India - Moonwards & Downwards

While India launched its first moon mission – Chandrayaan 1.A successfully moving moonwards, its markets spiraled downwards as if there was no tomorrow. Bruised and battered the Nifty and Sensex were indeed mauled. After Friday’s brutality Nifty lost 16% during the week and Sensex about 13%. The technicians now believe that India is now in a structural bear market (we heard about a structural bull market in 2007) as against a cyclical bear market, since the correction from the peak is now more than 62% - a key Fibonacci ratio. While the climb was strenuous the fall has been swift.



Foreign Institutional Investors (FIIs) considered key players in the rise have now withdrawn about USD 21bn. year to date. It is estimated that about USD40bn. was invested through secondary market in the 3 years starting 2005. The overall investment of FIIs is estimated at USD80bn. The year 2007 saw the maximum inflow of about USD17bn. It is estimated that the market cap at January peaks would have been about USD150bn. Since market has fallen by about 60% from the peak the market cap of FII holding has probably fallen by about USD90bn. which means that current market cap is aboutUSD60bn.plus USD19bn. already taken out i.e. USD79bn. The money that essentially will look to exit is the hot or leveraged variety, which would probably have come in the last 1 to 2 years of the boom and would be in the region of USD20bn. After adjusting for market cap another USD 4 to 5bn. is likely to move out. The fall has come about despite the domestic institutions (mutual funds and insurance cos.) pumping in about USD15bn. year to date. Talk about impact costs!


Here is the catch. While it is unlikely that foreign investors, given the current international environment are going to come back in a hurry, the local investors who pumped in substantial amounts as the market was falling have also seen major wealth erosion. Additionally the liquidity crises which the mutual fund faced with redemption payments even in liquid funds/debt funds delayed or not paid in full has seen a lot of faith erode. Corporates which contribute almost 60% of the mutual fund indutry corpus were at the receiving end as bank sources dried and they could not redeem their investments. This was because many debt funds were invested in unquoted papers of real estate and Non-Banking Finance Companies (NBFC). It will take a long time for trust to come back.


The money market became so tight that call rates were up at 23 to 25% at its peak. This was essentially caused by RBI supplying dollar to the dollar starved banks and their overseas branches, for oil imports and FII redemptions, thereby sucking large amount of rupee, leading to a major crash. It was a very dicey situation that the RBI faced where the need to supply dollars had to be balanced with how much it could let rupee depreciate without putting upward pressure on inflation. It was saved by drastically falling oil and other commodities. Otherwise the damage to rupee would have been much more. To the credit of RBI it increased the supply of rupee by almost USD20bn. by slashing the CRR (cash reserve ratio of banks – money to be kept with RBI as percentage of their demand and time deposits) from 9% to 6.5%. It also provided a liquidity window to mutual funds to the extent of USD4bn. to tide over the short term liquidity problem. It eased the external commercial borrowing norms, which was a cosmetic move as there is hardly any worthwhile liquidity internationally. The RBI also reduced the Repo rate by 1% more as a confidence building measure. The call rates after these actions are now below the Repo rates or there about.


SEBI (Securities and Exchange Board of India) the market watchdog, also eased the P-Note restriction that it had imposed on FII which to some extent saved forced selling but got a lot of flak due to its very flippant approach to policy issues. Further it notified the FIIs that they cannot short the market by borrowing stocks from other FIIs overseas. While this was to stop short sales through this route, the logic proposed was that the local investors do not yet have such an effective stock lending mechanism (stocks can be borrowed only for 7 days) and hence does not provide a level playing field.


In its Credit Policy announcement on Friday RBI did not announce any new measure as it stated that it wanted to see how the proactive measures taken pan out. It gave its assurance to the market that if necessary further policy tools would be used. It however felt that credit growth and money supply are still on the higher side and it would closely watch the inflationary pressures. This is stark contrast to the international markets where the money supply has gone stand still and but is now showing some sighs of easing. The fact that the Indian banks are closely regulated and supervised, a majority of them government owned (as major share holders) have indeed helped. This is not to say that the sector will not face any problems. Some of the aggressive private sector banks are expected to come out with negative news albeit they are in a denial mode right now. Even some private sector insurance companies which were overly active in the market during the heydays are expected to report negative surprises.


Rupee is expected to be under more pressure as external debt of about USD89bn.is set to mature by July 2009. This is 40% OF India’s total external debt.


So while the depositors will be backstopped the investors have some more suffering and pain to go through. A number of issues point towards this:

1. Corporate defaults especially from the real estate and NBFCs are expected. Some big names may be involved specially those who had leveraged themselves very highly to play the land bank game. Not only the land prices have fallen but the current projects are seeing a major slowdown. To some extent last week’s action has factored this in.
2. Consumer finance off-take has shrunk rapidly with high interest rates. On the existing book the recovery is going to be a challenge for banks. The shrinkage has also come because of this concern.
3. The automobile industry – two wheelers, commercial vehicles, ancillaries etc. have been under pressure for the last 24 months. While the input costs may come down with the commodity prices easing, the appetite of banks to lend to this sector directly or indirectly through NBFCs in the current environment will reduce.
4. Housing finance companies have reasonable chunk of their assets in the builder loans category. With many of these builders under cash flow pressure their loan servicing may not be as desired and defaults are possible.
5. Many of the industries were in a major investment phase and some had just completed expansions. These companies are going to face tremendous pressure in completing the projects and where completed in utilizing the capacities. Cash flows to service debts are also going to under pressure.
6. Banks have been told by RBI to restructure the SME (Small & Medium Industry) repayments of debt clearly indicating the pressure on the banks in recovering from such enterprises. Moreover 40% of such enterprises are exports oriented and are likely to see a considerable slowdown in their business in the coming months putting some more strain on the banks.
7. Companies that raised money by way of FCCBs will be unable to convert these into shares as the stock prices are way below the conversion price. So these will now remain as foreign currency debt in the books of the companies. Many of these are falling due in the next 2 to 3 years. The pressure will be further accentuated by the Rupee depreciation.
8. The Indian IT companies have a substantial part of their business coming from the BFSI (Banking, Finance and Insurance) sector from US & Europe. These companies will carry with them the same uncertainties as the US & European banking and insurance industry. Indecision on IT projects will be high as these institutions judge how much water they are in. Also consolidation at their end will add to this indecision further. Many of the bank captive units will be sold off (a la Citibank) and then to cut costs vendor consolidation is likely to happen in a major way. This means visibility for these IT firms will be lesser as we progress in resolving the current turmoil. Business models in this sector are likely to undergo some major changes.
9. Layoffs have started and in some companies the intention to do so after the current festival season has been announced.
10. The fiscal deficit is likely to be much higher than budgeted given the brunt of fertilizer and oil subsidies, farmer loan waivers and now the current environment which may call for such support in future. The worsening internal debt situation is going to put further pressure on government finances and inflation as it may crowd out the market.

No wonder a newspaper reports say that the sales of anti-depressants have shot up by 30%. So you know where to invest!!

Happy Hunting and a Happy Diwali!!