Friday, January 30, 2009

Weekend Crap: Hrithik Roshan’s Secret Ingredient and Much More…

This edition of weekend crap is different from the last week as this week's theme is going to be our votes. That is correct, this week we are going to give our votes for different interesting things, including a secret ingredient "owned" by Hrithik Roshan. Since I am the author of this piece, naturally only one person is eligible to vote.

Okay, since we traders are trapped in watching CNBC all the time, I ended up picking a couple of CNBC ads. So here we go.

Vote of Sympathy: Gaursons

Let us begin our weekend with a little vote of sympathy. Here is this one real estate company who (I know I know, nobody gives a damn about this one, just skip to the next one you heartless creature) has become "stronger in these difficult times". Yes, it is about Gaursons who have been saying 5000 times a day that they have become stronger during these difficult times.

Yes guys, we understand. We understand that you are trying to convince yourself that everything is all right. Carry on. By the way, it would be much better for your financial health if you stopped wasting all that money on such crappy advertising. Why not give a nice discount on your homes instead? At least you will end up selling something.

Vote of Enthusiasm for Acting With True Desiness: Japanese Firefighters

Okay. This one also needs to be treated with a little bit of sympathy. But here is this Japanese firestation. And, well, the firefighters burn the whole place down trying to cook. Don't believe me? Okay, here is the Reuters link to the story, Fire station burns after cooking mishap.

Of course, it feels so familiar! Well, if you are the firefighter, you should let a little fire get going. That is how our "regulators" work, our policymakers work and, well, everyone of us works. So let us celebrate our desiness and… let some of them Jap guys join in! Cheers.

Vote for "Feeling" Uber Cool When You Are Not: Singapore… Blogger

Okay, I decided at the last minute to add the word blogger to the para title just because I like Singapore quite a bit, having lived there for two and half years. But guys, give me a break. Two weirdos walk down the street naked and the whole country goes gaga. Mr. Leonard Tan, a "blogger" declares that the country has become "cool".

So here is the next "thingie" to do this weekend. Checkout this link for getting a shaky photo of a naked couple Naked couple in Holland Village!
Now, for a moment, I am inclined to feel the same way if some couple walked down naked across the road, well, more frequently. How about once every day? Okay, I will settle for twice a week. Less than that? Cool? No way.

Vote for the Secret Ingredient: Hrithik Roshan

This one is actually a bit disgusting. So the thing goes like this. There is an ad. There is Hrithik Roshan with a faux Italiano babe. There is strange music in the background. So here begins Hide & Seek Milano.

What happens afterwards? I do not know. But it feels sick to imagine it. I mean, guys, give me a break. You are baking biscuits. When you start talking about "secret ingredients", what the hell are you talking about? What else can be there in this setting other than "surplus body fluids" that spill over after you are done doing whatever you do?

So is there a secret to every Milano? I DO NOT WANT TO KNOW. And I am not eating this "thing" after finding out that Hrithik Roshan's body fluids have to do something with it.

Okay, this wraps up this week's weekend crap. I know you are feeling pretty disgusted, me too.


Weekly Wrap-up: Markets Limping Back to Normalcy and other Updates


Sanity Returning to the Markets

This week, after a long time, we could see some signs of life coming back to the market. I found quite a few encouraging things this week that give hope that we can get back to trading the markets like we always used to; which means that you can take trading positions that can run into days and not hours, or weeks instead of days. Signs that life is coming back to the market include the following:

  1. For the first time in months, fundamental bad news did not break the market overall or the shares in question. Thus, many negative surprises on the earnings side have been taken by the market in its stride and knee jerk reactions have considerably diminished.
  2. Broad, fundamental bad news has failed to dent the sentiment. Today, Moody's downgraded the entire banking sector. The news came in around noon time, the market paused in the middle of the rally and then resumed it. Markets rallied one and a half percent from that point before closing for the day.
  3. Intra-day volatility has shown a marked decline and past 20 trading sessions or so have not shown the 5% intra-day swings that plagued the market earlier.

It is not to say that we are going to see a bull run in the market or anything of the sort. What I mean is that SANITY is returning to the market and the beast is a bit more familiar than it has been over past four months. Of course, the bullish and bearish sides will keep on dominating at times.

How Much Damage Did Satyam Do?

I have already written quite a lot on the FII flow impact of Satyam episode (including during this week). A technical check of the market also paints a very revealing picture. Those who are familiar with my blog would remember that I had predicted a level of 3150 for the NIFTY for end January somewhere in early December. I was also anticipating a delayed rally beginning somewhere around end January that should have taken the markets past that crucial level of 3150. A revised technical check reveals the following:

Markets had been moving in a very neat triangular pattern post the October low. As it happens with all the triangular patterns, the market had to break out either on the upside or the downside (or the triangle simply runs out of space and a new pattern emerges).

All my technical momentum indicators predicted that markets would test the lower end of the triangle after the 6th January high and then a break on the upside would happen somewhere around mid-January. But that was not to be. Satyam news, in one fell swoop, knocked the market out of the trading range and the market has languished for three weeks after that.

Of course, you can take the view that market would have broken anyway following the US negative cues. Well, consider the following:

  1. Indian market moved sideways while the US market tanked over past two weeks. It does not mean that India outperformed the US after that. Quite the contrary, we are just ignoring bad news that will sink us later. But the market sentiment kept the market afloat while the world was tanking.
  2. If the Satyam drag had not been there, there was a fighting chance that the market would have either moved sideways in a much higher range or broken up.

Anyway, this is pure speculation now and does not mean much. But the more indicators I look at, the more evidence there is that Satyam has dealt a body blow to the Indian stock market; notwithstanding all the talk about this being just one bad apple, overall sentiment being ok, etc.

Rating Season Starts

Today, we had some newsflow related to ratings. Some of this was anticipated, some of it was already priced in. That is probably the reason why it was shrugged off so easily by the market.

First, the already priced in. For example, the rating action related to Wockhardt was already priced in. The whole market is aware of the forex pressure being faced by Wockhardt due to its FCCB exposure and business press has been replete with its efforts to raise more money. Hence, it was more of a formal confirmation by the rating agency that things were not necessarily going great for them.

The second one is a bit trickier (here is the Indian Express link to the news). It is clear that Indian banking sector is going to face significant headwinds. The derating, in that sense, is already known to the market participants. The bad news relating to banking will continue to flow in over the next few months. In a way, it is business as usual. We are in the middle of one of the worst slowdowns we have seen in the history of India (with something like 2-5% growth likely to be chopped off from the recent peak if we have a normal monsoon) and to expect banks to be able to avoid NPLs is wishful thinking.

So do we worry about it? I think most of this was anticipated and not really a cause for worry. The one rating action I would worry about is a country re-rating. That can deal a blow to India at this stage. But there is nothing at the moment that warrants a country level relook at rating by any of the agencies. So we should be safe if the currency reserves do not fall beyond a point and the fiscal deficit does not balloon further from what is already on the cards.

Obama's Outburst, Will CEO Compensation Change?

Obama's outburst on the Wall Street bonuses means that fat bonuses for the top bosses may be headed for the cemetery, given that most of the big guys have taken government aid in one form or the other. Here, you need to ask the larger question, what is the future of the CEO pay in general?

The CEO pay structure in the US stinks. There is nothing special one person can bring to an organization that justifies a $200 million compensation (remember Dick Grasso of NYSE?). Not only that, such stratospheric packages encourage CEOs around the world to demand and get higher and higher amounts of money. In that sense, the US has exported more than just financial crisis to the world. Bad corporate culture, focus on quarterly earnings, corporate accounting fraud, you name it.

There is nothing wrong in rewarding merit. But reward and sacrifice should go hand in hand. When the economy turns, the first casualty is the small guy when companies start laying people off. How many CEOs take corresponding pay cuts, forget about losing their jobs?

Will be good if Obama's outburst is channeled more on fixing the flaws in the system instead of just forcing a few CEOs to return their bonuses.

Japan's Woes May Become Global

Japanese economy is facing its worst slump since the Second World War (Japan Heads for Worst Recession as Industrial Output Slumps, Losses Mount, Bloomberg news). This does not actually reflect on Japan alone. The large export sector in Japan is already reeling under the impact of global recession. If you look at the outlook of the economy going forward, things may get even worse for them before they get better. There is no sign that the global trade slowdown is close to bottoming out. In that sense, the pain is far from over.

There is a bigger issue at stake here; the itch felt by the Obama administration to become protectionist. The first thing Tim Geithner said after taking over was that China was "manipulating" its currency. It was not an off the cuff remark and it was not inconsequential. The term was used in a written reply to the Congress. And currency manipulation calls for stiff countermeasures both under various trade pacts as well as under WTO. Vice President Joe Biden has "clarified" that substantive action is not on the cards yet. But the overall bearings of the administration are clear, Obama promised a lavish dose of protectionism during his campaign and he is just keeping his promise.

It is important to remember that massive drop in global trade and mindless protectionism was instrumental in converting a severe recession into a global depression in the 1930's. Global recovery now also depends on how long Obama and company can keep their protectionist impulses under check.

India on Auto Pilot

Finally, we had one full week with the country running on auto-pilot in most of the areas. We have a government that is heading for the "lame duck" status and in a few weeks' time, the Election Commission is going to ban most policy level decisions. Close to the election time, there is a policy paralysis anyway. We have a stand-in prime minister since Dr. Singh is out of action till March. We have no full time Finance Minister also.

Overall, this may not be such a bad thing. Given the track record of the government so far, India has progressed mainly despite the government, not because of it. This reduced dose of governance may actually not be so bad. Who knows?

A Lot More Pain in Store?


William Pesek in his column at Bloomberg elaborates the risks being faced by BRICs as well as the impact on global economy. His piece Davos Man Finds BRICs of Little Help in Crisis is, of course, written from a more global perspective; but the problems he outlines for India are almost understated.

Despite the hype around the BRIC economies, the fact is that all of these are heavily dependent on the global growth to keep their economies humming at a nice rate. Russia is heavily dependent on oil exports and its boom has been fueled by high oil prices. China's export powerhouse will collapse if the US consumer does not re-enter the buying frenzy of the past decade.

Looking at Brazil, historically it has been beset with capital flight. In the early parts of this decade, annual capital flight was estimated around $27 billion per annum. The reasons for this are structural, with massive income disparities and lack of faith in the local financial system. The recent global growth spurt reversed the net capital flows position of Brazil, but in a period of uncertainty, Brazil tends to struggle with low rates of growth due to massive capital flight.

India has gained probably the most from the recent boom as international capital plugged a long standing savings-investment gap for the country. Going by RBI numbers, gross external capital flows have risen from 13% of GDP in 1997 to a staggering 51% of GDP in 2007. This has helped plug a savings-investment gap of almost 10% of GDP that has been plaguing India for long (for details, please see Economic Impact: Pre-91 Situation? section of Satyam Impact or Capital Flight?).

All of this is set to reverse significantly. Commodity prices are already down and the impact is reverberating around the world from Brazil to Australia as all commodity dependent economies take a step back. Capital flows are highly cyclical and during times of crisis, the cycle quickly reverses. Export dependence is anyway cyclical in nature.

Looking at this, one gets the realization why all the talk about decoupling was a humbug. Yes, this block has a lot of growth potential but that growth in turn is dependent on the global economy. Brazil and Russia are heavily dependent on global commodity cycle and in periods of uncertainty both tend to lose massive amounts of capital. China needs the West as a market to sustain growth and India needs it for capital.

India Prospects

This is not to suggest that we will not grow this year or next. But the pace is going to slow down significantly, particularly due to slow and ad-hoc nature of response. Come to think of it, the whole world is gearing up to battle a massive crisis and we are managing the economy without a Finance Minister and a stand-in Prime Minister who has a full external affairs portfolio to handle. It is the equivalent of trying to steer a large corporation out of turbulent times without a CEO and a CFO. If your Board of Directors is as "diverse" as the Indian Parliament, what will happen to the corporation?

There is clearly a lot more pain in store for India. The long term gap in capital is hard to plug internally without a major bout of belt tightening. Without this gap being plugged, growth is unlikely to hit the old trajectory of 8%+. All the talk about exports being a small component of GDP and domestic consumption being strong is fine. But we are not talking about maintenance of consumption, we are talking about growth and investments are an integral part of that equation.

I also wish that economic policy was not conducted so casually in India. If the Prime Minister was to go in for surgery and Pranab Mukherjee was to step in, he should have shed his External Affairs portfolio till next elections, which are just 4 months away. The case for a full time Finance Minister is clear anyway. But, strange are the ways…

Back to Technicals



Technicals are getting more and more important for the next few trading sessions. Not the standard technicals of course. Yeah yeah yeah, as I pointed out in my earlier post…

But the main point is that we need to pay attention to the technical indicators over next few days to trade the market correctly. And going by the main indicators, the market seems to be headed up.

Nifty charts; overall picture

Looking at the technical charts of Nifty, it is clear that the market was moving into a triangle pattern before it broke on the downside and formed the current trading band around 2700 and 2870. This band has held till now and needs to be tested before the market can move up.

Looking closer at the charts; things look pretty interesting.

It is interesting to note that the breakdown outside the trading triangle happened as a result of the Satyam fraud being disclosed. There is further clue available from the fact that market has stabilized in a tight trading range instead of completely breaking down and retesting October lows (despite a lot of technical analysts predicting it would happen).

Instead, the market has become stuck in a declining range for past few days and a breakout is the only way to find direction.

As I discussed earlier post on technical analysis, there was a false signal on a breakout on the downside. I was categorical in stating that the market was not going to go down and the lower end of the range held. Now we had a false breakout on the upside yesterday on the technical charts.

But at the same time, there is enough momentum to test the upper end of the range over next few days. What is holding the markets back is a simple money balance problem. There are simply not enough liquid assets in the market to pursue a sustainable rally.

What Will Provide the Upside Trigger?

We do not know at the moment. But the charts do show a strong upside pressure on the markets. If you fit an Eliott Wave on the markets from the October low levels, the market is actually sitting on an overdue rally that has the capacity to take the market beyond the earlier high of 3150.

What is more important is that fundamentals at the moment are supporting a shortlived rally in the market. Over next few days, we will get a positive momentum from the bailout package in the US. At the same time, local players in the market (particularly insurance companies) are sitting on a pile of cash and itching to invest. Satyam seems to be on track for a slow recovery, though the long term future of the company is still in doubt.

There is another extremely positive signal coming from the markets. There was a clear sense of panic in the market over past few weeks. Any stock with any negative news would fall like a brick, while positive news was completely ignored. It has changed completely over past few days. Over past few days, we have seen that stocks have either stayed flat or have rallied on back of negative earnings news (e.g., Maruti, Tata Steel) and good results have inevitably been followed by nice rallies.

This indicates that the market has purged the poison for the short term and any positive cues will be used for fueling the broad market rally.

Last Genuine Rally?

Going beyond technicals, this is likely to be the last genuine stock rally for quite some time to come. I have held this view for almost a month now and want to reiterate it here again. It is unlikely that we will see a genuine rally any time soon after this rally as the market is likely to get truly directionless for quite some time, drifting slightly lower or higher; but not getting anywhere.

So make hay while the sun shines. We will probably see a break of the current trading range over next one or two trading sessions. After that, the rally may last for more than a week.


Thursday, January 29, 2009

Rally Still Intact?



Jan series had closed in the region of 2770 on 27th. Based on the market momentum indicators, I had posted my levels for Jan series close yesterday before the market opened. My range was quite tight (bad policy for making any prediction, but then I am not a commentator; so do not hedge my bets).

Surprisingly, the series was bang in the middle of the range by market close yesterday itself. The only logical outcome is to get out of whatever trades you have at such a time. At the same time, I was curious to see how the series can be traded after that. The only logical way to test it was to open a paper trade as the NIFTY hit 2800 nearabouts.

Towards the end, NIFTY did bounce back a little bit and closed about 16 points away from my range. Not too bad, but still fails the tight trade test.

Anyway, there will be more opportunities to make money in this environment. Volatility is unlikely to die down any time soon. In the meantime, this price action does not threaten the overdue rally in the markets. For next 3-4 trading sessions, bias is likely to stay upwards.


Satyam Impact or Capital Flight?



In my last post on Satyam, I had posted a graph showing continuous selling pressure by the FIIs post the break of Satyam news (Saving Satyam and Rescuing the Indian Equity Markets). The selling has continued non-stop, as shown by the following updated graph on the matter.

Clearly, this is not a pretty picture.

Fraud Impact

In some of my earlier posts, I had touched upon the fact that a fraud of this nature and magnitude dents investor confidence to a level where a serious overhaul of the system is necessary to bring investors back in the market. There is already the evidence of the 2002 accounting scandals in the US where the stock market continued to be in a bind long after the recession ended. There too, the confidence returned only after credible action was taken and Sarbanes-Oxley (SOX) was implemented.

This does not mean that there needs to be an undue regulatory burden on the entire corporate sector. Proposals like a second audit by SEBI, etc. amount to just that, an undue additional burden. What we need is credible action to fix the gaps in the existing system, e.g., the proposals doing the rounds on auditor rotation. But some action needs to be taken.

Capital Flight?

Situation is complicated by the fact that we are going to see a reverse flow of capital from EMs to the US market. I talked about it in detail my post EM and Indian Markets: Capital Flight Risks, this is going to become a trend over the next few months.

Segregation of Effects

It is quite difficult to segregate the effect of different factors at work here. Whether it is lack of confidence in the EMs or lack of confidence in Indian fiscal position or general loss of faith in the Indian accounting system; it is quite hard to pinpoint how much each of these things is amounting to.

I do not believe that Satyam alone is responsible for causing this mayhem. But it has certainly acted as a catalyst and it might have tipped things that were already balanced quite precariously. For example, if you look at December FII flows, you see a fine balance with a mildly positive outcome at the end. Satyam may just have added that small negative weight where everything tilted to the negative side. It might have played the role of the proverbial straw in breaking the camel's back.

Anyway, we can see that all the factors having any weight on flows at the moment are negative. If one of them eases at a time, another one is likely to take over. Hence, the overall flavor will continue to be mildly negative on the capital flow side. But that is not the main worry. The biggest risk is that of all the negative factors aligning and working at the same time (the perfect storm scenario). That will be the time of a major setback for the markets.

Economic Impact: Pre-91 Situation?

In the medium term, Indian market will have to find all the necessary capital internally. That is not a good thing. Indian savings rate is languishing in mid '20s of the GDP in terms of percentage. Investments, on the other hand, need to be in the region of 32-35% of the GDP to sustain 8% GDP growth. This creates a gap of around 8-10%. If you add the negative savings of the government in the form of fiscal deficit (2% till now, but likely to cross 5% this year), the gap is a staggering 10-15% of GDP.

Those who have the fortitude of stepping back and looking at these numbers objectively will realize that we are looking at a picture of complete stagnation at the domestic level. The savings rate has hardly budged since mid 1980s, the government dissavings are also in the same region. What has truly made the difference over past 20 years is the impact of international capital if you net out all the aggregates.

I do not think we can quickly change the variables that have been stable over two decades (though the fiscal deficit can come down to 2% from higher levels this year). Trying to fill this gap internally means monetary expansion, massive government debt, moribund private sector; clearly a pre – 91 scenario that nobody wants to return to.

What is the Solution?

At this stage, I do not know for sure. Possibly, raising the domestic savings rate again through tax incentive led saving plans. That has a downside in shape of lower consumption in near term. Monetary expansion right now but quick reversion to sound fiscal policy as soon as conditions improve globally. Or the final market-led solution; let the bad scenario play out and build confidence in India in the meantime. Or may be something else to stabilize things fast.

I think at some stage, the government will have to consider some means of jump starting capital flows again. Possibly something like the Resurgent India Bonds or some other vehicle to mop up international capital to plug the savings-investment gap in the country.

Market Impact

This makes me jittery as a trader. Clearly, I do not see many upsides in the future. Though, my view on one rally led by the massive policy push in the US is still intact, there is not much bullish push left in the Indian market after that. But still, the market can be played for some upside as there is enough juice left in the market to at least test the earlier 3150 highs on the NIFTY.

Trade with caution, that is the only piece of trading advice I can offer at the moment. For long term long-only investors, the situation is pretty clear. No need to hurry, pick your choices slowly and carefully. And if you end up missing something, do not panic. In all probability, you will get a second chance to pick up on the cheap.


Wednesday, January 28, 2009

Bond Yields: Reality Bites but Daydreams Save the Day (for Some)


Despite the brave fronts put up by "liquidity is flush" brigade, bond yields continue to tick higher. Benchmark yields today touched a high of 6%, a level seen only for some time post the Satyam shock. What is happening in the market is pretty straight forward, at least I could see it coming (I do not want to get started on my post-counting spree; part of the reason is that now I have quite a collection, too large to keep counting). While market analysts can continue to be in denial, a trader cannot afford to do so. Being in denial is a trader's road to bankruptcy.

What is surprising is the "information management" being used to manage the yields. The signals emanating sound very convoluted as a result. On one hand, you have many top guys saying there is ample liquidity in the system and so on. It is interesting to note the sequence and the timelines.

Last week

Then, we had a comment last week from Finance Ministry that RBI would not go in for a rate cut; given rates have been cut less than a month back.

What happened next is more intriguing. The government was supposed to come out with a fresh borrowing schedule at the end of last week. So we had a "source" (I think from PMO) saying that a rate cut IS happening. So it cooled yields a bit that had started to tick up.

Come Tuesday…

…and the Monetary policy is out. No rate cut. Instead, another shock on fresh borrowing schedules. Then a "clarification" from the government that there is no plan to raise the borrowing amount.


The market has had enough and yields keep on ticking higher, touching 6% for a second time in January. This time around, no one is believing that a barrage of borrowing is not going to hit the market any time soon.


For somebody who has been writing on the matter for more than a month now, it does not come as a surprise. Of course it is a surprise for those celebrity commentators who have been jumping up and down with joy on "ample liquidity" and have been harping on low call money rates. But the situation does not come as a surprise because there is only so much the government can do under the circumstances. The moment it mentions higher borrowings, the market goes up. Then there is firefighting to get them back down and not scare both bond and equity markets into a selloff.

But if the borrowing is going to happen anyway, it is inevitable that the rates will go up from where they are. If it is inevitable, why bother to "massage" the information to soothe the market? The answer lies in the way policy is conducted in India.

Shooting in the Dark

Ad-hocism. That is the way policy is generally set. It is a bit like a Hindustan Unilever commercial. Simplified problem, simple root cause, simple solution, here is the product. Guy loses his promotion, culprit is a dirty shirt that does not clean with any detergent, enter the white knight in form of a soap bar. Outcome? Two promotions in one shot instead of just one… If only things were that simple…

I have railed many times against this simplistic approach to policy setting. My series on the matter is still stuck at one post though (Of Bad Policy, Muddled Thinking and Half Baked Solutions…) and I need to complete that work. That aside, this tendency allows the bureaucratic mind to lapse into imagining that yields are going down as they dole out "information" to the market. Whether it is interest rates, or fiscal stimulus, or the state of the economy, or investment in infrastructure. Instead of fixing what is broken, we tend to break into a song and dance sequence like a Bollywood flick and presume everything is fine.

Add to this a complete lack of ground level, reliable economic data. In all probability, the Finance Ministry probably does not know how much it needs to borrow. Under normal circumstances, all that you need to measure is deviations against the budget. If you keep on going by the budget numbers, that would give you a fairly good estimate, give or take 10%. This year, commodity price roller-coaster, subsidy changes, "stimulus" package, etc. would have made the budget a bad reference point. So? 'We do not even know how much we are going to borrow'. 'May be 25, no 15, no no no, more…'

Add to this, eternal hope. May be things are going to improve over next couple of months. Why not wait?

Of course, the trader sitting on the bank desk cannot "imagine" himself into profits. He has to create them and he has to own up his own actions. "If you fool me once, shame on you; if you fool me twice, shame on me…"

What Does it Change?

One word: Nothing. The market is going to take a course that is defined by the fundamentals. Right now, fundamentals are all aligned for a weaker rupee, higher interest rates for commercial sector, capital outflows, tightening stance by the banking sector, slowing economy and a stock market that keeps losing steam every now and then (notwithstanding the current rally).

So trade to make money, leave day dreaming to those who can afford it.


Pre-trading Session Call: Nifty Likely to End Jan Series Around 2850

My range for expiry would be between 2840-2850. We have two trading sessions left. All the best.

Disclaimer: Please do your own research before making ANY trade or investment. I shall NOT be responsible for any losses based on my views. My views are for my use only and I post them only for information purposes.

Monetary Policy: How to Trade It and Some Thoughts


There are very few market commentators whose views I listen to and respect. Ajay Shah of NIPFP is one such commentator whose views I have grown to respect over the years. When he says something on the economy, I have found that it makes a lot of sense to listen to his views and pay attention.

Ajay's views on the economy are well known. He has been writing for years on making the markets more efficient, on streamlining financial regulation, making the system work without too many misfires, etc. When he says that the current monetary policy review has lost a great opportunity in correcting some of the problems, he is right.

I happened to listen to his interview on CNBC-TV18 today and the two main points he made were the following:

  1. The RBI has wrongly chosen to look at CPI numbers to hold the policy rates steady instead of cutting rates. RBI should have cut rates instead of having a wait and watch approach (italics mine, and wording is not exact as I do not have the transcript of the interview).
  2. Since the monetary easing is not transmitting outside the banking system, RBI should have taken the opportunity to remove some of the bottlenecks and ease the flow of credit.

I agree with the second point, disagree with the first. And it is important to keep the difference in mind because understanding this is the key to understanding the basis for next policy move, its impact on the economy and what approach traders/investors need to take for making decisions.

Why Primary Article Inflation Needs to be Watched

Ajay's main argument is that RBI is taking a very restrictive view of inflation because technically, it is still relying on inflation data without seasonal adjustment. This is a fact. Non-adjusted inflation number shows a very lop-sided picture and it is wrong to base policy decisions on a number which is unreliable. Reams have been written on this issue but nothing much has changed. So much so that RBI already has put in place a mechanism to compute seasonally adjusted inflation numbers but does not release them.

The reason is not hard to understand. Our policy makers have been hiding behind non-adjusted numbers for long because it suits them at critical junctures. For instance, come May 2009 and you will see negative inflation numbers due to high base effect of last year. This suits the government very well because it can tom-tom negative inflation before the elections. If you run a history check, it will emerge that most of the times, the move to do away with such a sloppy system has been abandoned mostly because of the happy coincidence that such a bad approach suits someone's interest. Not a way to run economic policy but then there are a lot of other things that are wrong with the system.

But the fact that RBI does not release seasonally adjusted numbers does not mean that it does not take them into account. Quite the contrary, I believe that they would be actively monitoring this number too. And that may be the reason why they are disregarding the year on year number.

While seasonally adjusted or point to point annualized inflation numbers for all commodities would already be in the negative, that is not true for food and primary articles. The fact is that inflation in this area continues to be high even on a seasonally adjusted basis. Hence, unless you disagree with the view that skewed inflation situation (also see Is Inflation No Longer a Concern?), the policy action is the right one. One can, of course, take the view that it is wrong to focus on primary articles in such times of crisis and RBI should take a more aggressive approach.

In this respect, I would say that you should make up your own mind. If you agree with the former view, then RBI is right in taking a slightly restrictive stance. If you agree with the latter, then one has to agree with Ajay.

Structural Bottlenecks

The second point raised by Ajay is quite well put. While all the regulators around the world are struggling with the problem of liquidity not permeating beyond the banking system, situation in India tends to be especially bad during downturns. What is an exception for the world tends to be a rule for India.

It is also true that raising money for second and third tier borrowers becomes tough during bad times. It is not an Indian phenomenon. During times of stress, primary markets for securities that are not AAA (or equivalent) rated tend to shut down in the US, as was witnessed during the 1980s. But the banking channels continued to function.

But the problem of banking channels seizing in India and liquidity getting limited to primary levels only is not only due to RBI's inaction. There are a number of culprits that can be held responsible:

  1. RBI's need to manage government borrowing. It is a unique situation no other central bank has to grapple with. RBI has to not only conduct policy but has to carry the burden of managing government's debt also. The US Fed does not have to do it, it is treasury's headache. If there is a large fiscal deficit, the headache of managing the debt fallout should be on Finance Ministry not on monetary regulator. It will require a thick research paper to analyze how it has messed up the conduct of monetary policy. The only thing I want to say is that it is a significant disruption.
  2. Recovery channels are still clogged despite debt recovery tribunals. Delivery is closely related to possibility of recovery, something that is quite slow and unpredictable in India. While court orders took the fangs out of debt recovery tribunals, it is not the only problem. Weak legal safeguards against misstatement of assets (Satyam is truly an exception in this regard, other promoters tend to get away without any consequence) mean that balance sheets cannot be trusted. Slow speed of action means that culprits can alienate assets at leisure.
  3. Bankruptcy laws make liquidation a generation long process. It takes forever to get to assets, if there is anything left after decades of delay.
  4. Overlapping regulations with yawning gaps in crucial areas. This is a familiar problem. Create one regulating agency, give it half baked powers. Create another one, with conflicts. Then hold back the critical powers with the Ministry or the department in a Ministry. It is a familiar story, SEBI went through this, TRAI went through this and so on.

RBI can fix some things in this environment, but there remains a lot that is outside the purview of RBI. While I do agree with Ajay's point on the matter, I doubt RBI can do much in one Monetary Policy to substantially improve credit flow in the system. That is the key to the whole problem. We need substantial action, fast.


I still believe that RBI would be cognizant of both the problems and would be actively monitoring the problem. Hence, rate action will happen fairly early; probably as soon as primary article inflation returns to a single digit number.

The second part is more tricky to deal with and cannot be resolved with moral suasion alone. And so long as the problem continues, rate action is going to be more or less ineffective. Government's borrowing program will keep on neutralizing liquidity injections. A safety oriented banking system will keep on putting more money into government bonds and keep raising holdings far beyond the SLR.

I do think that at some stage RBI will look at providing some liquidity through a direct or a truncated channel to the corporate sector. This could be through an indirect purchase of AAA-rated corporate commercial paper. While it is not going to help second rung commercial sector, it will ease up things considerably as AAA-rated corporation demand will shift away from the banking channel.

Overall, RBI will have to resort to much more substantial QE operations as liquidity keeps on drying up. My bias is towards increasing crunch in the tertiary channel, forcing more and more small players into a corner.

Impact on Markets

Borrowing rates will continue to rule high for all. If RBI resorts to direct injection of funds as I am inclined to believe, it creates a significant market skew in favor of large cap corporations. It means that small and medium cap stocks are going to significantly underperform the benchmark indices.

Overall market view is also that all future rallies in the market are going to be limited to large caps only. In the current downturn, small and medium caps are going to be much worse hit as margins drop and costs rise. The hurdle rate for projects will rise dramatically and disproportionately, forcing smaller companies to abandon projects and take bottomline hits. Accounting scares will also put a dampener on small cap rallies, with downside bias much more pronounced. Thus, those who declare good results will not rise but the ones coming out with bad results will take solid hammering.

Hence, those looking to go long or pick stock for long term should limit themselves to large caps only. Shorting small caps is not possible; hence staying away is the only option.

Tuesday, January 27, 2009

Monetary Policy Review: Why We Admire Reserve Bank of India So Much


The monetary policy today did not bring any surprises. I do believe that the continuing hawkish bias of RBI is going to do some harm to the potential recovery. But one thing you can always credit RBI with is that they will always take a very well thought out view of the economy; a statement you cannot make about the rest of the policy making machinery of the country.

Most of the items and implications of the policy have been discussed and will be discussed in the media. I want to keep this post limited to a few key concerns that are not openly debated but have the most serious implications on the economy and the markets.

RBI stated many things in its Monetary Review yesterday and monetary policy statement today. One prime concern that is showing through is that inflation in primary items continues to rule high. This is something that the market tends to ignore. Despite a clear spike in CPI year on year, most of the commentators keep on harping on the fall in WPI. Clearly, it is a case of people using a selection bias and taking into account only such information as suits their position.

Primary Concerns

The concerns on this count continue. In my post last week, Is Inflation No Longer a Concern?, I had outlined how disruptive the skewed inflation can be for the growth momentum in India. This assumes greater significance because consumption is the only growth engine left for India in the near term. The other engine, the rising urban professional class, has been decimated in the triple whammy of high equity exposure, high real estate exposure and a complete collapse in the job market.

This means that Indian economy is flying on one engine only now. All other engines, external sector momentum, infrastructure growth and urban middle class, have effectively been shut for the near term. Jeopardizing the last remaining engine of growth is sheer folly, to say the least.

Both the last and the current RBI guvs have kept an eye out for this discrepancy. And this time around, RBI has sent a fairly strong signal out to the market and all the people hankering for rapid rate cuts. The inflation skew still matters and the explicit statement regarding this should make some of the analysts see some light.

Headwinds and Roadblocks

The economy continues to face headwinds as things keep on unraveling globally. While we will keep on searching for positive signs and keep hoping for the best, that is as far as we can go. At the end of the day, the economic cycle has to play itself out.

Unlike the rest of the world, Indian government has very little leeway on the fiscal side. Despite repeated advice by market participants of being "bold", the government can ill-afford to push the fiscal lever much. Sound economic policy management would require the government to take a countercyclical stance; restrictive during boom years and expansionary during a bust. But a strongly pro-cyclical stance during the boom years has now put the government in a spot where there is no choice of being countercyclical. An expansionary policy and lax fiscal discipline during boom years has meant that the government has been caught "naked" when the tide went out.

RBI, on the other hand, maintained a mildly countercyclical stance towards the latter half of the boom years. The result is that RBI has not only borne a greater share of the burden of keeping the economy afloat but will have to continue this task in near future.

"Bold" Advice

Coming to the advice of being bold on the fiscal front; part of the reason I have not written on it till now is that I find it very immature. India is not the USA, not a developed economy. It is a developing economy, a country with a net deficit in capital stock and a weak external account. Given these conditions and the need to depend on international capital for at least the next decade, the government can ill-afford to spoil its "balance sheet". The last thing the country needs at this moment is a downgrade by international rating agencies.

Hence, aggressive fiscal policy is out and rightly so. Any "boldness" at this stage can create far more problems than it will solve. Especially when nobody believes that government spending in India is efficient or is even desired. If all the money you are spending is believed to be going to graft, spending more is not a positive sign.

Back to Reserve Bank of India

So rightly or wrongly, we have to keep coming back to the Reserve Bank. The very same RBI that has been accused of being overly hawkish, even causing the downturn in India. It is a different matter that if RBI had been lax like the finance ministry, today we would have been left with practically nothing to fight the current menace with.

But the Reserve Bank is fighting from a very tough position. Despite the "experts" saying so, inflation is still a concern (as I have been arguing in multiple posts for weeks, culminating with my last week post). This forces RBI to be watchful and not ease too aggressively. At the same time, the economy is reeling under falling liquidity as borrowings by the government will increasingly crowd out private sector. Cutting headline rates is not enough because the quantity of money is also important. Hence, there is a crying need to pump in more money in the system. This creates two conflicting goals for the Reserve Bank.

A very aggressive quantitative easing is difficult to implement (again, pointed out in Too Little Too Late? in early December, QE on the Cards, Bond Yields Point to Headwinds, Bond Yields…2: The Coming Crunch, and so on). In fact, the current situation is a complete mish-mash because the RBI has to defend the currency, supply money to the markets, keep primary inflation number down, keep interest rates low to stimulate growth, manage the government's borrowing program without killing the private sector, ensure that the banks deliver credit at low rates despite no liquidity in the system and so on. If anyone believes that all of these goals can be managed or will be met simultaneously, one is setting oneself up for a very nasty surprise.

The final conclusion is that RBI today is painted in an extremely tough corner. What they are trying to achieve is very tough to pull off. So far RBI has been one of my favourite Central Bank (though I do not agree with the currency policy, but we all have our likes and dislikes) around the world. What they have managed in a policy environment like India is quite remarkable. I would hate to see them fail because our lives and future depend upon it. Under the circumstances, if they achieve even part of the goals, it is commendable and brings a lot of respite.

Liquidity Pass Through

The RBI also discussed the fact that there is ample liquidity in the banking system but that is yet to pass on to the commercial system (for a general discussion on the problem, you can refer to Levels of Liquidity section in Back to Fears of Depression). The US Fed had also struggled with the same problem in September/October and ended up opening a direct window for corporate Commercial Paper market.

This time around, RBI also has opened a direct window for the NBFCs. This may not help much. One of the problems with economic policy is the trickle through lags. The longer the channel, the longer it takes for the effect to reach the intended audience (this is the reason why it takes months for a money supply increase to trickle through to the final level). A detail discussion of that phenomenon can be at a different place, the point I want to make here is that sooner or later RBI will have to find a way to quicken the liquidity trickle through mechanism and at some stage the bank may end up lending more directly or through a shorter channel to the commercial sector. The economy is unlikely to recover in a hurry and pressure to resort to this kind of approach will keep on rising as banking channel becomes more and more risk averse.

External Sector Woes

The guv also answered a very important question raised by many in his press conference today afternoon. Why we are so vulnerable to the external sector and are suffering so badly at this juncture. He shared a few data points that drive the point home perfectly.

All numbers as percent of GDP



Two way trade (exports + imports)



Two way trade + capital account flows



Segregating the capital account from the trade account, gross two way flows are more than 60% of GDP, a number that indicates how important a part international capital has played in the Indian growth story. This reversal has literally taken the wind out of our sails and it will take us some time to find enough capital internally if the global conditions do not improve.


The monetary policy statement by RBI was important today not because of some rate cuts here and there or lack thereof. RBI has very clearly articulated how it sees the economic and how things are going to pan out. The course of action chosen is conservative but well thought out. To someone like me, it brings enormous comfort to know that the Central Bank is not turning a blind eye to yawning gaps and glaring issues.

I think the "smart money" verdict on this is going to be positive, though the environment is so tough that thinking of new flows is wishful thinking. But then, there is only so much a central banker do.

Friday, January 23, 2009

Weekend Crap: Mitali Mukherjee Beats Maria Bartiromo... and Much More to Boost Desi Pride

Okay, so a completely whipsaw market has forced an early and long weekend on us. With nothing tradeable at the moment, there is ample time to indulge in all the things useless. At the same time, it is too early to write a comment on the week and a wrap up; hence better to enjoy a few diversions.

Our today's theme is Desi Pride, inspired by exploits of "Rah Rah Rahman" (borrowed headline from The Times of India). Of course, it makes the chest swell much more if the giver of the pride happens to be a firang.

Desi Pride Swells Even More

This time around Desi pride and chests and much more should swell as The Compleat Trader has done some early weekend research. Our very own Mitali Mukherjee of CNBC-TV18 has made it to the 25 sexiest TV anchors in the world!!!

"Hold it cowboy! Don't get carried away"… that was my "rational mind" rebuking me.

Shut up rational mind! If the whole country can go gaga over AR Rahman getting some globe of some color, why can't I celebrate the "great success" (those who have seen Borat would understand) of Mitali?

Anyway, you can follow this link to get to the full list of cool mamas. The sweetest part is that ol' sweetheart Maria Bartiromo did not even make the list. Man, have we Indians ARRIVED!

No Need to Cringe Any More

Those of us who regularly cringe over the utterances and rants of some of our "righteous" people on issues related to our national pride and other sundry things, CRINGE NO MORE!!! For there are far worse nut jobs elsewhere in the world, much worse than our episodes of "Italian dogs" and sundry. So here is one such great example from the bestest "righteousest" people on Earth, The US of A. The episode is quite old, but if you go to the Youtube page, it still gets everyone quite worked up; and even till date, people keep on ranting on this. The funniest part is that it happened on Fox News national network, LIVE. Make sure you watch till the end to get the complete juice out of it.

Here is the Youtube link: cultural learning of America for make benefit glorious nation of Kazakhstan… oops I got carried away again. Watch Borat if you have not done that till now, this clip could fit right into the movie.

Even More Desi Pride, We Don't Dump Our Politicians Like Them Fools

So the Bush era is over. The other day CNBC anchor Erin Burnett was thanking God that Bush had decided to honour his "contract" and quietly walked off at the end of his term. She was also quite thankful for the fact that he did not start a revolution so that he could stay on.

But clearly, he has quite a few fans, including a lot of Indians. Too bad he was not an Indian politician. Guess what, Indians are not "ahsaan faramosh" like them Americans, who do not let a great President come back for even a third term. We cherish our politicians, that is why they keep coming back, again and again, back from the prison cell, the hospital and sometimes almost from the grave. And guess what, we Indians elect them right back, and give them NSG security so that our beloved netas do not come in the harm's way.

Boy, my eyes are getting moist with emotion. Anyway, Bush fans in India should take heart that "poor boy" is not alone. He DOES have some fans in America. Sample this from MSNBC:

"Just how genuine they are," said Pam Hallal of Indianapolis. "I'm sure he's glad to be done with his eight years. He did his best for our country and I appreciate that." (MSNBC)

In the meantime, my heart is swelling with Desi Pride. Hey yo Bushie boy… don't you wish you were a politician in India? But you are not hahahaha… Eat your heart out…

Okay, this concludes our short section of weekend crap. Such is the fate of us traders when the market is less than kind to them. You have to just kill time to get to the market close. Anyway, now that the market is about to close, we close our post right here.

Thursday, January 22, 2009

Is Technical Analysis Still Useful?

Trading Tools; Indian Markets;

Technical analysis had a "late start" in India. I still remember my formative years when the favourite book of all "sophisticated" market analysts used to be Using Dow Theory, a book that was probably the first one on technical analysis and was written more than 100 years ago. Not that there is anything wrong with reading a 100 years old book. But the point is that till about 10 years back, relatively few people were using technical analysis.

And that makes technical analysis very successful. The irony of the technique is that the more people use it, the less useful it becomes. In essence, that is the destiny of all trading techniques. If your technique is good enough to squeeze a small amount of inefficiency out of the market, sooner or later everyone will latch onto it and it will eventually stop yielding any advantage. It is a zero sum game and your profit is someone else's loss.

Deteriorating Returns

This is the biggest problem with any trading system. It started fairly simple and early trading systems in the 1970s were fairly rudimentary. If you happen to read Ed Seykota, the first big practitioner of trading system based approach; it looks like a cakewalk to make money. Even simple rules like moving average crossovers were good enough to give you a nice bundle of money. Today, though trend following systems still work, the amount of sweat that goes into a mildly profitable system would have made a multi-billionaire out of you twenty years ago.

That malady afflicts technical analysis in a big way. Ever since the technique became widely popular and used in the '80s, returns have been dwindling. The '80s were known as the years of the technical trader. But come '90s, all technical traders started losing money, some of them started bleeding. Some notable examples are Richard Dennis (of the Turtles fame) who stopped trading in 1990 and came back with computerized trading many years later, but faded again; Stanley Druckenmeyer of the Quantum Fund (handpicked by George Soros) who stopped trading in 2000; Victor Niederhoffer, the legendary mathematician trader who went bust in 1997 and again in 2007.

All of these traders got stung by one basic fact, all trading systems depend on market inefficiencies to money. And the more the traders chasing the same inefficiencies with the same approach, the less the likelihood of success for each of them. And for people who either trade technicals or use systems based on technical principles, going has generally been getting tougher in markets with higher levels of sophistication.

Technical Analysis in Indian Markets

Things have not been so bad in India. Till now, it is possible to bump into someone, somewhere who can tell you that he made a few crores in the market and follows "mainly technicals". But during past six months, all hell seems to have broken lose. I have been following daily technical recommendations on CNBC-TV18's website to check whether it works to follow the technical advice. What I have found is quite discouraging for those who want to rely on the technicians.

Most of the times, the market level advice turns out to be wrong. I do not follow individual stocks, so cannot comment on them; but on markets, the recommendations are all over the place. I initially thought of fading the consensus view (there is a lot of value in listening to someone who is ALWAYS wrong, do the opposite of what he recommends and you will make money). But even that did not make sense because they were not even consistently wrong. In practical terms, six months of painstaking research yielded me precisely nothing; simply because there was no correlation with actual course of the market, neither positive nor negative.

As an aside, the high point of my "research" was the comment by one popular analyst on December 22. He was asked by the interviewer where, according to his reading, would the December series Nifty close the month. His answer was a classic (and came after a lot of beating about the bush); on a Monday morning, you cannot predict which way the index would go, hence it was not possible to predict. The funny part, the series expired on December 24. If you cannot take a call on the likely price two days later, what help can such an analysis give you?

Modifying the Technique

The problem has been known for quite some time. It is no longer useful to rely blindly on the reversals indicated by charts, breakouts, support and resistance levels. TA generates so many false signals that if you follow it religiously, it can drive you mad with frustration.

A good example is the current situation with Nifty. All the technical analysts were first hung up on 2800 as the crucial level for Nifty. A break would have started the index on the path to 2500. But that break came many days ago and since then, the level has been passed at least half a dozen times on the way up and down. Neither did the index go to 2900 as a result of break of 2800, nor did it go down to 2500. And then the focus shifted to 2700.

Now the problem with TA is that you as the analyst are not the only one to see it. A thousand people will see the "signal" with you and there is no limit on who can see it and who cannot. The moment entire market starts seeing the "signal", it becomes useless.

Watch Out for False Signals

This is the reason why it is absolutely important to watch out for false break-outs, support breaks, resistance breaks and so on. If 2700 was a true support, a break should have seen the Nifty at something like 2600 by now. But when 2700 is seen as the crucial level whose break will make a lot of money for the bears, they will go for an overkill the moment market reaches close to it, or there is a minor break. This itself starts showing the market as having "convincingly" broken the support. If the market actually has buy side depth, all it means is that a stronger buying side has been given cheap stock. And all the bears are now sitting oversold, vulnerable to a short covering rally.

This drama plays out day in and day out in the markets. Now, given the high volatility in the market, the frequency has gone up quite substantially.


This gives rise to another phenomenon: Whipsaw. No matter which side you trade, you lose. In a market that is looking for direction, false signals abound. The result is high volatility in which essentially nobody makes money, except the market maker and the broker who earns commission on overtraded positions. Traders looking for direction just keep watching as their stop losses keep getting hit. No matter which side you are or where you put your stop loss, the market will just wander upto that point, slap you with a nice stop and get back where it started from.

The Fix

There is no easy fix to this problem. One fix is that you stop using technicals altogether. If you have the patience to build a different system for trading the markets, you can just drop TA and start using something else that works.

But everyone cannot do it so easily. So, here is another alternative that can work for some.

  • Trade when it works for you, not otherwise: This discipline can make a lot of money for you. If you have spent some time identifying the signal where you definitely make money, trade only on that signal. Do not trade when market is getting into a whipsaw mode.
  • Do your own research: Closely tied to the point above, do some research of your own to understand which technical patterns repeat in your chosen security. It varies from market to market. What does not work for Infy stock may work for Soy futures. Or you may notice some other pattern that works. Whatever it is, use it to build an edge.
  • Take reaction points with a pinch of salt: Do not go overboard on break of a "critical" point. Tread with caution and do allow for the possibility of a false signal.
  • Go with better risk control: Do not pile on 150% of your capital (through leverage) into a single signal. Build multiple confirmation points for your view and scale into your final position in a staggered way with confirmation of each such point.
  • Do not overly rely on others' analysis, including mine: Do not listen to me, or anyone for that matter. Do your research. Use analyst views as source of trade ideas, not as gospel truth.

Following these tips does not mean that a profit is guaranteed. There is a lot more to profitable trading than just good analysis and a few basic tips. That is why it can work for some, for others it may not. But I do hope that these tips can help you refine your thoughts on how to push your trading and investing profits a bit further.

Happy Trading!



Is Inflation No Longer a Concern?

Indian Economy; Economic Policy

Yesterday's The Economic Times had a news item that was relegated to a corner and, I am sure, was not noticed by too many people. According to the news, CPI for rural and agri consumers has gone up from 11.11% in November, 08 to 11.14% in December. More significantly, the rate has jumped by almost 5 percentage points versus December, 07 (from 5.63%).

Most of the market commentators have been of the view that we are going to see a negative rate of inflation on the WPI sometime down the line. Hence, inflation is no longer a concern and consumption can stay strong.

The divergence in WPI and CPI paints a different picture. Since both the indices measure different items with different weights, it points to a major problem that has been ignored for years. The kind of inflation that we have in India actually hits the bottom of the pyramid the worst. This is not a positive indicator.

India currently is in middle of a socio-economic transition where a vast number of people can look forward to a worthwhile future. This section has been trapped at the bottom of the pyramid for decades. And inflation at consumer price level is the worst enemy of any process to get them out of their tight spot.

Hardest Hit

It is no secret that inflation, even under normal circumstances, hits the poorest in its worst form. At the edge of existence, any increase in their nominal incomes is promptly destroyed by price increases in primary goods. This leaves no scope of savings and investment, a pre-requisite for participation in a market economy system. I will not go in for too much of detail on this because there is an abundance of material on this matter. Some very good economists have contributed on this and I have nothing better to add there.

My concern at the moment is quite different. The pattern of inflation in India has changed in such a way that the impact has become even more skewed. Inflation today is happening in categories where the poor do most of their consumption, whereas other items are seeing a price reduction. So, the poor are seeing a very high level of inflation and at the same time, the middle and upper class people are getting compensated elsewhere to such an extent that they may not see any inflation at all.

Clear Threat to Growth

It will not be an exaggeration to say that this creates a growth hazard even in the medium term. A major part of the Indian growth story is the fact that a large section of the poor and the underprivileged are finally able to consume beyond primary goods. A sector like telecom, for example, is not hot not only because of rising urban affluence, but also due to the fact that almost every section of society can use it.

The skewed nature of inflation is a big threat to this process of economic empowerment. Even as far back as 2006, my other economic blogs (discontinued in 2007 due to my getting busy with other engagements) highlighted this concern. Even when the WPI inflation at that time was sub-5%, CPI inflation was relatively high (5-6%). Still, it was a manageable position due to higher rate of income growth.

Now, the skew is on the verge of getting disruptive. Not only does it dampen the consumption story, it gives rise to further income disparity in the society.

Why It is a Bigger Threat to India

Simply because we house almost half the poor and the destitute of the world. Destitution is a problem everywhere, including in a country like the US (and excluding a few Scandinavian countries). But it is the extent of the problem that matters. In the US, the destitute would probably constitute about 1% (or less) of the population. Here we are talking about a quarter of the population.

Going by region, the disparities are even higher. Thus, North West India, Western India and South have accelerated well past their North Indian plain brethren economically. The socio-economic picture is truly bleak among the worst managed of the Indian states.

Not only does it place a drag on the country as a whole economically, but the worst affected places are also a threat to social stability in the longer run.

No Magic Fixes

Clearly, this is a longer term problem and there are no quick solutions. Another factor is the international commodity cycle that has made controlling food prices much harder. The third problem is that while the government in India spends heavily on subsidies, they are doled out in such a sloppy manner that the solution makes the problem worse.

Moreover, unlike other areas of the economy, any progress in this area cannot happen without a strong commitment from the government. Market is clearly dysfunctional in these aspects.

Back to the Economy

Many will take the view that I am picking up a minor item and making too big an issue out of it. To that, I want to say only one thing: so far we have felt we are safe from any economic shock because we have not been hit by very high inflation. It allows the government a lot of flexibility on both monetary and fiscal policy. But what if the fall in inflation is only a temporary phenomenon? What if deflation in a few commodity items is masking a much bigger problem waiting to explode upon us?

In other words, apart from the skewed nature of the inflation and its impact, the numbers also show that inflation is accelerating in areas that are not affected by international commodity prices. Now, if you consider the possibility for a moment, any spike in international commodity price cycle will have us with our backs to the wall.

In that sense, it is a dual threat. If commodity prices turn up, we are in a tight spot. Otherwise, it has potential to slow down consumption growth significantly because of a threat to demand growth by the poor.

How Does it Impact Long Term Growth?

So far, the long term Indian growth story has been intact. Skewed inflation or not, nobody believes that India will fail to return to 7% growth once the current mess (both international and internal) clears up. Let us hope it stays that way.

Stock Market Manipulation or Just Panic?

Indian Stock Markets


In my earlier post, I had discussed the possibility of unscrupulous operators getting together and using the general apprehensions about promoter-led companies to make a quick buck. The earlier case was that of Rolta and now Educomp has happened.

Though the company has alleged it to be the work of a cartel, we cannot go by such assertions. Still, more such cases will strengthen the suspicion that some section of the market is trying to take advantage of the situation.

These instances have happened in every market for sure. The US is a good example. To the extent that market manipulation was an almost legitimate tool in the hands of the tycoons of early 20th century. Icons like Andrew Carnegie made their fortunes in industry consolidations. Some of these industry magnates followed stock market practices that would be downright illegal today. India was no exception to this. Anyone who was a part of the rampant IPO issuance phase and "listing booms" of early 1990s in India would regard today's markets as squeaky clean.

But that was prior to the period when we had demat, settlements used to happen weeks after trades and we had no international interest in the market. By global standards of today, what is happening raises some question marks on institutional frameworks to protect the average investor.

The real risk in such a situation is not faced by the institutional or the large investor. The small investor/trader, on the other hand, faces an added risk which is quite large. What do you do if you are running a long on such a stock when someone, suddenly creates panic and the share drops 50% of its value? What if you end up exiting the stock at depressed value, only to watch it climb back up all the way? You just lost one-third or half of your money just because someone got smart and tricked you out of it. This is a direct equivalent of a daylight robbery.

Risk Control

It becomes quite tough under such circumstances. While I would not recommend a complete avoidance of second rung stocks in this situation, some caution is needed. Particularly because it makes risk management quite difficult. What if you presume that the rumour is wrong and stay put in a position instead of exiting at a decent level? You will end up losing more. So in such a situation, you cannot take a call either way.

It is important here to differentiate between the normal rumour-mongering in a depressed environment and clear cases of manipulation. Rumours abound in the market, both during bullish times and bearish times. And all you probably need to do is to avoid listening to them. More often than not, they do not cause price rises or collapses to the extent of 50%.

This situation is different and till there is some stability in the mood of the market, it is quite risky to initiate fresh longs in any stock that is vulnerable on this count.

Wednesday, January 21, 2009

Saving Satyam and Rescuing the Indian Equity Markets

Indian Markets

As time goes by, the fact keeps becoming clearer that the company is running out of time. In my post Kings of Denial, I had pointed out the fact that to expect customers to NOT defect is wishful thinking. IT buying does not work like commodity buying. When you are betting the reliability of your entire business infrastructure on the vendor, the first thing you need to be sure about is the ability of the vendor to survive.

In the short history of this industry, examples have abounded of cases where a superior technology platform and clear leadership have come to naught when there was a question mark on the financial viability and survival of the vendor. There is the famous case of ERP vendor BaaN and there is Sybase. If you start digging up such examples, you will see that doubts on survival mean a death knell for any player in an industry where reliability is paramount.

Losing Time

In that sense, Satyam is losing time. Since it is clear that the company may not be able to continue in its current shape for very long; some sort of a quick solution would be absolutely necessary. Otherwise, the customers will start the process of moving away from Satyam as a vendor.

And that is the start of a downhill journey. Due to the multi-year, long term nature of IT contracts, once the migration process starts, it will become an irreversible process. Once this process starts, a continuous decline in revenue will mean that doubts over survival will persist well into the future. This effectively means a slow death for the 4th largest vendor from India.

Decisive Action or Hasty Move?

Different commentators in the industry have praised the Indian government for a quick action. The board was superseded quickly in one fell swoop. But the downsides of government action are usually visible only after a while. Former Treasury Secretary Paulson discovered it after the Fannie Mae and Freddie Mac rescue. Part of the blame for the way capital markets froze in September, 08 goes to the way the rescue was structured (here is an excellent link on the story on Bloomberg).

In case of Satyam also, the government may have earned quick brownie points for "quick action", the fact is that the main shareholders were kept completely out of the process. A corporation, unless nationalized, belongs ultimately to the shareholders. In this case, by keeping them out, the government has done more harm than good.

The Satyam board and management today faces a peculiar problem. No matter how hard they try, everyone, whether it is an investor or a customer, knows that they are a temporary "fix". They are neither "permanent" nor "management". And that means no respite for the company until some sort of stability returns.

Raw Deal for the Shareholders

The shareholders have been given a complete short shrift. First, a promoter with 5% share was allowed to run haywire in a regime of political patronage. And when the government took control of the situation, the largest shareholders were kept completely out of any kind of rescue of the company.

This, in terms of respect for property rights of people, is matched only by the rescue of AIG by Henry Paulson, where the Fed just turned everyone's holdings into the company into dust.

Granted, no one cares about the individual investors. But large funds owned as much as 60% of Satyam. Even they have not been given any say till now in how the future of the company will be decided.

Political Patronage and Blocking the Probe

Equally discouraging is the way the Satyam probe is being conducted. So many days into the crisis, it is not known what the extent of the fraud is. At least the cash amount should have been known by now.

The way Raju's arrest has been handled is another story in itself. SEBI has not even been allowed to question him, no assets have been frozen and there is nothing to suggest even an attempt at recovery of stolen money. The Andhra Pradesh government itself is making a mockery of governance by extending patronage to a discredited business house. Instead of chasings stolen assets, the local police are preparing to arrest independent directors in cases that have not been investigated for 10 years and the people in question have resigned long ago from their board positions.

Smirking at the Markets

All this points to an attitude of taking markets for granted and making regulatory functions a farce. Clearly, small investors cannot do much about it. But international institutional investors are less than kind to markets with this attitude. A clear example is Russia. FIIs may invest there when things are extremely good, but the first sign of trouble and everyone is out. India, on the other hand, has prided on better regulatory framework and has been amply rewarded over past ten years.

But all the good work has been reversed in one single stroke. Despite the earning season that is not so bad, the withdrawal of money from the market has been consistent. Even on extremely good days, the FII numbers have been negative.

People I regularly speak to attribute this to a negative general economic outlook. But there is a clear pattern here. FII flows had begun to turn fairly positive and early January was seeing healthy positive numbers, before Satyam happened. And selling post Satyam has been relentless.

Undoing the Damage

It will take a long to undo the damage, that much everyone knows and agrees on. But the government is certainly not helping the cause of the market by taking over the management completely and letting things drag on. This does little to customer confidence and investor confidence. Instead, the investors need to be involved in the process of running the company. The sanctity of property rights needs to be restored. Raju had no moral right to run the company, but why are the other shareholders being deprived of their ownership rights?

The earlier this ad-hoc management status of the current board is taken away, the better for the company and the markets. Had the government allowed the remaining shareholders to decide on constitution of the board and allowed them to put a management in place; it would have had multiple advantages. One, there would be some sense of permanency in the status of the board. Two, even if the current board appoints a CEO and a CFO, they will be a "transition team" at best. The moment true owners of the company, its shareholders, take control; they have every right to change the management and put a team of their liking in place. The customers would certainly be aware of this problem and it increases uncertainty for them to a considerable extent.

Apart from involving the shareholders, there is a need to put structural safeguards in place. Running a fair investigation and bringing full weight of existing laws to bear will certainly help overall sentiment of the market. If, on the other hand, the scamsters are eventually let free, India will justifiably lose its sheen among the emerging markets.

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