RBI 3rd Quarter Monetary Policy Review 2010-11 – Containing inflation to remain predominant objective

The RBI monetary policy soap opera verdict is out. The mixed global recoveries rather still subdued and the inflationary pressures in emerging market economies (EMEs) including India has been on the top of the radar of RBI in its Third Quarter Monetary Policy Review 2010-11. From the earlier stance of growth-inflation dynamics, the RBI moved to anchor the inflationary expectations likely due to sharp increase in the prices of primary food articles and the recent spurt in global oil prices.

Key Policy Measures:

•  Repo rate, the rate at which banks borrow from RBI, up by 25 bps at 6.5 per cent
•  Reverse repo rate, the rate at which the RBI lends to banks, up by 25 bps at 5.5 per cent
•  Cash Reserve Ratio (CRR), the portion of deposit that banks keep with the central bank retained at 6.0 per cent
• The inflation target revised upwards to 7 per cent from 5.5 per cent for march-end 2011
• The baseline projection of real GDP growth retained at 8.5 per cent with an upward bias.

Domestic Outlook

The domestic economy is on strong trajectory path as revealed by the 8.9 per cent GDP growth in the first half of 2010-11 powered mainly by domestic factors including strong consumption. The strong agricultural output on satisfactory kharif production and higher rabi sowing will contribute significantly to overall GDP growth in 2010-11. The industrial output also showed buoyant figures; however, the significant volatility adds uncertainty to the outlook.

Inflationary Concerns

The headline inflation as measured by WPI remained uncomfortably high since Jan 2010. Although it moderated between Aug and Nov 2010, it reversed in Dec 2010 mainly due to sharp increase in prices of vegetables specially onion, tomatoes, garlic etc and petrol prices. The current inflation level is also contributed by structural demand-supply mismatches in other cereal items. Considering all the scenarios, the baseline projection of WPI inflation for March 2011 has been revised upwards to 7 per cent from 5.5 per cent earlier. The sources of price pressure – fuel and non-fuel commodity prices and some food items could be non-responsive to RBI monetary policy actions. Going forward, the price level will depend how the global and domestic prices evolve.

Liquidity – still in deficit mode

Since the outflows caused due to 3G and WIMAX payments, the liquidity remained in deficit mode in the financial system. Also, the sluggish deposit growth, far below the RBI projection along with the non-food credit growth of 24.4 per cent worsened the liquidity in the system. Meanwhile, the RBI also intervened by cutting SLR by 1 per cent and initiated OMO transactions worth Rs. 67,000 crore. The additional liquidity support to banks up to 1 per cent of NDTL has been extended up to April 08, 2011. Under this, the bank may seek waiver of penal interest purely as an ad hoc measure. The 2^nd LAF will be conducted on a daily basis up to April 08, 2011.

Burgeoning CAD (Current Account Deficits)

The current CAD expected to be around 3.5 per cent of GDP is not sustainable as feared by RBI. CAD, an outcome of net exports and imports may get worsened further if the global recovery improves. Till now, the capital flows, which so far have been broadly sufficient to finance CAD may get adversely affected as the global recovery can trigger the flight to safety.

Global Scenario

There has been a significant improvement in global growth prospects in recent weeks; however, the recoveries are still fragile with uneven scenarios in Euro region and Japan. The deflation fears looming largely on advanced economies got some reprieve with early signs of inflation. The real GDP growth in the US improved to 2.6 per cent in Q3 2010-11 after witnessing a muted growth in 1.7 per cent. The retail sales and corporate capital spending has improved. Unlike in advanced economies, Emerging Market Economies (EME) has been affected by burgeoning inflation trends due to spurt in global food prices including a spurt in crude oil. 

With better signs of sustainable recoveries, the global growth in 2010-11 is anticipated to be less frictional and will show firm signs of sustainable recoveries. With rising prices on increased demand, inflation would be a global concern in 2011.

Why the rate hikes?

The market had been anticipating a tougher stand from RBI as the inflationary issues failed to settle down. While the market had mixed anticipations – 25bps vs 50bps hike, the RBI followed a calibrated approach – hiking the policy rates by 25 bps only – after taking a “comma” stand for few weeks in its policy rate hikes. The current policy rate is still below the pre-crisis level. Since March 2010, it has increased rates by six times. Also, keeping the LAF corridor at 1 per cent, the RBI intended to bring down the volatility in overnight rates within the corridor.

Happy Reading!

-          Amar Ranu

A new ranking for Universities in Economics

Economics lovers!

A new ranking is in place for the best department of Economics in globe; it is based on online voting. Alas! It does not include any Indian university; however, it includes an Asian University i.e. National University of Singapore. Massachusetts Institute of Technology (MIT) tops the chart followed by Harvard University and University of Chicago. For more, click here.

So, Economics lovers! Go and grab your choice university; of course, the admission comes with their tough admission patterns. :)

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How the ranking has been done?

- A total of 58,013 votes are taken which includes almost all major locations of the globe. The maximum numbers of voters are from North America followed by Europe. The rest are from South Africa, Australia, New Zealand and Asian Countries too.  Out of the blue it includes New Delhi too.

- Overall total number of submitted ideas = 183

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Disclaimer: This project, All Our Ideas is financed by grants from Google and CITP at Princeton
University. It is a research project to develop a new form of social data collection that combines the best features of quantitative and qualitative methods. 

Happy Reading!

-         Amar Ranu

How many zeroes can you think of – Try Zimbabwe Bank notes and play in Billions or Trillions

Imagine a situation – a $ 5 could buy you enough bread in India while in Zimbabwe, back in 2008, 700 million Zimbabwe dollars bought a loaf of bread. Playing in Billions/Trillions had been a fun in Zimbabwe until the government abandoned its currency in early 2009 and decided to revalue its currency, removing 12 zeroes. Now, 1 trillion in Zimbabwe dollars is equivalent of one Zimbabwean dollar. Under the new valuation, the largest note is a 500-dollar Zimbabwean dollar. Earlier, the largest Zimbabwean bank note was for 100 trillion dollar (wow...hope India would become a $ 100 trillion dollars soon) and one U.S. dollar was worth more than 300 million Zimbabwean dollars. 

Hyperinflation or Deflation?

Currently, the world is divided into groups – with one set of countries majorly developed states flirting with the deflation and another set of countries majorly developing states like China, India etc battling to control burgeoning inflation. India has a serious concern on inflation due to structural issues on which the central bank has raised it many times. Recently, the RBI governor D Subbarao commented – “When I meet other central bank governors, they tell me `why don't you give us a bit of your inflation. That's how desperately they want some inflation and how desperate we are to control inflation”.

The hyperinflation has its own history.  Prof. Steve H. Hanke, Professor of The Johns Hopkins University and Senior Fellow of The Cato Institute has calculated the highest monthly inflation data as given below:

So, it is not only Zimbabwe but other countries like Hungary and Germany have also faced the hyper inflation in the past. Still, Hungary holds the record with the highest monthly inflation rate in the past. 

Now soiled Zimbabwean Dollars find new takers..

Western visitors to Zimbabwe are looking for zeros. They are toying with the soiled Zimbabwe bank notes, not in circulation now, most notably the one hundred trillion Zimbabwe dollar bill as an economic souvenir. The report says

The one hundred trillion Zimbabwe dollar bill, which at 100 followed by 12 zeros is the highest denomination, now sells for $5, depending on its condition. That bill and others -- among them millions, billions and trillions, were abandoned nearly two years ago, when the American dollar became legal tender in the hopes of killing off the record inflation that caused all those zeros.

"I had to have one," said Janice Waas on a visit to the northwestern resort town of Victoria Falls. "The numbers are mind bending." She got her so-called "Zimdollar" in pristine condition, from a street vendor who usually sells African carvings.

Call it the passion or curiosity; everyone now wants to get a pie of it. No wonder inflation – be it hyperinflation or deflation is a weapon of mass devastation. Hope in India, someone must be listening!

Happy Reading!

- Amar Ranu

Cash Strapped or Cash Hoardings – Look at these numbers

The world might be running high of rising asset prices and abundant liquidity which have heightened the inflation across the world. Last day, the republic of China raised its bank reserve requirements by 50 bps, the sixth time in less than a year and 4^th time in last 2 months in order to tame the inflation. Liquidity in the financial system has been another issue around the globe after the financial crisis. However, it eased after the developed countries announced a series of quantitative measures to ease the situation with US coming out with TARP, QE-I and now QE-II.  Sovereign crisis fear the European region which has questioned the existence of a unified region.

Amidst all these developments, many financially sound companies or marginally affected due to globe hoarded the money awaiting the new ideas for which they hoarded the cash in large quantum. The VRS Research team at Standard & Poor with the help of Capital IQ data examined the top 50 publicly traded companies globally, excluding financials, ranked by their latest reported quarter’s total cash and short-term investment holdings. The sum total for these companies’ cash balances is approximately US $ 1.08 trillion, almost near to cash holding for the entire S&P 500 Index.

We found 17 U.S.-based companies among the top 50 global corporate cash holders--which means that among specific nations, two-thirds of the top 50 global cash holding companies are headquartered outside of the U.S. From the perspective of dollar amounts, the 17 U.S companies account for $458.2 billion, or about 42%, of the top 50's global cash holdings. Meanwhile, the cumulative cash holdings of the 13 companies located in Asia and Australia, among the 50 below, amount to more than $270.1 billion, or about 25% of the group's total. In Europe, we find 17 companies among the top 50 global cash holders with aggregate cash holding total of $287.7 billion, or about 27% of cash balances among the global top 50.

With the abundance of capital abroad, there is a likelihood possibility that the firms may go for increased cross-border mergers and acquisitions as well as for strong earnings growth outside the U.S. After 2008 crisis, this domain has almost died given the tight liquidity scenario in their home country and globally. However, currently, the list could serve as a starting resource for ideas on who may be buying, where deals could occur, and possibly where profits may emerge.

Happy Investing! Happy Reading!

-        -   Amar Ranu

(Permission sought from S&P to post their articles on this blog)

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TINA plus S – Curve Effect = M100, a Midcap ETF

After the success of MOSt Shares M50 ETF, the fundamentally managed ETF and the remixed version of Nifty 50 which created record in terms of largest number of ETF investors, Motilal Oswal Asset Management Company Ltd. (MOAMC) has come out with a unique and novel product MOSt Shares M100 ETF having TINA (There Is No Alternative) and S-Curve effect. It is India’s first mid cap ETF based on CNX Midcap Index.

Mid Cap Space – unfilled opportunity for investors

Investors have always been scouting for mid cap space for better returns in comparison to large cap stocks, even at a higher volatility. Many fund houses sensed this opportunity and introduced active mid-cap funds; however, most of them failed to beat their benchmark, categorically CNX Mid Cap over a longer period of time. Moreover, the high expense costs (on an average 2.1 per cent) for these funds have been eating their returns. So, practically, investors have been left with no option but to invest in these funds relatively at higher costs.

MOSt Shares M100 ETF

MOAMC known for its innovations have filled this gap with the launch of MOSt Shares M100 ETF, India’s first mid cap ETF based on CNX Midcap Index. The primary objective of the scheme is to seek investment return that corresponds generally to the performance of the CNX Mid Cap Index, subject to tracking error. 

Why M100 ETF with CNX Mid-Cap Index?

1)     The Fund proposes to keep the expense ratio within 100 bps unlike in active funds which have 2 per cent plus.

2)     In longer investment period say 3 years and 5 years, CNX Mid Cap has outperformed the average midcap fund by a good margin.

3)     The volatility of CNX Mid Cap Index (25.5 per cent) is less than Nifty 50 (26.1 per cent); so, you are getting higher returns even at lower risk.

4)     None of the constituents of CNX Mid Cap has more than 4 per cent exposure in the index; so, they are avoiding concentration risk, an important factor if the market moves uneven.

5)     CNX Mid Cap Index is driven by consumption growth story with majority exposures to HealthCare, FMCG, Auto, Construction etc; so, in long term, the index is going to perform better in comparison to other indices.

6)     Being an ETF, it trades like a share and acts as a fund with no entry and exit loads and portfolio disclosed on daily basis.

TINA and S-Effect

Frankly speaking, the TINA affect applies here – There Is No Alternative to this product in the market. Historically, CNX Mid Cap has bitten its large index counterpart in long year’s category. So, logically, the investors will get exposure in Mid Cap stocks at lesser costs (1 per cent – proposed). Moreover, the S-Curve effect applies to mid-cap stocks – from inception to high growth to maturity i.e. Small Caps -> Mid Caps -> Large Caps. These hidden gems are under-researched, under-owned and under-valued. So, they provide a good growth opportunity in future. 

Word of Caution

1)     Mid cap stocks provide better returns in comparison to large cap companies; however, they have the downside effect too in bear market. However, investors planning to hold for longer years (minimum of 3-5 years) can get good returns over Large Caps.

2)     The proposed expense ratio (up to 1 per cent) is a win-win situation for investors; however, the fund house may go for the maximum permissible expense of 1.5 per cent which can deter the performance. However, it is still below the average expense ratio (over 2 per cent) of active mutual funds.

Should you buy?

First of its kind, the mid cap space has always been dominated by active funds. However, with the availability of this product, the investors fraternity must be excited to get exposures in mid cap stocks at comparatively lesser costs.  Also, the ETF story has started running in India which generally works at lower costs and in the long run, the history says that passive funds work better than an active funds. No doubt ETFs are going to bang in coming years.

M100 rocks!

Happy Investing!

- Amar Ranu

Fiscal Deficits at sub-5.5 per cent vs Higher Borrowing – which one to stick with?

Too many cooks spoil the broth! Rightly said... Post the global financial crisis, many countries – developed and emerging economies went for expansionary monetary and fiscal policies to revive their slowing economy. In India too, the slowdown of economy forced the Central Bank, the RBI and Central Government to announce a series of monetary and fiscal policies which shook the Indian Government’s finances. Three major expenses like provision for Sixth Pay Commission, Loan Waiver and MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Program) and various other subsidies including policy rate cuts led to significant intensification of the India’s Fiscal Deficit.

These unplanned expenditures in terms of loose policies and subsidies have badly affected the fiscal deficits. For Fiscal Year 2010-11, the Central Government fiscal deficit and combined gross fiscal deficit have been pegged at 8.2 per cent. However, there is an apprehension that it can shoot up further. In FY 2009-10, the fiscal deficit was 6.8 per cent of GDP. For FY 2011-12, it has been projected to bring it down to 4.4 per cent.

So, what happens if the fiscal deficit shoots up?

It means that the government will borrow extra to finance their planned and unplanned expenditures. If the government borrows extra for its spending, the level of money supplies rises which may compel to print more money, thus, leading to a hike in inflation rate. 

Current Scenario

With the improvement in economic conditions, the RBI has rolled back many of its accommodative measures introduced in year starting from 2008-09 bringing the policy rates to pre-crisis level. The net borrowing of Rs. 3.81 lakh crore will be executed smoothly except at few occasions where it has been devolved to PDs. However, the 3G and WIMAX auctions which collected worth Rs. 75,000 crore created the liquidity fissures which became a daily headache for RBI. In many occasions, the RBI has reiterated its comfort in repo borrowing up to 1 per cent of Net Demand and Time Liabilities (NDTL). However, the borrowing has been in range of over 2 per cent of NDTL which prompted the RBI to cut the SLR to 24 per cent and also introduced bond repurchase worth Rs. 48,000 crore under OMOs in four tranches.

The tight liquidity scenario was contemplating that the government may go for cancellation of some of its regular weekly borrowing as it has some unspent revenues lying with them. However, the Finance Ministry found support after the Nominal GDP data was released which rose on high inflation and on account of new series in headline inflation as measured by WPI. The nominal GDP
which expanded 19.8 per cent in the first half of the fiscal year 2010-11 provides the room for additional borrowing if the growth rate is intact in the 2^nd fiscal and the budgeted borrowing would amount to 5 per cent of the GDP only. The nominal GDP figures have risen due to burgeoning high
inflation rates which have been in double for most part of years and a new inflation index i.e. 2004-05. 

View

Since the fiscal numbers are calculated in current prices and if the government sticks to the number plan, it may have an additional room to borrow. The 5.5 per cent budgeted Fiscal Deficit of the GDP was thought of on account of assumption of 12.5 per cent growth in nominal GDP. However, it has grown at 19.8 per cent in the first half of the FY 2010-11; so the government may announce in reduction of Fiscal Deficit number at sub-5.5 per cent or may go for additional borrowing.

Given the tight liquidity scenario, it is unlikely that they will go for additional borrowing.  However, the quantum of OMOs done totaling Rs. 41,266 crore (in four tranches) may give a reason to borrow again beyond the budgeted specified limit if the liquidity improves in the financial system so as to finance its social schemes. After all, the election preparation is on!

Happy Reading!       - Amar Ranu

Financial Stability Report 2010 – A well documented story on Indian Economy

The Central Bank, Reserve Bank of India released its 2^nd Financial Stability Report (Firstone released in March 2010) and thus, it enters into the selected league of countries which publish Financial Stability Review/Report on a periodic basis. In the wake of the global economic crisis, it has become prudent for the Central Banks across the global to assess their financial stability and conduct many stress tests so as to test the nerves of the economies.

Broadly, the report covers that the financial sector remains stress free; however, the intermittent capital flows poses a big challenge as these kinds of flows are very volatile and may get reversed at time of extreme volatilities in origin countries. However, these portfolio inflows have helped financing the burgeoning current account deficit.

It also cautioned that the global economic recovery remain uncertain especially the European region needs to be watched out. Prolonged low interest rates in developed countries encourages higher systematic leverage and also creates a yield seeking environment wherein investors get into crowded traded.

The report also pointed out some soft domestic points where an eye needs to put up. While the domestic growth remains buoyant, the high domestic inflation is a cause of concern due to structural issues. The downside risks still remain and the stressed liquidity conditions warrant caution too. The bubble up in housing sector, especially in some particular regions like Mumbai, Noida, Bangalore and
other cities have prompted tightening of prudential norms which included increasing the provisioning ratio and raising the LTV ratio for higher loans. Read more…

2010 would be remembered a year in Financial Regulation with the passing of Dodd-Frank Act in United States to regulate banks and other financial institutions. We hope that the Central Bank will come with regulations in untouched domains and will take them under their umbrella.

Also read other countries Financial Stability Report/Review which are given below:

Austria – Dec 2010

Canada – Dec 2010 & June 2010

China – Sept 2010

Chile – Sept 2010

ECB – Dec 2010

Germany - 2010

Global by IMF – July 2010

Greece – July 2010

India – Dec 2010 & March 2010

Ireland – 2007

Italy – Dec 2010

Mauritius – Dec 2010

New Zealand – May 2010

Portugal – Nov 2010

Singapore – Nov 2010

South Africa – Sept 2010 & March 2010

Taiwan – May 2010

UK – Dec 2010

Happy Reading!
- Amar Ranu

Dematerialization of Mutual Fund Units – Simplifying the Investment Process

For quite few months, Mutual Funds in India have witnessed investors’ friendly regulatory changes, thanks to SEBI.  Right from the ban of entry loads in Aug 2009 to facilitating transactions in mutual funds schemes through the existing stock exchanges infrastructure in Nov 2009, SEBI now allowed mutual fund investments to be held in dematerialized form. It means that investors will have the option to convert their existing mutual fund investments into dematerialized form and buy/sell units through stock exchanges.

Background

With the removal of entry loads, SEBI intends to bring an advisory model where the intermediary charges a fee directly to the investors for providing advisory services to them. This reduced distribution incentive for distributors who found difficult to serve customers in far-flung areas or tier-3 & 4 cities. With this intent to provide mutual fund services to every nook and corner of India, SEBI decided to utilize the existing stock exchange infrastructure for mutual fund transactions.

Dematerialization of Mutual Fund Units

1.       Process

·        If you are an existing demat account holder, you can submit a Conversion Request Form (CRF) from your DP and submit the fully filled CRF form along with the Statement of Account to your DP. After due verification, the DPs will co-ordinate with the Asset Management Companies (AMC) and their Registrar and Transfer Agents which in turn after due verification
will credit the mutual fund units to your demat account.

·        If you are not a demat account holder, you will require to open a demat account with a DP before you can convert existing mutual fund units in demat form.

2.       Subscription of Units

Investors can subscribe to Mutual Fund units through their Stock Broker using the Stock Exchange platform. Upon subscription, the AMC/RTA will credit the mutual fund units to your demat account.

3.       Redemption of Units

Investors can redeem their dematerialized mutual fund units through two different modes. They can submit Redemption Request Form which in turn will send to the AMC/RTA after due
verification. The AMC/RTA will verify the form and credit the maturity proceeds in the bank account available in the depository system.

Why should you convert Mutual Funds into demat form?

1.      Consolidation – Even you are holding mutual funds investments with a number of AMCs, say 10 or 20, you can view all the transactions in a single statement instead of managing and collection statement of accounts from all AMCs.

2.      Easy Monitoring – Once you have your holdings at one place, you will be able to monitor them effectively and can also analyze its performance in one go.

3.      Fast transactions – Having all Mutual Fund units in a demat account can allow you to buy/sell the units without any inconvenience. It can be done either through a phone call or an online instruction unlike in physical units where you need to sign the repurchase form with each
AMCs and submit it in their point of presence (PoPs).

Drawbacks

The holding of MF units in demat account will necessarily lead an additional cost, a cost charged by stock broker on maintaining the demat account along with transaction charges. Currently, all brokers are offering transactions on MF units at free of cost which they might abandon once the volume picks up.

The impact will be minimal for those who already have a demat account with DPs. The potential of dematerialization of mutual fund units nullifies the cost associated with the demat account. Once powered with the demat units, the convenience and ease of transactions will definitely overrule the process of managing transactions with different AMCs. It provides a single platform to transact across multiple fund houses and their associated schemes. This is one of simplified steps which will help in simplifying investors’ financial life. Moreover, dematerialization of mutual fund units will improve the documentation process.

The glitter of Gold – its unprecedented hike

Old is Gold – the Gold shines more than its spark. In the current global financial breakdown, Gold emerged as the safest asset and its price headed northwards reaching a record $ 1,431.25 an ounce on Dec 07, 2010, the longest Bull Run in at least 90 years. What led to the unprecedented hike in its prices? India and China hoard a major portion of gold outputs in the world.

In the 19^th century, the Gold Standard took place and lasted until the First World War. It was partially reestablished during the interwar period. The Great Depression of the 1930s brought the gold standard to a final end.

In that era, the world subscribed to the Gold Standard which implied specific rules for the system of international payments. International payments lead to gold transfers between countries. Banque De France explains in its Focus (authored by Gong Cheng, Laurent Ferrara, Yannick K and Pascal T)

When a country runs a balance of payments deficit (surplus), it has to make (receive) a payment in gold. Domestic gold holdings decrease (increase) and domestic money supply contracts (expands). Domestic money supply is thus determined by the balance of payments. This provides an adjustment mechanism to external imbalances. Suppose for instance that a country runs a trade deficit. This leads to a decrease in gold holdings and a monetary contraction. This contraction generates a decrease in domestic prices. With lower relative prices, the country becomes more competitive and its current account is brought back to balance. This adjustment mechanism was described by David Hume in his famous 1752 essay.

The more can be read here…

However, the Gold Standard met its ending with the major economies moving away and after the Second World War, the Bretton Woods system replaced the gold standard. Instead of a gold parity, countries announced a fixed but adjustable parity to the dollar, which in turn was initially fully convertible into gold.

While there were many advantages but it got several drawbacks, which would probably turn out to be very dangerous and a source of instability for the world economy.

What led to Gold roaring a high of $ 1,431.25?

No doubt the financial crisis prompted investors in lapping up gold in big denominations; the back end analysis shows that the assets soared of Gold ETFs accumulating the major portion of world gold output. Globally, the 10 biggest such funds now hold a combined 2,113 metric tons of gold, more than the official reserves accumulated by every country in the world save four: the U.S., Germany, Italy and France. India and China hoard of major portion of gold outputs. Recently, the Central Bank of India, RBI bought a major portion of gold which also helped in showing investors’ interest in gold.

The story goes as below:

James Burton, the then Chief Executive Officer of California Public Employees’ Retirement System (CALIPERS) didn’t invest a penny in Gold of the total assets of $ 142.8 billion managed in 2002. The quiet obvious reason – the yellow metal had been in a bear market for two decades.

Christopher Thompson, the Chairman, World Gold Council convinced him to help in allowing investors to buy a previous metal they had shunned for generation. The key was dividing bars of gold into securities tradable on the New York Stock Exchange. And thus, the SPDR Gold Trust got its way and found the cheapest way of holding gold which now holds around 1,299 metric tons of gold valued at $ 57 billion, more than Swiss central bank. Their popularity (number of other Gold ETFs) helped driving unprecedented gains for the precious metal which can go even higher, as per analysts.

Read more on the parabolic rise of Gold.

Should we continue subscribing to it?

Gold’s worth is determined by fears of inflation or financial collapse. Unlike other eatable assets which are determined based on economic factors, gold’s true value is hard to judge for retail investors. In India, the demand will be factored by its sparkle coupled with the ETF demand.

Happy Reading!

Amar Ranu

Corporate Bond Markets - Robust Credit Cultures a Key to Development

Post the recent global economic crisis, there has been a significant shift in powers from developed nations to emerging market economies (EMEs). The sovereign crisis of European Countries, famously called as PIIGS (Portugal, Ireland, Italy, Greece and Spain) have questioned the dominance of emerging nations. In order to boost the economy growth, several developed nations have pledged to keep their interest rates at or near zero for an elongated period. The sovereign ratings of PIIGS have been cut and their fiscal deficits have reached to a record high.

The Asian story depicts a different perspective; the strong domestic consumption especially in India and China has led to the rally in the economy which has forced the central banks and governments to roll back their accommodative measures to tame the inflation. Out of these issues, it remains an important question how developed our bond markets – government bonds and corporate bonds are and it helps in measuring the pulse of the economy.

While the Asia-Pacific countries have made a good progress in developing local corporate bond market, they have a long way to go ahead. In India, Government Securities market are fairly developed on account of large quantum of government borrowings which have led to active trading and price discovery in securities of all tenures. However, in corporate bond market, we have a long way to go.

M. T. Raju, Upasana Bhutani and Anubhuti Sahay (2004) in their working paper “Corporate Debt Market in India – Key Issues and Policy Recommendations” have rightly pointed out for the need of “Single Trading Platform” instead of different platforms operated under NSE, BSE and FIMMDA. It tells that the different platforms allow liquidity bifurcated. They also emphasized the need of repo market in corporate debt. Recently, the RBI allowed the repo trading in corporate bond which might provide the liquidity in corporate bonds.

In another commentary report by Standard & Poors – “Fostering Robust Credit Cultures Is Key to Developing Deep and Liquid Corporate Bond Markets in Asia-Pacific”, Thomas G Schiller rightly pointed out that many Asia-Pacific seek to build market maturity and sophistication so as to attract many issuers to their countries. They have been emphasizing on robust credit cultures which are built on key elements such as transparency, independent and objective credit analysis, risk-based pricing, creditors’ rights and arm’s length relationships. In his commentary, he explained about the growing and maturing corporate bond markets in Australia, Hong Kong, Japan, Korea, Malaysia, New Zealand, Singapore, and Taiwan, and emerging markets in China, India and Thailand. About India, he mentions that India is a mostly sound credit culture that is still improving in some areas such as creditors’ rights. India’s corporate bond market is small but growing rapidly. Issuance grew by about 60 per cent over the two years to end-financial year March 31, 2010. However, the recent regulatory developments are enabling bond market development, including: the easing of issuance and listing requirements; the enhancement of disclosure requirements for issuers; the clearing of bonds through stock exchanges; and the introduction of credit default swaps (CDS) and interest rate swaps. He concluded that the process of building capital markets in banking dominated environment is a long and laborious one because it involves changing of a country’s business culture.

Read more about other countries here.
Happing Reading!

- Amar Ranu

(Permission sought from S&P to post their articles on this blog)

Equity Outflows dampened; Net assets grew to Rs. 6.65 lakh crore

In 2010 YTD, FIIs have been pouring money (referred as ‘hot money’) following the continuing global economic turbulence all over and thus, in some aspects, the inflows have been providing a temporary relief to burgeoning Current Account Deficits (CAD), expected to be over 3 per cent in current Fiscal Year. On the contrary, Mutual Funds have been bleeding seeing their assets depleting rapidly, especially Equity outflows. However, in Nov 2010, the situation improved in favour of domestic Mutual Fund Industry. On an average, the total industry AUM increased to Rs. 6.65 lakh crore, up by 2.92 per cent. Since the last four months, assets had been depleting continuously. The maximum growth was seen in Liquid/Money Market where the assets grew to Rs. 99,190 crore, a growth of 15.37 per cent over the last month.

Gilt Funds, where the investments are predominantly in Government Securities have seen an increased activity where a lot of investments flew in. The AUM grew to Rs. 4,410 crore, an increase of 11.08 per cent while the total inflows were Rs. 431 crore. This is the only category which has been witnessing positive inflows for the last 6 months. The high gilt yields scenario is throwing an opportunity for investors to reap the capital gains once the yields come down on account of eased liquidity situation, low inflation and improved economic outlook.

In Equity, the outflows continued albeit at much lesser amount. In Nov 2010, it saw an outflow of Rs. 41 crore only in comparison to an average outflow of Rs. 3,523 crore in last five months. The ELSS category too continued with the net outflow. This month, the outflow had been to Rs. 62 crore. In last eight months, the category saw the redemption of Rs. 993 crore, the maximum in recent years. However, the Balanced Fund category which involves a mix of Equity and Debt investments saw an inflow to the amount of Rs. 255 crore. However, its AUM declined to Rs. 18,871 crore in Nov 2010 from Rs. 19,462 crore in Oct 2010.

ETFs continue to move unidirectional with inflows. The Gold ETFs have drawn an added interest from investors which led to an inflow of Rs. 172 crore. In last 19 months, the category witnessed positive inflows in 18 months, the maximum among all categories. In other ETFs section, the inflows continued with a major addition of Rs. 328 crore. The AUM also rose to Rs. 1,852 crore in Nov 2010 from Rs. 1,690 crore a month earlier.

In Income category, the total AUM increased by 3.99 per cent to Rs. 3.31 lakh crore. The category saw an inflow of Rs. 11,307 crore in Nov 2010.

There were no new funds launched in Equity category; however, there was an open ended Gold ETF (Axis Gold ETF Fund) and Fund of Funds investing Overseas (JP Morgan EEMA Equity Offshore Fund) launched in Nov. However, there was a flurry of Fixed Maturity Plans (FMPs). A total of 36 FMPs was launched in Nov 2010 collecting a total fund of Rs. 5,281 crore. The liquidity deficit has sent the short term yields higher which have helped the Fund Managers to lock in the opportunity in dolling out FMPs which provide tax benefits in comparison to other investment products.

Source: MOSL

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Policy Tools post Global Financial Crisis – US Perspective

Since 2008, the world economy is in bad shape! Post the Lehman fall in Wall Street in 2008, the contagion effect ran scathe through the entire global economy. The governments in conjugation with their respective Central Banks announced a series of monetary and fiscal policies which helped in containing the reversal in growth and boost the economy. Also many countries announced bail out programs for many of its big institutions who had over leveraged themselves and became a victim of sub-prime crisis.

It is largely considered that the world biggest economy, United States defines the path of the market and the world market swings around it. Since the financial crisis that emerged in summer of 2007, the Federal Reserve used various liquidity and credit programs and other monetary policy tools. These tools aimed at addressing severe liquidity strains in key financial markets, cultivating faster economic recovery by lowering the longer-term interest rates and providing ready available credit to troubled and fractured financial institutions.

Here is a brief about the different policy tools used by Federal Reserve; these tools are widely used by other countries too.

Open Market Operations – The Federal Reserve considers it as the principal tool for implementing monetary policy. The objective of OMO can be a desired price (Federal Funds rate) or a desired quantity of reserves. The federal funds rate is the interest rate at which the depository institutions lend balances at the Federal Reserve to other depository institutions overnight (similar to Call rate in India).

However, Fed objectives on OMOs have varied over the years. During the 1980s, it concentrated on attaining the specified level of the federal funds rate and in 1995, it explicitly targeted federal fund rates. Table 1 explains the movement of Fed’s fund rates.

The Discount Rate – It is the interest rate charged by the Federal Reserve Bank to commercial banks and other financial institutions on loans under its lending facility – the discount window (Similar to Call Money in Overnight Segment). The Federal Reserve Bank offers three discount windows to depository institutions – primary credit, secondary credit and seasonal credit, each with its own discount rate. All discount window loans are fully secured.

In the primary credit program, the loans are extended for a very short term (usually overnight) for financially sound institutions. Those institutions which are not eligible for primary credit may apply for a secondary credit to meet short-term liquidity needs or to resolve severe financial difficulties. Seasonal credit is extended to relatively small depository institutions that have recurring intra-year fluctuations in funding needs, such as banks in agricultural or seasonal resort communities. The rates charged are minimum in Primary Credit followed by Secondary Credit while the discount rate for seasonal credit is an average of selected market rates.

Reserve Requirements

Against specified deposit liabilities, the banks are required to hold a minimum percentage of holding in reserve in the form of vault cash or deposits with Federal Reserve Banks. Reservable liabilities consist of net transaction accounts, non-personal time deposits and Eurocurrency liabilities. Since Dec 27, 1990, non-personal time deposits and Eurocurrency liabilities have had a reserve ratio of zero. Beginning Oct 2008, the Federal Reserve Banks will pay interest on required reserve balances and excess balances. The table 2 shows the reserve requirements as decided by Federal Reserve.

Interest on Required Balances and Excess Balances

The Federal Reserve pays interest on required reserve balances – balances held with Federal Reserve to satisfy reserve requirements and on excess balances – balances held in excess of required reserve balances and contractual clearing balances.

The interest rate on required reserve balances and excess balances is determined by the Federal Reserve Board. It gives the Federal Reserve an additional tool for the conduct of monetary policy.

Term Asset-Backed Securities Loan Facility

The Term Asset-Backed Securities Loan Facility (TALF) is a funding facility that will help market participants meet the credit needs of households and small businesses by supporting the issuances of asset-backed securities (ABS) collateralized by loans of various types to consumers and businesses of all sizes.

Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans.

Term Deposit Facility

It is a new tool announced in 2010 by which the Federal Reserve can manage the aggregate quantity of reserve balances held by depository institutions. It will facilitate the implementation of monetary policy. Funds placed in term deposits are removed from the accounts of participating institutions for the life of the term deposit and thereby drain reserve balances from the banking system. Reserve Banks will offer term deposits through the Term Deposit Facility (TDF), and all institutions that are eligible to receive earnings on their balances at Reserve Banks may participate in the term deposit program.

While the above mentioned policy tools are currently operative, some of the programs has been wound down on improved economic scenario. The Money Market Investor Funding Facility expired on Oct 30, 2009, and the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility were closed on February 1, 2010. Also, the final Term Auction Facility auction was conducted on March 8, 2010.

The world dynamics has changed; so with geo-political issues. PIIGS (Portugal, Ireland, Italy, Greece, Spain), once a flying and splendid investment horizon have been on the verge of sovereign crisis. We believe that the Keynesian has left a strong theory to be followed by US which have initiated many quantitative programs – QE-I (worth Trillion dollars) followed by QE-II (worth US$ 600 billion). 

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Source: Federal Reserve