Eqiuty Markets give a thumbs up to budget 2010-11

Of the past 19 budgets presented in India, bears were leading the bulls by a whisker 10-9 (i.e, the equity markets had fallen 10 out of 19 times immediately after the budget was presented). However, the response of the market to Pranab Mukherjee’s Budget 2010-11 has helped bulls draw level. Both Sensex and the Nifty made handsome gains immediately after presentation of the budget. The gains have continued to grow during the two weeks post budget presentation. The consistent run up since the budget, has some investors worried. How long can this bull run last?

Although, the long term trend for our equity markets is definitely up, because of the spectacular turn-around in the fortunes of the Indian economy after a brief slowdown. If the recent economic data is an indication, the economy is firing on all cylinders, and might surprise us with a GDP growth of well over 7% in 2009-10. The budget has given a booster dose to the India growth story with consumption oriented incentives. In the short run, some of the budgetary measures may seem to be inflationary, but removal of supply side bottlenecks will ensure easing of the inflationary pressures from the 2nd quarter of fiscal 2010-11.

The post budget bull run is driven by FII investments, FII's have pumped in over Rs.10,000 crores in the equity markets since presentation of the budget. But domestic institutions and retail investors have been booking profits in this bull run. Two major factors that need to be watched by investors for sustainance of the current bull run are:

• Strengthening Rupee: The rupee which was trading around 46.50 to a dollar before budget closed at 45.45 on Friday 12th March. Analysts expect the rupee to remain firm during the current month. January industrial growth at 16.7%, and the marked improvement in exports augers well for the stregthening rupee.
• Falling VIX: The Nifty VIX, which measures the immediate expected volatility of Nifty, closed at 19.73 on friday 12th March, its lowest closing since its launch on November 1, 2007. The VIX breaking down below 20 is likely to trigger a further upside in the NIfty.

Investors are cautioned to watch these two key indicators closely, and any reversal in any or both should be taken as a cue to trim your positions in the equity markets. After all, it is not a bad idea to take some profits home as the old proverb says 'Make hay while the sun is shining'.

Budget 2010-11: Cheers for the Tax payer

According to Pranab Mukherjee, Minister of Finance "The union budget cannot be a mere statement of government accounts. It has to reflect the government's vision and signal the policies to come in future." Viewed in the context of this statement, the Union budget presented by the FM on 26th February 2010, is a precurser of the changes envisaged during the remaining tenure of UPA II government.

FM has enumerated the undernoted challenges before the government:

• Quickly revert to the high GDP growth path of 9%, and then find the means to cross the 'double digit growth barrier'.
• Harness economic growth to consolidate the recent gains in making development more inclusive within a fixed time frame.
• Remove weaknesses in the government systems, structures and institutions at different levels of governance.

The message of the FM is pretty loud and clear: Growth cannot be sacrificed at any cost. Some economists may term the budget as inflationary, but the govt. is confident that the growth in demand complimented by augumenting the supply side mechanism can stiill avoid an inflationary bias, while steering the economy on the growth trajectory. Budgetary allocation fo infrastructure development has been raised to Rs.1,73,552 crores (46% of total plan outlay), and spending on social sector has gone up to Rs.1,37,674 crores (37% of total plan outlay). Augumenting fresh resources to the tune of Rs.75,000 crores through disinvestment of PSU stock and 3-G spectrum sale will enable the FM to reign in the fiscal deficit to 5.5% in 2010-11, as against 6.9% envisaged in the revised estimates for the year 2009-10.

In his endeavour to deliver inclusive growth, FM has made sure that while selective subsidies and cash subvevtion would continue to be made available to the weaker sections of the population, the burden of taxes shall be shared amongst a large cross section of the population rather than a handful of tax payers. The tax bonanza to IT payers is a step in this direction. The revision of tax slabs upwards will lead to a substantial cash in the hands of individual tax payers which will give the necessary boost to consumption and saving, and lead to the feel good factor amongst the honest tax payers of the economy. Whereas these measures would lead to a revenue loss to the govt. agg. Rs.26,000 crores on the direct tax front, shall be more than made up by the additional revenue of Rs.46,500 crores through indirect taxes including service tax. There has been an appreciable shift towats indirect taxes to ensure inclusive participation in taxation.

In meeting the third objective, FM has spelt out the following initiatives:

• Tax reforms: Roadmap for role out Goods and Services tax (GST), and the Direct Tax Code (DTC), wef 01.04.2011 has been laid. This will lead to uniformity and simplicity in the tax structure.
• Nutrient based fertiliser policy already notified shall be applicable from 01.04.2010. FM has spelt out that Kirit Parikh committee recommendations on deregulation of motor fuels shall be taken up by the cabinet soon.
• Companies bill 2009, will address issues related to 'Corporate governance'.
• National Clean Energy fund will encourage research in innovative projects and will ensure use of alternate energy resources like solar and wind energy.
• Unique Identification Authoriry of India (UIDAI) under the Charmanship of Nandan Nilekeni will be able to roll out the first set of UID numbers in the current year.

Individual Tax payers owe a special thanks to the FM for the special IT bonanza in this years budget.

Banks to move from BPLR to 'Base rate': Implications

The issue of Banks differentiating between old and new borrowers has come under the scanner of 'Competition commission'. Existing borrowers feel cheated when their bank offers a lower rate of interest to the new borrowers, while they are not allowed a reset for their existing outstanding loans. If they want to liquidate the loan and move to another lender, they are required to pay a hefty pre-payment penalty ranging anywhere between 1-3%. Banks have justified this juglery on the pretext that they need to protect their Net Interest margin (NIM), and the banks can offer loan reduction to existing borrowers only with a time lag, because they need to overcome the mismatch between their asset and liability buckets. Moreover, with more than 50% of the loans sanctioned at sub-BPLR rates the concept of the BPLR has been rendered redundant.

To enable the banks to set their lending rates in a scientific and transparent manner, the Reserve Bank of India has proposed a system that will replace the existing system of benchmark prime lending rates (BPLR) with base rates. The formula for calculating the base rate will take into account the cost of deposits, cost of complying with CRR and SLR requirements, and the need to retain a profit margin. There will be a markup depending on the cost of operation for a particular type of product and premiums for credit risk and tenor of loans. The existing BPLR system does not quickly or adequately respond to changes in policy rates, thus reducing the effectiveness of monetary policy. Transparency will be enhanced under the new syatem. The priority sector lending at sub-BPLR rates will be unaffected as the base rates will be set much lower than the existing BPLR of the banks.

Based on the 2008-09 numbers, the base rate varies from 5.22% for Citi to 8.91% for OBC. Broadly speaking, foreign banks have the lowest rate followed by public sector banks and then private banks. Currently, the PLR of most banks are more or less the same. It would be interesting to find out  that once the base rate scale is known to all potential borrowers and varies according to a uniform predetermined formula, potential customers would have a choice provided the banks have the willingness. With savings bank deposit rates set to be calculated on daily balances from 1.4.2010, banks profitability will be under some more pressure. Most Banks have sought period till the end of June 2010 for implementation of the new lending regime.

Speculation: A blessing in disguise!

We take many decisions in our day to day life, without really knowing the outcome of those decisions. There is always a probability of success or failure of that decision. For example, during the rainy season, we have to take a decision whether to wear a raincoat or not, based on our expectation whether or not it will rain during the day.What exactly is speculation? Speculation in respect of the financial world includes the buying, holding, selling, and short-selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives or any valuable financial instrument. It is different from buying because a speculator does not buy goods to own them, but to sell them later. The reason is that he wants to profit from the changes in market prices. Speculation is one of the market roles in  financial markets. The others are hedging, long term investing and arbitrage. Speculators do not plan to keep an asset for a long time.

Common features of non speculative markets are:

• Almost total absence of leverage, and has limited depth
• Shares, bonds and other assets are bought primarily for cash and not on credit
• The expectations of capital gains are low
• Trading volumes are low, and trading is dominated by a small group of people.
• The markets are traditionally undervalued markets

A majority of the Asian markets, including India were non-speculative markets till the 80's. In India, in the 70's and 80's people bought homes only to live in them. Gold & silver held by the families were non-speculative in nature. With the globalisation of asian economies an element of speculative interest has been built in these markets. There has been a lot of interest in these markets from the foreign investors largely because of the huge growth potential, as most of these markets had been depressed for long, because of the lack of speculation. The Asian markets led by China and India are currently going through a long term "bull phase", which is marked by higher speculation.

According to John Templeton "Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.” An investor should not be unduly worried about the higher volatility in our markets, because just like small cap growth stocks tend to be more volatile than established blue chips, emerging markets tend to be more volatile than matured western markets. But then they also have the potential to deliver higher returns.

However, investors must be aware of the speculative excesses, which often cause the end of bull markets. Here are some of the symptoms of speculative excesses:

• The long the uptrend in the market, the higher is the likelihood of creation of a mania or 'herd instinct'. Long term bull markets survive only if there are intermittent corrections within the bull run
• In the maniac phase of the bull market the mood is euphoric, and even dud stocks rise appreciably
• The number of new issues is very high
• The mania is whipped by the media, because their business survives on creating the hysteria.
• Towards the end of the maniac phase, insiders resort to double standards - painting a rosy picture about their businesses in public but paring their holdings in the company
• Sometimes it results in surfacing of 'Ponzi schemes' and 'Swindlers'. The likes of Harshad Mehta and Ketan Parikh are the creations of the excessive speculation phase.

Sir Isaac Newton amply sums up this frenzy when he says: “I can calculate the motions of heavenly bodies, but not the madness of people”. Speculation is good for the markets, untill the above symptoms appear. Investors can safely ride the current long term bull market in India, but must guard against the above factors to protect their interests.

Vision 2020: Where to Invest?

Indians have traditionally been one of the highest savers in the world, but they have rarely looked beyond the traditional asset classes. The coming decade promises to offer a lot of opportunities for investment. At the outset we must understand the difference between 'Saving' and 'Investment'. Typically, savings instruments take care of our liquidity needs, and they are hardly able to beat the inflation. The better part of our surplus money, therefore, needs to be directed towards investment, to enable us to acheive our cherished goals. The ideal way to plan for the future is to seggregate one's portfolio into: Core portfolio also known as strategic investment, and the other part could be the sattelite portfollio also called tactical investment. About 60-70% of the corpus needs to be allotted towards the core portfolio.

The Core portfolio should be made up of the following asset classes:

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  Cash/ Cash like instruments: These instruments offer the highest safety and liquidity, and help us to create a contingency fund to overcome unforeseen circumstances. Bank deposit form a large chunk of this asset class. As bank deposits typically follow the interest rate cycle, they tend to rise when inflation is high. It is advisable to get into long term bank fixed deposits when the interest rate cycle is at its peak.
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  Bonds/ Other fixed income instruments: These instruments are typically used for parking your surplus cash, when the outlook for equity and other risky asset classes turns negative. Rather than putting money directly into Govt./ corporate bonds one must invest through debt market schemes of mutual funds to take care of liquidity and diversification issues. These investments would give a slightly better return as compared to bank deposits.
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  Eqiuty: Also known as risk capital, equity markets are prone to more risk and volatility as compared to fixed income instrumrnts. But history tells us that in india equity markets have given far superior returns over longer investment durations. The core portfolio should include a decent amount of equity for all types of investors. Care should be taken to invest in divetrsified equity funds that invest in large cap stocks, which are less prone to volatility. Typically, the investemnt horizon for equity investemnt should be more than 3-5 years.
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  Bullion: Indians have been investing in bullion since time immemorial. Gold has been traditionally treated as a hedge against inflation. But strictly speaking gold has not lived upto this expectation in the long run. Gold is a typical asset class, whose price is determined more by speculation rather than the intrinsic worth. We generally buy stocks of companies based on their past perforamnce, but gold investment does not follow any such yardstick. However, gold must form atleast 10% of the core portfolio simply as a tool for diversification. The best way to invest in gold is through Gold ETF's.
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  Real Estate: Real estate also must form a reasonable part of the core portfolio. But we must keep in mind that this is one of the most illiquid asset class. While going for a second house/ real estate investment, one must identify a reasonable price for it - a common yardstick should be a rental of 4-5% of the purchase price plus the chances of a capital appreciation in excess of 5% per annum. While going for a residential property it must be noted that plots offer better rate of appreciation as compared to built up flats, become it is the price of land that appreciates, the price of construction does not appreciate.

Other asset classes or investment avenues should form a part of the non-core portfolio. Here active churning is required to take advantage of the dynamic pricing environment. The non core portfoilio can include investment in high beta mid-cap stocks, investemnt in commodities other than gold, and currency/ future and option trading. One must indulge in building this portfolio only if you understand their characteristics and market behavour. The next decade will also provide Indian investors an opportunity to invest in cross currencies and other physical foreign assets.

Vision 2020: 'Decade of the Discerning Investor'

The Indian investor never had such a wide choice of investment avenues as he now has. On the one hand this has created an enormous opportunity for 'wealth creation', but at the same time it has imposed a lot of responsibilty on the investor to take prudent measures to avoid 'wealth destruction'.

The generation of 50's and 60's was essentially a generation of savers, there were very few investment products available to them for investing. But, in their hindsight, they were prudent enough to invest a decent part of their savings into gold and real estate. Entrepreneurial spirit picked up in our country in the 70's and 80's, but the predominance of higher income tax rates ensured that investors did not look at alternate investments beyond those that offered tax benefits. The first mass equity related product US 64, popularly known as units, became popular during this period. However, the equity cult was ushered in India by Dhirubhai Ambani in the 80's. But assured return products like Public Provident Fund and Govt. Bonds like NSC, KVC which offered risk free/tax free return of upto 12% never allowed riskier assets to be a part of the Indian investor's portfolio.

The decade of 90's came as a major game changer when Indian economy embraced globalisation, though reluctently in the initial period. The economic stability and the higher growth of the economy led to advent of the bold new Indian investor who was no longer afraid to take risk. A slew of new products like GDR/ ADR/ Variety of Bonds were introduced during this decade. This process continued through the next decade. To guide the investor in choosing the best among the new products a breed of financial advisors including stock brokers, mutual fund advisors, real estate advisors, tax advisors established themselves during the decade gone by. But, unfortunately, in their quest to make more money at the cost of the investor, most of them merely did the job of 'product pushers'. The system of embedded commissions ensured that the so called advisor could give advise even without having a proper understanding of the markets and still could make a lot of money at the cost of the investor.

Towards the end of the last decade, several positive steps have been taken by the regulators to send the message across that it is the end of the road for the 'commissions regime', the advisor would have to earn his fees from the client in lieu of the advice given. The online trading platform has ensured drastic reduction in brokerage. Similarly front loaded commissions on Mutual Funds have been stopped, and a move is on to reign in the insurance commissions. The new direct tax law aims to make the taxation system a simplified affair with a large number of deductions withdrawn, but with more than commensurate reduction in tax rates/ tax slabs.

The new decade promises to be the decade of the 'Discerning investor'. A variety of new products are in the offing: REITS (real estate investment trusts), extension of currency & commodity derivatives, a slew of international investment products. The regulators are bound to create an environment where the investor will be free to take an informed decision based on genuine information. To help the investors take informed decisions, a new breed of qualified advisors will take over from the product pushers, who will guide the investors through the maze of investment opportunities. The investors will not be averse to a fee based system to remunerate the advisors for the services rendered.

There will be lot of opportunities for 'Wealth creation', provided an investor takes decisions based on his risk profile and life goals. The investor will have to balance his Risk-reward matrix to meet his financial requirements. The next decade will open a window to several new opportunities for Indians to invest, we must seize the initiative and invest wisely, because sky is the limit for creating wealth in the coming decade. I propose to highlight the various asset classes for the new decade in my next post.

Vision 2020: 'India's Decade of Glory'

While the decade gone by transformed India from a sleeping economy to a vibrant economy, the world has taken note of, the decade just started is destined to be 'India's decade of glory', that promises to fulfil the 'Vision 2020'. There are some very strong indicators that are pointing towards India's march towards becoming the fastest growing economy that will dominate the world by 2020:

• With a younger work force, that is technically more qualified, India has the potential of supporting a sustainable GDP growth of around 10%, India can overtake China as the fastest growing economy during the current decade, as China is likely to be faced with an aeging work force and the spectre of being faced with the compulsion of letting its currency appreciate steadily against the dollar, that will lead to a slowdown in its GDP growth rate over the decade.

• The political clout of India is going to increase in the world, as its economic prowess spreads. India is most likely to join the elite club of permanent members of the UN Security Council. Its quest for altrnative sources of enegy is likely to make India more or less self sufficient in meeting the growing energy demand during the current decade. The astronomical rise in price of crude oil will make it compulsory for nations to search for alternate energy resources, and India is poised to lead this revolution by promoting the use of Solar, Wind, Hydel and Nuclear energy.

• The democratic institutions in the world's largest democracy will flourish in the new decade. There may be initial hiccups in the domestic political landscape as the demand for smaller states gathers momentum, but the smaller states may be administratively easier to control in the long run. By 2020 India may adopt the US kind of federal set up with over 40 states. The technological advancement in administrative set-up in the aftermath of the implementation of the unique citizen ID project will aid in smooth administation of the country. The 2- party system at the centre of the federal structure is likely to provide a stable political environment in the country by 2020.

• India has the potential to become the most sought after Business as well as Tourist destination in the sub-continent, overtaking the likes of Singapore, Malaysia by 2020. Themes like Eco tourism, Education tourism, Health and Medical tourism will lay the foundation of India becoming a major tourist hub by 2020. Infrastructure development supported by a highly sophisticated and efficient transportation system will help India achieve this status.

However, India needs to guard against terrorist attacks from across the border, and the insurgency from within. Our foreign policy needs to be revamped to give an impression to the world that we are not a soft state. Similarly our security forces will have to be equipped with modern gadgets to thwart any attempt to disturb the peace of our country.

Our markets will also reflect the mood of a resurgent economy, but there will be some sectors and some asset classes which are likely to outperform the broader markets. I propose to cover the market scenario for the coming decade, in my next post. Wishing all of you 'Happy Investing' in the new decade.