journal of finance vol 25

8/9/2019 Journal of Finance Vol 25

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Volume 25 / January 2009

FINANCIAL ADVISOR

PPPRRRAAACCCTTTIIICCCEEE JJJOOOUUURRRNNNAAALLLJOURNAL OF THE SECURITY ACEDEMY AND FACULTY OF e-EDUCATION

SAFE UPDATES KEEP INFORMEDThe Securities Academy and Faculty of e-Education

Editor: CA Lalit Mohan Agrawal


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Editorial Preamble: India under Storm1. THE WORST IS YET TO COME

India under Storm

India is currently facing three different kinds of crisis on the economic front. The first is self-inflicted, thesecond has been imposed on us by the US, and our neighbour Pakistan has caused the third.

The origins of the first crisis self-inflicted lie in the manner in which the policymakers tackled theproblem of inflation. The RBI took a number of steps to tighten liquidity, forced financial institutions toraise interest rates and not only made credit unavailable but also very expensive. Besides the Centralgovernments huge fiscal deficit had already sucked a lot of liquidity out of the system.

It was pointed out by economists that the rising prices of the demand-inelastic essential commoditieswould not respond to monetary measures and that steps taken to tackle to inflation by RBI would have anadverse impact on growth. Thus by its mistaken policies, the RBI made matter worse. Money becamescarce; money became unaffordable; and it impacted demand from both consumption and investment. Theeconomy, as predicted, slowed down. If the government had not compromised growth while tacklinginflation, India would have been in a much better position today to face the global meltdown.

The second crisis the financial crisis in the US has multiplied our problems, as it has caught us off-guard. The government had not anticipated this crisis, and if the crisis could not be anticipated, how couldit be mitigated? Under pricing of risk is inherent in the modern financial system. The US failed miserablyto do so. The rating agencies failed too. International financial institutions like the IMF also failed toanticipate the crisis. No one knows even today the extent of the risk involved, where the risk is lodged andwho owns the risk. Clearly, we have not yet seen the bottom. The worst is yet to come.

The result is that liquidity has vanished from the system globally. The consumer does not want to borrowand buy. He wants to save whatever he has. The financial institutions are getting increasingly saddledwith non-performing assets. Even if they have the money, they are reluctant to lend. Nobody is keen tomake fresh investment. Lay-offs have become the order of the day.

Two questions are bothering all of us today, first, what need to be done to get over the crisis; and second,is the government doing enough and in time?

As far as the first two crises are concerned, the steps taken by the government so far have beenincremental and ineffective. It has only undone what it had done earlier to tackle inflation. Doing a bittoday and a bit tomorrow is the surest way to push the country into deeper trouble. Yet unfortunately thisis exactly what the government is doing a bit today and a bit tomorrow.

The government is needed to ensure adequate affordable credit to overcome a massive credit crunch. Thiscredit crunch is painful for large industries, but it is disastrous for smaller companies and consumers. So,

a lot depends on when banks finally get back to the business of providing credit.

Besides, whatever steps the government takes at the moment such as, providing cheap cash tocorporates through a variety of refinance window not only are bank reluctant to lend, even corporatesare loath to load up their balance sheets with fresh debt. Many of them are drawing down their existingcredit lines with banks to finance existing projects but are unwilling to bet on new projects. Withaggregate demand having fallen, India Inc is also contending with reduced topline and bottomlineprojections. In such a scenario, they may not be in a mood to pile up additional debt.


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India under Storm

Let us take the third crisis caused by our neighbour Pakistan. The attack on the Taj and Oberoi wascalculated to send a clear message to the foreigners that India was highly unsafe.

Travel plans and many foreigners have already canceled hotel bookings. This horrible event, preceded asit was by a series of bomb blasts in important cities earlier, is bound to impact adversely on travel,

tourism and the hospitality industry. It is bound to send negative signals to potential foreign investors.Pakistan has destroyed its economy, now it wants to destroy ours.

India should treat such attacks as acts of aggression against our country and defend itself with all itsmight. Self-defence is our inalienable right; we must exercise it with the support of the internationalcommunity if possible; without its support if necessary. Pakistan must pay the price for allowing itsterritory to be misused for the Mumbai attack. A weak India cannot be an economic super power.

This is the time to launch a war not only against terror but also against poor infrastructure, both physicaland human in our country. Road, irrigation projects, housing, health and education in the rural areasshould receive our highest priority. Highways, power plants, transportation systems, railway tracks, portsand airports should be our next target. Quality higher and technical educational institutions and

institutions imparting skills must be set up on a large scale. Our cities must be revitalised with mostmodern civic amenities. All this could be done through vigorous public-private partnership. All viableschemes could be funded through the market with only seed capital from the government.

The government should not allow the crisis to go waste. We converted the 1991 balance of payment crisisinto an opportunity to usher in economic reforms. This crisis offers us a similar opportunity. But, it seemsthat the government is taking the global meltdown a place of shelter as the crisis has given it a place tohide. The government has successfully convinced the people that all the present economic ills are becauseof the global crisis. But, the moment of truth will have to be faced sooner than later, because things willonly get worse in future. Will the government show courage and vision that the crisis is not wasted?

Declining political capability

The Indian political system is simply proving incapable of providing any coherent road map or blueprintfor dealing with the grave challenges that our economy and society are facing. A few facts may bementioned to substantiate the argument that politics has proved itself not worth much in dealing with thecrisis at this juncture.

First, the authority of the central government to provide a coherent all-India policy perspective has beencompletely eroded and the Congress-led UPA government has shown that every single group within thecoalition is pursuing its own agenda. Every single group is concerned with maximising its electoral gainsby championing one or the other local issue with an eye on its local constituency.

The agenda for dealing with critical national problems has become subservient to the politics and agendaof localism. It is not only the UPA constituents which are working at cross purposes, the erstwhilesupporters of the coalition, the Communist parties, have never lost any opportunity to oppose and criticiseeconomic and foreign policies pursued by a government, which they had supported from outside.

Mulayam Singhs Samajwadi Party (SP), too, has a similar story. The SP is not only supporting the UPAfrom outside but is also engaged in keeping the government on tenterhooks by its criticisms. How can thegovernment, in such circumstances, provide any effective political leadership during this grave crisis?


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India under Storm

Second, a crisis situation demands an across-the-board political consensus. The UPA cannot make theBJP and the Communists, two major opposition formations in the Lok Sabha, to agree even on aminimum economic programme for dealing with the serious crisis that India faces.

The opposition parties have taken their role to oppose the government too seriously and any hope of evena round table conference between the government and the opposition groups for arriving at some

minimum consensus on policy interventions is currently not all possible.

Third, the new economic policy paradigm followed by India, especially beginning with 1991, has madestate government autonomous players in economic policy matters by keeping in mind specificities of theirlocal situations. The highly centralised system of economic planning and governance by the centralgovernment has come to an end not only because of the imperatives of the new economic policies, butalso because very powerful regional parties have emerged as very active players in political and economicdecision-making processes of India.

The regionalisation of politics and the refederalisation of the system of governance in the 21st centuryhave altered all the rules of the game of consensus making in Indian politics.

In the current circumstances, it seems desirable to bring the central and the state governments togetherunder a common umbrella of consensus on policies.

But that, even though it might be desirable, may not be possible because regionalists do not see anycommon ground, not only among themselves but also with the Central government.

India cannot overcome the current challenges without political strength based on collective nationalconsensus but unfortunately when the need of the hour is cohesive and consensus-based politics, thecountry is ideologically divided and fragmented. Surprisingly, our politicians do not seem to be aware ofthe gravity of the situation or else they would have shown greater interest in arriving at the consensus on

possible solutions to the problem. It will be unfortunate if this conveys the impression that theauthoritarian political system of China has greater capability to deal with economic challenges than thedivided and fragmented democratic political system of India.


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1.2 SECURITY MARKETSThe Agony wont Last Forever

Who wants to think about investing at a time like this? Your large-cap stocks have become small-caps,your triple-A bonds are suddenly triple-Cs, and your homes value is so deep underwater you need scubagear to get in the front door. Yet, the world is not coming to an end.

And in the new equilibrium, whenever it comes, the US will return to its productive heritage. China and

others will devote more of their grand productive capacity to raising the living standards of their owncitizens. If all goes well, global growth will get a more stable footing.

Youve probably already lost a lot of money. Dont lose more by joining market timers. Risk aversion isso extreme that good stocks and bonds could see ridiculously low prices.

Also, theres a huge penalty for seeking maximum safety due to meager return. The most frighteningpossibility is that well get all the pain with none of the gain.

Todays prices are bound to look cheap within a decade and probably sooner, unless the global economygoes into a long and severe depression. The common theme is profiting from panic by acquiringunderpriced assets that others have abandoned. Some example: Arcelor-Mittal, the worlds largeststeelmaker has a stock price thats only twice its annual earnings per share. That sounds like a rarebargain unless you think the world has all the steel itll ever need.

Remember that every recession is unhappy in its own-way, and its impossible to say how this one willunfold. In fact, most economists have stopped predicting when the global economy will recover. Franklyspeaking, there are no tools available for anyone to predict how long this downturn will continue. Yet, forcommon investors, right cues on macro indicators will help a lot during this difficult time.

European Central Bank (ECB) President Jean-Claude pointed out that markets were underestimating theimpact of central banks and governments response to the financial crisis. Since, rounds of aggressiveinterest rate cuts, bank bailouts, and massive spending totalling trillions of dollars, have failed to cheer up

investors pounded by a daily barrage of news of layoffs, corporate losses and grim economic statistics.

Prof Gary S Fields of Cornell University says that stimulus packages being provided by variousgovernments would act as boosters to the economy. I am sure, many more stimulus packages will followsooner or later, and that would stop the economy from deteriorating further.

1st week of December 08 Sensex ends below 9K despite hints of a stimulus package

Daily review 28/11/08 01/12/08 02/12/08 03/12/08 04/12/08 05/12/08Sensex 9,092.72 (252.85) (100.63) 8.19 482.32 (264.55)

Nifty 2,755.10 (72.20) (25.10) (1.35) 131.55 (73.60)

The stock markets zoomed on Thursday in anticipation of an economic stimulus package the government

will announce on Saturday. But it would be rash to think that in the middle of the worst global slump astimulus in any one country can do more than mitigate the pain. The fact is that the global economy needs

to recover; so, while welcoming the stimulus, we must be modest in our expectations.

Weekly review 28/11/08 05/12/08 Points Percentage

Sensex 9,092.72 (8,965.20) (127.52) (1.40%)

Nifty 2,755.10 (2,714.40) (40.70) (1.48%)


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Security Markets

2nd week of December 08 Key indices gain 8% despite negatives

Daily review 05/12/08 08/12/08 09/12/08 10/12/08 11/12/08 12/12/08Sensex 8,965.20 197.42 492.28 (9.44) 44.61Nifty 2,714.40 69.60 Holiday 144.25 (8.10) 1.20

The Sensex and Nifty gained by about 8% over the week as a slew of monetary and fiscal policy measures

announced by the government. The government announced major tax cuts across the board to boost

demand. The RBI also cut key short term lending and borrowing rates by 100bps each.


Sensex 8,965.20 9.690.07 724.87 8.09%

Nifty 2,714.40 2,921.35 206.95 7.62%

3rd week of December 08 Sensex ups 4.23%, settles above 10,000-mark

Daily review 12/12/08 15/12/08 16/12/08 17/12/08 18/12/08 19/12/08Sensex 9.690.07 142.32 144.59 (269.69) 361.14 23.48

Nifty 2,921.35 59.85 60.55 (87.40) 106.40 16.75

The key benchmark Sensex settled the week above the psychological important 10-K level. .The rally waslargely sparked by increased possibility of a fresh rate-cut by the RBI as also strong indications of

announcement of the second stimulus package by the government to tide over the slowdown. Such hopes

also gained credence after the US Federal Reserve and Bank of Japan slashed key policy rates during the

week to support ailing economies.


Sensex 9.690.07 10,099.91 409.84 4.23%

Nifty 2,921.35 3,077.50 156.15 5.35%

4th week of December 08 Sensex dips by 7.63% as FIIs pull out

Daily review 19/12/08 22/12/08 23/12/08 24/12/08 25/12/08 26/12/08Sensex 10,099.91 (171.56) (241.60) (118.03) (239.80)

Nifty 3,077.50 (38.20) (70.65) (51.80) Holiday (59.60)

After breaching the psychologically important 10-K level, the Sensex fell by 7.63% in the week as FIIs

pulled out at the year-end. Negative factors such as lackluster trading in global markets in view ofChristmas holidays, a sharp fall in advance tax payments and fears of poor corporate earnings in the

third quarter virtually dismissed easing inflationary pressure that further raised possibility of cut in rates.


Sensex 10,099.91 9,328.92 (770.99) (7.63%)

Nifty 3,077.50 2,857.25 (220.25) (7.16%)


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Security Markets

End of the December 08 and beginning of the New Year 09 Sensex up 3.41% & further 3.32%

Daily review 26/12/08 29/12/08 30/12/08 31/12/08 01/01/2009 02/01/2009Sensex 9,328.92 204.60 182.64 (68.85) 256.15 54.76

Nifty 2,857.25 64.95 57.30 (20.35) 74.30 13.30

Weekly review 26/12/08 31/12/08 Points % 02/01/09 Points %

Sensex 9,328.92 9,647.31 318.39 3.41% 9,958.22 310.91 3.22%

Nifty 2,857.25 2,959.15 101.90 3.57% 3,046.75 87.60 2.96%

Monthly review

Month March 08 April 08 May 08 June 08 July 08 August 08 Sept. 08 Oct. 08 Nov. 08 Dec. 08

Date 31.03.08 30.04.08 30.05.08 30.06.08 31/07//08 29/08//08 30/09//08 31/10//08 28/11//08 31/12//08

Sensex 15,644.44 17,287.31 16,415.57 13,461.60 14,355.75 14,564.53 12,860.43 9,788.06 9,092.72 9,647.31

Points Base 1,642.87 (871.74) (2,953.97) 894.15 208.78 (1704.10) (3,072.37) (695.34) 554.59

% Base 10.50% (5.04%) (18.00%) 6.23% 1.45% (11.70%) (23.89%) (7.10%) 6.10%

A Classical Eight Year Time Cycle

A technical analysis shows that Indias equity market will stabilise from April onwards, as it is likely tobottom out in February/March 2009, when it would complete a downturn of 13-14 months.

The analysis reveals how the BSE benchmark indice, Sensex is following a classical eight year time cycleand even though we have already witnessed four sell-offs during the bear run January 2008, March2008, July 2008, October 2008 the possibility of one more cannot be ruled out. During 1992-93 andlater 2000-03 bear market phase, Indian stock market witnessed four to five major sell-offs.

The analysis shows stark similarities of both time andprice wise correction in this eight year cycle withprevious ones: In the previous eight-year cycle during 1992-93, Sensex lost 56% from a high of 4,546 to

touch a low of 1,980. In the present cycle, the dip was almost 58% from a high of 6,150 in 2000 to a lowof 2,594 in 2001. Timewise, while the 1992 cycle completed the bear course in 12-16 months, the 2000cycle took 19 months to hit the downcast. Remember, in technical analysis, both time andprice forecastsmust be achieved. In 2008, we were sitting again on this very important cycle. This time (2008) while theprice wise correction has been achieved to the tune of 64%, the time wise correction is yet to take place.


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2.1 INDIAN ECONOMYNeed Bold Steps to Revive Growth Momentum

It has now become clear that Indian economic growth has slowed down considerably in the current yearafter recording robust rate of nearly 9% average over the past five years. While the global financial crisis,the most severe since the 1930, has done much of the damage, the growth momentum was also affectedadversely in first half of 2008-09 by the tight money policy of the RBI to contain inflation.

Growth is flagging in many sectors especially the labour-intensive, export-oriented ones. With exportsshrinking, vulnerable sectors such as SMEs (like those making handicrafts or apparel) feeding exportmarkets are finding it hard to survive. Larger companies are cutting production and postponing capitalinvestments, in turn adversely affecting the jobs. The stock markets have crashed because of foreigninstitutional investors (FIIs) pulling out from India, which has also exerted pressure on the rupee. It hasbecome difficult for enterprises to raise capital in India and in international markets.

Although the Indian economy may still manage to grow at 7%, one has to be prepared for furtherdownside risks associated with deepening of recession in the west. The IMF is projecting the G-3economies, viz, the US, EU and Japan will actually be shrinking in the next few quarters. Hence,emerging economies like India will have to look inwards for the growth stimuli.

The policy response of the government has so far been limited to easing liquidity by reducing CRR andrepo rates. While all these steps are in the right direction, but there is need for propping up the growthmomentum. The time has come for taking bold steps to revive the growth momentum of the economy.

1. Petrol to be cheaper by Rs 5, diesel by Rs 2

The government on 5th December 2008 slashed prices of petrol and diesel by Rs 5 and Rs 2 a litre,respectively. Petroleum minister Murli Deora told that the reduction was an interim measure and thatthe government would continue to watch the global prices of crude oil and react accordingly. This is firstreduction in over two years. Consumer saw a steady rise in home budgets over the past year withincreasing price of fuel, fruit, vegetables, food items and travel. The cut in petrol prices was long awaitedafter the fall in crude prices. Retail prices of petrol were increased by Rs 5 a litre, diesel by Rs 3 a litreand cooking gas by Rs 50 a cylinder in June when crude prices hit $122 a barrel.

2. Across the board 4% cut in Cenvat

The government on 7th December 2008 affected an across-the-board 4% cut in central value added tax(Cenvat) as part of an economic stimulus package. The Cenvat on non-petroleum products would comedown to 10%, 8% and 4% for different categories. Unveiling the package, Planning Commission deputychairman Montek Singh Ahluwalia said the market forces would compel manufacturers in a competitiveenvironment to bring down prices and pass on tax benefits to consumers.

3. Extra expenditure to boost growth

The Lok Sabha on 19th December 2008 allowed the government to spend an extra Rs 42,480 crore in thecurrent financial year to stimulate the economy and help it sail through the global financial crisis. Thistakes the total additional spending sanctioned this fiscal to more than Rs 1,40,000 crore above thebudgeted spending of Rs 7,50,000 crore. The bulk of the additional money would be spent on flagship programmes to provide education and create rural jobs). The expenditure is being raised to stimulatedemand and make supply side more attractive.


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Need Bold Steps to Revive Growth Momentum

4. Mid-Year Economic Review 2008-09

The governments mid-year economic review on 23rd December 2008 called for an aggressive monetarypolicy and fast tracking of reforms to counter the impact of the global financial turmoil on Indias growth.

According to the report, the deteriorating global environment would moderate Indias performance, butrapidly falling inflation would facilitate aggressive monetary easing, to facilitate a growth of 7-8%.

The mid year review of the ministry of finance projected more on the plusses than the minuses. However,in the context of the ongoing crisis, the Indian economy has many strength, prime among them being itslower degree of openness. To that extent, it is relatively sheltered from the worst consequences ofdevelopment elsewhere in the world. Besides the reason for growth holding up close to 7% is that the fullimpact of the global slowdown hit us with a lag. So, the government will have to bring both policy levers fiscal and monetary into play but it must tread a careful line, try to spur growth only where it can, easepain where it cannot do anything to spur growth.

5. RBI Monetary Stimulus

The RBI on January 2,2009 reduced its repo rate - the rate at which banks borrow from the central bank from 6.5% to 5.5% while the reverse repo rate the rate which RBI pays to banks for parking funds withit from 5% to 4%, the lowest ever. The cash reserve ratio the slice of deposits that bank need to parkwith RBI has also been reduced by 50 basis points to 5%, a move which will release Rs 20,000 croreinto the banking system.

6. Fiscal Stimulus, Mark II

The government announced the second and final installment of its fiscal stimulus package.Complementing the central banks monetary measures, government announced specific measure to boostcredit availability, offered additional sops to exporters

Credit availability has been hiked in a variety of ways

Interest ceiling on external commercial borrowings has been removed; Cap on FIIs in the domestic corporate debt market has been jacked up two-and-a-half times from $6

billion to $15 billion;

A special purpose vehicle is being created to lend to NBFCs to the tune of Rs 25,000 crore; IIFL is being permitted another Rs 30,000 crore by means of tax-free bonds; and State governments are being allowed to borrow an additional Rs 30,000 crore from the market. In addition, PSBs would be given additional capital to the extent of Rs 20,000 crore over the next two

years, so that they can lend roughly 10 times as much additionally.

\

Need Bold Steps to Revive Growth Momentum


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The stimulus packages announced does not amount to very much in concrete term.

Except on the monetary front where theres a fresh infusion of liquidity and a reduction in the repo andreverse repo rates, other measures merely amount to easing restrictions imposed in recent years whencapital flows were robust.

This is an inevitable consequence of the limited options available to government on the fiscal front, whereit is considerably over-extended. But it impacts the efficacy of any stimulus package and puts excessreliance on monetary policy.

Easing of restrictions on external commercial borrowings is unlikely to translate into increased accessto overseas loans at a time when overseas credit markets have frozen; except at exorbitant rates ofinterest that corporates are well-advised to spurn.

Likewise the sharp hike in the cap for foreign institutional investment in corporate bonds is not likelyto see many takers.

Given the countrys long and far-from-happy experience with target-oriented lending, raising credittargets for banks does not mean much either. Government babus may chastise banks for not meetingtheir targets but bankers know who will be at the receiving end when these loans go bad.

Exports sops will help, but only at the margin, since the basic problem is one of lack of exportdemand.

Infrastructure development could give a welcome boost to growth but the public sectors track recordhere is dismal.

It is doubtful if IIFCLs greater access to tax-free bonds to finance infrastructure will mean very muchon the ground, especially in the short-run when the pain is likely to be the maximum.

So that leaves us relying on monetary policy to deliver.

The problem is, beyond a point, monetary easing is like pushing on a string. Apart from the fact thatexcess liquidity can store up trouble for later, there is no dearth of liquidity in the system.

In fact, banks have been parking funds with the central bank.

Credit offtake is also fairly robust, given slower economic growth.

If corporates are complaining of lack of credit, it is not that credit is not available per se but that it isavailable at a higher price, reflecting (rightly) the higher uncertainty and hence higher risk premium.

A reality check, whether by corporates or government, seems to be in order.


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2.2 INDIA INCIs the jobs panic justified?

It was bad enough when Iceland got into financial trouble and practically sank into the frigid NorthAtlantic. It was worse when your next-door neighbour lost his home to foreclosure. But now things arereally getting scary: Your own job may at risk.

Gen-next is suddenly learning to live within its means as companies begin the ruthless chop-chop onsalaries; wage earners are scrambling two-steps ahead of bankruptcy.

Take Ankit (not a real name), a financial executive with a leading corporate house, who has just enteredthe school of hard knocks. With an annual salary of Rs 10 lakh and the promise of a hefty rise every year,

he didnt think twice before taking loans for a flat and a car. Then his world fell apart. Struggling with

the credit crisis, his company forced a salary cut. Repaying the loans is today Ankits biggest worry.

Economists predict: Things will get worse, perhaps much worse, before they get better. Everybodywants to know how long the jobs hemorrhage will last and how bad it will get. Ankit is just one of thehundreds of executives faced with the same crisis. Pessimists predict the economy will keep losing jobsuntil late next year or 2010. Whats undisputable is that things are really bad right now.

Employees in real estate, financial services, information technology and related services (ITeS) shouldprepare themselves for further salary cuts. In most companies, lower-and-middle-level employees wouldbe the first to face the axe, and the temporary staff and contractual workers will have to bear the burnt.

1. It seems India Inc is in panic and morale is at an all time low

In our country morale and sentiments has a much larger role to play than it does elsewhere. Inrelationship-driven culture, breakdowns in internal relationship in bad times can damage the business a lotmore than the benefit that healthy competition brings in good times.

Next, decision-making in India is still largely centralised at the very top, often with just one person. Giventhe top corporate culture, when top bosses and entrepreneurs panic, they project their own bad mooddown the organisation, without a thought as to what it does to overall productivity and internal morale.

However, job bust wont last forever. There are forces at play that will eventually pull the economy out ofits free fall. The quick-snapback scenario assumes a reasonable healthy financial sector.

If the financial system keeps struggling, the spiral will continue: Cash-strapped companies will be forcedto step up layoffs, causing cutbacks in consumer spending that will push employers to cut even more jobs.

Economists cautioning everybody that: As long as financial conditions are as impaired as they are,questions about when the job market will hit bottom are premature.

Remember, the slowdown/ recession isnt all bad: Unsupportable debts are being erased. Consumers arerebuilding their savings and lowering their living standards to match reality. And through distress sales,foreclosures and bankruptcies, assets are being taken away from weak hands and given to strong ones,creating the conditions for future growth.


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Is the jobs panic justified?

2. Coca-Cola India defers increments

Soft drink major Coca-Cola India is deferring annual increments for all employees by a quarter, following

a communication from its headquarters in Atlanta to all regions.

This is for the first time that increments have been deferred in Coca-Cola India.

The usual practice in the company has been to give annual increments effective from April 1, for allemployees. But in 2009, annual increments will be given out in the month of July. The senior leadershipof the company has taken the lead by forgoing their merit increase by a year.

In addition, regions have been asked to minimise travel costs of executives as far as possible, and resort topractices such as video conferencing instead.

3. Cost-saving exercise at Reliance

Mukesh Ambani has embarked on probably the biggest cost-saving exercise for his $35-billionconglomerate, as Reliance group works on setting up a shared service centre that will integrate the corefunction HR, Training, Commercials & IT services of all the group companies into one unit.

The exercise will eliminate talent and competency overlapin the management of all group companies.

The groups expanding businesses, including forays into new sectors, saw much duplication of the corefunctions. But now, the same person will do a lot more at the same cost.

The shared service centre at Mumbai as envisaged will lead to substantial cost savings.

The details are still emerging with two global consulting firms working on consolidation of core functionsof group companies like RIL, RPL, Reliance Lifesciences and Reliance Retails, besides a host ofsubsidiary and associate companies.

The centre would leverage on common IT backbone as most of the group companies are already on SAP.So moving core functions like pay-roll management and training is a logical progression.

Going forward, it would also work on financial planning and analysis, balance sheet re-conciliation andpreparing boardroom reports for individual companies.

While the move may be a first for top deck Indian corporates, several global behemoths that operateacross geographies in insurance and retail have set up captive shared service centres in India leveragingon IT offshoring. The worlds third largest retailer, Tesco set up a shared service centre in Bangaloremore than three years back handling the companys core functions across countries.


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Is the jobs panic justified?

4. India Inc yet to get real

You know the crisis has begun to hurt when the grocery shop owner in a middle-class locality catches youunawares with a worried: Sir yeh crisis kab tak chalega. You also know, regardless of debates about

whether the earlier growth phase was inclusive or not, the slowdown is going to be inclusive.

But theres one class that seems not to have got it yet: India Inc.

According to news reports, many corporates were astonished at the former finance ministers suggestionthat corporates too must do their bit and drop prices. Drop prices?

Most dismissed the suggestion without a second thought. Just two days after the FMs appeal, HULreportedly raised the prices of a number of soaps, detergents, shampoos and toothpastes by 5-10%.

And after the government announced cut in the tax rate, with the exception of a few companies like

Maruti that promptly announced their willingness to pass on the 4% reduction in Cenvat, most seniorcompany officials hummed and hawed we need to see the fine print; we will look into it and so on.

Subsequently a few have announced price cuts; but typically they are only passing on the benefit of thelower tax, and theyre too, not fully.

Part of the problem is this is the first time corporate India has really been exposed to the full impact of abusiness cycle; that too a particularly vicious one.

In the past, when the Indian economy was relatively sheltered, business cycles had little impact oncorporates. A combination of reforms, greater globalisation and the nice (non-inflationary continuous

expansion) growth phase of the global economy saw companies grow their toplines and bottomlines at afurious pace. Their only mistake was to assume things could go on like this forever.

So when the downturn came, many corporates were caught unawares. Unlike companies in advancedWestern economies that have lived through previous ups and downs and are accustomed to ruthlessculling of businesses in downturn, this is a new experience for Indian companies.


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2.3 WARNING SIGNALS

1. US treasuries at risk of bubble trouble

US government debts, long considered the safest investment in the world, look like it too has been hit bybubble fever. Prices of US Treasury bonds appear dangerously overstretched after a soaring rally.

Yield on long-maturity bonds are below 3 percentage and only 1-2 basis points on three-month T-bills,the lowest in decades. Experts say: Treasuries are the riskiest securities on the planet. Treasuries havemoved into a self-destructing yield environment.

The rally in the nearly $5-trillion US government bond market picked up speed when Federal Reservehinted it may buy longer maturity government bonds. After buying billions of dollars worth ofgovernment debt, US institutional investors and foreigners including Asian central banks, could incurenormous capital losses. Fears of a bubble in Treasuries underscore how far investors have fled from risksince ballooning house price valuation in 2007, sparking a global economic crisis.

2. Spiralling US job cuts

The US experienced its sharpest monthly drop in employment in more than three decades duringNovember 2008, and there is no end in sight to the bloodletting as companies search for ways to cut costs.

This clearly demonstrates that the decline is accelerating.

The Labor Department said US nonfarm payrolls plunged by 533,000 in November, a steeper fall than the340,000 declines that economists surveyed by Reuters had expected. It marked the biggest tumble sinceDecember 1974 and means the economy has lost some 1.9 million jobs this year.

3. Holiday unemployment

As Americans prepare for the December holidays, more workers may face the prospect of holidayunemployment. US retailers, bracing for a soft holiday selling season, added fewer seasonal workers inNovember than in the past two decades.

Theres no place to hide, said Eric Kuby, chief investment officer, North Star Investment ManagementCorp in Chicago. Its clear that the economy is really soft for the next few months at least.

The news will continue to be bad and everyone knows that. A host of the US companies trimmed theirfinancial outlooks. Analysts expect there will be more to come. Its worse than we thought or we cantstock by our guidance anymore.

4. Trade deals must protect workers, planet

The US will insist on strong protections for workers and the environment in future trade deals, said USPresident-elect Barack Obama while nominating Ron Kirk to be the chief US trade negotiator.

President-elect Barack Obama said. Mr Kirk will help make sure that any agreement I sign as Presidentprotects the rights of all workers, promote the interest of all Americans, strengthens American businesses,and preserve the planet we all share.


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Warning Signals

Obamas stance could complicate efforts to complete the seven-year-old Doha round of world trade talksif it means the US will be adding new demands to those already difficult negotiations. Many developingcountries are suspicious of efforts to include labour and environmental provisions in trade pacts becausethey believe rich countries could use them as an excuse to block imports.

5. Tracking use of bailout money by banksAn oversight panel report alleged that the US Treasury has failed to reveal its strategy for stabilising thefinancial system, not answered questions asked by a government watchdog and has done nothing to helpstruggling homeowners.

There appears to be significant gap in Treasurys ability to track hundreds of billions of dollars oftaxpayer money. Since the Treasury Department didnt put any tracking mechanisms on it. They didnttell the banks what they had to do in order to get the money. It might be used for lending; it might be usedto buy other banks or might just be stuffed in vaults and left there.

The panel headed by Harvard Law School professor Elizabeth Warren, reserved its most strident criticism

for Treasurys approach to dealing with the home foreclosure crisis at the root of the economic turmoil.She said Congress may want to take a very hard look at how the money has been used by the banks thatgot the bulk of the initial disbursements.

6. US loses 524,000 jobs in December; cuts most since 1945

The US lost 524,000 jobs in December 2008, making last years collapse in employment the worst sincethe end of World War II and underscoring the severity of the recession President-elect Barack Obama willinherit. The decline in payrolls was in line with forecasts and followed a drop of 584,000 in November, bringing job losses for 2008 to 2.589 million, the most since 1945. December decline was the 12thconsecutive drop in payrolls. The economy created 1.1 million jobs in 2007.

Economists say Were seeing pretty ugly numbers as the recession is worsening. Its going to bedevastating in terms of consumer confidence and spending. The next couple of months will be dismal.

The outlook for 2009 is no brighter as retailers from Wal-Mart Stores Inc to Macys Inc slash profitforecasts and manufacturers including Alcoa Inc cut output and staff. The figure will intensify pressure onUS lawmakers to speed Obamas proposed fiscal stimulus in an effort to save or create 3 million jobs.

Obama is pressing for a stimulus plan of about $775 billion, including tax cuts and spending oneverything from roads and schools to the energy network. He called for dramatic action as soon aspossible to help pull the worlds largest economy out of a slump thats into its second year. If nothing is

done, this recession could linger for years.

Federal Reserve staff cut projections for the domestic product and the job market, stating theunemployment rate was likely to rise significantly into 2010. Job losses threaten to pull the economyinto a reinforcing cycle of rising unemployment and declining household spending, what policy makerscall a negative feedback loop, which is difficult to snap once its begun.


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3.1 MUTUAL FUND INDUSTRYListing of MF Close-Ended Schemes

Its a mixed bag of emotions that accompanies any change. Enthusiasm on the part of those who haveadvocated it, confusion and despair for those who have to put it in place and anxiety among those who areexpected to reap the fruits of these changes.

The responses to Sebis latest guidelines about the need for asset management companies (AMCs) to listnew close-ended mutual fund schemes have been no different. While those within the industry arewelcoming the decision, many investors are worried about what this means to them.

In fact, getting a clear picture of how the close-ended mutual funds work is crucial before you look at thechanges that have taken place.

A close-ended mutual fund distinguishes itself from an open-ended one with respect to the stage atwhich you can enter this fund. Buying units of a close-ended mutual fund is only possible during theNew Fund Offer (NFO) period.

Moreover, with close-ended mutual funds having a fixed tenure, selling was supposed to beundertaken only once the period is over.

The possibility of withdrawing from the fund by paying an exit load, however, existed.According to the minutes of a Sebi meeting in early December, it will be obligatory for AMCs to list theirclose-ended schemes. Simultaneously, it was stated that no early exit would be allowed in any close-ended mutual fund schemes. In simple terms, what this means is that you will no longer be able to go toyour AMC, pay an exit load and redeem your money.

The new rule will mean investors looking for an early exit will have to redeem the investment through thestock exchange, and not through the fund house.

This will also mean the onus will no longer be on fund houses to ensure liquidity. Since the trading ofunits takes place only on the exchange, net asset values (NAVs) will not be impacted even if there aresudden redemptions. Investors who stay on in the scheme are protected as the fund manager is not forcedto sell securities before maturity at a huge discount.

Many experts see this decision by the Sebi as being advantageous to the investor on multiple fronts. Theypointed out:

Only those investors whose investment horizon is in line with the tenure of the scheme will now lookat investing in close-ended funds.

The guidelines will help the fund contain the interest rate risk on the debt portfolio by matching thematurity of its debt securities to that of the fund.

It will also help the fund remain fully invested through its tenure, thereby reducing a cash drag onreturns.

It is further expected that the time period of the fund will be sufficient for even investments in equityto give yields.


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Listing of MF Close-Ended Schemes

Make choices

As always, the simplest key to deciding whether or not close-ended funds should be a part of yourportfolio involves checking whether the product is in tune with your long-term investment goals, keepingin mind the returns that are promised vis--vis the risk that you will be taking.

You should also have reasonable clarity on your liquidity requirements in the near future and whether youwill be able to hold on your investments till they mature.

Experts recommend that investors should not base their decision solely on short-term movements in themarket. The short-term performance of a close-ended fund could mirror the nature of the underlying stockand hence could be highly volatile.

As an asset class, close-ended mutual funds could be a good choice if you are an investor with your eyesset on appreciation of your capital over a long time period.

Allay fears

While experts see a lot in favour of the guidelines, current investors can be rest assured that they still havethe option of liquidating their assets with the AMC.

It is said that the guidelines that have been issued will only be with respect to funds that will be launchedin the future. Current investors in close-ended schemes are allowed to exit, subject to relevant exit loadsand other costs.

However, for those entering the scheme now, the only difficulty will be with regard to selling.

Those who want to sell may not be able to find buyers and even when they do, they may not be getting theprice they want.


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3.2 CURRENCY MARKETWhats behind the dollars surprising strength?

Investors have every reason to hate the US dollar. The rising deficit; the deteriorating economy; theplunging stock and bond markets; but rather than getting hammered by the financial crisis, the greenbackis soaring. Early August, the consensus view was the rupee would stabilise in the range of Rs 43-45 to adollar over a six-month horizon. This view changed dramatically after the October meltdown and the

same research firms began talking about the exchange rate sliding to Rs 52 and even lower by end 2008.

Whats behind the dollars surprising strength? Against all odds, how it regains in the past four months whatit lost against most currencies in the previous three years?

First, the dollar has benefited from the fact that it continues to be the international currency ofexchange, trade and reserve.

Second, the euro, the pound, and emerging-market currencies may also have been inflated after a six-year run-up. A basket of foreign currencies rose 25% between 2002 and mid-2008 versus the dollar.The euro jumped 45%. But earlier this year some investors started betting the bubbles would bust,driving down the price of the currencies and conversely benefiting the dollar.

Third, theres the fear factor. During tough economic times, investors often flee from risky currenciesand other risky assets for safe havens like the US dollar and US treasury bonds.

Fourth, the strengthening of the dollar is also helped by the fact that Japan and the economies of theeuro zone are as deeply sunk in recession as is the American economy and growth in China and Indiais projected to be lower than it had been in the previous few years.

Fifth, there was also a lurking worry that Indias balance of payments (BoP) was deteriorating. Afterall, the exchange rate in India is largely determined by capital flows.

But, so many questions are still unanswered.

How will the dollar fare once the full impact of the US governments $700-billion bailout packagebecomes known is not clear?

Will investors start shunning US treasury bonds once they realise full impact of US fiscal deficit? Will foreign investors confidence in the US economy fade with the prospects of its future

economic growth?

If the answer to these questions is yes, then it is clear that the global economic recession has not yet ledto the much needed correction in the global financial system; and If the US economy remains in aprolonged recession, it would be foolish to expect that somehow the US would continue to increase its

purchase of goods from the rest of the world to keep the world economy going, and it would be foolishand even dangerous to keep financing American imports through debts.

According to the most recent forecast of the world economy by the IMF, advanced economy willexperience almost a one-percentage point reduction in their GDP in 2009. It is clear from these forecaststhat world economic growth in the next two to three years would heavily depend on Asian economies.Asian economies have to creatively invest their resources in productive activities instead of parking themin US treasuries. Thats the only way Asia can bring the world economy out of recession.


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4. FINANCIAL SECTOR: TRANSFORMING TOMORROWUnforgettable Trends Of 2008

Easy liquidity, low interest rates, caring regulators and noisy financial institutions created bubbles acrossall asset classes in all parts of the world. It is like a giant teddy bear with hot air inflating all parts of theballoons, it does not matter which part of it springs a leak; the effect was seen across all the parts.

No one could recall any other year like the one that is just ending. Food prices sky rocketing in the firstquarter and then crashing by October. Crude oil prices touching $147 per barrel and then plumbing to fouryears lows at $40 per barrel. Inflation after rising to 13% declined to 6%.

A financial market meltdown that has seen the international icons biting the dust and nearly 50% ofmarket capitalisation simply vapourised. But we cannot yet say that the end is in sight and that 2009 willbring cheer and positive news.

In fact, we should be prepared for the worse. Many economists expect GDP growth will be about 5%in the second half of 2008-09 making the annual growth to be about 6.5%. From all indications, this islikely to come down further in the first half of the next year (April-September 2009). Whether we have anupturn in the second half of next year will depend on the state of the global economy and policy measuresthat are taken now. Given that the US and global economy are likely to remain in negative territorythroughout 2009, an upturn in the second half looks increasingly unlikely.

Indian industry faced a similar downturn during the 1997-2001 period and came out of it stronger andmore competitive. The same effort is needed again. Last time though the downturn lasted four years andthe growth rate plummeted to about one percent before the upturn started. Hopefully, this will not berepeated and the downturn phase will be shorter and shallower this time. The present downturn is anintegral part of the business cycle and sooner rather than later lead to the economic upturn.

4.1 FINANCIAL ADVISORS:Weigh impact on investors

2008: We learned what we dont know

Its the end of an era.

The great lesson of the past year is how little we understand and can control the economy. This ignorancehas bred todays insecurity, which in turn is now a governing reality of this crisis. Go back to the onset ofthe crisis in mid-2007. Who then thought that the US government would rescue Citigroup or the insurancegiant AIG; or that the Federal Reserve, striving to prevent a financial collapse, would pump out more than$1 trillion in new credit; or that US Congress would allocate $700 billion to the Treasury for the samepurpose; or that General Motors would flirt with bankruptcy?

It was once believed that the crisis of subprime mortgages loans to weaker borrowers would be

limited, because these loans represent only 12 percent of all home mortgages.

WRONG: Subprime mortgage losses triggered a full-blown financial crisis. Confidence evaporated,because subprime loans were embedded in complex securities whose values and ownership were hard todetermine. Similar doubts afflicted other bonds. Demand for all these securities dried-up. A loss ofconfidence and credit threatened failure.


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Unforgettable Trends Of 2008

It was also believed that American consumers could borrow and spend more, because higher home

values and stock prices substituted for annual savings. Consider, from 1985 to 2005, the personal

savings rate dropped from 9% of disposable income to almost zero. But over the same years,

households net worth (assets minus liabilities) quadrupled, from $14 trillion to $57 trillion.

WRONG: In recent years, consumers increasingly overborrowed, especially against inflated home values.With the housing bubble now collapsed, net worth is falling. Homeowners equity in their homes is at arecord low of 45%, down from 59 percent in 2005. Consumers have responded by tighten their belt.Retail sales have dropped for five straight months; vehicle sales are a third below 2006 levels.

And it was also believed that the rest of the world would decouple from the United States. As

Europe, Asia and Latin America expanded, their buying would cushion our recession. A better-

balanced world would emerge, with US trade deficit and surpluses elsewhere.

WRONG: The crisis has gone global. The economic growth in 2009 will be the lowest since at least 1980.The crisis has spread through two channels; reduced money flows and reduced trade. Global financialmarkets are interconnected. Customer redemptions forced US mutual funds and hedge funds to sell inemerging markets, whose stocks dropped more than 50% from their peak. Credit has tightened, as moneyflowing into developing countries shrinks 50%, says the World Bank. The bank expects trade, up 7.5% in2007, to fall in 2009 for the first time since 1982.

So much that was unexpected has happened; and we learned that the boom and busts origins are hidden.These lie in the side effects of declining inflation that started in the 1980s and, in the process of reducinginterest rates, boosted stock prices and housing values. We also learned that prosperity, apparentlyforgiving of mistakes, bred the complacency that undid prosperity.

4.2 INCLUSIVE CEOsInnovative responses to problems

Housing blues

Housing is at the root of the slump and dismal housing data showed the United States and Britain weresinking deeper into recession and authorities from Washington to Tokyo worked hard to spend their wayout of the worst downturn in decades. A record drop in US existing home sales and prices showed theworlds biggest economy could be in the longest downturn since the World War Two.

Japan had its share of gloom, reporting a record drop in exports and a similarly sharp collapse in businessenvironment. Japans government on 24th December 08, approved its biggest-ever budget to revive itseconomy a record 88.5 trillion ($980.6 billion) budget for the next year starting April 2009. Japanese

Prime Minister Taro Aso said: Japan cannot avoid the tsunami of the world recession, but it can try tofind a way out. The world economy is in a once-in-a-hundred years recession. We need extraordinarymeasures to deal with an extraordinary situation.

Britain, the worlds fifth-largest economy, is in an equally dire shape. The Royal Institute of CharteredSurveyors said house prices were set to fall by 10% next year, confirming the bleak out-look. On 23rdDecember 08, Spain, Europes fifth-largest economy, declared it had stumbled into recession and NewZealand data showed it was suffering its worst contraction in eight years.


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In a telling sign how bad things become, Australias religious leaders saw it necessary to speak up,calling for support for victims of the financial crisis and asking how the international captains of financecould have got it so wrong. We celebrate Christmas this year at a time of economic turbulencethroughout the world unknown since the 1930s. This situation is unlikely to improve quickly, even here inAustralia, so our first thoughts should be with those who have already lost their jobs.

4.3 MICRO-FINANCE PROFESSIONALSDeveloping alternative credit delivery models

Christmas 2008

LONDON: Its been a funny kind of Christmas this year. Theres a hush in the air, a sense of everyoneholding their breath, a lull before another storm. Office Christmas parties, that bellwether of corporatemood, was both subdued and low key. Festive sales, the high point of most Britons shopping year, cameearly this year for weeks, high streets have been decorated with sale signs, anywhere from 20% to 50%.

In some ways, the mood is eat, drink, and be as marry as you can, for tomorrow you may be out of a job, a

home, or a business. Christmas, of course, is the make or break season for retail, entertainment, pubs,hospitality and many other sectors literally. These few days will pretty much decide which companiessurvive to see another Christmas, and who might have to go into oblivion.

But dont be fooled by the surface signs of festivities. We know this is one Christmas thats going intohistory. So were taking a last rest break before we are hurled into a New Year. Everyone knows, butnobody wants to face it this week. Companies dont like sacking people just before Christmas, nor dobanks like foreclosing and evicting people from their homes. January will bring bad news crashing oneveryones heads. January is also the month when personal bankruptcy figures peak. Savings, for all thosewhove lost jobs, are dwindling most reckon that on average, savings last about six months.

4.4 TECH SAVVY PROFESSIONALSTake first step to ensure efficient and reliable system

Volatility spillover

The idea that growth in the so-called emerging markets is no longer hitched to that in the mature markets can be shelved for now. An IMF working paper shows that advanced markets influence marketmovements in emerging markets. The study shows clear evidence of spillover effects from maturemarkets on the bourses in emerging markets.

The paper (Volatility Spillovers and Contagion from Mature to Emerging Stock Markets, WP/08/286 December, 2008) mentions that likelihood ratio (LR) tests strongly reject the null hypothesis of no

volatility spillovers whatsoever from mature markets, for most emerging economies. However, thespillover response varies over time and place.

The data for Indian stock markets and their correlation with mature markets point at increasing movementof both sets of indices in tandem. From a correlation coefficient of just about 0.2 in 1996, the figure seemsto have touched 0.6 earlier this year, which indicates increasing correlation and coupling of market trendsacross geographies. It implies that stock markets are getting better integrated with the mature marketsabroad. For instance, in recent months, stock indices appear to have fallen and risen on global cues.


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4.5 RISK MANAGEMENT CONSULTANTSEducate Engineer and Enforce

Official announcement

Day one December 08, the nations business cycle arbiter declared: The US economy slipped intorecession in December 2007 and the downturn could be worst since World War II. Months of uncertaintyover whether the US economy has entered a recession ended when the National Bureau of EconomicResearch (NBER) made an official announcement to that effect.

Putting an end to all speculation, the bureaus seven member Business Cycle Dating Committee, theofficial arbiter responsible for calling a recession, announced US recession actually began in December2007. This is the first official recession since 2001 after the dotcom bubble.

Jeffrey Frankel, a Harvard University economist who sits on the NBERs committee said I think thatweve got a ways to go, that this is going to be probably a deep and long recession. It could be the worstpost-War recession. We dont know yet.

The current downturn was particularly tricky to define because gross domestic product remained positivein the first half of 2008. The committee looked at payrolls, which peaked in December 2007 and declinedin every month since then, as well as real GDP and other data to determine when the recession started.

Part of the reason for the confusion is that unlike most other economies (where recession is taken as twoconsecutive quarters of decline in real gross domestic product) the US follows a more complicatedsystem. The NBER defines a recession as a significant decline in activity spread across the economy,lasting more than a few months, visible in industrial production, employment, real income andwholesale/retail trade. Because a recession influences the economy broadly and is not confined to onesector, the committee emphasises economy-wide measures of economic activity.

NBER gives relatively little weight to real GDP, because it is only measured quarterly and is subject torevisions, and focuses instead on monthly employment numbers, personal incomes, manufacturing andtrade sector sales and industrial production. There is also a great deal of subjectivity involved ininterpreting the data. A host of macro-economic numbers are analysed and discussed threadbare by thewise men of the committee before an economic downturn is officially recognised as a recession. Notsurprisingly, this usually happens much after the event in this case almost a year later.

Having said that, does it make a difference now that we have a name to the malaise? Not really. Arecession by any other name would spell as much trouble. The US is among the last advanced economy toformally announce a recession. It has been preceded by the UK, much of the Euro-zone, New Zealand and

Singapore among others. The good thing is governments, especially in advanced countries, have beenvery proactive, using both monetary and fiscal levers to kick-start faltering economies. The big question iswell it ensure the recession does not become depression.

Senate Majority Leader Harry Reid said in a statement: The announcement simply makes official whatwe have long known with rising cost of living, rising unemployment, record foreclosures and depletedsavings, we must do more to help families make ends meet.


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4.6 CREDIT COUNSELORSResolve convertibility and recompensation issue

Interest rates

The Fed Reserve on 16TH December 2008 slashed its target interest rate to nearly zero in an effort to battle

a severe financial crisis and worsening recession. The radical step quickly prompting rate cuts elsewhere.Hong Kong followed the Fed with a full point rate cut to a record low of 0.5%. A number of economistsnow forecast an even bigger reduction.

The Fed announced that it was reducing it target for the federal funds rate to between zero and 0.25%,down from 1%, a level that was already the lowest target rate in a half century.

Fed Chairman Ben Bernanke initially underestimated the fast-moving crisis, but now hes deadly serious.As a student of the Great Depression, Bernanke does not want to go down in history as the Fed chairmanwho allowed the US and possibly the world to slip into the worst slump since the 1930s.

And the central bank pledged to use all available tools to fight the current downturn. It also said it wasmulling purchases of longer-term US Treasury debt and would consider other ways to tap its burgeoningbalance sheet to support the economy. A series of initiatives to encourage lending by loss-scarred bankshas already pushed the Feds balance sheet to $2.2 trillion from $887 billion over the last three months.Some analysts think it could eventually top $3 trillion.

True, the Fed has finally reached the end of the line on cutting rates they cant go below zero. But itremains essentially unlimited in how much it can stimulate the housing market and broader economy bybuying up mortgage-backed securities, Fannie Mae and Freddie Mac corporate debt, and other assets. Andthe range of assets the Fed is permitted to acquire in an emergency is almost unlimited. Whats more,starting in early 2009, the Fed will pump money into markets for students, auto, credit cards and small-

businesses loans in hopes of helping those parts of the economy.

Critics of the Fed say the central bank is running unacceptable risks of losses by itself. Its going tomake the situation worse. In the short-run, it does postpone come of the pain, but the economy isgoing to be in worse shape a year from now. Eventually we will have hyper-inflation, where the dollarloses almost all its value.

Merrill Lynch senior economist Drew Matus predicts, Even with all the Feds heroic measures, therecession is going to be a long one, and the recovery is not going to be a big one. And, if the economydoes begin to recover, perhaps in the second half of 2009 or possibly later, the Fed will have a verydifferent problem on its hands: how to soak up all of the excess liquidity it has created so it doesnt

stoke inflation or some new asset bubble. The Feds assets a measure of how much the fed has lent,directly and indirectly could go as high as $5 trillion.

In a Dec 17 research note, Ed Yardeni of Yardeni Research wrote: After one bubble bursts, the onlyway to get out of the resulting recession, and to avoid a depression, is to create another bubble.Thats not what anyone wants, but its certainly better than the alternative a downturn that wouldrival the Great Depression.


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4.7 WEALTH MANAGERSMap out the details to translate into benefits

Unconventional policy measures

Over the past few months, despite a rash of conventional measures, the race to the bottom of growthforecast charts continue. Conventional policy measures of slashing benchmark rates have had little effectand injecting endless billions of liquidity into the financial system has not stoked lending.

Of course, there is a reason why unconventional measures are not used. Precisely, because they areunconventional suggests they are untested and their outcomes unknown and indeed perhaps undesirable.But we live in uncertain times and unconventional measures will no doubt be considered. In case of theFederal Reserve, its now got very little room to manoeuvre. This is where the Feds future course ofaction will get really interesting and unconventional.

The Fed has always been the lender of last resort, but only to distressed banks and financial institutions.We have witnessed this in the past few months where many banks had to be bailed out. This is still theconventional stuff. What is unconventional and will likely next is that the Fed will become the lender oflast resort to non-financial companies as well.

In other words, industrial companies will be able to approach the Fed window to borrow directly from theFed. There has been no prior history here, except perhaps in Japan. Post the implosion of the Japanesebubble, industrial companies were able to approach the Bank of Japan (BoJ) for financing. The BoJ lentas much as 30% of GDP to compensate the post-bubble credit crunch. We reckon the Fed will do thesame. Clearly, this situation is larger and possibly direr than the Japanese one and the odds of a morebloated Fed balance sheet are high.

Auto bailout package:

The US government agreed on December 19 to rescue GM and Chrysler with up to $17.4 billion in loansto stave off a collapse of US auto industry that would have cost hundreds of thousands of jobs and dealt asevere blow to an economy already in recession. Of that amount, $13.4 billion was earmarked for GM.

The Bush administration on 29th of December expanded its bailout of the US auto industry, saying it wasbuying $5 billion in equity in GMAC and increasing a loan to General Motors by $1 billion.

The Treasury Department said it would buy $5 billion in senior preferred equity with an 8% dividendfrom KMAC as part of an effort to ensure the solvency of a company considered crucial to GMs survival.

It also said it would lend up to $1 billion to fund GMs purchase of equity in support of GMACsrecognition as a bank holding company.

GMAC won Federal Reserve approval to become a bank holding company last week, a move intended togive it freer access to emergency government funds and help it avoid bankruptcy. The company, co-owned by GM and private equity firm Cerberus, has lost $7.9 billion over the last five quarters as thecredit crunch lifted its borrowing costs sharply and the value of many of its assets plunged.


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4.8 FINANCIAL PLANNERSValue unlocking for all stakeholders

US stimulus package

Barack Obama won the election, and in normal times, his campaign agenda ought to be front and centre.But these are not normal times. So the tricky question is: Will he focus mainly on reviving the economyand relieving the financial crisis? Or will he use the economic crisis as a vehicle to advance a moreambitious social and economic agenda?

The two approaches are at odds. The first aims at building political consensus and economic confidence;the second would intensify political conflict and economic uncertainty.

Every new president is assaulted by his own supporters, who want him to put their particular agendas atophis to do list. Thats already happening, as Obama allies clamor for speedy action to provide universalhealth insurance, combat global warming and support trade unions. But, any programme to refashion theenergy and health-care sectors - to take these obvious candidates - would be complicated and contentious.

The notion that green investments would be large, permanent net creators of jobs is mostly a mirage.Somehow these investments must be paid for. If that happens through higher prices, higher taxes orcuts in other government programs, then green jobs will mainly substitute for other types of jobs.

As for curbing health-care costs, the trouble is that the first affect of Obamas health-care programwould probably be the opposite. Expanding insurance coverage would initially rise health spending, asgreater demand for medical care met a (relatively) fixed supply of doctors and hospitals.

In fact, Obama and the nation would be better served if he concentrated for his first year on stabilisingthe economy while patiently laying the groundwork for more far-reaching proposals.

The hallmark of this economic crisis has been its capacity to surprise: the desperate plight of the BigThree US automakers is the latest reminder. We can expect more surprises, because the US and globaleconomies continue to weaken at a worrying pace. Consumer confidence has plunged. Abroad, signs areno better. Worldwide manufacturing production is declining at an 8% rate. Germany is in recession;China growth has slowed sharply.

Against this backdrop, even theparallel pursuitof crisis management and sweeping domestic reform is atbest distracting. In practice, it may be politically poisonous.

Whats most important now is to prevent the recession from feeding on it. This is a clear danger.

Consumer spending has declined. Eroding tax revenues result in state budget deficits. So states faceincreased taxes or large spending cuts to balance their budgets.

The odds are that Obamas economic stimulus plan will include tax cuts and increased spending. We and he- are caught up in a web of contradictions. We need to discipline our appetite for health care andenergy; and also we need to reconcile our desire for government benefits and our willingness to be taxed.


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4.9 ONE-STOP-SHOPSDedicated to offer related services under a roof

Mother of all monetary crises

The ongoing global financial tsunami that originated in the US poses a serious threat to the stability ofworld economy. Already the financial crisis has spread from the US to Europe, Japan and major emergingeconomies. The loss of wealth due to decline in share prices is in scores of trillions of dollars. Similartrillions are being lost in wealth in real estate. The crisis has spread from the Wall Street to the MainStreet with a serious recession in the US which is sure to have a contagion effect across the globe.

Even worse is the scenario of the future of the US dollar. The US is pumping more and more dollars intothe world economy. Seriously aggravating the burden of its external debt, which is already over $20trillion? If the confidence in the US dollar is shaken and the dollar goes into a free fall, we may well havewhat has been called mother of all monetary crises.

Faced with appreciation of their currencies in relation to dollar and fall in exports, major economies maywell embark on competitive devaluation and protectionism, leading to a downward cobweb of productionand employment in the world. The Great Depression of the 1930s may well repeat.

We must not let that happen. We must make dispassionate analysis of the causes of the crisis and devicecorrective measures however bitter they may seem.

While analysing the US financial crisis, it has become conventional wisdom to blame the greed offinancial players on the Wall Street. But what else do we expect from the financial players? Profitmaximization is their job, and their religion. It is the job of the regulators to make them work within therules, which prevent greed turning into macroeconomic imprudence. The real failure of the US system liesin its lax regulations that originated from a failed doctrine of self-regulating markets. Along with the laxregulations, the spending spree in the US was fully encouraged by the authorities in order to preventrecession in the economy, in the wake of dotcom crisis and 9/11. Federal funds rate was brought downfrom 6.24% in 2000 to 1.35% in 2004 and remained below the 2000 level in 2007. And, the Federalbudget balance was changed from a surplus to a deficit.

But now, the world must act. First, rescue of the US financial system will have to come from the use ofdollars in the system that created the problem in the first place rather than pumping more dollars into thesystem. Second, we must have a genuine international currency as the international reserve currency.Third a coordinated effort should be made to create alternative sources of demand in the world economyas the US net imports decline inevitably.

The G20 summit in Washington DC on November 15 could be a venue for considering these matters.Unfortunately, as indicated by the White House press release, the US seems to be putting the summit inthe framework only ofreform of the regulatory and institutional regimes for the worlds financialsectors and strengthen the foundations of capitalism by discussing how the summit leaders canenhance their commitment to open competitive economies, as well as trade and investmentliberalisation! Given the US veto power in Bretton Woods institutions; it can prevent the much-neededrestructuring of global financial infrastructure.


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4.10 CONTINUING LEARNING CENTRESTake informed decisions

Unforgettable trends of 2008

1. Commodities scaled new peaks: We saw peaks we hadnt even dreamed of. Energy prices were 80%higher, grains up 60%, fats and oils up 34%, and fertilisers up 140% as the impact of decades of under-investment caught up with us. Farmers made lifetime-high profits. Traders, brokers, processors andrefiners made fortunes as demand chased elusive supply. So did punters, hedge funds, index traders andretail investors. Eye-watering volatility was the ultimate adrenalin-guzzler, hot making and addictive.

2. Consumers kept everyone guessing: First, everyone made it appear as if they couldnt get enough. Thenwe discovered they could. Till August, the worlds appetite for energy, food and metals seemed insatiabledespite rocketing prices. Punters became convinced demand was indestructible. Then commodity pricesovershot consumer wallets and punctured their own balloons. The subsequent drop in demand has been asdramatic as the increase. On July 11, at $147/ barrel, crude oil was cheap. Today near $40/ barrel, itsexpensive. Analysts are ducking shoes.

3. Ethanol called the shots: 3/4thof future energy demand will come from cars and trucks. Flex-fuel andhybrid cars, electric and hydrogen-powered cars will make fuel go that extra mile. In their desire forenergy-independence and Green brownie points, politicians rushed to make blended fuels compulsory.This new demand permanently changed the nature and price of food crops. Experts say ethanol may haveraised US maize prices by anything between 47% and 70%. The impact of this was felt around the world.

4. Market gets snapped shut: In 2007, India was pretty closely integrated with global commodity markets.Then the doors were padlocked to stop food and feed from heading overseas. Spooked by inflation, thegovernment wanted to kill any chance of food shortages.

5. Old business model collapsed:It was curtains for companies doing stock and sale of commodities. Thelethal combo of holding goods instead of cash, and falling value wiped them out. The other big casualtywas financing of entrepreneurs and traders by public sector trading companies and other large moneybags.In a volatile market with declining margins, this style of business is like yesterdays newspaper.

6. World reaped record harvests:Who knew the earth could be so bountiful? Some heavy-duty infusion ofcash and good weather stimulated farmers and yields in a way nothing else could for decades before.Record harvests of wheat, rice, cereals, oilseeds, beverages, and cotton have pushed prices back to 2006levels. Even so, more than 900 mn stayed hungry across the world.

7. Carbon markets came of age:The world created a $100bn market out of paper that gives companies the

right to pollute. The worlds carbon markets grew by 80% in 2008. Consultancy New Carbon Finance,which tracks market, says this growth is expected to continue to 2012 by when it should reach $550billion. And the market may cross $3 trillion by 2020.

8. Government is back at the helm: Industry everywhere is behaving like the aggressive adolescent whocomes running back home to mommy at the first sign of trouble. After years of trying to shrug off control,the mood has firmly swung the other way. In India, at least we are more honest. Government was alwaysmai-baap, and like dutiful kids, we never made a serious bid for independence.


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11. GLOBAL OUTLOOKGlobal pathways

Financial innovation and regulation

The world is passing through a difficult time; more so, the developed world. The industrially advanced

countries are now officially in recession. It is not known at this stage how long will this recession last andhow deep will it be. This will be perhaps the deepest recession in the post-World War II period. Theimpact of the financial crisis is felt by the developing economies as well. Growth is slowing down in allthese countries. Globalisation spreads both prosperity and distress. The contagion works both ways.

Evolution of the crisis: The international financial crisis originated in the sub-prime mortgage crisis,which surfaced nearly two years ago in the US. With interest rates rising and home prices falling; therewas a sharp jump in defaults and foreclosures.

However, this would have remained as a purely mortgage market crisis but for the fact that these sub-prime mortgages were securitised and packaged into products that were rated as investment grade. Once

doubts about these assets arose they turned illiquid; it also became very hard to price them, As a result, itstarted affecting a host of institutions, which had invested in these products. These institutions were notconfined to US alone. Financial institutions in Europe and to a much lesser extent in East Asia had suchassets on their books.

With the failure of a few leading institutions and most notably Lehman Brothers, the entire financialsystem was enveloped into an acute crisis. There was mutual distrust among the financial institutions,which led to freezing up of several markets including the overnight inter-bank market. Many think todaythat letting the Lehman Brothers to fail was a great mistake. The crisis in the financial system has nowmoved to affect the real sector in a significant way.

Regulatory failure: What stands out glaringly in the current episode is the regulatory failure. Theregulatory failure was threefold. First, the regulation was soft and unfocused on segments of the market,which should have been closely regulated.

Second, some parts of the financial system were either loosely regulated or were not regulated at all, afactor which led to regulatory arbitrage with funds moving more towards the unregulated segments.

The third failure lies in the imperfect understanding of the implications of various derivative products. Inone sense, derivative products are a natural corollary of financial development. They meet a felt need.However, if the derivative products become too complex to discern where the risk lies, they become amajor source of concern.

Rating agencies in the present episode were irresponsible in creating a booming market in suspectderivative products.

Quite clearly, there was a mismatch between financial innovation and the ability of the regulators tomonitor them. It is ironic that such a regulatory failure should have occurred at a time when intensediscussion were being held in Basel and elsewhere to put in place a sound regulatory framework.


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4.12 ISSUES OF THE PRESENTFreedom to get & fail in the system of free enterprise

Crisis of confidence

Had the Sensex been at 30,000 today? Then, we might have justified the level by quoting many facts andstatistics. Some of them could have been:

The interest rates are on their way down and back to the levels of two years ago; Inflation is down to nearly 6%; The rupee is at an all time low of 50 against the dollar; The crude prices are below $ 50 a barrel; With the new pay commission for the central government employees and significant pay hike

announced for the PSUs, the urban purchasing power should be strengthening;

The year has had its standard quota of monsoon; The September quarter of the year 2008 ended fairly well, at 7.5% growth; Nearing elections, the government has been bending backward, easing up on an array of policies; The government has already announced its continuous commitment to invest heavily in infrastructure; Real estate prices are down to more realistic levels and home loans are headed southwards as well; The worst hit suffered by an Indian bank by the subprime crisis is the ICICI Bank, according to which

the hit is a mere $32 million that has been accounted for by the bank;

Our foreign exchange reserves remain a healthy $260 odd billion; The Mumbai terror attack has unified the country like never before. Mumbai is in the move again.But sensex is not at 30,000. It is closer to 10,000. Our gloom about the financial crisis is all about thesensex plummeting below 10,000. So our financial crisis is really a crisis of sensex rather than any realeffect of the subprime related crisis. Why did sensex crash from 20,000 to fewer than 10,000 within ayear? Not because our economic fundamentals have crashed overnight. Why did sensex climb from10,000 to 20,000 earlier in the first place (a question rarely asked)? Not because our economy had performed some unheard of miracle. The sensex soared because some foreign institutions, with theirhome markets hardly offering any investment opportunities invested heavily in our market. And it

plummeted when they took a big hit back home, needed their money fast and pulled back theirinvestments. Soon they will have no option but to bring the investment back to our doorstep.

It is strange that when prices fall in general, we are all happy because goods are now better value. Butwhen stock prices fall, we shed copious tears. Exactly the same stocks with exactly the same economicfundamentals were great buys with sensex at 20,000; but they are bad investments with sensex at some10,000 odd! I think ours is a crisis of confidence, and an imagined one at that. Our financial crisis is onlyin our minds. So let us not over-react irrationally.


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5.1 BANKING SECTORTough Time

1. Direct selling agents (DSA)

If 2007 was a defining year for recovery agents, 2008 is turning out to be a year best forgotten for DSA.After explosive growth in 2007, many DSAs are fighting to survive, with banks going slow on retail loansin the current year and new do not disturb laws making it difficult to reach customers. Also, with Credit

Information Bureau of India kicking off operations, DSAs are finding it tough to bring in applicationsfrom prospects rejected by other lenders.

DSAs are firms that distribute home and personal loans and credit cards for lenders. Although DSAs have

been employed by foreign banks for over a decade, they came into their own at the turn of the centurywhen Indian banks discovered the retail borrower.

The rise of DSAs coincided with ICICIs high-profile transformation into a retail bank. Not one to be bogged down by external restrictions on its growth plans, ICICI Bank set out to become the second-largest bank in the country with a little over 700 branches. With abundant liquidity in the market, buthampered by the absence of branches to distribute products, the bank created a whole industry of

marketing professionals across the country.

Over the years, the DSA employee developed a persona of his own. It was of a pushy man who corneredhis prospect on the phone or at offsite marketing kiosks. Put your signature on the cross and I will fillin the rest was a standard line. After being exposed to public sector bankers, whose only objective wasto find flaws in loan applications, DSAs gave a culture shock to retail borrowers. Even if loans wereturned down by one lender, there were DSAs of other lenders who were willing to pay an incentive forrejected files. Banks were happy to pass on the processing fee to the DSA.

The first sign of trouble began with defaults in the small-ticket personal loan segment the Indian bankers subprime. While this killed the personal loans, the credit crunch following the international

financial crisis resulted in large employers like ICICI Bank cutting down on home and retail loans. Theslowdown in business has forced DSAs to reduce headcount while some have had to shut shop. Otherfirms are looking at widening their distribution to include products such as insurance.

2. Business correspondents (BC)

Two years after the RBI permitted banks to outsource banking services to BCs for getting under-banked parts of the country in the financial inclusion folds, BCs are having a tough time keeping their headsabove water. BCs attribute their losses to the small volumes of business in rural and semi urban areas.

For instance, SBI offers its BCs Rs 10 for opening a new no-frills or zero balance account and 50 paisa

on every transaction of Rs 1000. This means to generate minimum revenue of Rs 10,000 a month a BCwould have to open 1,000 new no-frill accounts from its outlets. In addition, the ticket sizes of depositsand withdrawals in under-banked areas are very often less than Rs 1,000.

In order to sustain themselves, BCs have now started offering rural customers a variety of other financialservices such as insurance to compensate for losses in trying to extend banking outreach. Companies suchas Zero Mass Foundation and Fino Fintech Foundation which function as BCs say it could take anywhere between three and five years for them to br

journal of finance vol 25

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