Easy Cash Turns Killers for Indian Retail

The retail boom has come to grinding halt in India. Just a few months back Reliance had announced restructuring of its retail business. Then Subhiksha problem appeared, it was unable to finance its operations. Now, Vishal retail has run into trouble. The company is also facing liquidity crunch and is shutting down a large number of shops and cutting its employee numbers to stay afloat.

Easy money had made it possible for Indian retail companies to go for expansion mode straight from incubation. This had become corporate philosophy for expansion programs of major retailing companies. Every company in hurried desire to gain the first mover advantage had indulged in aggressive expansion on borrowed money. Once the liquidity problem stated becoming apparent in Indian market, these companies started facing cash trouble to run their operations. Easy availability of cash had led to more companies becoming overtly dependent on borrowed money to run their operations.

Subhiskha, like other retail companies over-ambitiously expanded everywhere leaving the company totally starved for cash. They didn’t bother either about its cash flows or cash reserves. This left company bewildered about its future and how to manage the current operations. Vishal Retail another darling of markets, followed similar path of growth and couldn’t see the situation getting out of hands.

Easy availability of cash in the market made retail companies short sighted with assumptions that markets would continue to grown and cash would remain available. This hypothetical assumption got translated into the business model, for which companies are paying today.

US Presidential Inuaguration and Market Gains

There is high expectation on Mr. Obama to deliver. Markets are banking on his economic proposals to revive the Wall-Street. Not all presidents have succeeded in matching the market expectations. If we look at look at the presidential inauguration since 1980s majority of presidents have given markets a respectable gain a year after their inaugurals.

Bill Clinton is the president who gave markets’ their biggest gain a year after his first presidential inauguration. It was whopping 28.9%, highest for any president sine 1980. he is the only president to have given markets positive gains in both terms as US president. Ronald Regan and George W Bush, are other two presidents who have been president twice. They are also the presidents who gave negative returns to the markets a year after inauguration of their first term. But they succeeded in giving markets a good gain a year after inauguration of their second term.

George W Bush has been the worst performers amongst all presidents since 1980s. Markets have gained only 7.4% a year after his 2005 presidential inauguration. His father George H W Bush had performed better, markets gained over 16% a year after his presidential inauguration in Jan 20, 1989.

It would be interesting to watch how markets perform during these turbulent times.

"The Worst Predictions About 2008"

"Just about everybody got wrong-footed by 2008, but some people's mistakes were truly spectacular. Here are some of the worst predictions that were made about 2008. Savor them—a crop like this doesn't come along every year.

1. "A very powerful and durable rally is in the works. But it may need another couple of days to lift off. Hold the fort and keep the faith!" —Richard Band, editor, Profitable Investing Letter, Mar. 27, 2008
At the time of the prediction, the Dow Jones industrial average was at 12,300. By late December it was at 8,500.

2. AIG (AIG) "could have huge gains in the second quarter." —Bijan Moazami, analyst, Friedman, Billings, Ramsey, May 9, 2008
AIG wound up losing $5 billion in that quarter and $25 billion in the next. It was taken over in September by the U.S. government, which will spend or lend $150 billion to keep it afloat.

3. "I think this is a case where Freddie Mac (FRE) and Fannie Mae (FNM) are fundamentally sound. They're not in danger of going under…I think they are in good shape going forward." —Barney Frank (D-Mass.), House Financial Services Committee chairman, July 14, 2008
Two months later, the government forced the mortgage giants into conservatorships and pledged to invest up to $100 billion in each.

4. "The market is in the process of correcting itself." —President George W. Bush, in a Mar. 14, 2008 speech
For the rest of the year, the market kept correcting…and correcting…and correcting.

5. "No! No! No! Bear Stearns is not in trouble." —Jim Cramer, CNBC commentator, Mar. 11, 2008
Five days later, JPMorgan Chase (JPM) took over Bear Stearns with government help, nearly wiping out shareholders.

6. "Existing-Home Sales to Trend Up in 2008" —Headline of a National Association of Realtors press release, Dec. 9, 2007
On Dec. 23, 2008, the group said November sales were running at an annual rate of 4.5 million—down 11% from a year earlier—in the worst housing slump since the Depression.

7. "I think you'll see [oil prices at] $150 a barrel by the end of the year" —T. Boone Pickens, June 20, 2008
Oil was then around $135 a barrel. By late December it was below $40.

8. "I expect there will be some failures. … I don't anticipate any serious problems of that sort among the large internationally active banks that make up a very substantial part of our banking system." —Ben Bernanke, Federal Reserve chairman, Feb. 28, 2008
In September, Washington Mutual became the largest financial institution in U.S. history to fail. Citigroup (C) needed an even bigger rescue in November.

9. "In today's regulatory environment, it's virtually impossible to violate rules." —Bernard Madoff, money manager, Oct. 20, 2007
About a year later, Madoff—who once headed the Nasdaq Stock Market—told investigators he had cost his investors $50 billion in an alleged Ponzi scheme.

10. A Bound Man: Why We Are Excited About Obama and Why He Can't Win, the title of a book by conservative commentator Shelby Steele, published on Dec. 4, 2007.
Mr. Steele, meet President-elect Barack Obama.

A good compilation for Forecasters."

Government to Relax ECB Norms

At a time when funding has become increasingly difficult for corporates across the globe for expanding capacity and growing businesses, since global economic slowdown made the lenders apprehensive of funding projects. The government is expected to relax norms, as early as next week, to make it easier for domestic companies to raise money through External Commercial Borrowings (ECBs), in a bid to boost a slowing economy,

Among measures recommended by the committee of secretaries include, permitting realty firms to tap ECBs, relaxing borrowing norms for non-banking finance companies (NBFCs), increasing the ECB limit 50 per cent to $750 mn under the automatic route (without RBI’s approval and raising the price ceiling at which overseas loans can be raised.

At present, real estate firms are not allowed to tap the ECB route and NBFCs are allowed to borrow within guidelines specified by the Reserve Bank of India (RBI). For the real estate sector, norms could be relaxed only for integrated township projects, realty firms were demanding infrastructure status for real estate apart from using ECB proceeds without restriction.

Earlier in the year in October, the government had permitted companies to use the ECB route up to $500 mn per financial year for rupee expenditure under the automatic route (see table). In addition, the India Infrastructure Finance Company Ltd (IIFCL) was allowed to raise Rs 10,000 cr of tax-free bonds and function as a refinancer for the sector.

Project awards by authorities such as the National Highways Authority of India have come to a virtual standstill because of, among other things, concerns over the viability of projects and high interest rates. Meanwhile, the government has decided to revise upwards cost estimates of 60 highway projects worth Rs 70,000 cr by up to 20%, to help road developers borrow more funds and boost road building activity across the country

The government is also expected to relax the pricing allowed for borrowing foreign exchange loans by raising the spread or premium charged over the international interest rate benchmark, the London Interbank offered rate (Libor). At present, a company cannot pay more than 300 bps over Libor on loans for three to five years and not more than 500 bps over Libor for loans above five years.

Montek and Chidambaram mock India’s Economic Scenario

Montek Singh and Mr. Chidambaram for past few days have been giving some really exaggerating statements about the economy. They continue to assert that Indian economy will grow at 8%. Now, how that suppose to happen. The global credit lending is expected to come down drastically during next year and India desperately needs it to continue its infrastructure and capex. Indian companies were already raising debt for international market as credit rates in India were high. How are Indian companies expected to grow at same rate in this inconducive economic environment? Plus they were quick to add how fundamentally strong Indian economy is.

How come economy be fundamentally strong where commodities are playing havoc to the economy, crude prices have endangered the aviation sector and is pushing inflation, housing boom is about to go bust with high credit rates and our exports are threatened due to global slowdown. They were not done yet, they made another comment on liquidity situation.

Yes there is liquidity problem, there are not many ready to lend to consumers and corporates are finding it hard to credit at lower rate (which is next to impossible). There is credit problem in the economy, but what about the money that FIIs have brought into the market by selling share and converting them into dollars! The problem, we don’t think is of liquidity in the capital markets but of leveraging and speculation on cheaply borrowed money. Now that it is difficult to leverage and get cheap credit there aren’t many players to do so in the stock markets. So, we have more and more selling and less numbers of buyers.

IRDA Defers MTM Rules for Insurers, Mulls Benchmarks & Disclosures to value Insurance Companies

Giving a huge reprieve to the insurance industry and saving it from losing several hundred cr this financial year, the Insurance Regulatory and Development Authority (IRDA) has postponed making it mandatory for insurers to mark-to-market (MTM) their portfolio in gilts from this fiscal. IRDA had issued a circular in March 2008 asking insurance companies to value gilts at the lower of the amortised cost and the market value to compute the solvency margin from this fiscal. But, the plan has been deferred now as the regulator is yet to finalise guidelines on segregating the investment portfolio.

The MTM rules would have hit the solvency margins of insurers if it would have been implemented from this year. Solvency is the ability of an insurer to pay claims. Solvency margin is the excess of assets over liabilities that an insurer maintains as a prudential measure in the interest of policyholders. It is similar to the capital adequacy ratio (CAR) for banks. The solvency margin guidelines are structured in such a way that insurers have to bring in more capital as their business goes up. With businesses having grown sharply, insurers are feeling the pressure of maintaining solvency margins at 1.5% of the statutory requirements. If the companies were to mark-to-market all debt capital available for meeting solvency margin requirement would take a hit.

The banking industry too has been already been hit hard by the rise in the yields on government securities. However, they have been protected to some extent as the regulator allows them to classify most of their debt investments as ‘held-to-maturity’. Such a classification shields these securities from the mark-to-market requirement. Insurance companies have been demanding a similar HTM category.

IRDA has deferred the MTM requirements to help companies adhere to their solvency requirements. Else, the margins would have taken a knock in a volatile market where interest rates are moving up. Hence, companies will continue to follow the book value method for computing the value of debt they hold for solvency margins.

IRDA is also on track to develop commonly-accepted benchmarks and disclosures to value insurance companies as this would be crucial when Indian partners dilute their shareholding. The present regulation requires Indian promoters with a majority shareholding to dilute their stakes through an initial public offering (IPO) at the end of the tenth year of operations.

Valuation of companies is generally based on the price-earning (PE) multiple, a high PE multiple suggests that investors expect higher earnings growth in the future. But this exercise is much more complex for insurers. Once an insurance company receives the premium from the policy holder, there are various things that the money goes into before getting invested such as the money for commission and other marketing expenses. The balance is invested in debt and equities and interest is added to the original investment. Then, on the date of valuation the solvency margins and mathematical reserves are deducted from this corpus.

The balance amount in the corpus is used to pay claims and the net money that is available is the profit. If the insurance product is a participating product eligible for bonus only 10% of the profit belongs to the shareholder. The balance is used to declare bonus and belongs to the policy holder. If it is a non-participating product, the entire profit belongs to the shareholder. Hence, the profit can vary widely as the actual experience may differ from what has been assumed in pricing cost, claims experience, investment yield and so on. In the worst-case scenario, the projected profit will be much lower than what has been assumed in the pricing. Valuation of insurers, hence, hinges on the assumptions and hidden profit which can fluctuate wildly.

Internationally, this issue has gained prominence with professional bodies setting valuation norms. Rating agencies event comment on these norms. Further such issues are expected to take the centre stage, when the industry consolidates through mergers and acquisitions. Currently, the new business achieved profit, which reflects the value of a company’s earnings potential under a set of assumptions is used for the valuation of insurers. Another method is the embedded value method or the value of the existing business in the books of the company.

Figures - India’s insurance sector accounts for around 5% of the GDP and has the largest number of life insurance policies in force in the world.

Finance Ministry mulls changes in ADR, GDR pricing formula

In a bid to aid Indian companies to raise money overseas, especially in the present falling market, the finance ministry has proposed changes in the pricing formula for global depository receipts (GDRs) and American depositary receipts (ADRs). In falling markets, the current pricing norm effectively results in the overseas issue being priced farther from, and higher than, the prevailing domestic market price. Companies wishing to tap the overseas market may not do so as the offer price is not right. The ministry has proposed to reduce the time period for calculating the minimum offer price for overseas issues to two months from six months earlier.

The government move comes after representations from companies and intermediaries that the pricing formula effectively shuts out the fund raising avenue. Companies have struggled to find takers for these issues as the shares are available cheaper on the bourses.

Currently, the ADR/GDR issue price is determined on the basis of the higher of the last six months’ average price or last 15 days’ average price. The idea to keep six months average price was to avoid promoters from doing bulk allotment at a discounted price. The logic was that the promoter or interested parties cannot artificially depress prices for such a long period. The finance ministry has now proposed to reduce it to the higher of the two months’ average price or the last 15 days average price. The new pricing rules are expected to reflect accurate and more realistic prices of the ADR/GDR issues.

Experts in the industry have come out with mixed opinion for the move as some feel that the timing of the issue is more critical, whether two months or six months, especially in the present volatile markets. These are the companies which are in desperate need of alternative financing routes as debt becomes scarce and expensive in the local market as the Reserve Bank unleashes anti inflationary measures. It is more important to give companies a free hand on pricing, they feel. However, many experts also feel that the reduction in time period will help companies come out with far better realistic pricing than the previous waiting period helping them raise money.