes at 58% of the total tax collection. According to budget estimates for 2009-10, the direct tax proposals are revenue neutral whereas the Indirect tax proposals would bring in an additional Rs.2000 crores. Let us sum up the impact of current year Tax proposals:

Individual Taxation:

• Basic tax exemption limit raised by Rs.15000 for Senior citizens and Rs.10000 for others.
• 10% surcharge applicable on income above Rs.10,00,000 abolished
• Fringe benefit Tax (FBT) payable by employers abolished. Perquisites to be taxed at the marginal rate of tax in the hands of employees
• Allowance for medical treatment of a dependent with severe disability increased from Rs.75000 to Rs. 1 lac (Section 80DD)
• Deduction for interest on loans for higher education widened to cover all fields of studies after completion of schooling (Section 80E)
• Wealth tax exemption limit raised from Rs.15 lacs to Rs.30 lacs.

Corporate Taxation:

• Minimum Alternate Tax (MAT) on book profits increased from 10% to 15%
• New Pension Scheme (NPS): Income of NPS trust exempted from income tax, DDT and STT.
• Commodity Transaction tax (CTT) abolished
• Easy presumptive tax for small businesses upto turnover of Rs.40 lacs at 8%.

Indirect Taxes: As a result of changes in indirect tax rates LCD TVs, Luxury cars, Branded jewellery and essential drugs become cheaper, whereas Set-top boxes, cotton apparel and branded fuel become dearer. Law firms brought under the purview of service tax.

Budget Analysis II: Beneficiaries of Govt. Spending

Govt. spending in Budget 2009-10 is slated to go up by one third to a record Rs.10.2 trillion. The proposed increase in budgetary allocation will accelerate growth of the economy. Some of the important expenditure side allocations are:

• Jawaharlal Nehru National Urban Renewal Mission (JNNURM): Allocation is Rs.12887 cr. (higher by 87% over last year)
• Target for agricultural credit flow is fixed at Rs.325,000 cr (up 15% from last year). Interest subvention scheme for small crop loans continued, an additional 1% subvention is proposed for timely payment of crop loans.
• National Rural Employment Guarantee Scheme (NREGS): Allocation is Rs.39100 cr. (higher by 144% over last year)
• Bharat Nirman: The outlay under six schemes covering Bharat Nirman has been increased by 45% over last year.
• Infrastructure financing: IIFCL will evolve a takeout financing scheme to enhance availability of long term funds and to refinance PPP projects.
• Interest relief for Export credit extended by six months upto 31st March 2010.
• Streamlining subsidies: Move to a system of direct transfer of fertiliser subsidy to farmers and introduction of a nutrient based subsidy scheme to ensure balanced use of fertilisers. Oil subsidies to be guided by a revised formula (to be announced later) to protect the upstream oil companies.
• The budget for Highway development and Railways has been stepped up by 23% and 46% respectively.

These and other steps outlined in the budget will ensure higher spending to boost demand and will result in restoring higher growth in GDP in the coming years. The focus of this budget has been to reduce the gap between the rural and urban India. Companies focusing on demand generation from rural India are likely to benefit the most from the increased allocations in budget 2009-10. The spoiler in the party, however, could be the deficient Monsoon rains.

Budget Analysis I: Understanding Deficits

In a series of write-ups starting today, I would try to unravel the mystery behind the 'Union Budget', the fiscal document of Indian Government. At the outset, let us try to understand the nature of deficits: Budget Deficit is a common economic phenomenon, that occurs when the spending of a government exceeds its financial savings. Deficit differs from debt, which is an accumulation of yearly deficits. Famous economist John Maynard Keynes believed that deficits help countries climb out of economic recession. The first budget under the new UPA regime is a 'borrow and spend budget' attempted to spur economic growth.

To counter the global slowdown, the govt. provided three fiscal stimulus packages during the last fiscal (FY 2008-09), which has lead to the fiscal deficit for FY 2008-09 ballooning to 6.2% of our GDP. The level of govt. spending budgeted for FY 2009-10 is Rs.10.2 trillion, up 36% from 2008-09, directed largely towards funding social sector programmes. This will result in a huge spike in Govt. borrowings or fiscal deficit which is projected at 6.8% of GDP in FY 2009-10, a level never seen since 1991. The higher borrowings will lead to interest payments climbing up to 20% of total govt. spending. The FM has taken a big gamble, and he may be playing with fire, unless economic growth is perked up soon. Although the FM has categorically sated that fiscal deficit will be reigned in below 4% within the next 2 fiscals, it will be a test of govt.'s fiscal prudence.

The Govt. will have to tread carefully, as the higher Govt. borrowing may crowd out private investment, leading to a pressure on inflation and push the interest rates higher which will be a roadblock for faster economic growth. It may also result in lowering India's sovereign rating by international rating agencies. The budget aims at restoring higher consumer spending and corporate investments. In his budget speech FM has outlined 3 major challenges for the economy:

• To lead the economy back to the GDP growth rate of 9% pa at the earliest
• Deepen and broaden the agenda for inclusive development
• To re-energise the government and improve delivery mechanisms

The FM has sacrificed short term gains/measures for the sake of long term growth. It is a consumption lead, growth oriented budget and we wish the FM success in his endeavours.

Return of the big 'Bull Run'

A 'Bull Market' can be defined as a prolonged period in which investment prices rise faster than their historical average. Bull markets are a result of economic prosperity/ economic boom or investor psychology, or a mixture of both. Bull markets are typically characterized by general optimism, investor confidence and expectations of strong results by companies. Long term investors pray for continuation of the bull run. Equity markets of the world have had two distinct bull markets in the recent past: The bull market of 90's lead by technology stocks, which ended with the dot com bubble; and the bull market of 2007-08 lead by commodity stocks,which ended with the sub-prime crises and recession. Looking at the spectacular rise in equity indices since their mid March '09 lows, the question foremost in every body's mind today is: has the Bull market returned for Indian equities?

I for one hold a strong view that worst is over for the Indian equity market, and we are fairly close to the start of a spectacular 'Bull Run'. The reasons for my conviction are many:

• Economic Growth in India, lead by the domestic consumption, continues to be robust. World Bank has upgraded India's growth prospects for 2010, some economists have forecast Indian economy to overtake the growth of China's GDP next year.
• The installation of a stable Govt. at the centre has been responsible for revival of 'Investment appetite' in India. According to Nasdaq Equities Magazine article political changes are one of the three biggest causes of Super Bulls and Super Bears.
• According to technical trends 'Fibonacci analysis and Elliot wave theory', the last bull run in India lasted 57 months (from April '03 to January '08), hence the current bear phase should last around 19 months, or around August '09. This would be the time for revival of the next secular bull market.
• Soft interest rate scenario and lower inflation auger well for the start of the next bull run, as the returns from fixed income securities is continuously on decline. The money waiting on the sidelines will thus flow to equity investments.
• With the pension sector reforms, and the launch of 'New Pension Scheme' from 1st May 2009, close to Rs.1,00,000 cr. is likely to be invested through this scheme, a fair chunk of this money will find its way to the equity markets.
• Relative stability/strength of the Rupee vis-a-vis the US Dollar augers well for the flow of FII money into Indian equities. The revival of PE (Private equity) investments is also positive for Indian markets.
• The recession in World Economy has reached its peak, and economic revival is expected to start from the last quarter of 2009. This will restore stability to the fortunes of global businesses of Indian companies.
• The strong rural demand will give a big push to Indian domestic companies. The stimulus packages announced by the Govt./ to be carried forward through the budget will have a positive effect on the demand.

Coming to the fair value of our markets, I would like to stick to the basics: The historic PE multiple for Indian markets has been around 15. At 15000 BSE Sensex, our markets are fairly valued at 15 times forward PE, or 17-18 times trailing PE. For small investors, it is advisable to wait for an entry at lower levels (around 13000 on the Sensex, or 3900 on the Nifty). If the markets turn euphoric post budget, it would be prudent to book some profits above 16000 on the Sensex.