Economic Fallout of Terror Attacks

I had hoped that this time it is going to be different, and so it has been. The public outcry against terror is much more visible this time as compared to the past. While the country gets ready to fight terror on the political front (people are demanding a safe environment to live, heads have started to roll, irresponsible politicians are scurrying for cover, international community is being mobilised), it is the economic threat that looms large on the Indian economy.

India's external deficit has been mounting, with a slowdown in export growth. India's current account deficit was being financed through Foreign direct investment and NRI remittances. But the global financial turmoil has lead to flight of capital from India, it is estimated that about $12 billion worth foreign investment in Indian markets has been taken out since the beginning of 2008. This has lead to a lot of pressure on the Rupee. The impact of declining commodity prices including crude, which is a positive for Indian economy, has largely been offset by the declining Rupee.

Investors operating in international markets deploy capital in overseas markets based on their perception about the ability of the respective Governments to safeguard their citizens against terror attacks. Indian Government's ability to protect its citizens has suffered a severe jolt. The Indian market is not only facing flight of capital but the ability of Indian firm's to raise funds through ECB and Bonds is also drying up. The recent terror attacks are likely to accentuate the situation further. This may lead to a severe economic crises with the pressure on Indian rupee mounting.

India is a deficit ridden economy, which needs huge overseas capital infusion at this juncture. The Govt. needs to give positive signals to the world that it means business in tackling the menace of terrorism, but it has to rise above the vote bank politics. Luckily the Govt. has the tacit support of the masses to take some harsh political/economic measures in the long term interest of the Nation.

Mumbai Terror Attacks: A serious blow to 'India Growth Story'

The nerve centre of India's commercial capital Mumbai is under siege by terrorists. Commando oprerations to flush out terrerists have started as I write this piece. In the past, markets have rebounded with vengeance after each terror attack. We have become so used to hearing the same old explaination of the 'Never say die spirit of the Mumbaikars' after each successive attack on Mumbai. Will this time be different?

Our hearts go out to those who have suffered during the troubled times. This is a time for serious introspection. This time it is going to be different, because this is a war on India, much worse than the 9/11 in the US. The anguish of the ordinary Indian has to come out openly to let the terrorists and the rulers think alike that enough is enough. It spells bad times for the markets, but then our survival as a nation is far more important than making a few bucks on the markets.

These attacks have come at a time when the economy is reeling under the impact of severe recession in the developed world. It will further erode the investor confidence in the Indian economy. Consumer confidence is also likely to suffer adversely. The immediate impact will be a pressure on the Rupee and falling bond prices. The end result will be a severe slowdown in the economic growth. The 'India growth story' will take a back seat for the time being. The ruling party at the centre is bound to fare poorly in the state elections under way. Meanwhile, investors should brace up for a turbulent period ahead in equity markets, the market may be heading for new lows in December. The worst hit sectors would be hospitality and transportation.

Let us hope our polity takes some positive measures to rescue the economy from this unprecedented crises, that essentially stems from our callousness in the past. This is a war on India and perhaps the last chance for the polity to revive the 'Spirit of the Nation'.

Bond Market Investments

Bonds are a core element of any financial plan for investment and wealth creation. A bond is a debt security and the purchaser of a bond is a lender of money to a government, corporation, or any other entity known as the issuer. In return for the loan, the issuer promises to pay the lender a specified rate of interest during the life of the bond and to repay the principal (face value of the bond) on maturity. It is recommended that investors maintain a diversified investment portfolio consisting of bonds, stocks and cash in varying percentages, depending upon individual goals and objectives. Because bonds typically have a predictable stream of payments and repayment of principal, many people invest in them to preserve and increase their capital and to receive consistent interest income. Whatever the purpose—saving for your children’s higher education, buying a new home, planning for a stable retirement income or any other financial goal—investing in bonds can help you achieve your objectives. The diversity of fixed-income securities presents investors with a wide variety of choices to tailor investments to their individual financial objectives.

After you decide to invest in bonds, you then need to decide what kinds of bond investments are right for you as the bond market offers investors a lot more choices than the stock market. Asset subclasses of bonds include:
* Different maturities: long-term (10 years or longer), intermediate-term (3-10 year) or short- term (3 years or less)
* Different issuers: government agencies, corporate, municipal, international entities
* Different types of bonds: callable bonds, zero-coupon bonds, inflation-protected bonds, high- yield bonds, etc.

Bonds are considered less risky than stocks because bond prices have historically been more stable and because bond issuers promise to repay the debt to the bondholders at maturity. The bond markets are extremely active, with interest rates constantly changing in response to a number of factors including changes in the supply and demand of credit, monetary & fiscal policy, exchange rates, economic conditions, market psychology and, above all, changes in expectations about inflation. In the recent past, rising interest rates and expectations for economic slowdown have impacted bond prices. As interest rates change, so do the values of all bonds in the marketplace. However, changes in interest rates don't affect all bonds equally. Generally speaking, the longer the bond's maturity, for example a bond that matures in ten years is more affected by changing interest rates. Also, the lower a bond's "coupon" rate, the more sensitive the bond's price is to changes in interest rates.

Virtually all investments carry some degree of risk that you might lose some or all of your investment. When investing in bonds other than government-guaranteed securities, it's important to remember that an investment's return is linked to its credit as well as market changes. The higher the return, the higher the risk. Conversely, relatively safe investments offer relatively lower returns. Bonds that are below investment grade are considered speculative, sometimes they are also called 'junk bonds'. A government bond is a bond issued by a national government denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. Government bonds are usually referred to as risk-free bonds, because the government can raise taxes or simply print more money to redeem the bond at maturity.

In India, individual investors can consider investment in Bonds by direct investment in Bond issues or through Debt oriented Mutual Funds. The options for direct investment in Bonds include:

• Govt. securities issued by RBI through banks- the tenure of these bonds can be between 2-30 years and interest is paid semi-annually. These can be held in a Subsidiary General Ledger (SGL) acccount maintained with your bank.
• RBI savings Bonds- these are taxable and the tenure is fixed by RBI, interest is paid semi-annually or you can opt for the cumulative option as well
• Infrastructure Bonds- issued by specific institutions such as NHAI, REC etc., they carry special tax exemptions under section 80C of IT Act, but have a 3 year lock in period. These bonds are rated by credit rating agencies. Loans can be availed under all the above bonds from banks.

CHALLENGES FACING THE INDIAN BANKING INDUSTRY

Indian Banking sector has emerged almost unscathed from the recent global financial crises. The regulatory system in India has stood the test of time, as many renowned global banks have fallen from grace. The nemesis of the global financial system lay in their high-risk lending and ambitious derivative plays. In fact, the financial soundness of India's banking system means the sector "approaches the current financial turmoil from a position of strength," said Goldman Sachs economist Tushar Poddar. Comparing the subprime lending debacle that originated in the US to the "activities of a casino," Prime Minister Manmohan Singh said this month he wanted reform of the global financial system to tackle the "economically damaging role of excessive speculative activity".

The current crisis will not have a big impact on the health of India's banking system simply because the country did not have the exotic derivative instruments or permit the unsupervised mortgage lending that triggered the meltdown. Bureaucratic and regulatory controls that frustrated many international investors proved to be a good firewall for India's banking system against the credit virus from the West.

The major challenges facing the Banking industry are:

• Development of new skills in Sales and Marketing: The growth is being driven by new products and services such as smart cards, e-banking, consumer finance and wealth management services in retail segment, and investment banking in the wholesale banking segment. All these activities require a high level of skill development amongst employees.
• Windfall treasury income: The volatility of interest rates will ensure that the banks are no longer able to generate enough profits through treasury gains. With net interest margins already under pressure, weaker banks will suffer an erosion in profitability.
• Competition from foreign banks: In the past few years the share of foreign banks in India has been declining, due to the restrictions on their expansion. With the implementation of the Basel II norms and the liberalization of branch licensing policy, foreign banks will emerge as a formidable force in the years to come.
• Enhanced service quality: With the demographic shift in the profile of customers, the demands for higher level of customer centric approach are becoming evident. Banks will have to constantly upgrade their service platform to provide quick and efficient customer service. The redressal of customer grievances will also play a greater role in the choice of banks by customers.

Inflation at 8.98%: Unravelling the 'Jigsaw Puzzle'

The rabbit is out of the hat. Inflation (That is measured by Wholesale price Index - WPI in India) is down to 8.98% as on 1st November 2008, as compared to the figure of 10.72% declared for the week before. This is likely to have a ripple effect on the mindset of the analysts, market operators. But for the common man the inflation data still remains a jigsaw puzzle: with the price of fruits and vegetables at their peak (tomatoes at 40 Rs. a kilo or potatos at 20 Rs. a kilo in the retail market), he is unable to appreciate the fall in the inflation rate.

In this blog on 24th August 2008, when WPI was at its peak of 12.6%, I had carried an analysis of inflation under the title 'Inflation: What lies beyond the figures!'. Let us once again try to unravel the mystry behind the figures:

• In India the benchmark for measuring headline inflation is WPI (Wholesale price index), which is released every Thursday by the Department of Industrial Policy & Promotion (DIPP) under Ministry of Commerce & Industry.
• As a consumer you and me are more impacted by the CPI (Consumer Price Index), generally CPI follows WPI with a lag effect, that is retail prices start falling at a later stage as compared to wholesale prices.
• The WPI figures released every week, that haunt the headlines, must be taken with a pinch of salt. They represent the growth in inflation rate on a year to year(YOY) basis, so are influenced by the base inflation rate. In India the WPI during November 2007 was only 3.4%, so the low base effect makes the comparison look absurd.
• The composition of WPI is loaded towards manufactured articles which account for 64% of the weightage, food articles and fuel & lubricant catagories account for 22% and 14% respectively. Whereas the CPI carries a weightage of over 50% for Primary articles.
• The sharp fall in inflation figures on a week on week basis, as on 1st November 2008, is due to the sharp decline in commodity prices especially steel goods, and the sharp decline in price of unadministered petroleum goods such as Naphtha and Aviation Turbine Fuel (ATF)
• If the Govt decides to reduce the price of Petrol and Diesel marginally, as is being widely anticipated, the WPI will fall below the 8% levels soon.
• The spike in inflation in the past few months was due to international factors, namely the 'commodity bubble', which has burst leading to the sharp decline in inflation numbers. Authorities in India extended the inflation argument to the extreme and have stifled the economic growth in the bargain.
• The collection of inflation data also leaves a lot to be desired, the Govt. machinery is inept in collating the figures realistically leading to distortions. That is why the provisional figures released are revised on a regular basis.

All said and done the WPI continues to decide the policy of the Govt. of India as well as RBI. In that sense this current fall is significant: it signals a softer interest rate regime, forcing the RBI to reduce Repo/ Reverse Repo rate shortly. This will reduce the interest burden on the companies, thereby improving their profitability. But the result will be seen from the Quarter ending March 2009, the results for Quarter ending December 2008 are likely to be depressed. The markets may initially cheer the good news. The fact to be appreciated is, that the long term India story still remains good despite the forecasts of a severe slowdown, but then forecasting in these tubulent times is fraught with a lot of risk.

Remember, Merril Lynch who forecasted Indian stock market (BSE sensex) to rise to 25000, when the index was around 20000 in December 2007, Merril Lynch itself got lynched in the process. Investors should, therefore, think long term and not get bothered by the whole lot of data dished out at regular intervals, who knows the fairness of the data. The real economy is much more than just a few sets of figures!

'ASBA' : SEBI's gift to small investors

The process of refund of application money to unsuccessful applicants is a cumbersome process which is responsuble for delay in listing of new issues on the bourses. To overcome these drawbacks, SEBI has introduced an innovative payment mechanism for retail investors applying for new issues and select rights issues. This payment mechanism is called Applications Supported by Blocked Amount (ASBA), and has been introduced with effect from September 1, 2008.

The salient features of the scheme are:

• Available for retail investors (investors with application amount upto Rs. 1 lakh) for IPOs
• All existing shareholders can avail of the facility in a Rights issue, provided shares are held in DEMAT form
• Bidding allowed only at cut-off price
• Bids cannot be revised
• Bids may be in physical form or electronically through a branch of a Self Certified Schedule Bank (SCSB), where the investor maintains his account
• The application money remains blocked in the account till the announcement of basis of allotment by the Company
• In case of a successful bid the appropriate ammount is unblocked and transferred to the issuer company's account

The first company to benefit from the issue was '20 Microns Ltd'. The efficacy of this system will be tested only in a buoyant market. The system is expected to provide an incentive for small investors to aggressively participate in IPOs/ Rights issues.

ULIPs De-mystified

Unit linked Insurance plans (ULIPs) are increasingly becoming popular with the investors. Of the new insurance plans sold during 2006-07, ULIPs accounted for 57% of them. Private insurers have been aggressively marketing ULIPs. Although ULIPs may be seen as a product akin to mutual funds, since they are sold by insurance companies they are to be treated as exotic insurance products, regulated by the insurance regulator IRDA. Let us try to unravel the mystry behind ULIPs:

• What are ULIPs: ULIPs are essentially Term insurance plans with an add on investment option. ULIPs retain a portion of the premium towards risk cover and invest the balance in a mix of equity/ debt instuments. Being treated as an insurance products they are also entitled to tax benefits under section 80C of IT Act.
• Flexibility: ULIPs offer more flexibility as compared to the traditional Insurance plans, where your money is mostly invested in debt. ULIPs allow the investor to choose an investment plan according to his risk appetite. They are thus structured as long term wealth creation products. Additional benefits available on a ULIP are riders to cover accidental death, medical insurance; and the facility for top up (additional investment) under the existing plan.
• Charges: Generally, ULIPs levy charges in the shape of fixed upfront charges, as compared to Mutual funds where the the fund management charges are back ended. Thus the explicit costs in case of ULIPs are recovered in the initial years of the policy term. ULIPs may charge more than 30-40% of the premium as administrative costs in the inintial years, however, these charges reduce to about 1% by the 5th year. On the other hand, Mutual funds charge 2-2.5% as fund management expenses on an ongoing basis. Over a 10 year period, ULIPs are able to catch up with the returns vis-a-vis mutual funds, due to low recurring costs. It is, therefore, advisable to hold on to ULIP investments for long term.
• Investment Risk: Traditionally, life insurance is seen as a risk mitigating proposition. Mixing investment with risk coverage may sound funny to some, as ULIPs expose the individual to a disproportionately higher risk as compared to pure term insurance. Ideally, a pure term insurance plan is suited to your insurance needs, but since an insurance agent gets a very low commission on term plans they are seldom promoted by them.

Considering the above facts, if you have decided to go for a ULIP policy, try to understand and evaluate the following facts before acting:

• Administrative Charges payable
• Amount of death claim payable
• Exit charges payable
• Partial withdrawals allowed
• Flexibilty of Switching between plans
• Don't get lured by fancy returns promised by your advisor.

Obama's landslide win: Is it a time to rejoice?

Barack Obama's meteoric rise to the head of the largest economy of the world has been greeted with euphoria across the world. A campaign that started off as a showdown against Bush administration's inept handling of international affairs culminated in the American people's resolve to get out of the financial mess that has been created by the meltdown at Wall Street. Obama may be entering the 'White House' with a lot of hope but the financial mess will require a lot of grit and patience to be cleaned up. Obama's relative inexperience will mean that a lot will depend upon the team that he is able to put in place to deal with the worst economic crises that the US is facing after the 'Great Depression'.

It is too early to analyse the impact of this change on the Indian economy, but going by Obama's utterings in a run up to the Presidential election, it could be a mixed bag for India:

Positives: Leaning towards socialism, a pro middle class approach; Likely increase in R&D spending in the US; Economic policy to promote alternative energy (Solar & Wind energy): Affordable Healthcare- increase in spending on healthcare. A caliberated, less threatening security environment, including a possible pull out of US troops from Iraq, Afghanistan may de-escalate the global threat to the security of India.

Negatives: Increasing tax rates on higher income groups - a threat to US spending; Massive increase in State controlled regulation over insurance, banks, hedge funds etc; Pricing power of Pharma exporters to US will decrease; Not likely to accept India as Nuclear state, may force us to sign CTBT; Lesser outsourcing - a dampner for Asian expats; May like to play the role of mediator in resolving Kashmir issue.

The world markets after the initial euphoria are likely to decline or settle in a groove, till such time concrete measures are taken to resolve the global economic crises. The road ahead for Obama is laid with a lot of landmines, where he has to tread cautiously - the entire world will be anxiously watching the steps of the 'New World Hero'.