While there is no shortage of doomsayers in India, and to be fair a relative abundance of negative economic indicators, there is some evidence that the rest of the world may be regaining confidence in India as an investment destination. International (foreign) investors have been net purchasers of Indian stocks to the tune of $400mn so far in December and last week were net buyers of Indian equities for five consecutive days, an 8 month record. While these figures have a long way to go before offsetting the massive outflows of FII which India has witnessed since the credit-crunch exploded on the global scene, they do provide some temporary succor.

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The crash of the Indian Stock Market since January 2008 has been widely attributed to FIIs pulling their money out to meet liabilities and redemptions. According to this article, however, FIIs have only pulled out $12.7bn and still have another $53.7bn, or almost Rs. 270,000 Cr. left in the market. 

A lot of market experts are talking about the market being near the bottom (”Valuations just cannot get any cheaper! The Indian growth story is sound, even at 7%!”) Let’s be clear on this: these falling prices are not about fundamentals - its simply about lack of liquidity. FIIs are not exiting the market because they want to, but because they are being forced to - nobody wants to book such massive losses, and nobody would argue against the fact that as an emerging market India is looking pretty cheap.

The fact that there’s so much FII money still in the market - 80% - is quite scary (more…)

First of all let me clarify that in my opinion, there is *absolutely no chance* that ICICI Bank can collapse. Its too well capitalized, its too big and its too important to the Indian financial system for that to happen.

I posted a small article this morning, which has been getting a lot of pageviews. I never expected, however that I’d get a response from ICICI themselves. This is what they left in the comments section of my post:

September 30, 2008

Dear Sir/ Madam,

We greatly value your relationship with us. In the context of the developments in the international financial markets, we thought it pertinent to bring to you our perspective of the prevailing situation.

We would like to bring to your attention that the Indian banking system is well regulated and significantly insulated from global developments. This is because it is mandatory for all Indian Scheduled Commercial Banks to retain 34% of the deposit base in the form of Government Securities (SLR) and cash with RBI (CRR). Besides, sound policies of RBI have ensured prudent credit practices in the Indian Banking system.

ICICI Bank is already compliant with the BASLE II requirement in respect of risk management practices and capital adequacy. At 13.4%, ICICI Bank has one of the highest capital adequacy ratios in the Indian banking industry. Last year, ICICI Bank raised Rs. 20,000 crores (US $ 5 billion) of equity capital, which almost doubled our equity capital base. We have a net worth of over Rs. 47,000 crores (US$ 10 billion), again one of the highest in the banking industry in India We have consolidated total assets of over Rs. 4,84,000 crores (over US $ 105 billion), which is diversified across a wide range of asset classes across retail, wholesale and rural banking.

ICICI Bank is amongst the most profitable banks in India. In FY 08, ICICI Bank made a profit of Rs. 4,158 crores (US$ 900 million).

ICICI Bank has the highest credit ratings in the Indian financial sector. We have AAA ratings for our instruments, such as senior bonds, subordinated bonds, and deposits. We have the highest foreign currency bond ratings assigned to any Indian bank from Moodys and S&P.

We continue to invest in growth, indicating our confidence in the opportunities in the Indian market. In 07-08, ICICI Bank added 650 new branches, taking the total strength to over 1400 branches.

We thank you for reposing trust in us over the years. We look forward to setting new benchmarks in service levels in India and to create a bank that you will continue to be proud of.

As a testimony to the above, please find below the clarification given by Reserve Bank of India.

Date : 30 Sep 2008
RBI Statement on ICICI Bank’s Financial Position
There are reports in some sections of the media that based on rumours regarding the financial strength of ICICI Bank, depositors are withdrawing cash at its ATMs and branches in some locations.

It is clarified that the ICICI Bank has sufficient liquidity, including in its current account with the Reserve Bank of India, to meet the requirements of its depositors. The Reserve Bank of India is monitoring the developments and has arranged to provide adequate cash to ICICI Bank to meet the demands of its customers at its branches/ ATMs.

The ICICI Bank and its subsidiary banks abroad are well capitalised.

Alpana Killawala
Chief General Manager

Press Release : 2008-2009/412

Sincerely,

Nazia Sayeed
Office of Head Service Quality
ICICI Bank Ltd.

It was nice of the folks at ICICI to respond to my humble blog, albeit with a standardized message. I’d like to clarify that I don’t think that ICICI is going to collapse, but at the same time I do feel that it is relatively more at risk in terms of Subprime exposure than other Indian banks. I certainly do not think that given the level of depostitory requirements that Indian banks must comply with - that there’s any reason reason to start pulling out your money from ATMs. Just as the US government protect retail deposits, so would the Indian government. 

At the same time, there is the possibility that ICICI will face larger than expected losses from its exposures. Make no mistake - ICICI has already earmaked $260mn+ (Rs. 1000 Cr.+) for losses due to exposure to Credit Derivatives. This was way back in January, and then was talked about again in March. A *lot* of time has passed since March, and alot of negative developments have also taken place. 

My worry is that in light of the recent events (Lehman, HBOS, AIG collapse etc.) that there may be  further losses. That’s the scary thing about the Subprime mess. When on entity falls over - other firms it owes fall over. Those other firms also owe somebody, who owe somebody else and so on. Suddenly, before you know it, you thought that a counterparty that was good for its promise to pay you what they owe you, no longer is in a position to do so.  

According to this article in the Business Standard, its UK arm has 89% of its non indian investments book - estimated at $3.5bn - has an S&P rating of A- or above. ‘Only’ 18%, or $700mn has exposure to the US.  I think that an ‘A-’ isn’t a fabulous rating, mind you. The highest rating given by S&P is AAA, after which we have AA, A, BBB, BB etc. to until D. Note that BB and below is rated as ‘Non investment grade’ or ‘junk’. And remember, these are the same ratings agencies that gave AAA ratings to those Subprime backed assets that are actually at the root of this entire mess.

The article goes on to say that ICICI bank asserts that the UK subsidiary has ‘no exposure’ to US subprime. Surely they do have some exposure, albeit indirectly, otherwise they wouldn’t have had that $264mn mark to market loss in the first place?

In fact, according to this article in the Financial Express, ICICI bank has a total of $2.2bn worth of expsosure to credit derivatives. What the underlying for these credit derivatives are, we don’t know. To an extent that is not even that important. I wonder, has ICICI booked all of those losses? Did it close out those derivative positions? Hopeful they did.

Thus, while a ‘collapse’ of ICICI bank, in my opinion, is highly unlikely, we may learn of larger than expected MTM losses on the back of credit derivatives. If this does happen, while the depositor doesn’t have anything to be worried about, it wouldn’t exactly be good news for the ICICI bank shareholder.

Disclaimer: This is not investment advice nor should be construed as such. Do *not* make any investment decisions based on what you read in this article, or anything else on this blog. All views presented here are solely the opinion of the author’s.

Disclosure: I don’t own any shares of ICICI bank.

One of our reader’s comment on Gautam’s post brought up an interesting point, regarding oil and it’s affect on the dollar (and by association the rupee). The question arises: Why has the Rupee done an about-turn against the dollar? The Dollar Smile Hypothesis developed by Stephen Jen at Morgan Stanley helps explain the correlation.

In very general terms, currency valuations are based on the growth rate of the particular nation. Since the US economy has been growing at a slower clip, the dollar should weaken against the global basket of currencies. We have seen exactly that, especially last year where we reached 39 Rupees a dollar from 46. However, a curious thing has occurred in just the last couple months: the dollar has in fact strengthened against the world’s currencies including the Rupee as we can see:

The theory suggests that the dollar has a convex relationship to US economic growth. Thus while it remains (more…)

by Karan

The fact is that I was terrified of even stepping out from the aircraft. I had been warned by virtually everyone who had traveled to South Africa, “dude, be careful”. One person even went to the extent of suggesting that I carry along a gun (seriously!).

However, now that I have spent a few weeks here, I feel that the dangers of visiting this rather beautiful country have been grossly exaggerated. Sure, there is crime! But people here are so neurotically pre-occupied with the subject that our poor ol’ bandit hardly stands a chance: electric fences, motion activated alarm systems, laser security, steel barges and if that isn’t enough, there is a good chance that the “victim” will own a personal weapon.

Leaving aside the local “culture” however, I find South Africa to be a rather attractive investment destination (more…)

There has been a lot of chatter in the market about FIIs staying away from the Indian markets because they feel that the valuations in India are still relatively quite expensive. Index PE ratios, when looked at in comparison to historical levels are a good way to determine how cheaply/fairly/expensively the companies that make up the index are relative to their historical levels.

But first, an explanation of how an ‘Index’ is calculated: There several ways to create an ‘index’ but the method commonly used is the ‘free float market capitalisation methodology’ where very crudely Indices are calculated adding together the market capitalisation of each of the companies chosen for that index based on some sort of criteria, dividing that figure by the sum of the market capitalisation of those companies that met the same criteria in a base year and then (more…)

Manmohan Singh prepared a Working Paper for the International Monetary Fund in December 2007, in light of the curbs imposed by the Securities and Exchanges Board of India (SEBI). It clearly explains the history and origins of P-notes and suggested at the time what the impact of the curb may be.

Some history:

Since 1992, when FIIs were allowed to invest in Indian equity markets after the balance of payments crisis, an offshore market for PNs developed as a primary conduit for foreign investors to invest in India.

The origins of such flows stems from the bilateral tax treaty that India has had with Mauritius. The main provision of the 1983 treaty was that no resident of Mauritius would be taxed in India on capital gains arising from the sale of securities in India. The treaty therefore gave capital gains exemption for investments routed via Mauritius. Despite the uniform reduction in capital gains tax arbitrage that existed from the early 1990s through July 2004, it is interesting to note that there has been a rapid growth in the market for PNs in the last three to four years.

In the decade, short term capital gains have been as high as 40% and long term capital gains as high as 20%. However, since July 2004, the tax treatment on short term (security held for less than 1 year) capital gainshave been reduced to 10%, and there are no taxes (more…)

We haven’t heard much (except Bhave telling some investors that SEBI may allow it, read BS article here) about Real Estate Investment Trusts (REITs) since SEBI released the draft guidelines in December last year - but I think that its a very interesting concept and worth a revisit.

Real estate in India has experienced exceptional growth since 2004-05, with some cities even experiencing a more than 50% price rise on a compounded annual basis. While pundits and the common man alike are slightly nervous owing to double digit inflation, rising crude prices, and a stumbling equity market - leading to a cooling of real estate prices in tier 1 cities, residential and commercial real projects in tier 2 and tier 3 cities are holding firm. 8 months have already passed since the equity market crash of January this year, and while many are forecasting a further drop in the markets, others are talking more optimistically about us already having bottomed out, and the interest rate cycle having peaked. This bodes well for the real estate market, and as inflation and interest rates start coming off over the next 6 months (we hope) - this will lead to a resumption of the real estate bull run.

With this backdrop, Indian investors are slated to have access to real estate investment trusts (REITS) as the country is poised to embrace deregulation and further formalization of its booming real estate market.

The move is driven in part by the demand fuelled by domestic players looking to implement ambitious expansion plans. Reits have been introduced in most of Asia’s leading markets (Singapore, HK and Japan) in the last seven years and the introduction of Indian Reits will prevent the profitable Reit business going overseas. Moreover, as property prices in the the US and elsewhere crumble in light of the subprime mess, foreign investors seeking to allocate their capital to real estate will seek to put their funds elsewhere - e.g. developing economies such as India, where although there has been recent turmoil, fundamentals are strong, and this may be a good opportunity to get in at a bargain. Reits would certainly be a mechanism that simplifies investment (more…)

In many ways the US has recently been facing the kind of balance of payments problems which have been seen many times before, but most often in emerging economies.

For several years now, the US has run a large trade deficit by feeding domestic consumption with cheap imports from emerging economies, most notably China. The large flow of money out of the economy was offset by inward capital investment from Europe, Asia and the Middle East.

Since the credit crunch started to bite, the stability of the US financial system has been called into question by the failure of Bear Stearns and the public difficulties faced by Fannie Mae and Freddie Mac. Coupled with the Fed policy of cutting interest rates to fend off a recession and the gloomy consumer outlook underpinned by housing market instability, the US has become a much less attractive destination for international capital.

Along with low liquidity in global markets, the deteriorating attractiveness of the US has put pressure on the dollar to weaken to keep the money flowing in. These were the main factors behind the dollar hitting lows against the EUR, GBP and JPY in Q1 2008.

However the dollar has strengthened in Q2 and the beginning of Q3, largely due to the weakness of other developed economies; the Eurozone and the UK flirt dangerously with their own recessions and the outlook for the Japanese economy looks little better. Whether the dollar rally will continue depends largely on three factors; firstly, whether the Fed can maintain stability (more…)

Given the recent news SEBI considering (but not doing anything yet) about revoking the P-note ban, I thought it might be a good idea to revisit the topic. Thank you to Akshay for passing on info that has helped me better write this post.

In India, only domestic investors, or ‘Foreign Institutional Investors’ (FIIs) - those foreign institutions that have registered with SEBI, are allow to invest into the equity markets directly. Participatory notes (P-notes) allow foreign investors, such as hedge funds, which are not registered with SEBI to invest easily in the Indian equity market.

Practically, the way that P-notes work is that a foreign investor - say a hedge fund - would deposit funds with an FII that is authorized to issue P-notes, who would use the funds to purchase shares as instructed by the hedge fund. The FII would then issue a P-note to the hedge fund, which is essentially a certificate that says that it is entitled to X shares of company ABC, and any capital gains or losses and dividend payments would be passed onto the hedge fund. In return for this service, the hedge fund would pay the FII a fee.

A crude example: If a hedge fund not registered with SEBI wants to buy one share of Hindustan Unilever Limited (HUL), their FII would pick up a share of HUL for Rs. 240 and write a contract that says that in return for a fee and the Rs. 240 paid by the hedge fund, when the hedge fund asks the broker to sell the share they will comply and pay back the hedge the Rs. 240 plus or minus the rise or fall of the share price and the dividends if there were any.

Because foreign investors bought P-notes from reputable FIIs (they knew that they wouldn’t go back on the agreement), and there was a healthy supply of P-notes going around, foreign institutions were able to trade these P-notes amongst themselves.

On October 16, 2007, N. Damodaran, the then SEBI chief issued a decision to curb foreign participation through P-notes as he felt that there was excess money being pumped into the Indian market unchecked leading to volatility - which is always bad thing, especially for the retail investor (more…)

It was widely believed that CS Bhave was strongly in favour of overturning earlier SEBI chief’s N. Damodaran’s decision to curb Foreign participation through P-notes (more…)

With the emergence of large domestic (Pantaloon’s Big Bazaar) and international players (Metro AG, Tesco, Tesco/Trent- read my post on this, Bharti/Wal-Mart) in large scale organized retail, I got to thinking – how does this affect the margins of consumer product companies such has Hindustan Unilever, Colgate-Palmolive, and Cavin Kare? On one hand, you might see margins (the different between how much you sell for and how much it costs you) on goods increasing due to a lower distribution cost – its easier to distribute 100,000 bars of Lux soap to one Metro AG in one go, than distribute that amount in rural India.

On the other hand, since these stores buy in bulk, they’re in a much better position to negotiate on cost – therefore pushing margins down. Moreover, many of these stores (more…)