Protect from Protectionism

Virus of global meltdown has made world to dance over its tunes. In amidst of all this, western countries are resorting to an antivirus called “protectionism” to fight this financial meltdown.

Before going into gist of this post, Lets have brief look on Protectionism:
According to Wikipedia : Protectionism is the economic policy of dampening trade between states through methods such as tariffs on imported goods , restrictive quotas and various other government restrictions aimed at discouraging imports and prevent foreign take over of local markets and companies. In short it is the opposite of free trade and globalization.

History
Being the” super power”, all good and bad things related to world economy are initiated by USA. In one of my earlier post “fight of words: R vs. D” I had mentioned about Hawley –Smoot Tariff, which came into forth during times of great depression of 1930’s. As business were slowing down in order to protect its own industries American government created “Hawley –Smoot Tariff in 1930’s , which meant to charge high import tariffs on imports , this led to deterioration in global trade leading to economic retaliation.

Present situation
Free movement of goods and services across nations was one common link on which all economists since World War II had agreed upon. Current crisis have hiited so hard that western nations: the leaders of globalization and free trade, are spreading a new wave of isolationism.
With Barrack Obama admistration coming with a stimulus package of $ 800 billion which contains a clause “Buy America” has led to agitation among other economies. This “buy American clause which has taken heap all over imposes restrictions on use of non- American material in all public work programmes that will be funded by stimulus package. Similar sort of protectionist policies are also be followed in Britain with government infusing funds in banks to keep them solvent and insisting that funds to be used nationally.

This sort of protectionism will have adverse impact on world trade. For short term countries mite benefit from such measures but in long run this would impede their global competitiveness. Protectionism will increase cost of production and will result in inefficient allocation of resources. End result of such a policy would be only benefit incompetent industries which can’t compete at international level, whereas efficient industries will loose the most out of them.
For instance it mite be the case that, that steel, cement manufacturers may benefit from the “buy American” clause but technology sector which consists of biggies like Microsoft, Intel, Apple, General Electric and so on will take a back seat if in retaliation countries like China, India and other emerging markets who have trade relation with America impose tariffs on goods produced by these companies.

In comparison to 1930’s protectionist policy, present day policy is more discerning. Though in current slowdown fewer tariffs have been raised, but modern protectionism comes with tighter licensing requirements, import bans and anti dumping measures. Rich countries have played clever by introducing discriminatory procurement provisions in their fiscal stimulus bills and offered subsidies to ailing national industries.

International trade has covered a long journey from 1930’s period to current day crisis. And we all believe that world has less to fear from protectionism in present times. Over the period a strong safeguard system in terms of international agreement has been built which maintain tariffs in limit. The global supply chains which have integrated national economies together tightly have made it difficult for government to raise tariffs without harming producers in their own country. However these safeguard systems may fail when there is intense use of anti dumping, use of domestic subsidies and other kinds of swarming protection. Most of the countries are in position to raise tariffs as their applied rates are below maximum allowed by WTO commitments. They may tend to do so on risk of disrupting the global supply chains.

U- Turn of Globalization

It’s a well known fact that slowdown in trade is result of ongoing global recession. Even in earlier slowdowns trade has fallen on account of slowdown in demand , but current downfall in trade is arbitrary i.e. that though trade has fallen in volume , the striking feature is that it has depressed on account of falling prices and stronger dollar.

Most economists argue that tremendous growth in global supply chains is responsible for such fast dropdown in global trade. It means that countries not specialize in final products but in products used in process of production. For e.g. in earlier times truck made in America which had used American steel and parts would enter trade data only it was exported. But now if that truck uses Indian, and processed in other country then slowdown in demand in America would effects its counterparts also.

Therefore in this sense Buy America clause mite turn out to be bust for American economy. For instance if take a look at auto sector. The American government is working hard to provide big stimulus to save its auto industry. However most of these manufacturers have global businesses and to protecting an automobile company in one country would affect its operations in others as well. For e.g. if us government did not provide any rescue package for general motors its worldwide operations, including business that it outsources in India, would be affected.

Therefore the it mite be the case that in era of global supply chains in international trade , this rescue plan of America mite turn out to be another problem for them.

Curse of Indian SME’s

Over the years Indian Small Scale Sector has been able to create a significant position for itself in the Indian industrial economy. By employing around 28.3 million people it becomes the second highest source of employment in India. Apart from this it accounts for 49% of overall exports.

SME’s in India are dominant in sectors like textiles, chemicals, auto components, leather and machine tools. With the current slowdown mounting, this sector scores high rank of coming into its grip. This is evident from the fact that despite of 2 fiscal packages announced by government and easing of interest rate by RBI to infuse much needed liquidity in this sector banks are still hesitant to lend them due to their low creditworthiness.

Let’s look at the better picture of it:

Leather Industry
For instance let’s look at the case of leather industry; this sector was registering growth of about 20% in second half of 2008 but got crumpled by global slowdown. The main reason is accounted as slowdown in orders from western markets like UK & USA. The European Union and US markets contributes to about 25% to 65% of Indian export revenue.
Apart from this competition from china is becoming tough as Chinese government helping them to follow aggressive export policy which in turn helping them to bag more orders. If such scenario continues it is estimated that about 2-3 lakhs of jobs will be lost out of 25 lakhs of total workers employed and number can further increase.

Small service industry
In this aspect there is one interesting example to watch out; we all know how radio cabs industry has gained momentum in past few years. Estimates show that chauffeurs use to earn around 15000 per month around few months back, but with downfall in business their incomes have scaled down to 3000-4000 per month. This drastic decline in incomes of these chauffeurs is due to decline in number of duties on daily basis and burden of daily subscription of Rs 700 which is mandatory for them to pay.
If we need to check out an example of particular industry this one I Found out in one of the newspapers was of Chakradhar Chemicals Pvt Ltd, a medium-sized 13,000-tonne capacity micronutrient fertilizer company based in Uttar Pradesh. Company employs around 70 people and has been hard hit by rising cost of raw material and transport while salary expenses have increased by 16% on year-on-year basis.

Textile Industry
If we go 2 years back i.e. around 2007 Indian textile industry was on brink of rapid growth. However in present day the industry is pleading for urgent help for its resurrection. India is the world’s second largest exporter and consumer of cotton. In past few months cotton prices have surged nearly by 30% which has wiped of the demand for cotton textiles and garments from international markets. This has resulted in workers of textile industries to go for forceful voluntary retirement.

As discussed above major demand for Indian textile comes from US and Europe, with these countries battling the slowdown demand has been completely wiped of, this is despite of rupee depreciation, which is beneficial for exporters.
Numerical estimates show that Indian exports declined from $3.9 billion to 3.8 billion from the month of January to August, which was before US meltdown in September. The overall drop in value terms was 1.6 percent, with the drop in exports of garments a much higher 4.8 percent. The situation has worsened; total output of the textile sector has dwindled down to 10%. Study conducted in November by the Federation of Indian Chambers of Commerce and Industry (FICCI) pointed out that investments in the textiles industry were falling and so was its profitability.

I figured out few examples which have been hardly hit by this recession. While traveling by train in state of Punjab , as soon as train arrives in city Ludhiana , the recorded voice says city’s textile industries contributes about 80% of the country’s wool production. However but present day situation is different , most of the garment companies in city have suffer losses more than 50% over the last year , which creates 4,00,000 jobs in Ludhiana itself.

Remedy for This!
According to estimates of ASSOCHAM (Associated Chambers of commerce and industry of India) the SME’s were becoming tender during its first quarter with both manufacturing and hiring dwindling down to 10% and 7% respectively.

Therefore need of the hour is to restructure loan repayment plans for textile companies. According to most of the experts the medicine which can heal this bruised industry is easier terms for bank credit and reduction in taxes for textiles.

Let’s hope the new government which will form after upcoming general elections provide some respite to this beated down sector

Perspective of Fiscal Multiplier

Though we are in amidst of a severe financial turmoil, but this gives us opportunity to learn the working of various concepts of macroeconomics in reality , which we have always studied in books. One of such interesting concept which strikes my mind recently was how is fiscal multiplier working when governments of all countries are resorting to massive bailouts.

Let’s first have a brief look on concept of fiscal multipliers:
According to Wikipedia Fiscal Policy Multiplier refers to the idea that the initial amount of money spent by government leads to an even greater increase in national income. In other words an initial change in aggregate demand causes a change in aggregate output for the output that is multiple of the initial change.

In view of government bailouts, where government is trying hard to provide stimulus to their respective economies in order to increase aggregate demand, we need to analyze role of these fiscal multipliers.

As we know major fiscal policy instruments are government spending and taxation, which impact aggregate demand, resource allocation and income distribution. In current slowdown when worldwide governments are resorting to excessive government spending in order to raise demand, multiplier effects of spending on economic output turns out to be small.

First lets analyze the case where fiscal multiplier is 1, what does this imply- this simply means that an increase of one unit in government spending will lead to an increase by one unit in real gross domestic products (GDP) .Therefore , added public goods are provided free of cost to the society. This outcome is no magic but optimal utilization of resources like labor and capital, which add to production of more good and services.

If multiplier is greater than 1 , ( multipliers via government spending range usually between 1.5 to 2 ) in this gross domestic product rises more than government expenditure. Thus we have additional goods and services which give the room for to raise private consumption and investment.

Historic view
We all know about the great depression of 1930’s, it was the time when the Keynesian tonic was applied to the much damaged US economy. It is much evident from past experience that government spending is linked to overall business fluctuations in the economy. In times of World War II enormous fiscal expansion was done in terms of increased defense expenditure, which led to freedom of global economy from grip of great depression. This in turn proves the existence of large multipliers.

But going by studies of economists some flaws of Keynesian theory come to highlight. According to them the increase of US defense expenditure led to a large multiplier of 0.8.However if we analyze it the other way round, it gives us a very practical and real picture. Accordingly, the increase in war expenditure led to erosion in other components which comprises the GDP. There was massive down surge witnessed in private investment, nonmilitary government expenditure, and net exports. This resulted in a depressive effect rather than a multiplier effect. However in times of peace increase in government expenditure had led to large multipliers. All growth from 1941 to 1945 cannot be attributed to military outlays, many economists believe that multiplier during peace time was significantly different from zero.

Current scenario
The major question comes back to the current crisis, with global economy facing a severe downtrend; will government stimulus lead to large multipliers?

If we compare American economy of 2001 with today we will get a much clearer picture. In 2001 though economy was in recession but at that time there was room for households to use their tax cuts as down payment for car or cover their costs of mortgage refinance.

In current phase credit markets are bruised badly, therefore financial institutions won’t be able to take advantage of income generated by increased government spending to the same extent leading to much smaller multipliers.

Markets Free Fall: Despite of RBI rate cut & low Infaltion

Tackling the global finacial meltdown , RBI yestrday came with the move of cutting repo rate and reverse repo rate by 50 bs points. Currently Repo Rate ( the rate at which RBI lends to commercial banks) stands at 5% and Reverse Repo rate ( the rate at which banks lend to RBI) stands at 3.5%.

The move was taken in view to ease lending rates for corporate india and individiual borrowers in order to create demand in economy. however markets responded negatively to this move by plunging in red , falling by 261.14 points ending at 8185.35. lot of selling pressure came in from largecap stocks all making new 52 weeks low.

Even low inflation numbers couldnt turn up the market sentiments. Inflation came down to 3.03% for the week ended feburary 21.

Renewed FII selling is taking our markets down. However, next week a global rally can be expected as the US markets are in the highly oversold zone.

Gold Exchange Traded Funds

Gold has remained one of the favorite avenues of investment for Indians. Around 23% of investment is done in gold by Indians.

Amid the current global turmoil and the bear run share-market scenario, people are going for the traditional and safer option of investment: gold. They are investing in the yellow metal in a significant volume. With the advantages of gold over any other form of investment — security being the most desired — people are buying gold in all forms, be it coins, biscuits or jewellery, besides exploring new options like Exchange Traded Fund (ETF).
I have seen many people are not familiar with gold ETF, which have become quite significant in past few years. So this post in brief will provide readers to explore this avenue of investment in this downturn.

What are ETF’s?
A security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold.

What is Gold ETF?
Gold ETFs provided investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold, and to buy and sell that participation through the trading of a security on stock exchange. Gold ETF would be a passive investment; so, when gold prices move up, the ETF appreciates and when gold prices move down, the ETF loses value.
Gold ETF provides return that before expenses closely corresponds to the returns provided by physical gold. Each unit is approximately equal to price of 1 gram gold. But, there are Gold ETFs which also provide a unit which is approximately equal to the price of ½ gram of Gold.

Brief history
The first proposal of a gold exchange traded fund was originated by an Indian company called Benchmark Asset Management; a proposal was launched with the SEBI (Securities Exchange Board Of India) in 2002. This proposal was not approved at that time.
The Australia Stock Exchange was the first to launch a gold exchange traded fund in 2003 by Gold Bullion Securities under the symbol ‘GOLD’. This fund was fully backed, insured and deposited by gold bullion.

Difference between Gold Etf’s & Mutual Funds
Disparate Asset Classes
It is the nature of asset classes which differentiate gold etfs and mutual funds from each other. While former falls under the category of commodities, later comes under equity category. In Gold Etfs investor is vested with the opportunity, to invest in units of gold, which are traded on exchange as single stock. The units issued under the scheme represent the value of gold held in scheme. However in case of mutual funds, fund mangers invest in equity and equity related securities of gold mining companies. Since gold mining companies are not listed on Indian stock exchanges, the gold mutual funds invest in world gold funds that invest in gold mining companies across the world.

Returns attainable
Basic motive behind any investment is to gain high returns. The world gold fund has given absolute returns of 31.9% in the period since its inception in August 2007 to July 2008. Most financial advisors advise that investment in gold must be made for the purpose of diversification and at any point in time, about 10-15% of your assets must be invested in gold.

Nature of funds
Basic aim of both the funds is another important point which differentiates both the funds from each other. “The fund simply buys and holds gold on behalf of the investor without actively managing it. The aim is to give returns as close as possible, post-expenses, to that given for gold as a commodity,” however when investing in a mutual fund, the investor can rely on the expertise of a fund manager who indulges in active portfolio management and is able to make crucial decisions regarding selecting stocks of gold companies.

Benefits of trading in ETF’S
In ETf’s investors have the opportunity of buying as less as 1 unit on the exchange. Investors don’t have to pay entry or exit load and expenses on brokerage are less. Here gold etf’s score over mutual funds as in case of later investor has to bear defined load structure, entry and exit loads and other expenses.

There are five gold ETFs in the market today, namely Gold BeEs, Kotak Gold, Quantum Gold, Reliance Gold, and UTI Gold ETF. According to data published by Value research online, the returns from all the gold ETFs over the last one year have been practically identical.

IF you take a look at gold prices in the past few months, they have been moving in just one direction-- upwards. From Rs 10, 650 for 10 grams last January 2008, the price has moved to Rs 15,490 today. Gold price is at a seven month high and is up by 10% since January this year. The World Gold Council reports that global demand was up by 4 per cent in 2008.

Gold and stock markets have negative correlation, which can be witnessed in current scenario where volatility in stock markets have led to sky rocketing gold prices.

In 2009 itself Gold etf’s have outperformed gold mutual funds. ETFs have given 29 per cent returns in 2008 and over 8 per cent till now in 2009. In this current financial turmoil investing in shining yellow metal turns out to be the safest bet!!

Inflation slided to 3.92%

Inflation eased to a 13-month low of 3.92% for the week ended February 7 on the back of a sharp fall in the prices of edible oils and
manufactured products. An ET poll had forecast that the inflation would fall to 3.91% for the week from 4.38% in the week before and 4.97% in the corresponding week last year. Inflation based on the wholesale price index has eased sharply from a 16-year peak of 12.91% in August 2008, due to a sharp fall in commodity prices
and a slowing demand. The drop in inflation has led to renewed calls for aggressive rate cuts to boost the flagging economy.

Fight of words: R Vs D

We all are familiar with ongoing financial crisis, but most of us don’t know whether to call it a financial recession or depression. I have seen many articles, papers where there is confusion between with what to quote current crisis with “recession or depression”.

Before finding an answer to this, let’s find out difference between the two:
On searching on various search engines the basic difference which, I got is as follows:
Recession: an extended decline in general business activity, typically three consecutive quarters of falling real gross national product.
Depression: a decline in real GDP that exceeds 10%, or one that lasts more than three years.

Therefore the above definitions indicate that the basic criteria of indentifying depression or recession are to measure extent of economic decline. A depression is simply a magnified version of recession. The last two depressions in the U.S. were both in the 1930s. From August of 1929 to March 1933, real GDP declined by approximately 33%. There was a period of recovery following this depression, but in 1937-38 the economy dipped again in a less severe depression. All other economic downturns since that time have been recessions or just plain old tough time.

Transpose of Recession to Depression
Recessions gets transformed into depression, when government applies wrong measures in controlling it.
According to James Pethokoukis, "4 Ways to Turn a Recession into a Depression (U. S. News 11/4/08), there are ways that good and bad policy can effect an economic downturn.
· Bank closures
Although the American taxpayer may well have to provide what is being called, "the mother of all bailouts" the Federal Reserve has already committed $7 billion to prevent the collapse and run on the banks. It has also raised the federal deposit insurance (FDIC) from $100,000 to $250,000 to discourage shaking depositors from withdrawing their cash.
· Increasing of taxes
During the period of great depression, according to the revenue act tax rate was raised from 25% to 63%. Economists regard this as one of the most inaccurate steps taken.
· Hawley –Smoot Tariff
As businesses were slowing down, to protect its own industries American government created a Hawley-Smoot tariff in 1930, which meant to charge high import tariffs on imports, this led to deterioration in global trade leading to economic retaliation.

New distinction between Recession & Depression
However there are economists who differ from above definitions of recession and depression. in present times they believe that difference between a recession and a depression is more than simply one of size or duration. In making distinction between the 2, cause of the downturn should also be taken into account. A standard recession usually follows a period of tight monetary policy, but a depression is the result of a bursting asset and credit bubble, a contraction in credit, and a decline in the general price level.
If we go back in past, economic downturns that followed the collapse of the Soviet Union and those during the Asian crisis were not really depressions according to this criterion. Another significant aspect of this distinction between a recession and a depression is that they call for different policy responses. A recession triggered by tight monetary policy can be cured by lower interest rates, but fiscal policy tends to be less effective because of the lags involved. By contrast, in a depression caused by falling asset prices, a credit crunch and deflation, conventional monetary policy is much less potent than fiscal policy and one tends fall into what is called as a “ liquidity trap”.
Present day situation
After all this discussion, the only question dwindle in our minds is “where we are today’? Well if we go by all definitions, America’s GDP may have fallen by an annualized 6% in the fourth quarter of 2008, and cause of this downturn is the largest asset-price and credit bubble in history—even bigger than that in Japan in the late 1980s or America in the late 1920s. So this means we are back to 1930’s?
Well many economists tend to deny this notion of 1930’s depression, because policymakers are unlikely to repeat the mistakes of the past. Though we are far off from situation of great depression, and policymakers won’t make same mistakes. But you never know they commit some new one’s as these are same policymakers who predicted that nationwide housing bubble burst is impossible, but today nothing is hidden, we all know the truth and truth is always bitter…..

Low Inflation Offset by Low IIP numbers

The lower inflation numbers failed to boost sentiment in the markets, which were dragged by the negative industrial numbers. The Sensex remained in the negative territory amid weak Asian markets.
The Sensex was down 62 points at 9556 levels.
The rate sensitive sectors realty, auto and banking stocks were mostly in the green in anticipation of a rate cut by the RBI. On the other hand, metals, IT and oil & gas stocks dragged the benchmark index.
The industrial production for December contracted by 2 per cent, as compared to 8.6 per cent growth a year earlier. The fall was led by a led by a 2.5 per cent contraction in the manufacturing output. Inflation for the week ended January 31 was at 4.39 per cent as compared to 5.07 per cent a week earlier

Soruce : NDTV Profit

Unhealthy Report Card of Corporate India

With the outburst of satyam saga, New Year also started with quarter 3 results of corporate India for FY 2008-09. With global meltdown riding on peaks, doleful results of major companies all over the world were predicted and result of Indian companies are no exception.

Global financial markets from past few quarters have been posting unhealthy performance. Despite of various fiscal bailout packages announced by economies, there impact on combating this ongoing recession is yet to be seen.

Coming back to India, the 3 quarter earning season was gloomy for the economy, as all major companies showed losses in their balance sheets. On the basis of sectoral performance, the major hit sectors are the export oriented, gems and jewellery and textiles. Battling with low demand, slowdown hitted real estate and infrastructure have passed on their negative fortunes to also cement and steel industry. These two segments have shown dejected performance on account falls in prices of finished goods and low demand from key user segments.

Also interest rate sensitive sectors like automobile are facing bad times. A leading two-wheeler company has not only posted a decline of 17% in net sales but also a whopping 25% decline in net profit for the Q3 FY09. Major commercial vehicles players have also shown dismal performance for the quarter. Moreover, the numbers released Society of Indian Automobile Manufacturers , on production and sales gives a gloomy picture of this sector.

Though IT companies have posted good results in Q3 FY09, it can be partly attributed to the rupee depreciation. Going ahead, the weak guidance given by IT companies indicates a rough ride in global markets. Though banking sector have posted positive results but surging NPA’s can prove out to be trouble in coming quarters.

Oil marketing companies benefited through artificially propped up petro product prices, while pharma and FMCG companies continued with their standard 5%–15% growth pattern.
Despite of the measures taken via monetary and fiscal policy, slowdown is evident in all the sectors, and deteriorating job scenario in 2009 is painting a picture of slowdown in quarters to come.

Inflation at 5.07% on Jan 24

IInflation for the week ended Jan 24 slipped to 5.07% from 5.64% as prices of food items eased after rising for two consecutive weeks.

This was lower than a forecast 5.21 per cent in the wholesale price index in the 12 months to Jan. 24, compared with 5.64 per cent in the previous week. It would be the slowest annual rise since Feb 9 last year when inflation was at 4.98 per cent. Inflation had fallen to an 11-month low of 5.24 per cent on Jan. 3, but it rose in the next two weeks following an eight-day nationwide truckers' strike that pushed up food prices.

source: Economic Times

The classical school

Classical economics is a school of economic thought whose major developers were William Petty, Adam Smith, David Ricardo and John Stuart Mill. Classical economists attempted to explain growth and development. During the time when capitalism was emerging from past feudal society these great economists came with their theories which marked the era of industrial revolution and bringing about major changes in society. Classical economists reoriented economics away from an analysis of the ruler's personal interests to a class-based interest.

Publishing of book wealth of nations by Adam Smith gave birth to modern economics in 1776. The book identified land, labor and capital as three factors of production and major contributors to nation’s wealth. Smith for e.g. identified the wealth of a nation with the yearly national income, instead of the king's treasury. Smith saw this income as produced by labor applied to land and capital equipment. Once land and capital equipment are appropriated by individuals, the national income is divided up between laborers, landlords, and capitalists in the form of wages, rent, and profits. Wealth of nations highlighted a disproportionate number of ideas about the organizations and markets that survive today –nearly 300 years later, and an economic revolution or two after publications. Adam Smith was regarded as “Father of Modern Economics”.

The centeral thesis of welath of nations is that capital is best employed for the production and distribution of wealth under conditions of governmental non-interference , or laissez-faire, and free trade. In Smith's view, the production and exchange of goods can be stimulated, and a consequent rise in the general standard of living attained, only through the efficient operations of private industrial and commercial entrepreneurs acting with a minimum of regulation and control by the governments.in order to prove this ,he came out with a theory of invisible hand, which highlighted that market system appears to organize itself and even after an unexpected economic crash returning to pre-disastrous state with no intervention by greater body or so.
In today’s time book can be a difficult read for modern economists. Much of what is discussed in the book makes very little sense in a modern context - but still, the concept of an equilibrium market, where various negative forces may be applied, generally from interventionism and negative economic situations, holds strong to this day.

Evolution of Economics

The word “economics” is derived from oikonomikos, which means skilled in household management. As the western world began its transition from agrarian to industrial economy, modern economic thought came into being. Before modern economics which came into being around 1th century there existed number of economic thought particularly European Mercantilism, and French Physiocraticism. Of which, neither fall in to the classification of formal economics, and both lack the structural and systematic processes required for formal knowledge creation.

Mercantilists’
This was the economic philosophy adopted by merchants and statesman during the pre-classical era started after 1500. Mercantilists’ believed that nation wealth came primarily from accumulating gold and silver. Their philosophy can be summed up in following manner:
1. All available land should be employed for agriculture, manufacturing and mining.
2.Exports of monetary items such as gold and silver should be banned, such that mechanisms of trade stay within the country.
3. Imports should be grossly frowned up and when need arises should be traded in exchange for other goods.
Mercantilism introduced the concept of double entry accounting, which is a primary form of bookkeeping in today’s time. This system represented the pinnacle of commercial interest to level of national policy.

Physiocrats
Idea of economy as a circular flow of income and output was developed by group of French philosophers in 18th century known as physiocrats. They believed that only process that yield net result is agriculture. According to them agriculture is sole source of wealth in an economy. In an opposition against mercantilist trade theory, the physiocrats propounded a policy of laissez-faire, which meant minimal government interference in the economy.

Introduction

We have always known economics as a subject which exists in our school or college syllabus. Definitely for me it is one of the very interesting subject and one of my passions to explore the subject from start to finish.
A thought recently clicked my mind that we all know economics as a subject that exist as part of our course in schools and college , but we hardly know how this subject came into being. As a matter of fact the origin of this subject lies in western world where it came into existence around 17th & 18th centuries.
Therefore in this part of my blog I’ll be sharing with you how economics came into being and ill share with you works of various economists whose names are somehow being forgotten by us:
This part of my blog is for those, who really have liking and passion for this subject. Hope you guys like this part of blog also.

Gold Prices shot up to Rs 14, 175

Gold prices shot up by Rs 435 per 10 grams to a new peak of Rs 14,175 on the bullion market in Mumbai on Thursday following renewed buying from stockists and investors on the back of firm trend in global markets.
Silver also moved up in line with gold prices as well as renewed industrial inquiries.
Volatility in other assets that forced investors to park their funds in precious metals as a safe investment also boosted the prices of these metals.
Gold strengthened more than two per cent in Europe to a three-month high, as investors preferred to invest in the metal from the current uncertain scenario.
According to market perception, China taking an interest in gold as an alternative to U S Treasuries, and of a European fund buying bullion, also influenced the prices. Spot gold climbed to a high of $926.10 an ounce and was quoted at $918.50/920.50 an ounce up from $906.75 in New York late on Thursday.
Gold futures rebounced in New York after two sessions to above $900 an ounce as gloomy economic news in the US triggered safe-haven buying.
Gold for February delivery ended up by $16.90 an ounce to $905.10 on the Comex division of the New York Mercantile Exchange. March silver also rose to $12.145 an ounce. Gold was rising as "economic malaise continues to batter the world", a dealer said.
Turning to the domestic market, standard gold (99.5 purity) shot up by Rs 435 per ten grams to Rs 14,175 from Thursday’s closing level of Rs 13,740. Pure gold (99.9 purity) also rose to Rs 14,240 from Rs 13,805.
Silver ready (.999 fineness) jumped by Rs 575 per kilo to Rs 19,795 from Rs 19,220 on Thursday.

source : NDTV PROFIT

Indian Pharma: A Dark Horse

Over the years pharmacy has grown in the form of pharmaceutical sciences through research and development processes. It is related to product as well as services. The various drugs discovered and developed are its products and healthcare it provides comes under category of services.
The Indian pharmaceutical industry is in the top rank of India’s science based industries with a vast array of capabilities in the complex field of drug manufacture and technology. This sector is categorized as highly organized sector registering turnover of $ 4.5 billion and growing at a rate of 8% to 9% annually. The Indian pharmaceutical industry is capable to meet country’s demand for any drug. The manufacturing units within the country are capable of meeting about 80% of the country’s drug requirement. There are about 20,000 production units in India with products sold at competitive lower prices than international drug prices. It ranks high in the third world in terms of technology, quality and range of medicines manufactured. From simple headache pills to complex antibiotics and complicated cardiac compounds, almost every type of medicine is made indigenously.

The Indian pharmaceutical sector is highly fragmented with more than 20,000 registered units. Drastic expansion has been witnessed in last 2 decades. The leading 250 companies control 70% of the market with market leader holding nearly 7% of the market share. It’s an extremely fragmented market with severe competition and government price controls.

Playing a key role in promoting and sustaining development in the vital field of medicines, Indian pharma industry boasts of quality producers and many units approved by regulatory authorities in UK and USA. International companies associated with this sector, have stimulated, assisted and spread head this dynamic development in the past 53 years and helped to put India on the pharmaceutical map of the world.

India has 300 pharma companies of large and moderate size and another 10,000 small and tiny firms. But 70% of the production is by 100 larger companies. The industry manufactures around 440 of bulk drugs and almost entire range of formulations. About 1/3rd of India’s production – close to US $ 3.5 billion- is exported and exports are growing at 25% per annum. Exports to US fetch India about half billion dollars, while Germany, UK, Italy, Japan are among others. Large quantities of medicines are being exported from India to china, Brazil, Mexico and Nigeria.

PATENT REGIME
The signing of trade related intellectual property rights (TRIPS) agreement in 1995, which committed India to honor the WTO mandated product regime from 2005 marked the beginning of fresh chapter in industry’s evolution and India has finally transited into product patent regime from process patent. Process patent is the form of protection under which the process by which drug is manufactured is given protection. As there were many loopholes in this system companies very conveniently made very minor changes in the product and sold patented drugs at a lower price. Because of this MNC’s like Pfizer, Eli Lily was reluctant to launch their new molecules in Indian market. But under the product patent the molecule gets the protection and others cannot develop the similar molecule till the patent is valid.

POST 2005 SCENARIO
By issuing a patent ordinance, India met a WTO commitment to recognize foreign patents from January 2005, the culmination of 10 year process. In this new scenario, the Indian pharmaceutical manufactures won’t be able to manufacture patented drugs. To adapt to this new patent regime, the industry is exploring business models different from existing traditional ones.
New business models include:
1. Contract research ( drug discovery and clinical trials)
2. Contract manufacturing
3. Co-marketing alliances.

The focus of Indian pharma companies is also shifting from process improvisation to drug discovery and R &D. The Indian companies are setting up their own R &D setups and are also collaborating with research laboratories like CDRI, IICT etc.

CONTRACT RESEARCH
In 2002, the industry for clinical trials in India was $ 70 million. This market is growing at the rate of 20% per annum. According to experts, it will be industry worth anywhere between $ 500 million to $ 1.5 billion by 2010.
The global R&D is spending to the tune of $ 60 billion of which non-clinical segment accounts for $ 21 bn and clinical segment accounts for $ 39 bn. In terms of Indian prices this translates into ($ 7 bn at 1/3rd of US/EU costs) and ($ 7.8 bn of US / EU costs) respectively. This constitutes total potential for $ 14.8 billion for the Indian pharma companies.

CONTRACT MANUFACTURING
Many global pharmaceutical majors are looking to outsource manufacturing from Indian, companies which enjoy much lower costs both capital and recurring than their western counterparts. Many companies have made their plants CGMP compliant and India is having the largest number of USFDA approved plants outside USA.
The pharma companies are going for compliance with international regulatory agencies like USFDA, MCC etc for their manufacturing facilities.
Indian companies are proving to be better at developing API’s then their competitors from target markets and that too with non-infringing processes. Indian drugs are either entering into strategic alliances with large generic companies in the world of off-patent molecules or entering into contract manufacturing agreements with innovator companies for supplying complex under patent molecules.
Some of the companies like Dishman pharma, divis labs and matrix lab have been undertaking contract jobs for MNC’s in US and Europe. Even shasun chemicals, strides arcolabs, jubilant orgonosys and many other large Indian companies started undertaking contract manufacturing of API’s as apart of their additional revenue stream. The Boston consulting group estimated that contract manufacturing market for global companies in India would touch $ 900 million by 2010.


Growth Pattern of the Sector
The pharma industry has grown at 1.5-1.6 times the growth of the economy over the past couple of years. The industry has grown at a CAGR of 13 % from 2002-2007 and is expected to grow at a rate of CAGR of 16% over the period of 2007-2011. Accounting for the 2% of the world’s pharmaceutical market, the Indian pharmaceutical sector has market value of about US $ 8 billion. It ranks 4th in terms total global pharmaceutical production and 13th in terms of value. Over the last 2 years the sector’s market value has increased to about US $ 355 million because of launch of new products. According to an estimate 3900 new generic products have been launched in past 2 years. These have been by and large launched by big brands in the pharma sector. And in the year 2005 Indian pharmaceutical companies captured around 70% of the domestic market.
At present scenario only few people can afford costly drugs which have increased price sensitivity in the drug market. Now the companies are trying to capture the market by introducing high quality and low priced medicine and drugs. At present large number of Indian pharmaceuticals companies are looking for tie-ups with foreign firms for in license drugs. In 2005 6.2% of the disposable income was spent on healthcare as compare to 2.8% in 1995. Health insurance penetration is estimated at 10% in India and is expected to double in next five to seven years.

India is one of the top five manufactures of bulk drugs in the world and among the top 20 pharmaceutical exporters of the world. The value of the pharmaceutical output grew more than 10 fold from Rs 5000 crore in 1990 to over 65000 crore in 2006-07.india is now recognized a one of the leading global players in pharmaceutical industry. Europe accounts for highest share of Indian pharma exports followed by North America and Asia. The national pharmaceutical policy, aimed at ensuring availability of lifesaving drugs at reasonable prices is being finalized. Taking stock for the imperative requirement, the government has decided to set up six new institutes of pharmaceutical education and research (NIPERS) in different regions of the country. As anew initiative in pharmaceutical sector, the first pharmaceutical census of India is proposed to during 2007-08 to obtain robust database for the sector.

Pharma to emerge as Dark Horse in slowdown

In these tough times of recession [Indian] pharma sector has shown comparative resilience and has been relatively less impacted. There are two reasons for this: the domestic pharma market continues to experience healthy growth and the demand for generic (a biological equivalent of an originator pharmaceutical product) medicines is on the rise in international market.

Pharma is not completely immune to the slowdown and global economic crisis, but the impact is less severe. Over the past two years, the $8 billion domestic pharma industry has grown at a rate of more than 12%.
It is likely to see high single digit growth in 2009. The growing incidence of lifestyle diseases, rising disposable incomes, greater penetration of health insurance and expanding medical infrastructure will continue to foster growth in the domestic market. The fact is that however bad the economic environment, demand for medicines is relatively inelastic.

They will remain a hot centre for opportunity. There is also growing excitement as drugs worth $60 billion are expected to come off patent in the US in next few years. These positive trends signal a huge market opportunity for Indian pharma companies, who have over the years carved a niche for themselves, in most global markets

Investment scenario in India

Being the fourth largest economy in the world and has second largest GDP among developing countries , in purchasing power terms , India is poised for growth with macro –economic stability and by 2025 Indian economy is projected to be about 60% in size of the US economy.
Investment is the key element which has taken India on high growth trajectory. In this post we try to analyze current scenario of investment in 3 core sectors: infrastructure, education and security.
Infrastructure investment
India has emerged as land of opportunities for infrastructure sector. The potential is exorbitant as many sectors have opened up for participation and private investment. In the last few years a number of Road Projects have been taken up under ambitious National Highway Development Programme costing about US$ 12 billion, in which large number of foreign construction companies are participating. The telecom sector has moved forward at a brisk pace and power reforms have gained momentum while the disinvestments process has got underway in the Telecom and Oil and Gas sector. In order to have an integrated development of Transport system, National Rail Development Programme has also been launched in Dec. 2002 envisaging an investment of about US $3.5 billion.
India has been prominent in attracting most of the infrastructure projects with private participation in the region. For instance an important role behind the extensive growth of Indian IT sector and BPO’s is played by availability of robust infrastructure (telecom, power and roads) in the country. Relevant telecom facilities are an important prerequisite for the success of the software industry and over the years, the Government has taken steps to ensure that telecom remains a priority area.
Similarly, regular, reliable, uninterrupted power, a major necessity for running IT software and services businesses, has also received substantial attention from the Government. Recent steps to privatize the distribution of power and bring in greater efficiencies and customer centricity in the market have been welcomed by the ICT industry.
The overall roads and highways scenario in India has also witnessed major improvements over the last few years. Most cities and first and second tier towns are connected and interlinked to each other. Major investments have gone into the development of highways, both on the side of the central and state Governments. Clearly, the Indian Government has understood the importance of infrastructure to industries such as IT and created a conducive environment for its development and expansion.
Present meltdown
In the present economic crisis when all sectors are facing the heat of downturn, infrastructure sector comes with no exceptions. The major hindrance coming in way of growth of this sector is scarcity of funds. This holds true especially in the case of large scale, complex projects, as in case of hydro power projects, which have long gestation periods. The Government needs to consider introducing mechanisms/ instruments that allow efficient long-term funding of projects. In addition, limits on external commercial borrowings for such infrastructure projects should be removed.
In recently announced fiscal package by government, in order to boost investment in the infrastructure sector, the government authorized the state-run India Infrastructure Finance Co. Ltd (IIFCL) to raise Rs.100 billion through tax-free bonds by next March. Announcing a Rs.3,000-billion ($60-billion) stimulus package to pump prime the economy, a government statement said IIFCL, set up to finance infrastructure projects in the country, could use the fund to refinance port, highway and power projects, being developed under the public-private partnership model.

Scenario of investment in private education
Indian education system has witnessed an impressive growth path since independence. From just 0.1 Million in 1947, enrollments in the country have grown to more than 11 Million in 2005-06. The education system in the country saw a revolution with the emergence of a whole new class of education providers, including private institutes, distance education providers, self-financing courses in public institutions and foreign education providers.
Despite the fact of rising enrolment figures, the cumulative expenditure of states on educational services as a % of total expenditure has shown a decline of 18% in 2007-08. Inter-state differences in per capita education spending across states are widening. While per capita fund flow to education in 2005-06 was Rs 483 in Uttar Pradesh and Rs 487 in Bihar. It was Rs 1034 in Maharashtra and Kerala and Rs 1777 in Himachal Pradesh. A slowdown in government spending in key areas of education infrastructure in many of these states has happened despite a marked improvement in the fiscal performance of most of these states. This is in sharp contrast to the post -1997 periods when a fall in education spending could be attributed to shortage in government finances due to deteriorating fiscal health of states.

Aftermath of terrorism on India Inc
Recent terror attacks in financial of the country Mumbai will post short term impact on Indian economy according to many economist and analyst. Being the home of Asia’s oldest stock exchange, country’s central bank, capital markets regulator (SEBI) and India’s biggest corporate houses- Tata’s , Birla’s , Ambani’s , accounts for country ‘s $ 1 trillion (Rs 49.9 trillion) economy and contributes one third of its direct taxes. According to various economists though these attacks will affect country’s economy but deeper impacts will come from global slowdown.
National security is a critical factor that determines the level of investment — both domestic and foreign — along with conducive business environment, positive policy matrix and return on investment. Global investors apply these parameters diligently while making their decision on investment destinations.
In tough times like we are in currently, the portfolio investment and allocation decisions by certain global funds could be affected. However, investment decisions by various multinationals to enter a market for strategic reasons tend to be made with a longer term and global view in mind and should not get impacted, unless these attacks continue for prolonged period. While overall FDI flows at $17 bn were 137% higher in the first half of this fiscal year, the second quarter ended September 2008 has seen a slowdown of 30% in FDI flows compared to the June quarter. On the other hand, portfolio flows into India (FII) have already seen a massive outflow this fiscal year of over $9 bn through end of October, while FIIs had invested over $13 billion in the Indian markets last fiscal year.
The business confidence which was weakening due to current global turmoil will now bear the heat of this terror attack, with sentiments further going weak. The hardest hit industries will be hospitality, travel and tourism and luxury retail business. Already tourism sector is struggling to beat economic slowdown, now these terror attacks have added to their struggle with hoteliers are expecting large scale cancellation of bookings mostly from overseas visitors. This will in turn affect the aviation business which is already in battle with the slowdown. Another immediate victim of this attack would be luxury retail business. The Taj and Trident are home to around a dozen of luxury retailers including Gucci, Ferragamo, Jimmy Choo, Estee Lauder, Louis Vuitton and Fendi. Business would be impacted not only due to space but also sales because lot of sales comes from in-house guests. Most luxury brands prefer to operate out of five star hotels because India doesn’t have high quality luxury retail space.

Boom time for security industry
In the times when Indian industries are battling with wicked effects of global slowdown and recent terror attacks on Mumbai, the only industry poised to book high profits in future is Indian security industry. Private security in India will become a Rs 50,000 crore (Rs 500 billion) industry in four years as corporate have increased their spending on safeguards after the Mumbai terror strikes. The private security business, a Rs 22,000 crore (Rs 220 billion) industry now, would touch Rs 50,000 crore as security all of a sudden has become top priority for Indian Inc.
Terrorism now is a universal phenomenon and most countries are facing it. It is the other overwhelming factors that will affect investments. Yet, it’s imperative that we put in place a foolproof security system that can sense and eliminate these terrorist attacks. We also need to improve risk management systems and disaster recovery plans.
India’s position in the emerging financial and economic architecture is going to be substantial. Stakeholders of the growth are not Indians alone but the world community. That calls for a joint action against terrorism.

Fiscal stimulus package

In order to elevate the various sectors of Indian economy from global turmoil, government has finally uncovered its fiscal stimulus package, which gives 4% cut in CENVAT , in order to bring down prices of cars, cement textiles and other products.

The package which sought to lower down the impact of global slowdown on various sectors, with entailing a loss of Rs 8700 crore , in the remaining four months of 2008-09 , aims to revive sectors like housing, exports, automobile, textiles and small and medium enterprises (SMEs).
The key highlights of the package are as follows:
· Package includes, the CENVAT on all products – except non petroleum goods – have been reduced from 14, 12, and 8 % to 10, 8 and 4% for various categories.
Full exemption from basic customs duty has been effected on naphtha to provide relief to the power sector.
· With the implementation of the package the export duty on iron ore fines has been withdrawn, the levy on export of iron lumps has been cut from 15 to 5 per cent.
· Government seeks to provide relief to the dooming housing sector with public sector banks will shortly announce a package for borrowers of home loans in two categories: up to 500,000 rupees and 500,000 rupees to 2 million rupees.
· For small and micro enterprises, the limits under the credit guarantee scheme have been doubled to 10 million rupees. The lock-in period for loans covered under the existing credit guarantee scheme is also being reduced from 24 to 18 months to encourage banks to extend more loans under the scheme.
· In an incentive for the automobile sector, government departments are also being allowed to replace older vehicles within the allowed budget, in relaxation of extant economy instructions.
The Planning Commission deputy chairman, Montek Singh Ahluwalia, said the package will “minimise the impact of weak global economy on the Indian economy” and help achieve a seven per cent growth rate.
Announcement of package turned out to be a sigh of relief for realty sector majors like DLF and UNITECH, particularly in the non-metros by way of a demand-boost for houses, but felt that the package for home loans by banks should have been for borrowings up to Rs 50 lakh instead of the prescribed limit of Rs 20 lakh.
However some reactions were anticipating a fiscal package of Rs 70,000 crore, how ever now how will this package will lead to bounce back of growth of Indian economy on previous high trajectory path? For that we need to wait and watch!!!!!!!!!!!!!! Please put your valuable opinion on what do you think of this package, how this will impact Indian economy.

Foreign currency convertible bonds

While I was searching for this impact of US crisis on India and depreciation rupee I came across this term FCCB (foreign currency convertible bond).and I came to know this plays important role in Indian capital market.
Let’s see how it works
An instrument in debt market where in which convertible bond is issued in a currency which is different than issuer’s domestic currency. For e.g. reliance industries issues a convertible bond which is denominated in terms of dollars and not rupees. This is the mode of raising money by issuing company in terms of foreign currency. As the name suggests it’s a convertible bond, means bondholder has an option of converting it into stock. Therefore convertible bond is a mix between equity and debt instrument.

FCCB policy in India
MinistryFinancegovernmentofIndiadefinesFCCB.Accordingit:"Foreign Currency Convertible Bonds" means bonds issued in accordance with this scheme and subscribed by a non- resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments; "


We all know that 2-3 years back Indian and emerging markets were on high growth trajectory path and were giving high returns. At that time FCCB became the popular tool for raising funds from overseas market. Aggressive companies went for the FCCB route to fund their expansion/acquisition plans because of the shorter lead times associated with the process as well as for the fact that the company gains exposure in to a global investor base.

The reasons behing for fccb becoming so popular and companies opting for it aggressively were following:
· Being hybrid instruments, the coupon rates on fccb are particularly lower than pure debt or zero, thereby reducing the debt financing cost.
· Fccb are book value accretive on conversion.
· Saves the risk of immediate equity dilution as in the case of public shares.
Lucrative offer for investors
Investors can also book profits through fccb route:
· Assured returns to investors on bond in the form of fixed coupon rate payments.
· Ability to take advantage of price appreciation in the stock by means of warrants attached to the bonds, which are activated when price of a stock reaches a certain point.
· Significant yield to maturity (YTM) is guaranteed at maturity.
· Lower tax liability as compare to pure debt instruments due to lower coupon rates.

In May 2007, at least 10 companies converted FCCBs into equity at a price decided when the bonds were issued to respective investors. The list includes NIIT, Bharti Airtel, Sun Pharma, Glenmark Pharma, Amtek India, Jain Irrigation Systems and Maharashtra Seamless. FCCB holders have witnessed a significant rise in value of their investments in these companies on the back of a sharp rise in share prices since allotment of the bonds.

Present day situation
Indian companies that had raised money through fccb’s during Bull Run to finance their growth and acquisition plans are currently in situation of doom. With demise of Indian stock markets the conversion price of these fccb’s has gone several times higher than their current market price.
Various estimates show that India Inc has issued close to $20 billion of FCCB’s in the past few years. Now the investor will only exercise its option to convert his bond into fixed number of shares at predetermined price if conversion price is lower than the market price. Now in this scenario of dooming stock markets conversion price in most of the fccb issues is several times above the market price. Therefore in such a scenario investors won’t be interested in converting their bonds into equity.
Let’s explore now in this situation what options are left with the companies who have issued these bonds.
· Issuing companies will now have to search for resources to repay the debt along with redemption period whenever it matures. For this companies will seek to fresh borrowings, with high interest rates, which in turn would impact their profitability.
· Another option which companies have is to reset the conversion clause, to bring it closer to reality.

No doubt lender will get back his money, but this will create big pain for ordinary shareholder. With the current state of the stock markets, most of them will have to buy foreign exchange from the markets to get rid of their liability. But this will depreciation of rupee and create more volatility in forex market.
By looking at the below link you can check out data for companies which have raised money through FCCB and where they stand today.
http://www.business-standard.com/india/storypage.php?autono=336251

References:
Economic times
Business standard

IIP NUMBERS: INDIA INC IN TROUBLE

Well here is a breaking news…..as given by all news channel………I don’t know how much you follow this number…..but INDEX OF INDUSTRIAL PRODUCTION IS OUT and its 1.3% for august 2008 in comparison to 10.9% in same period last year.

In India, the Central Statistical Organization (CSO) is responsible for compilation and release of the Index of Industrial Production (IIP). This is a monthly index and is intended to measure changes over time in the volume of industrial production. The base year of the current series of IIP in India is 1993-94 which being revised to 1999-2000 is. The current series of IIP with base 1993-94 is based on 538individual items clubbed into 283 groups of items. The distribution of these items (item groups) and weights (100) among the three sectors covered by the index is as under

Sector NO.Of items (item group) Weight
Mining 64(1) 10.47
Manufacturing 473 ( 281 ) 79.36
Electricity 1 (1) 10.17
TOTAL 538 (283) 100.00

The index is a simple weighted arithmetic mean of production relatives calculated by using Laspeyre’s formula
I=Σ(Wi*Ri)/ΣWi,

Where I is the Index, Ri is the production relative of the i-th item for the month in question and Wi is the weight allotted to it based on Gross Output. The item-wise indices are vertically aggregated at 2-digit of industrial classification based on weighted average, weights are proportionate to Gross Value Added.

The August 2008 Index of Industrial Production (IIP) stood at 1.3% as against 10.9% in same period of last year.
· Capital Goods growth was at 2.3% versus 30.8%.
· Mining growth declined at 4% from 14.7%.
· manufacturing growth declined at 1.1% versus 10.7%
· Consumer Durables growth declined at 5.1% from 6.2%.
The market which opened weak with all stocks in red, with this news tumbled more with sensex at 10,257 falling by 1070 points and the Nifty fell 298 points to 3,215, at 12:38 pm. BSE Midcap and Small Cap indices lost 7-9%. The two exchanges will halt trading if the Sensex falls 1275 points or the Nifty loses 390 points, which is 10% circuit.
With coming of these numbers lot of uncertainty about GDP growth rate has been generated. Many economists including MOF have said this to be an “industrial recession”. And have revised their estimates for GDP growth rate 6%.
It’s a bad time for world economies. But even with this finance minister quoting 7-8% growth rate for India and with this IIP numbers sounds doubtful.
This is a major concern for our economy and if you read this I would like to know from you what your expected growth rate for Indian economy is. Where India is headed.
Please post your valuable comments

Plague of US sub –prime crisis

Nowadays common topic of discussion among employees, students & all is subprime crisis, fall of Lehman brother, US economy & impact on India. I also had this question surrounded by my mind what exactly happened which led to such financial crisis in world’s strongest and powerful country.
I have seen many posts on this and from searching materials from various places, I have tried to explain, how this whole cycle of sub prime began and made whole world dancing on its tunes.

Let’s begin with
What are Sub Prime loans?
The sub-prime loans are loans which are given to borrowers with low credit scores. These are the loans which are granted at interest rates above the prime lending rate. These borrowers are subject to sub prime lending on their defaults in credit card payments or any other type of credit default or delays.
According to US standards these are people who have FICO score < 620.
Now you might be wondering what is this FICO score, what I get to know of this was:
A FICO score is a credit score developed by Fao Isaac & Co. credit scoring method of determining the likelihood that credit users will pay the bills.
Credit scores analyze a borrower’s credit history considering number of factors such as:
· Late payments
· The amount of time credit has been established.
· The amount of credit used Vs amount of credit available.
· Length of time at present residence.
· Nature of credit information such as bankrupts, charge offs etc.

There are 3 FICO scores to be computed by data provided by each of the 3 bureaus- explain, Trans union and Equifax. Some lenders use one of these 3 scores, while other lenders may use middle score.

How this sub –prime loans came into being?
If we rewind ourselves to period of 2000, it is to be noticed that after the tech bubble burst and fears of 9/11 attack in 2001 , federal reserve began to cut rates drastically and federal funds rate reached at 1% in 2003 , which in central banking idiom is essentially zero. The overall idea of federal behind these rates cut was to prevent economy going into depression and to increase money supply to encourage borrowing, which would spur investment and spending. This led to aggressive lending by banking and financial institutions. However there was a good proportion of demand was from sub prime borrowers, so naturally when banks lend to them, it was with the pleasing knowledge that interest rates would be higher for this class of loans.
Every individual aspires a dream of having his own house. Americans were no exception to this. These low interest rates and increased liquidity increased demand for housing, which led to continuous growth in the market value of these assets (i.e. Real Estate), which was the collateral for the debt. Another angle is that the average American is highly debt-oriented, and resultantly, refinance is fairly commonplace in the US. In order to capture the market, banks began to value these assets higher and higher, as a higher valuation meant a higher loan amount which could enable them to win a deal over competition. This higher valuation also had an impact on the real money-value of the asset.
What was the role of investment banks?
First let me here clarify here what is investment banking & how it is different from commercial banking:

Investment banking is a field of banking that aids companies in acquiring funds. In addition to the acquisition of new funds, investment banking also offers advice for a wide range of transactions a company might engage in. A majority of investment banks offer strategic advisory services for mergers, acquisitions, divestiture or other financial services for clients, such as the trading of derivatives, fixed income, foreign exchange, commodity, and equity securities.

Now let’s see how this whole cycle worked:
Our story begins with an American, who like evrybody else has a dream to own a house. Now in order to fulfill his dream he seeks for a home loan. However his credit history is poor. But things become easy for this American with the advent of subprine loans (explained above).

· A subprime borrower (in our story American) takes a mortgage from institution like Well Fargo Home mortgage at 2/28 ARM terms.
· As soon as deal is signed these instructions package these mortgages into MBS (mortgage backed securities) and sell them off to other financial institutions like investment banks (Lehman brother, Morgan Stanley, etc).
· The banks then proceed to securitize these loans, chop them up, and package them into products called CDOs or Collateralized Debt Obligations which entitle the holders to the cash flows from the underlying mortgages.
· These CDOs are then sold to other market participants like hedge funds, pension funds, other banks and insurance companies based all over the world.
· The CDOs may then be traded like any financial security and thus ended up being held by banks and other market participants all over the world.

The question revolving in your mind now would be why financial institutions would buy loans of sub-prime borrowers here comes the role of rating agencies:
A lot of criticism has been directed at the rating agencies and underwriters of the CDOs and other mortgage-backed securities that included subprime loans in their mortgage pools. Some argue that the rating agencies should have foreseen the high default rates for subprime borrowers, and they should have given these CDOs much lower ratings than the 'AAA' rating given to the higher quality tranches. If the ratings had been more accurate, fewer investors would have bought into these securities, and the losses may not have been as bad. The argument is that rating agencies were enticed to give better ratings in order to continue receiving service fees, or they run the risk of the underwriter going to different rating agencies. However the flip side is that it’s hard to sell a security if it’s not rated.

How this situation led to financial fiasco?
With the coming of these sub-prime loans for few years things went pretty well, as with low interest rates, economy started to surge upwards, with value of real estates assets touching the sky. This situation made it easy for borrowers to make payments, in case they did run into troubled waters they could top-up their loans, or re-finance their loans at more favorable terms. So this was kind of happy –go lucky times for financial institutions.
However as in case of every bollyood movies good times are snatched away by villains, something like this happened in US financial markets. The slowdown began in late 2006 and early 2007. With fast growing economy, money started to flow in to equities and money supply reduced. Following such a scenario FED started to increase interest rates. This situation made re-financing of loans by borrowers difficult. As loans became more expensive, the demand for housing reduced, leading to a reduction in the value of the asset. Now this led to a chaotic situation, where borrowers began to default on their loans at an alarming rate. The investing institutions who held the securities backed by this debt stood to loose.

These financial crises plagued like anything all over the economy. In this hue and cry banks stopped lending to each other. Most investment banks and hedge funds had to write down the value of their holdings or liquidate other investments to meet redemptions. With CDO prices at rock bottom levels, market players were forced to borrow heavily.

This led to a huge liquidity crunch in the global markets and subsequently runs on and the collapse of a few banks in Europe. With nobody ready to lend money, overnight rates in the money markets skyrocketed setting the stage for further runs on banks and even the freezing or possible collapse of the entire banking system.
Coming to Indian scenario, how all this is impacting India, will be covered in my next post……..till then enjoy reading!
References:
www.economictimes.com
www.investopedia.com
Financial blogs

Boom & Bust of Indian Real Estate Sector

Engulfing the period of stagnation, the evolution of Indian real estate sector has been phenomenal, impelled by, growing economy, conducive demographics and liberalized foreign direct investment regime. However, now this unceasing phenomenon of real estate sector has started to exhibit the signs of contraction.
What can be the reasons of such a trend in this sector and what future course it will take? This article tries to find answers to these questions….

Overview of Indian real estate sector
Since 2004-05 Indian reality sector has tremendous growth. Registering a growth rate of, 35 per cent the realty sector is estimated to be worth US$ 15 billion and anticipated to grow at the rate of 30 per cent annually over the next decade, attracting foreign investments worth US$ 30 billion, with a number of IT parks and residential townships being constructed across-India. However current economic crises in India have made buying a home a far fetched dream for many.
The term real estate covers residential housing, commercial offices and trading spaces such as theaters, hotels and restaurants, retail outlets, industrial buildings such as factories and government buildings. Real estate involves purchase sale and development of land, residential and non-residential buildings. The activities of real estate sector embrace the hosing and construction sector also.

The sector accounts for major source of employment generation in the country, being the second largest employer, next to agriculture. The sector has backward and forward linkages with about 250 ancillary industries such as cement, brick, steel, building material etc.
Therefore a unit increase in expenditure of this sector has multiplier effect and capacity to generate income as high as five times.

Path set by the government
The sector gained momentum after going through a decade of stagnation due to initiatives taken by Indian government. The government has introduced many progressive reform measures to unveil the potential of the sector and also to meet increasing demand levels.
· 100% FDI permitted in all reality projects through automatic route.
· In case of integrated townships, the minimum area to be developed has been brought down to 25 acres from 100 acres.
· Urban land ceiling and regulation act has been abolished by large number of states.
· Legislation of special economic zones act.
· Full repatriation of original investment after 3 years.
· 51% FDI allowed in single brand retail outlets and 100 % in cash and carry through the automatic route.

There fore all the above factors can be attributed towards such a phenomenal growth of this sector. With significant growing and investment opportunities emerging in this industry, Indian reality sector turned out to be a potential goldmine for many international investors. Currently, foreign direct investment (FDI) inflows into the sector are estimated to be between US$ 5 billion and US$ 5.50 billion.

MAJOR INVESTORS
· Emmar properties, of Dubai one of the largest listed real estate developers in the world has tied up with Delhi based MGF developments to for largest FDI investment in Indian reality sector for mall and other facilities in Gurgaon.
· Dlf India’s leading real-estate developer and UK‘s famous Laing O Rourke (LOR) has joined hands for participation in airport modernization and infrastructure projects.
· A huge investment was made by Vancouver based Royal Indian raj international cooperation in a single real estate project named royal garden city in Bangalore over period of 10 years. The retail value of project was estimated to be around $ 8.9 billion.
· India bulls real estate development has entered into agreement with dev property development, a company incorporated in Isle of Man, whereby dev got subscription to new shares and also minority shareholding the company. But in recent developments indiabulls have acquired entire stake in dev property development in a 138 million-pound sterling (10.9 billion rupees) share-swap deal.
· Apart from this real estate developments opens up opportunity for associated fields like home loans and insurance. A number of global have shown interest in this sector. This include companies like Cesma International from Singapore, American International Group Inc (AIG), High Point Rendell of the UK, Colony Capital and Brack Capital of the US, and Lee Kim Tah Holdings to name a few.

Simultaneously many Indian retailers are entering into international markets through significant investments in foreign markets.
· Embassy group has signed a deal with Serbian government to construct US $ 600 million IT park in Serbia.
· Parsvanath developers is doing a project in Al – Hasan group in Oman
· Puravankara developers are associated with project in Srilanka- a high end residential complex, comprising 100 villas.
· Ansals API tied up with Malaysia’s UEM group to form a joint venture company, Ansal-API UEM contracts pvt ltd, which plans to bid for government contracts in Malaysia.
· Kolkata’s south city project is working on two projects in Dubai.
On the eve of liberalization as India opens up market to foreign players there is tend to be competitive edge to give quality based performance for costumer satisfaction which will consequently bring in quality technology and transparency in the sector and ultimate winners are buyers of this situation.
However this never ending growth phase of reality sector has been hard hit by the global scenario from the beginning of 2008. Analyst say situation will prevail in near future, and latest buzz for the sector comes as a “slowdown”.

Sliding phase of the reality sector

In this present scenario of global slowdown, where stock markets are plunging, interest rates and prices are mounting, the aftermath of this can now also be felt on Indian real estate sector. Overall slowdown in demand can be witnessed all across India which is causing trouble for the major industry players. Correcting property prices and rentals are eroding away the market capitalization of many listed companies like dlf and unitech

Reality deals in major cities like Delhi, Mumbai, Bangalore, Chennai and Hyderabad have shown enormous downfall from October 2007 – March 2008. The downfall had been cushioned by fall in stock markets as it put a stop for wealth creation, which leads to shortage of capital among investors to invest in real estate activities. Apart from this in order to offset their share losses many investors have no choice, but sell their real estate properties.
Other factors which have contributed to this slowdown are raising interest rates leading to higher costs. Due to this almost all the developers are facing serious liquidity crunch and facing difficulties in completing their ongoing projects. Situation seems to be so disastrous that most of the companies have reported 50-70% cash shortfall. The grade A developers which are facing cash crunch include DLF ,MGF , Emmar , Shobha developers , Unitech , Omaxe , Parsvnath Developers, Hiranandani Group, Ansal API, BPTP Developers and TDI Group. As a outcome of this liquidity crunch many developers have started slowing down or even stopped construction of projects which are either in their initial stages of development or which would not effect their bottom-line in near future.
Also with increasing input costs of steel iron and building material it has become it has become unviable for builders to construct properties at agreed prices. As a result there may be delays in completion of the project leading fincial constraints.
At the same time IT industry which accounts for 70% of the total commercial is facing a slowdown. Many residential buyers are waiting for price correction before buying any property, which can affect development plans of the builder.


Aftermath of reality shock to other sectors
Cement industry hitted by reality slowdown
The turbulence in the real estate sectors is passing on pains in cement industry also. It is being projected that growth rate of cement industry will drop down to 10% in current fiscal. The reasons behind such a contingency are higher input costs, low market valuations and scaled up capacity which are in turn leading to reduced demand in the industry. High inflation and mounting home loan rates have slowed down the growth flight of real estate sector which accounts for 60% of the total cement demand. The major expansion plans announced by major industries will further add to their misery as low market demand will significantly reduced their capacity utilization.
Setting up new facilities will impart additional capacities of 34 million tone and 45 million tone respectively in 2008-09 & 2009-10. This is likely to bring down capacity utilization in the industry down from current 101% to 82%. Even as it loses power to dictate prices, increased cost of power, fuel and freight will add pressure on input costs.
Ambuja Cements too is trading at a higher discount than previous down cycle, suggesting bottom valuations. However, replacement valuations for Madras Cements and India Cements indicate scope for further downslide when compared to their previous down cycle valuations.
All this has added to stagnation of the cement industry.

Dying reality advertising
The heat of reality ebb is also being felt by the advertising industry. It is being estimated that all major developers such as DLF, omaxe, ansals & parsvnath have decided to cut down on their advertising budget by around 5%. The advertising industry in India is estimated to be around 10,000 crore. This trend can be witnessed due to weakening spirits of potential buyers and real estate companies call it a reality check on their advertising budgets. A report from Adex India, a division of TAM Media Research, shows that the share of real estate advertisements in print media saw a drop of 2 percent during 2007 compared to 2006. According to Adex, the share of real estate advertisement in overall print and TV advertising last year was 4 percent and 1 percent, respectively. It’s a known fact that infrastructure and real estate companies are responsible for advertising industry maintain double digit growth rate. Therefore it’s understood that a recent slowdown in Indian reality sector has made things worse for advertising industry. The Adex report indicates that the top 10 advertisers shared an aggregate of 16 percent of overall ad volumes of real estate advertising in print during 2007. The list includes names such as DLF Group, Parsvnath, Sahara, HDIL and Omaxe group. However, the real estate had maximum share in South India publications followed by North and West publications with 32% and 26% share, respectively, during 2007.
According to many advertising agencies consultants, this phenomenon is taking a toll as all real estate companies want a national foot print and also these companies are turning into professionals. Therefore they are setting standards when it comes to advertising to sales ratio.

Falling stock markets knock down reality stocks
Reality stocks have been hard hit by uncertainties prevailing in the stock market. The BSE reality index is the worst performer having shed 51% of its 52-week peak reached in reality. The BSE benchmark index has shed 24% since January. The country’s largest real estate firm DLF scrip lost 54% while unitech lost 64% from its peak. The scrips of Delhi bases parsvnath and omaxe have lost 68% each since January.
The sector is facing a major downfall in sales volume in most markets of the country. The speculators have exit the market and Mumbai and NCR, the biggest real estate markets in markets are cladding subdued sales. In Gurgaon and Noida, which had seen prices almost treble in four years, sales are down 70%, leading to a price correction of 10-20%.

Lets us have a look how major cities are afftected by reality downfall
Top 4 metros taking the lead – in slowdown
Delhi &NCR
While bears are ruling the stock market, the real estate sector in Delhi & NCR region has started facing departure of speculative investors from the market. According to these developers based in region the selling of flats has become very complicated at the launch stage due to lack of interest from the speculators. Developers attribute this to stability in prices against the past where prices were up surging on monthly basis. The scenario has changed so much in the present year that developers are now facing difficulty in booking flats which may delay their projects and reduce their pricing power for instance a year ago, if 100 flats were being sold in month at launch stage now it has come down 30-40 per month. Till mid 2007 speculators made quick money by booking multiple flats at launch of the project and exiting within few weeks or months. But now due to the stabilization of the property prices little scope is left for speculators to make money in short term. Therefore outcome is their retreat from the sector.

Mumbai
Mumbai real estate market, which witnessed huge increase in prices in recent years, which made the city to enter in the league of world’s most expensive cities, is now feeling the heat of slowdown. Property sales that have been growing at a clank of around 20% every year have been plumped by 17% in 2007-08.
Though slowdown news of property market in country’s financial capital has been much talked about, but it was first time that figures proved the extent of slowdown. Information about residential and commercial property sales from the stamp duty registration office show almost 12,000 fewer transactions during the last financial year compared to the year before. From April 2007 to March 2008, 62,595 flats were purchased in Mumbai as against 74,555 in 2006-07.
According to reality analyst sales volume can die out further in south as developers persist on holding to their steep prices and buyers anticipate a further fall with current rates beyond reach. They further add that market is on a corrective mode and downward trend is anticipated for another 12 months.
Between 1992-96, the market ran up the same way it did during 2003-07. Post-’96, the volumes dropped by 50%. This time again it is expected to drop substantially though not so steeply. The demand is now extremely sluggish and customers do not want to stick out their necks and transact at prevailing rates.
Chennai
in past few years we witnessed reality index gaining huge heights on BSE and it also impact could be felt allover India. Amongst them Chennai was no exception. With IT boom in past few years and pumping of money by NRI’s have led to prices touching skies. Chennai also witnessed a huge boom property prices over the last few years. However in past few months it has been facing slowdown in growth rate.
Following factors can be attributed to this:
· This is one of the common factor prevailing all over India- rise in home loan interest rates , which has made it extremely difficult for a normal salaried person to be able to afford a house.
· Depreciation of US dollar , which means NRI’s who were earlier pumping money into the real estate are now able to get less number of rupees per dollar they earn in US. Therefore many of them have altered their plans for buying house in India.
· The Chennai Metropolitan Development Authority (CMDA) has imposed stricter norms for apartment construction and penalties for violations are more severe than before.
· Failure of the legal system of chennai to prevent intrusion , forged documentsand illelgal contstruction has added to the problem as many NRI’S are hesitating to buy plots in chennai.
· Apart from this tsunami of 2004 has shaken the confidence of many investors to invest in real estate.
However many analyst are quite bullish about this region. Especially in areas like old mahabalipuram, south Chennai etc because of numerous IT/ITES/ electronics/automobile companies are expected to set up their centers in these areas. Once these projects are complete and companies begin operations their, many people would like to live near to such areas and outcome will be boom in residential sector.
Bangalore
As discussed for above cities Bangalore is also dwindling between the similar scenarios. Bangalore seems to be in midst of low demand and supply. This trend is due to myopic developers , due to sudden growth in Bangalore in last few years , lot of builders have catched the opportunity of building residential houses thinking their will be lot of employment , increase in salaries and hence demand for housing. Past few years have been jovial for Bangalore as IT industry was doing well and banking and retail sectors were expanding.
However with this sudden economic slowdown, due to which Indian stocks markets are trembling, interest rates are high, jobs and recruitment put on freeze have led to cessation of investment in local property markets.
According to the developers real-estate industry of Bangalore has experienced a drop of about 15- 20% in transaction volumes. Adding to it grade A developers have faced a dropdown of 50% on monthly levels of booking compared to what they enjoyed in December 2007.

Future outlook
Indian realty sector is struggling with worst crisis in recent years with most of the companies’ balance sheets showing losses after riding on a boom in last couple of years. The impact on Indian realty turns out to be so severe that realty index on Bombay Stock Exchange, an indicator of investor mood for industry has fallen by 25% in October 2008 and 75% in the past year. According to analysts this is just an indication of long term crisis as developers went aggressive on land acquisition without paying attention to the delivery of projects.
The story of crisis also started to be reflected in second quarter results of realty sector, where company after company reported of huge losses in their balance sheets.
· Realty major DLF , which had long ago raised Rs .100 billion over ($ 2 billion) in what was then the largest ever initial public offering in India , reported of 4% drop in consolidated net profits for the July-quarter.
· In similar to this was unitech, which reported a 12% profit decline in net profit.
· Parsvnath Developers, it was a second straight quarter of decline with a dip of 78.6% in July – September period.
· Another Delhi-based realty firm, Omaxe, which is also facing turbulent times for the second straight quarter, reported an 87.3-percent decline.

However in the current scenario Indian real estate market is going through a phase of correction in prices and there are exaggerated possibilities that these increased prices are likely to come down.

In this scenario what will be the future course of this sector?
Many analysts are of view that tightening of India’s monetary policy, falling demand and growing liquidity concerns could have negative impact on profiles of real estate companies. Slowing down would also aid in the process of exit of some of the weaker entities from the market and increasing the strength of some of the established developers. A prolonged slowdown could also reduce the appetite of private equity.
Its also been projected that large development plans and aggressive land purchases have led to a considerable increase in the financial leverage (debt/EBITDA) of most developers, with the smaller players now being exposed to liquidity pressures for project execution as well as a general slowdown in property sales. Property developers hit by falling sales and liquidity issues would need to reduce list prices to enhance demand, but many still seem to be holding on to the asking price - which, would delay the process of recovering demand and increase the risk of liquidity pressures.It was being witnessed that before the slowdown phase the projects were being sold without any hook at an extravagant rate. But at ppresent negative impact is highly visible as lots of high end projects are still lying unsold. In such a scenario , there may be blessing in disguise as high profile speculators will be out making way for the actual users.
But here also sector faces trouble as correction in prices has been accompanied by increase in home loan rates by the banks which have led to erosion of purchasing power of middle and upper middle class majority of whom are covered in the category of end users or actual users.
Therefore for future of real estate sector analyst call for a wait and watch method to grab the best opportunity with the hope of reduction in loan rates.