RBI ups CRR, repo rate to check inflation

Struggling to contain inflation within its targeted 5-5.5 per cent range, the Reserve Bank of India raised the cash reserve ratio (CRR) 50 basis points to 6.5 per cent from April 28 and the repo rate 25 per cent to 7.75 per cent with immediate effect.

With this, the central bank has raised the CRR thrice, by 150 basis points, and the repo rate five times, by 125 basis points, in the current financial year.

The CRR is the proportion of cash balances the RBI requires banks to park with it. The higher CRR will suck out Rs 15,500 crore from the banking system, adding to the Rs 27,500 crore drained through two previous increases.

THE COST OF INFLATION CONTROL
March 30, 2007 : CRR hiked by 50 bps to 6.5%; Repo rate hiked by 25 bps to 7.75%
Feb 14, 2007: CRR hiked by 50 bps to 6%
Jan 31, 2007: Repo rate hiked by 25 bps to 7.5%
Jan 31, 2007: General provisioning on standard commercial real estate loans, personal loans & capital market loans doubled to 2%
Dec 11, 2006: CRR hiked by 50 bps to 5.5%
Oct 31, 2006: Repo rate raised by 25 bps to 7.25%
July 25, 2006:Reverse repo and repo rates hikes 25 bps each to 6% and 7% respectively
June 8, 2006:RBI raises reverse repo and repo rates by 25 bps to 5.75% and 6.75%, respectively

The RBI will also reduce the interest on CRR balances from 1 per cent to 0.5 per cent. The rise in the repo rate will make it more expensive for banks to access overnight liquidity from the central bank. The central bank’s monetary tightening measures followed release of data that showed wholesale price inflation at 6.5 per cent for the third week in succession, ending March 17, 2007.

Impact of these hikes

The RBI has indicated that a sum of close to Rs 15,500 cr will be sucked out of the banking system, thereby further tightening liquidity (Call touched a high of 80% during the day) in the system.

Banks will witness a marginal interest loss in their CRR deposit as the interest paid on CRR has been reduced from 1% to 0.5% whilst the CRR has been hiked by 25 bps.

Tech spending in 2007: the cycle turns?

A rebound in spending on IT by corporations and governments, while not back to boom-time levels, has provided a solid foundation for the technology industry over the past three years. Will 2007 be the year things slow down again?

Here are some straws in the wind from recent global forecasts:

2006 2007
Forrester Research (IT spending) 8 pc 6 pc
Forrester (External IT purchases) 8 pc 5 pc
IDC (IT spending) n/a 6.3 pc
Goldman Sachs (IT spending) 6-7 pc “probably down"
Sanford C Bernstein (CFO survey) 5.2 pc 4.7 pc
Gartner (spending by big companies) n/a 2.8 pc

The danger, as IDC points out, is that falling profit growth in the US, along with a harder economic landing, could make current expectations look too optimistic. That would not mean a return to the dark days of 2001 and 2002, but it would certainly be a far less hospitable environment for technology investors - particularly given the current high valuations on tech stocks. (Thanks to Tech-Blogger on Financial Times - Mr. Richard Waters)

India’s Financial Services Sector

(Intresting piece from Harvard Business School)

Although India had Asia’s oldest stock exchange, its market capitalization to GDP level was much lower than that of developed Asian economies: using 2004 data, Hong Kong’s was 5.97, Singapore’s 2.36, and India’s 0.64.44 This stemmed from a number of factors. For much of the country’s history, the government had controlled the financial sector, including the amount of money companies could borrow. To raise money, they would often go public, usually selling the government minimum of 10% at low valuations. This corresponded to low liquidity and scanty trading volumes and thus in a negative spiral, lack of interest among analysts. In 2004 and the first 11 months of 2005, public stock issues in India raised as much money as was raised in the previous 14 years. Average deal size for companies going public had trebled between 2002 and 2005. “In a way,” observed a long-time investor in India, “buying the stock of most public companies in India was akin to buying a private company only worse. You had illiquidity and no control rights.”

Not only did the average Indian not have much money to invest in the stock markets until the early 2000s, but there was a highly liquid, government guaranteed option that paid handsome interest. Until 2000, passbook savings accounts paid rates between 12% and 15%, compared to an historic return of 17% to equities. Starting in 2000, however, interest rates had started to slide into the single digits, and by 2005, they stood near 6%. Said Oswal, “With no return to illiquidity, how could equities compete? Now our challenge is that the public still believes that interest rates are around 15%. As they start to internalize the recent drop, they will turn to equities in greater numbers.”

Indians historically had high household savings rates, in the vicinity of 29% of GDP, and the 300 million people in the middle class were moving into their prime saving years, but most of those funds were in banks. Mutual funds, the common way in which American retail investors participated in the market, only held INR 1.5 trillion ($34 billion) in assets under management at the end of 2004, with 10 times that amount, INR 16.2 trillion ($368 billion), in banks. In the U.S., for instance, mutual funds held nearly three times the assets of bank deposits.47 Figures from 2000 showed that only 8% of Indian households owned equities, and that overall, Indian households had only 4.5% of their wealth in the equity markets, compared to U.S. figures for the same year that showed 27% of households owning equities, and 15% of household wealth in equity markets.

Retail investors had been more active in 2005 and 2006, opening 1 million new depository accounts in the first seven months of 2005, which raised the total to 8 million by mid-year. Portfolio management services (PMS) had gained favor with those Indians holding equities, as capital gains taxes fell and the stock market rose. India’s “higher income population” – households with incomes above INR 200,000—was expected to almost double, to 32.3 million households between 2005 and 2009. These consumers were expected to increase the scope of product they demanded, moving from purely Indian financial products to globally oriented products.

As FIIs recovered from their fright at the crash of 2000, they had joined retail investors in Indian equity markets starting in 2003. In 2004, FIIs’ trading volume rose 105% from the year before, to $70.5 billion. Along with their faith in the vibrancy of India’s economy, FIIs also benefited from reduced capital gains tax rates.

The Indian broking industry was extremely fragmented but consolidating dramatically. The volume of the top five brokers had doubled between 2001 and 2005, but still was only 15% of the market. The top 50 brokers only had a 50% share . Small players were being acquired by larger domestic operators. At the same time, the industry’s efficiency had significantly improved. The number of registered brokers on the NSE, India’s largest exchange, had fallen by 3% between 1997 and 2005, while the number of trades had risen by 1,630% in the same period.

Competition was intense, as all the major foreign investment banks had entered the country, either independently or in joint ventures. By 2005, though, many of the joint ventures were dissolving, as the foreign partners, thought to want complete control of the operation, either bought or sold their stakes in the joint venture,. December 2005 had seen Merrill Lynch buy out its partner DSP for $500 million to increase its 40% stake in DSP Merrill Lynch to 90%. This effectively valued the operation, which focused on institutional broking, investment banking, and asset management, at $1 billion. In March 2006, Goldman Sachs and Kotak Mahindra Bank had severed their 10-year partnership for a nominal valuation. General sentiment held that Goldman had wanted the split to pave the way for setting up a proprietary operation. Even online broker E-Trade was staking a claim in India through a 27% share in brokerage IL&FS Investsmart. E-Trade was thought to be in the process of adding to that stake. Throughout this time, rumors swirled that Morgan Stanley and JM Financial, partners since 1999, would buy out their shares of the joint operation.

Much of this activity stemmed from the wild ride in the Indian markets. Total investment banking revenue had risen to $637 million by the end of 2006, almost 10 times 2002 levels. In addition, the benchmark BSE Sensex had doubled in value since 2003 and proven surprisingly resilient, as it recovered from a 29% drop in May 2006 only to rebound to new highs in October of that year.

Insurance Business Transactions - Explained by Warren Buffet

(Equitas is insurance company, in which warren buffet hold investment)

"The accounting procedure for retroactive transactions is neither well known nor intuitive. The
best way for shareholders to understand it, therefore, is for us to simply lay out the debits and credits. Charlie and I would like to see this done more often. We sometimes encounter accounting footnotes about important transactions that leave us baffled, and we go away suspicious that the reporting company wished it that way. (For example, try comprehending transactions “described” in the old 10-Ks of Enron, even after you know how the movie ended.)

So let us summarize our accounting for the Equitas transaction. The major debits will be to Cash
and Investments, Reinsurance Recoverable, and Deferred Charges for Reinsurance Assumed (“DCRA”). The major credit will be to Reserve for Losses and Loss Adjustment Expense. No profit or loss will be recorded at the inception of the transaction, but underwriting losses will thereafter be incurred annually as the DCRA asset is amortized downward. The amount of the annual amortization charge will be primarily determined by how our end-of-the-year estimates as to the timing and amount of future loss payments compare to the estimates made at the beginning of the year. Eventually, when the last claim has been paid, the DCRA account will be reduced to zero. That day is 50 years or more away.

What’s important to remember is that retroactive insurance contracts always produce underwriting losses for us. Whether these losses are worth experiencing depends on whether the cash we have received produces investment income that exceeds the losses. Recently our DCRA charges have annually delivered $300 million or so of underwriting losses, which have been more than offset by the income we have realized through use of the cash we received as a premium. Absent new retroactive contracts, the amount of the annual charge would normally decline over time. After the Equitas transaction, however, the annual DCRA cost will initially increase to about $450 million a year. This means that our other insurance operations must generate at least that much underwriting gain for our overall float to be cost-free.

That amount is quite a hurdle but one that I believe we will clear in many, if not most, years."

Letter to Shareholder - 2006: http://www.berkshirehathaway.com/letters/2006ltr.pdf

BANKING: Bond yields spike; Could result in significant MTM hit for few banks in 4QFY07; Valuations largely factors these hits

- Indian bond yields have moved up significantly in 4QFY07, as liquidity declined sharply on account of tax payments by Indian corporates and further auctions of bonds by RBI. Even the call money rate increased to 60% (avg rate of 40-50%) for the last couple of days. We understand that few investors (mainly MFs) have been selling government bonds to cash in on higher yields on short term debt (bulk deposits by banks, call money, etc) - While liquidity is likely to ease from April onwards, decline in inflation from May onwards will also help to moderate yields. Nevertheless, the higher yields in the current quarter are likely to impact 4Q results of banks.

- The 10yr bond yield is up ~50bps over Dec 2006, while the 2yr bond yield (more relevant now as banks have lowered duration significantly) is up ~70bps. At the current levels, most banks are likely to book losses on their AFS portfolio. Few banks like SBI, PNB, Canara Bank, BOB and OBC are likely to witness larger hits as they have higher proportion of their books in AFS category. Other banks like Bank of India, Union Bank, IOB and Syndicate Bank are likely to take very marginal hits due to MTM losses.

- Private banks which have a low-duration investment portfolio and largely hold securities in HTM (Held-to-Maturity) do not carry large risk. Nevertheless, there might be some depreciation on non SLR book, particularly for UTI Bank. - While MTM losses would hurt the bottomline, we believe that core earnings are likely to remain robust. Overall, margins are expected to remain stable (despite rise in deposit costs, as lending rates have also gone up) coupled with stable asset quality. Our discussion with few bankers suggest that recoveries have remained strong in 4QFY07 as well and NPAs could further improve for quite a few banks in 4QFY07. - Overall, valuations are already reflecting the risk on bond books, even as the very near term concerns on inflation and bond losses might continue. We would recommend selective buying. We prefer PNB, BOI, Union Bank and Syndicate Bank among PSU banks. Amongst private banks, we prefer HDFC Bank and ICICI Bank. (Motilal Oswal Securities)

UP Elections mandate day to watch out for

With Cong's recent debacle in the recent state polls and with UP polls round the corner, a new scenario is emerging.Congress and Mulayam are cribbing about the protracted election schedule, while BJP and Mayawati are Happy.The recent wins would rejuvenate the BJP Cadre and they sure would go all out on their favorite terrain - UP

The UP Election Schedule:
First phase on April 7
second phase on April 13
third phase on April 18
fourth phase on April 23
fifth phase on April 28
sixth phase on May 3
Final phase on May 8

Counting Day (OR) D-DAY for Stock markets--> MAY 11, 2007 (FRIDAY)

FBT on ESOP's

FBT on ESOP's don't understand what was the need for doing this. "PC has charged ESOP on the time of conversion".

First of all let me explain this phenomenon. ESOPs were used for retaining the employees and making them eat for profits for enterpreniual vision. secondly if all companies start paying in cash instead of stocks (for reason of reducing cost of retention because of FBT), there will be higher disposable income in the hands of emplyoees.Thirdly, At exercise of options profits is not realised in the hands so how can tax, it be charged on hypotetical income. Lastly, Tax is paid by company and not by employees who is getting capital appreciation.

Otherwise he could have charged tax for the sale share as salary (and not capital gain) in the hands of the employees when the sale the share which is exempt till now. This will helped both corporate as there margins doesnt get affected and retention issue could be helped in talent short IT industry. And also employees since they were asked to pay taxes out of realised income.

YEN CARRY TRADE

The Yen Carry Trade is simple....................

Right now, big investors can borrow Japanese yen at an interest rate of 0.5%. As long as they can invest that in something that pays more, they can earn the spread, or "carry." It's usually done by investing in U.S. dollars that pay 5%.

In other words, big investors simply borrow yen at 0.5%, invest in dollars paying 5%, and pocket the difference. They do it with leverage, so the returns are magnified to be phenomenally profitable. As long as the dollar and the yen are relatively stable, the profits are huge.

At first, investors just did it by selling yen and buying U.S. Treasuries. But steadily, investors have borrowed yen to take on more and more risk including buying stocks in China and India.

The leverage these guys take on magnifies the risks...
If the dollar strengthens versus the yen, the profits just get silly. But if the yen strengthens versus the dollar, these big investors can lose a substantial amount of money. The yen has been weakening for a long time, so this risk hadn't shown itself until investor in china got scared.

So, If you had borrowed a mountain of money in yen, you were now in the red, big time. You absolutely had to close out your carry trade to cut your losses before they became too great.

The initial trade was to buy Chinese stocks and sell the yen (the carry trade portion). So to close out that trade, investors had to sell Chinese stocks and buy the yen. Therefore, yesterday Chinese stocks crashed (triggering a domino effect throughout the world), and the yen soared. Plain as day. The success of the Yen Carry Trade created a self-perpetuating cycle. The trade's
success attracts more people, which weakens the yen and makes the trade more profitable. That, in turn, attracts even more people. The yen is now incredibly weak it's cheaper than it was before the Plaza Accord in 1985 (on a trade-weighted basis). It soared by 100% against the dollar after that.

In short, the Yen Carry Trade has created a flood of money around the world, looking for any investment that can make more than 0.5%. In other words, just about anything For example, high-yielding currencies, like the New Zealand dollar, have appreciated significantly. Yields on real estate in developed markets have fallen to all-time lows. And debt-funded private-equity deals have risen to all-time highs.

Asian economies like Thailand, China, and India are now facing an unprecedented "problem" of excessive money inflows. India, for its part, appears to have benefited significantly from the carry trade. The huge influx of money has created a benign interest rate environment that has fueled consumption and investment.

All the easy money entering India has fueled a boom that has used up all the "slack" in the economy. India has the raw human capital and the potential to produce all the goods and services that are in now in short supply. But there are numerous structural problems with the economy, mostly related to the government. These problems are easy to gloss over when money is easy, as it is now. But to me, the structural problems and the easy money combined are a potent mix that will become a problem for the Indian economy. It's already starting. For example, wages are growing at 20% a year. Property prices and housing costs for urban India are exploding. Headline inflation is at 6.73% (which grossly understates real inflation),
but short-term interest rates are excessively low at 7.5%.

I am not bearish on India; I believe it is one of the best economic growth stories for this century. It also has one of the best pools of human talent, entrepreneurs, and companies in the world. But the excess speculative money that's now here, caused significantly by the Yen Carry Trade, is getting carried away with the India story. It ultimately will do a disservice to India, causing our economy to overheat. The financial community is driven by fads and trends just like any other social community. Shifts between fads can be sudden and unpredictable and can have serious implications for investors, particularly in emerging markets. Given the problems the carry trade is beginning to create everywhere in the world, and given the almost one-sidedness of the trade, it is time to start taking the opposite view and to hold tight for what is likely to be the mother of all reversals.

I don't know if the 8.8% one-day fall in China or the fall in the Dow was the beginning of the end of the carry trade.
(source: from web)

One thing is for sure the risk appetite of global investor is going to change after this reversals. The little spreads in the assets class will now improve. Even though the story of India and china is very strong, but risk appetitie of global investor will come down. The stock in this economies
were trading after discounting 2009 and 2010 earnings. Atleast this situation will change.