Reliance: Staying sane during insane times (excess liquidity times)

The economic slowdown had hit everybody hard and RIL is no exception. Many of its projects like Reliance Retail, SEZ etc have been affected. But if one looks around RIL has managed to control itself really well during the Insane Years of 2005-2009. Not only it managed to focus and complete its major Greenfield projects – KG D6 oil & gas project, Jamnagar 2^nd Refinery project, East west pipeline project in time, but it also managed to stay sane and avoid the lure of mega international acquisition unlike its peers. And staying sane in such insane times is no mean achievement. If you don't agree, ask Tata, Birla or Mittal.

Last few years had been really mad years. Factor of production (land, labor & capital) prices had hit the roof and most businesses were unviable at market value of factor of production (not to be confused with historic value). The only way people could make money was by selling out stake or the business to public through IPOs, to private equity firms, to strategic investors or to competitors. The best and the biggest company in India fell for the lure of international acquisition including Tata group, Birla group and also the Mittal group. Ratan Tata had been bold enough to admit in public that they ended up buying Corus, Jaguar & Land Rover at peak prices and it had been a big mistake.

Others like Birla, Suzlon and Mittal had been equally foolhardy and now realize that they made a mistake although they might never admit in public. On the other end of the spectrum had been players like Ranbaxy who managed to exit the business at a very good price. We may keep arguing that selling out completely made sense or not but we all will agree that timing was amazing.

So why did it happen? Do these companies don't have smart people who can advise the management properly? I don't think it's a skill set problem (Finance Problem). I believe it's an individual's interest Vs Company's interest problem (HR Problem). I see a systemic problem here. The system has a built-in bias towards occurrence of the deal. The system incentivizes people who vote for the deal and penalizes who vote against the deal.

Today corporate world is designed in a fashion where you are paid incentives and bonuses for making deals and not for voting against it. Investment bankers make money when deal is done; consultants make money when deal is done. Even the company's in-house managers reap benefits in form of bonus, recognition in the organization, additional responsibility when the deal is done and a sane advisor who advises the management against it is a looser both ways. If the management goes ahead with the deal the one who advised in favor of the deal get the recognition, responsibility of the new company and all associated benefit. In case management decides against it for any reason, nobody gets anything. Hence, advising against the deal is a lose – lose strategy.

From Investment bankers to Media, for everybody occurrence of the deal is beneficial and hence in most cases the deal happens. Again, higher the value of the deal, higher is the commission (for I-bankers, consultants and experts), higher is the interest of the public (for media), and higher is the recognition & responsibility (for in-house managers). And to top it all the excess liquidity in the system, thanks to Mr. Alan Greenspan & company made sure arranging funding for it was never a problem.

So what helped RIL stay sane when others could not resist the temptation? This is despite Mukesh Ambani declaring in two consecutive AGM, the company's ambition for international acquisition and change of strategy towards inorganic growth. It seems there were few in RIL who were ready to take lose-lose strategy for self in the interest of the company. I hope RIL if not rewarded, at least recognized these selfless employees.

How the Financial crisis could have been handled better by the Bush Government

The way USA government is handling the Financial crisis is blasphemous and I believe they are living in fool’s paradise. A country which is threatened by outsourcing of jobs to country like India & China is able to dole out bailout of a Trillion dollar with such frequency!! To put things in perspective India’s GDP is around $ 1 Trillion per annum and that of China is around $ 4 Trillion per annum. (USA GDP is around $ 14 Trillion per annum). According to my estimates USA government has doled out around $ 8 Trillion as bailouts in the last 12 months. It works out to 8 times India’s GDP, 2 times China’s GDP and almost 57% of USA’s GDP!!! If USA government is made to payout 12% interest (rate of interest in India) on the bailout amount, USA would be paying interest equivalent to India’s GDP each year!!!

I believe everybody agrees that the financial crisis had been handled very poorly by USA and they have managed to survive due the Dollar Hegemony, otherwise they would have had the fate similar to that of Zimbabwe – mindboggling inflation rate with domestic currency rendered worthless. (I believe eventually USA will have to pay for it and dollar will crash soon).

I believe the Financial crisis could have been handled by following simple steps listed below. Why it was done the way it was done puts in question both - Bush government’s intelligence and the vested interest:

1. Guarantee total current, saving and fixed deposits in banks for 5 years: (currently FDIC guarantees deposit upto $ 200,000 per customer per bank). This would have taken care of the confidence crisis and people would have deposited money in banks without fear. It would have helped increase liquidity with banks and increased their deposit : lending ratio
2. Make all deposits in banks tax free for 5 years: This would have given incentive to save to US nationals. Currently savings rate in USA is almost negative and is one of the biggest reasons for the current crisis. This would have also reduced the cost of funds for the banks as deposit rate expectations of customers would have decreased. It would have also made bank deposits more attractive investment option in comparison to other options.
3. Provide banks with tax holiday on interest income for 5 years: This would have reduced the cost of funds in the economy and would have increased investment activities in the economy. This would have also made the banks balance sheets stronger.
4. Let the weak bank to fail and file for bankruptcy under Chapter 11: No bailout should be provided to any bank or company before it files for Chapter 11. Chapter 11 has been designed to provide businesses an opportunity to reorganize and survive if the possibility exists. If the banks / companies donot have inherent strength to survive they should be allowed to die. Contrary to the myth created by the Bush government, closing of few banks will not destabilize the system if depositors are protected. Jobs are not lost or created by such bailouts. If the business makes sense somebody will buy out in part or whole of the bank otherwise some other banks will grow to fill the void left by the failed banks – creating more jobs and business activity.
5. Strictly penalize wrong doers: The current US government plan is rewarding the wrong doers by giving out bailout. It should be doing exactly reverse. Negligent and reckless traders and bankers should be strictly penalized to create examples for others.

The above plan is superior to the plan used by USA government due to following reasons:

1. Incentivizes savings rather than expenditure: USA government has created a myth that an economy grows by spending more rather than saving (& investing) more. And hence they had been spending recklessly specially during the last 8 years. Sooner they get rid of this false notion the better.
2. Takes care of the confidence crisis: Full security of deposit creates confidence in banking system. People will park their saving in banking system without any fear as it would be as safe as US government security. We can see that there is so much fear currently that people are willing to park their funds in US government securities at almost 0% rate of return.
3. Makes banking fundamentally stronger: Tax holiday of 5 years on both deposits and advances makes the banking business fundamentally stronger. The spread for the banks improve, thus improving their profitability. It also reduced the cost of fund in the economy, which would stimulate investment and demand.
4. Fair and equitable: One of the most important reasons why this system is better than the Bush government’s plan is that it’s fair and equitable. It doesnot protect only the banks which are “too big to fail”. It spreads the benefits to depositors, borrowers, mortgagees, small and medium enterprise & businesses. Who should survive and who should not is decided by the market forces and not by Mr. Paulson.
5. No moral hazard: The proposed system doesnot provide any incentive to wrong doers. It also doesnot create a feeling of being cheated to people who had been handling their finances properly. It stops the practice of expecting bailouts on the pretext that others have got the same.
6. Lets the market decide: The incentive (in form of reduced taxes) is fairly divided among people who are saving and people who are borrowing for justified causes. On the other hand banks which are reckless and negligent are thrown out of the system. It’s the survival of the ones who manages their business well and Chapter 11 for the one who can’t.
7. Substantial less cost to the taxpayers: The cost to taxpayers in form of reduced tax collections from deposits and advances and from protecting of deposits would be substantially less than the billions of dollars of bailouts currently being doled out.

Terror Attack: What India should do now?

Everybody agrees its time to take hard decisions and our soft approach is costing us dear. At the same time world economic situation is grim and we should not loose focus on Economic growth. We should remember that the terrorist were targeting our economic growth and we should not let them win.

So what should we do now?

Diplomacy – Foreign Ministry

The need of the hour is tough diplomatic stand by India. The world is in far worse financial condition than India and they too can’t afford an India – Pakistan face off. Its time we assert ourselves and claim our rightful position in the world. I suggest following diplomatic steps:

1. Stop all diplomatic talks with Pakistan as Pakistan is a divided nation without a single command. The elected representatives are just lame ducks with no control over armed forces, ISI and other organizations. We should communicate to the world the futility of any talks with such lame duck government. We should cite example of Kargil war where Nawaz Sarif admitted that army / ISI acted without informing the elected government. The coup that followed is enough proof of that. Condition is no better today.
Declare that India will not enter into any talk with Pakistan until we have 24 terror free months. No cricket, no sadbhavna buses and trains and no trade.

2. Take a hawkish stand in front of the world. Tell USA that we supported them when they needed us and now its time for them to return the favor. Play back the video to them with Bush’s famous lines like “either you are with us or against us. There can be no fence sitters.” Tell USA, Israel etc that we have common enemy and we need to destroy them. Anyway USA is bombing Pakistan border which is a proof enough that we have ‘commonality of purpose’.

3. Show to the world that we have enough proof of Pakistan hand in the terror attack. Ask US and other intelligence agencies to come and work on the case with India team and see the proof themselves. Satellite phones, level of training, sophisticated weapons will provide enough proof of its origin. We don’t care which part of Pakistan – elected government / Armed forces / ISI is behind the attacks. For us all three is Pakistan and we need to ‘neutralize’ them. Tell the world that proof is much more than ‘weapon of mass destruction (WMD)’ proof provided by USA government and failing to support India this time would be a proof of ‘double standards’. (Famous lines of Obama where he admitted that he didn’t understand why USA attached Iraq during election campaign should be used to rub the point in)

4. Force the world to deny any bailout package for Pakistan. Recently IMF gave a bailout package of around $ 8 billion to Pakistan to tide over the economic crisis. India should fight hard against any such financial support to Pakistan. We should clearly communicate that Pakistan is using these funds to fund terrorism against India and financial support to Pakistan is equivalent to supporting terrorism. Similarly force USA to stop all financial and equipment aid being provided to Pakistan armed forces on the pretext of war against Al-Qaida / Afghanistan. Tell them that indirectly they are providing sophisticated weapons to India’s enemy which is promoting terror attacks in India.

Internal systems - Home Ministry

1. Modernize the security system: Need to make use of best technology available. Make sure we atleast have equipments better than those of terrorist like Satellite phones, AK – 56 / MP 5 etc. We should be investing in sophisticated weapons & armored vehicles for our forces and not luxury cars for bureaucrats.

2. Transfer 50% VIP security budget to anti-terrorism security: Transfer 50% of the budgeted amount meant for VIP security to security of public places. This would show that politicians are concerned. It’s important that politicians feel more venerable to terror. Otherwise we will breed RR Patil (Maharashtra’s home minister) like thought process that “in big cities such small things happen.”

3. Have a single Anti-terrorism body with enough decision making powers during emergency: We all must admit that the way we handled operations after the attack happened left too much to desire. The time taken by NSG to come to Mumbai, decision time to send them, availability of aircraft for them, weapons and training, communication systems, everywhere we were lacking. There was obvious lack of coordination between different forces which was evident from handling of general public and media at terror sites, sharing of information between different forces etc. Again we here that information relating to terror attack was available in parts with different government bodies. We need to have a single body where all such information flows so that we can solve the zig-saw puzzle in time.

4. Spend more on intelligence gathering & information systems: Every country has intelligence system which generally is beyond the petty politics. We also need to invest in a high-tech information system. We need to place more CCTVs in public places / have central control rooms to monitor these cameras placed at railway stations, markets, malls, hotels etc. Al five star hotels have CCTVs. We should team up with communication companies and use their unutilized optic fibre to have option of transmitting these feeds to central control centre in times of need. We also need to guard our borders better. Accepting bribe to allow any kind of traffic across border should attract highest level of disciplinary action.

5. Cut support to terrorism: Terrorism can’t survive without support from insiders. We need to make sure that all funding to terror organizations is nibbed from the bud itself. These organizations collect contributions in name of religion from people who are generally unaware of the purpose for which these funds would be used. We need to communicate in clear terms to people that any direct of indirect support to these organizations knowingly or unknowingly would be treated as act of supporting terrorism and would be dealt with strongly. Ban all organizations like SIMI etc. that support taking law in their own hands in name of militancy / freedom etc. Any donation in cash or kind to these organizations should be considered as an act of supporting terrorism. Also make strict laws against other sources of funding for these organizations like drug trafficking, etc. Generally drug trafficking and other such traffic across international borders and terror traffic use the same routes.

Concluding remark

First step towards solving a problem is to understand the problem and admit the nature of the problem. We need to admit that Pakistan is no more a single nation with single head of state. Pakistan is a fragmented divided nation where various government and non government bodies are trying to exercise control. We also need to admit that they are getting support from Muslim fundamentalists inside India and they are prospering due to our vote bank politics.

Once we admit and understand the problem solution would be simple. As done in a war first cut the supply lines of the enemy and then strike when they are weak. We need not go into war against Pakistan immediately although we should act hawkish and should be mentally ready for it.

We should kill Pakistan by isolating them & cutting all their supply lines. We should make sure that they don’t get the promised IMF package and any other bailout. We should go for war only if the world tries to act soft on Pakistan, in which case we Indians will have to take an assertive stand. And if and when we go to war we should make sure that then there is no looking back. We should divide Pakistan into bunch of primitive tribes which would keep fighting among themselves with primitive weapons and let us live in peace.

Admit it! The root cause of current crisis is OVERVALUED DOLLAR

….and the only solution is to devalue it.

The world leaders are giving the current crisis different name like “Sub Prime Crisis”, “Liquidity Crisis” etc etc. But any person with basic common sense can tell that sub-prime or liquidity can’t be a big enough issue to put the world economy in doldrums. The root cause needs to be diagnosed. Until we admit to the problem, we would be taking wrong medicine.

Let’s diagnose the disease. We have divided the symptoms based on the partial diagnosis made by leaders till date:

So called “Sub-prime Crisis”

1. US consumers are defaulting on housing loans & other loans in big numbers
2. Per capita consumption of US nationals has been 2x-3x in comparison to that of nationals of other developed nations. (per capita consumption of cars, steel, cement, crude oil etc)
3. USA’s fiscal deficit for the last few years is in excess of $ 400 billion each year

So called “Liquidity Crisis”

4. The world holds their savings / foreign currency reserve in USA securities. As it’s the world’s standard currency. And as the return on govt. securities has been falling other the years, nations have started investing in quasi-government organization’s securities like Feddie Mac and Fannie Mae.
5. The world has been buying these debts having faith in USA’s credit worthiness and credit worthiness of its institutions
6. USA financial institutions have packaged and repacked housing, credit card and other debts in form of CDOs etc and sold it to the world. Now these financial institutions are going bankrupt

So called “Outsourcing” problem

7. USA is dependent on China and other countries for most of its consumption. USA is importer of almost everything. Salary and cost differential in USA is leading to outsourcing of major chuck of goods and services from developing countries
8. Most of USA manufacturing industry is dead. US automobile companies are about to go bankrupt. Japan & others are able to build better cars at lower cost. IBM has sold out the hardware business to Lenovo.
9. Salary level in USA is substantially higher than in developing countries, which is leading to brain drain problem for developing nations and job loss problem for USA.

So called Consumption led "growth”

10. Standard of living is higher than rest of the developed world. Per capita consumption of US nationals has been 2x-3x in comparison to that of nationals of other developed nations. (per capita consumption of cars, steel, cement, crude oil etc)
11. Consumption has been growing without increase in jobs. Salaries are high despite of limited skill advantage. Imports has been growing and exports have been falling
12. China & other countries had been investing their foreign exchange reserve in US securities against nominal return of 2-3% when opportunity cost of the fund is much higher

Diagnosis:

Point 1-3: USA as a nation and US nationals has been living beyond their means. Consumption led growth has been financed by debts which has started to haunt USA

Point 4-6: World has been duped by the financial engineering of US financial institutions and misplaced faith in USA’s credit worthiness. However, now the world is slowly realizing the risk & mistake

Point 1-6: The world economy growth in last few years was led by unsustainable debt driven consumption by USA. Problem in servicing of debt is leading to world economy going into financial crisis.

Point 7-9: USA has become inefficient and high cost economy. They are unable to compete even in traditionally strong sectors like automobiles, IT hardware etc.

Point: 10-12: Consumption in USA has been growing despite of fall in production activities because developing countries had been subsidizing USA consumption by investing in dollar denominated securities with nominal return.

Actual Disease:

Dollar is Overvalued

Point 1-12: USA currency is overvalued. Due to overvaluation imports are cheaper and exports are costlier. Hence import led consumption is increasing while manufacturing is falling. Overvalued dollar has killed domestic industry and has made US economy inefficient.

“Invisible hand” is absent

Point 1-12: If it was any other country the demand and supply of Dollar would have corrected the currency imbalance. However, as Dollar is the world’s standard currency of trade – the excess supply of dollar had been leaking away into foreign currency reserves of other countries in form of US securities. As other nations were ready to lend to USA against its nominal rate securities USA has accumulated unsustainable amount of debt which it is not in a position to pay back.

SOLUTION – DEVALUE DOLLAR!!!!!!!!

Therefore the only solution to the current problem which we prefer to call ‘Dollar Hegemony’ is to devalue dollar. My estimate is: 40 to 50% devaluation in dollar is required to bring it to parity. And of course dollar should loose its “World’s standard currency of trade” status.

The implications:

Positive for US:

1. Fall in real value of outstanding debt: As dollar value will fall by 50% the value of debt in real terms will also fall by 50%. Again value of houses in dollar terms would double. This would be a big relief for the mortgage market and can help turn it around. It will help US nationals deeply in debt.

2. Manufacturing will become competitive: Salaries in USA will adjust automatically. They are at unsustainably high levels which is making USA uncompetitive. Once dollar is devalued by say 50% automatically salary in USA would fall in 50% in real terms. Making USA industry competitive again. Companies like General Motors etc will be able to compete against Japanese and German cars. Salaries & other retirement benefits of US employees is the major issue pulling these companies down.

3. Imports will become uncompetitive: Imports from countries like Chine etc are undervalued due to overvalued US dollar. Once exchange rate is readjusted imports will become uncompetitive restricting unsustainable level of import driven consumption

4. Job creation: Increased manufacturing activities and reduced imports will lead to job creation in the economy. Foreigners like Indian nationals who are taking up large chunk of US jobs in IT, technology research, doctors, nurses etc will find it no longer viable to move to US as in rupee terms their salary is US would be reduced substantially. Outsourcing problem would be solved to a great extent.

Negatives:

International Impact: Devaluation of Dollar will have a huge international impact. Countries like China which hold substantial foreign reserve in dollar denominated securities will suddenly see their reserves depreciating by as much as 50%. Devaluation of dollar will make their exports to USA uncompetitive leading to large scale unemployment and bankruptcy in their country. This will create social unrest through out the world. It can lead to war between nations for resources.

Crash of financial system & global trade: The whole financial system which is today based on faith in US dollar will come crashing down. The world will need to devise a new order for trade and financial settlement.

Elasticity of import & exports: Not all exports and imports are perfectly elastic. Oil imports will not fall substantially in volume in short term. Similarly replacing IT talent of India would be difficult in short term. Similarly for exports, even if the prices fall substantially volume of exports might not increase for arms and ammunition etc.

Savings & Retirement fund: People who had been saving rather than going for debt driven consumption would be penalized due to wrong doing of borrowers. It will create a moral hazard. Their saving would depreciate by 50% overnight in real terms and they might not have enough retirement funds to take care of their old age.

Conclusion:

The international repercussion of Dollar devaluation is so grave that it can’t be done overnight. It has to be a slow process with enough time for nations to adjust. Countries need to be given time to liquidate their dollar denominated foreign exchange holding. World also need time to device and operate new financial and trade order.

But what need to be done immediately is to recognize the real Disease. The world currently suffers from Dollar Overvaluation. Admitting to the disease is the first step. Denial will only aggravate the disease and create other complications due to wrong medicine. Unless we come out of denial mode world will not start moving in the right direction. Bush & Paulson of the world might say that ‘fever’ called sub-prime crisis / liquidity crisis has been cured but it will come back again and again in some form or other – Bear Stearns / Lehman Brothers / AIG / Citi Bank / General Motors / Ford / Chrysler / …………………………………………

Open letter to Prime Minister of India (Sh Manmohan Singh)

Dear Sir,
The financial crisis faced by the world is a graver situation than that of managing the stock market. What Finance Minister Sh P. Chidambaram is doing currently is pushing the dirt under the carpet and hoping it is not uncovered before the next elections.
To be fair to you the current problem is US making and not of your making but this Financial Tsunami is not fair in its impact any would destroy everything that comes on its way. In 1991 you built the dam of Globalization that powered & irrigated our fertile land for almost two decades. But today this dam is in risk and it can destroy the fertile land. You being the architect of the dam knows better than anybody else how to save the dam of globalization destroying own lands.
We need to do two things urgently to avoid importing the US financial crisis:
1. Diversify the foreign exchange portfolio and move out of US treasury bonds and other dollar denominated financial instruments.
2. Start trading in Crude and other major foreign trade items in Euro and other currencies rather than dollar. At least diversify
As you know law of demand and supply applies to all currencies except dollar due to dollar hegemony. The dollar is already over valued due to this even after years of fiscal deficit and relentless borrowing. However, the current financial crises pose a real risk to dollar and dollar hegemony. All the billion dollar looses that US government is nationalizing has to be paid somehow and ultimately it would be paid by printing more dollars. And as you know very well, printing more dollars means distribution of USA loses to the world.
The printing of dollar, inflation and depreciation of currency is a very slow process and something that can be handled in the long run. The risk current situation poses is sudden devaluation or crash!!
The world is currently standing on thin ice which is melting with each passing day and everybody is wishing that it never reaches a situation when we go down under. The current crisis is sign of crack on the thin ice floor. If we all keep standing till the end we all will go down into great depression soon. As the cracks become big, grave panic would be created and one or few of the members would try to run to the safer place. And we should remember that goliath named China is also standing with us on the same thin ice and if he moves, due to its weight the ice floor will surely break. We have to make sure that we more to a safer place before the goliath begin his move.
(The thin ice here is Dollar based financial system where all major international trade is done in dollars including crude & petroleum products and major share of foreign exchange reserve is kept in dollar denominated securities. People standing are nations who are part of the international financial system and the cracks are the financial crisis. Going down under is Great Depression & the safer place is a world of neutral currency with no single currency hegemony).
China has more than trillion dollar of foreign currency reserve and most of them are parked in low interest paying dollar denominated securities of US institutions like Freddie & Fannie. Sooner than later China will realize that US government with its increasing nationalization of loses would not be in a position to return back these reserves. The only option for US govt is to print more currency to pay back China and others and that would create excess dollars in the world economy leading to collapse of the currency. China to reduce the loss would start moving out of dollar into other currencies or Gold. Or if it’s a fools and doesnot understand the risk of thin ice would force US government to increase the interest rate on these securities. Either ways, the US will be faced with increased financial crisis and the current financial system will collapse.
Again shift of oil trade to other currencies would reduce the demand for dollar required for oil trade and hence the currency will collapse.
Believing that not moving can save us all is foolhardy. One: sooner or later somebody will panic and run across the cracking thin ice floor. (in fact few countries have already started the move). Otherwise the foolhardy US financial management will ensure that the ice melts so much that the whole world goes down into great depression. USA is rooted in his own system and it can’t run. Its time that we desert him otherwise we all will go down with him.
Its time the world decide to move to a world of neutral currencies where value is derived from demand and supply and no single country has enough power to govern the world financial system. The only thing that is stopping us all is the ‘fear of change’. In the long run, the new world would be better than the current one for all of us.
Sir, I hope as in 1991 you will be bold enough to drive the change rather than closing your eyes to the thinning ice hoping that we don’t go down under before the May elections.

Regards,
Neeraj Gutgutia

“Distress Sale” is keeping Dollar Strong temporarily

The US financial companies are falling like bunch of cards, the economy is in recession, and import bill is rising still Dollar is becoming strong. What’s happening?

“As our U.S. trade problems worsen, the probability that the dollar will weaken over time continues to be high. Running a huge trade deficit is costing us money, sooner or later. Already the prediction I made last year about one fall-out from our spending binge has come true: The ‘investment income’ account of our country - positive in every previous year since 1915 - turned negative in 2006. Foreigners now earn more on their U.S. investments than we do on our investments abroad. In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience ‘reverse compounding’ as we pay ever-increasing amounts of interest on interest.” – Warren Buffett

The USA economic performance and current financial crisis should and will lead to depreciation of dollar. My bet is this crisis would dethrone Dollar from being the “standard currency” of the world and this phase would go down in history as end of dollar era. (Read: End of Dollar Hegomony)*

Against the general logic dollar is appreciating due to fire sale or distress sale by US companies. US companies are selling out their investments (equity investments in developing markets, bonds etc), subsidiaries (Citibank, Lehman Brothers) to strengthen their balance sheets. They are also selling out stakes (Citibank, Merrill Lynch etc) to Temasek and Saudi funds of the world at ‘fire sale’ price in distress attempt to survive. This temporary phase of ‘fire sale’ is leading to fall in buyer country currency and appreciation in Dollar. The temporary upside blip is due to unsustainable capital inflow.

For the time being this may lead to appreciation in Dollar but it is also reducing the future income of USA from abroad. Temasek and Saudi investors of the world will be taking out dollars from USA every year in form of dividends, salaries and expenses.

Apart from future income this fire sale is also reducing the US aura that was derived from these financial institutions. USA is no more ‘the land of endless opportunities’. Soon US B-Schools won’t be as attractive place to study as finance institutions retrench jobs. The fall of these might corporations like Bear Stearns, Lehman Brothers, General Motors, Merrill Lynch, Citi group would end the awe that people have for USA. And with the awe “Made in America” brand would loose its premium.

Biggest Export of USA is neither Intel Chips, nor Boeing Aircrafts, nor McDonald burgers nor Microsoft Windows. The biggest export of USA is Dollar (as investment good). As a result of this financial crisis the world will stop seeing dollar as an attractive investment and that would be the demise of Dollar. And then Dollar depreciation would lead to further depreciation of dollar as US exports & imports are fairly inelastic.

*PS: Sanjay Kaler thanks for sharing this Ron Paul speech. This is the best piece of info I have read on this topic till date.

‘Confidence’ is the underlying asset for Dollar. Do your own valuation of ‘Confidence’

I have lost confidence in US Dollar and I am betting that Dollar will soon crash. These sorts of things don’t happen very often and therefore so called ‘experts’ (Microsoft Excel operators) will not be able to predict it. But once in a looooooong while these things happen as it happen with Russian Rouble. Russia was looked upon as superpower when that happened and predicting crash in their currency was nothing less than blasphemy then. Eventually it happened and then people marked those events as end of USSR era. I believe the current period will go down in history as end of USA era.

As I had mentioned 3 years back here in my blog the underlying asset to Dollar is Confidence and not Gold as it should be. And as you know the confidence is a very fickle asset, you don’t know when it disappears.

Newsweek: "Americans are glum at the moment. No, I mean really glum. In April, a new poll revealed that 81 percent of the American people believe that the country is on the "wrong track." In the 25 years that pollsters have asked this question, last month's response was by far the most negative. Other polls, asking similar questions, found levels of gloom that were even more alarming, often at 30- and 40-year highs………… "

Dollar is the prime currency today and is the standard for international trade. Almost all of international Crude Oil trade happens in Dollar. Most of the trillion dollar reserve held by China is in Dollar and same is true for more than 300 billion dollar reserve of India.

For decades now dollar has been the acceptable standard and nobody ever questioned it. After the Bretton Woods Agreement in 1944 when dollar became the international standard for trade, USA was supposed to keep Gold as underlying asset. However, in 1971 USA, unilaterally, has done away with that practice and has been happily printing Dollar ever since with Confidence as the only underlying asset. Till date Confidence has been an appreciating asset all the while with USA companies ruling the world economics. But with the turn of events over the last 12 months – Housing price crash, subprime, Credit crisis, bankruptcy of banks and financial institutions, bankruptcy of automobile companies - USA looks much more venerable today. This bubble has built up over the years as USA kept borrowing from the world to meet the domestic consumption bill of its nationals. CDOs etc had managed to delay the inevitable by creating fake confidence, but then it can only delay.

I believe the current government will continue to delay the inevitable will all kind of financial jugglery just to keep Republican chance alive in the next election. But the new government will have to clean the house and we can expect Dollar Crash prediction coming true around that period. In the meanwhile like Indian Government, USA government will keep on increasing the deficit bill (by off balance sheet items) impact of which will be felt with a lag only after the elections.

Frankly all countries will get adversely impacted by the Dollar Crash in the short term but for the long term general good it’s high time that World practices some “currency diversification”. Few major impacts against which countries & companies should guard against are:

1. Holding all or substantial part of Foreign exchange reserve in Dollar or Dollar denominated US government securities. India and China both are running this risk and I believe many more country is doing the same. It’s high time that we diversify.
2. International trade in critical items like crude only in dollar is another big risk. You don’t know when exactly the music will stop and you should guard against being caught with the parcel when the music stops.
3. Financial instruments which increase your exposure to Dollar. In the current world of financial derivatives, carry trade etc there may be many financial bombs hidden in your treasury department which you might not be aware. Its time to check your cupboards.
4. There are other risk like too much dependence on USA for exports which is difficult to diversify in the short term (IT companies face major risk here)

Sudden move by countries like China and India to diversify there foreign exchange reserve risk or move towards crude trading in currency other than dollar can trigger the crash but we don’t have any other option but to walk the thin ice. Sooner than later the ice will melt.

USA Government and especially Fed are trying to avoid the inevitable. Now it’s a matter of your confidence in their capability to tide over this crisis. I don’t have the confidence and hence I suggest diversification. (Note even if the dollar crash doesn’t happen there is nothing to loose by diversification. Diversification to currency like Euro will only help in the long run).

When will the stock market bottom out?

At last the crash I had been waiting for such a long time seems to be here. I must admit the market remained irrational for longer time then I expected. But then it’s impossible to exactly time the market. By fundamental analysis you can just say what is logical and what is not. And now readers of my blog will admit that all I said is coming true.
Still doubt my capabilities? Lets have a bet on what would be the extent of correction of when can we say that the market has bottomed out. Game??
My bet is - the stock market will bottom out only after there is a steep correction in the real estate market. By steep I mean 40 – 50% correction!! We will see builders defaulting on loans and banks taking over projects. We will see few builders defaulting on their project commitment and customers running from pillar to post to protect their savings. We may see a couple of suicide or crime related to property prices crash.
People say analysts are generally not specific with their recommendations so that they have an escape route later. Well I will get as specific as possible. Running rate in Bandra East is Rs.12000 – 15000 per sqft and in Goregaon East is Rs. 8000 – 10000 sqft. Wewill see prices in Banda East falling to region of 6000-7500 per sqft and in Goregaon East to 4000-5000 per sqft. My bet is correction would be around 50% in these areas. And these are the prime areas – areas like Kharghar, other parts of Navi Mumbai will see steeper correction. People will realize that Airport, SEZ and Sea-link story are too far in future to price in today.
Logic: The logic behind it is simple. Cost of factors of production – Land, labor & capital has today become so high that most of the projects are intrinsically unviable. Specifically land.
The sunrise industry of this boom of 2005-2008 was – Real Estate & Retail, Airlines, Power and Financial Sector. Retail is already in losses. People are putting in more and more money in hope of future profits; same is the case with Airlines. 3 or 4 with deep pockets will survive rest will sell out or die. In real estate I have already mentioned that it’s all set for sharp correction. In power sector most of the upcoming projects have been based on fossil fuels. It’s a grave mistake and we will soon realize it. Financial sector has already seen correction world-wide and effects will be felt in India soon.
If the best earning guys take the maximum loan to finance their expenditure rather than investments the economy is in trouble and that what happened to India due to the consumerism rush. (note: car and house is expenditure and not investment). Salary corrections, job stagnation, no-bonus announcements will lead to lower future earning expectations and hence loan taking capacity. Added to this looses in the stock market and real estate market will make the customers/investors much more reasonable and cautious.
People say – India Story is intact. I too believe in India story but for that Indians need to invest & work hard not speculate. Last two years earning money had been so easy that people and started resisting working in their regular business with 12-15% return. It was a common belief that it’s better to put the money in stock market or real estate and earn 40-50% return per annum. Everybody can see the result now.
India story has been spoiled by our Mr. Bubble maker – Mr. P Chidambaram. Things which lead to current state are:
Zero capital gain tax: By having zero capital gain tax on long term capital gain from stock market Chidambaram forced common hard working people to ignore their jobs and businesses and rather speculate in stock market.
Forcing Indian Financial Institutions to invest in market to support prices: Not only he made these FIs weak he also created bubble in the market by not allowing periodic corrections
Tax benefits on house purchase and high income tax rate: High tax rates and rebate on house purchase forced people in their twenties to take up 20 year housing loan. A recipe for disaster.
Farm loan waver: Not only it added to fiscal deficit & made the banks weak it created moral hazard. Farmers and other borrowers will always look for waivers rather than paying up in time. Oil Bonds and fraudulent accounting practice: On the one hand he promised to keep fiscal deficit low and on the other hand “off-balance sheet” he dole out oil subsidy in form of oil bonds. Oil price is a difficult problem. But he should not be using such fraudulent accounting practice.
If you see all the 5 points above are clear case of living for today and spoiling the future. India Story can’t remain intact with such fools in power. (I had mentioned these points in my blog several time in the past, I hope in the changed scenario I am making more sense).
There have been other party spoilers like Anil Ambani, Real Estate players and these I-banks for the valuation game they played. But at the end of the day the rule is – “Caveat Emptor” – ‘Let the buyer beware’. It’s only we customers are to blame for falling in their trap and not looking at the fundamentals.
So, willing to take the bet? Tell me when you think the market will bottom out. My bet is after there is correction of around 40% in real estate market.

PS: Bottom out doesnot mean that market will see a ‘V’ shape bounce back after that. It would be ‘U’ shaped. It might take few years to go back to mount 21K again.

Has the Bubble Burst? No not yet

Readers of my blog know that I had been predicting burst for quite a while now. And to be very frank the current correction in the stock market can’t exactly be called a burst – it’s too soft a landing to be called a burst, it’s just a correction.

What is a “Burst?”

Burst is something that is followed with lot of pain for example:
1. Crash / Substantial fall in prices of all asset class including shares & real estate. (Has fallen a bit but not substantial)
2. Huge cash loss to speculators and erosion in value of portfolio (happened to an extent but still not at a scale as experienced during a burst. Generally lead to liquidation of long term assets to pay off. Even lead to couple of suicides).
3. Realization that many projects taken up in boom time are not actually viable. This generally happens when people bid more aggressively then one should actually bid (good examples may be Reliance Power’s Sashan Project, Reliance Energy’s Sewree – Nava Seva Sea-link, IPL etc.). Many projects get scrapped, delayed or ‘restructured’ after burst.
4. Fall in prices of factors of production – Land, Labour and Capital. (Currently cost of capital and land has corrected a bit but labour cost is still moving north).
5. Inability to pay debts relating to housing loan etc. This is generally accompanied by lack of willingness to pay because of substantial fall in market value of property. (It has happened in USA but not yet in India)
6. Another remarkable feature of all burst is fall of something which was considered in fallible. For example: big companies like Enron, Worldcom etc. (This time it might be one of the big banks like – Citibank.)
7. Growth engines hitting the wall and come down crashing – this bull runs growth engines have been – Financial engineering (banks), Real estate prices and Power sector. Crash should be more evident in these sectors.
Again the Piped Piper of the last two bull runs were Harshad Mehta and Ketan Pariekh – this time it’s Anil Ambani. Anil Ambani’s fall from grace can lead to end of Bull Run. Last two bulls used ‘not so legal methods’ to use Banks cash to manipulate the market. This time it might have been cash from Mutual funds through ‘not so legal methods.’ International banks financial engineering (read sub-prime) is of course there.

So what are the factors which should be looked forward to which can accelerate the pace of correcting into a Burst / Crash.

1. Coming to light of ‘not so legal’ means of using public money (mutual funds / banks) by certain individuals to manipulate the market. Mutual fund is a big risk area. General public is not following the basic ground rule of investing – ‘Never invest in something you don’t yourself understand’
2. Impending elections in two of the biggest democracies of the world and sudden realizations things are not as stable in terms of policy etc as it was assumed to be
3. Realization that many of the declared or bid for project are not actually viable at these prices
4. Sudden change of policy or tax rules (for example currently stock market earning are almost tax free – Short term capital gain (STCG) attracts only 10% tax rate with Long term capital Gain (LTCG) is tax free. Dividend is tax free in hands of shareholders and Mutual fund investments attracts tax benefits under section 80C – It’s almost perfect for investors and as Aamir Khan said in Dil Chahta hai – it’s difficult to improve something which is already perfect. So tax changes most probably would have negative effect. Even decrease in tax on other avenues of savings like for fixed deposits would have negative impact on stock market due to flow of money to other avenues.)
5. More glaring sub-prime related mess in the international economy
6. Fall of a heavy weight (like Citibank etc)
7. Crash in real estate prices and Oil price fluctuation
8. Currency adjustments – ( change of parity in important currencies like Chinese Yuan & American Dollar)
9. Decease in capex by China. China the world's growth driver would breathe a bit easy with Capital expenditure after the Olympics. This would slow down demand for Steel, cement, and construction goods around the world.

Reliance Power Limited (RPL) IPO: All about Brand Power

Fair price per share = Rs. 130
Brand power per share = Rs. 320
Price per share = Rs. 450

Most brand valuation methods are biased towards ‘sales generation’ potential of the brand. Lux brand is to be valued by the no of units of soaps that can be sold under the brand and the premium price it can command because of the brand.

Now there is “RELIANCE” brand. Unlike other brands it’s not about the no of units of product it can sell but no of shares it can sell and the price premium it can command. And then you need to be a financial wizard like Anil Ambani (ADA) to be able to actually convert brand power into cash. He has created an unprecedented buzz around the IPO. The whole power sector has been re-rated after his big ticket IPO announcement. He had played his cards amazingly well – from making the Investment Bankers (IB) to toe the line to grabbing headlines he has done everything right. The “Power On. India On” campaign is also neatly done. The advertisement has that ‘energy’ about it which generates excitement.

However, there is a problem. Although he shares the ownership of the ‘RELIANCE’ brand with his brother Mukesh Ambani (MDA) he alone is reaping benefits through RPL IPO. In fact bad performance of RPL IPO can seriously dent the valuation of RELIANCE brand and that would affect both the groups. MDA in his speech to employees on the occasion of father’s 75th Anniversary stated that the group has always believed in doing first and talking about it later and will maintain the same in future. It made me wonder whether he was hinting to the reverse strategy being followed by his brother in case of RPL IPO.

The most admirable part of ADA’s wizardry is how he made the IBs toe the line. Deep inside everybody knows that the issue is highly priced but nobody has the guts to speak up.

One of my investment banker (IB) friend remarked “I had never felt so ashamed of my profession like this time. None of the investment bankers have the guts to stand up and tell ADA that pricing is ridiculous. Everybody is hoping that somebody else will bell the cat”.

Another remarked “I always thought I understand the markets well and then something like this (RPL IPO) happens and I realize that markets are too irrational to understand”.

Another remarked “Since Reliance IPO announcement, Power sector prices are not marked to Earnings but to Vision!!”

The world of IBs, where people have the competence to see beyond the brand wrapper has been silenced by awe of ADA and greed of business / money.

But beyond the IB world there is a world of small investors who swear by the “RELIANCE” brand name. I am not sure if even half of them understand that ADA and MDA groups are two different groups now. They don’t understand the nuisances of valuation business. What they understand is that Reliance group has given mind blowing returns to its shareholders in past and expect it to do the same in future. For them RELIANCE is magic wand which turns to gold everything it touches. A RELIANCE IPO can really drive the whole market crazy. Already there is a mad rush to open new demat accounts as was in the case of Reliance Petroleum IPO. ADA mentioned in one of the press conference that if regulation had allowed he would have offered full 100% to retail investors. However, deep inside he knows that getting retail section over subscribed would be the biggest challenge considering the Rs. 100,000 cap per applications. Around 6 lakh applications (assuming historic avg. of Rs. 50,000 per application) would be required for retail section to get fully subscribed. There are around 1 crore dmat accounts in the country and many of those are in-active. Hence retail section is not expected to get over subscribed by more than 3-5 times in the best case scenario. With huge amount of international money waiting to flow into India getting other sections over subscribed would be easier and most probably would be done in minutes of issue opening.

ADA would require some real hard selling. But few will dare bet against him. I believe he knows the game well and will be able to get his issue subscribed. Great market is already quoting a premium of around Rs. 400. Period starting 15 January would be really exciting. I suggest small investors to keep an eye on the subscription figures on the NSE website and wait till the last day before applying.

Valuation

Present value of future cash flow (FCC) method gives a unbelievingly low valuation. I believe ADA’s valuation has been based on the thumb rule – 1 MW = 4 crores. Hence for proposed installed capacity of 28200 MW he is expecting a valuation of Rs. 1,15,000 Crores. Well for installed capacity that valuation might be ok but for proposed capacity??!! Major chuck of the projects would not start operating before 2013.
Valuation marked to vision!!

Implementation Skill & Feedstock Issue

And how many years it will take ADA to install 28200 MW capacity?! Reliance track record for in power sector has never been great. Check out history of Hirma power project in Orrisa and such other projects proposed in late 90s and early 2000s. Apart from captive power projects Reliance doesnot have a track record of building profitable power projects. 40% of the proposed capacity is dependent on Reliance Industries Limited (RIL) supplying gas from its KGD6 fields. The case is under major dispute and resolution cannot be expected soon. (The relations between MDA and ADA is like India-Pakistan now. Even after 60 years firing would continue at the borders and this gas agreement is one such border. After resolution, ADA would require at least three years to build the plant and other infrastructure like pipeline etc. And although I salute ADA for his Financial Wizardry, I still doubt his implementation skill (click to read my previous blog on his implementation skills).

Yes, Reliance is famous for its implementation skills. But which Reliance? – ADA or MDA? – it’s the MDA’s Reliance which has the implementation skill as its core-competence. Please don’t confuse between the two.

Secondly, I personally believe the future belongs to ‘green power’. Rather than betting on coal and gas for power, sources like Wind and Hydro power should be banked upon. Considering the spiraling oil prices the cost competitiveness of fossil fuel as feed stock in future is doubtful.

Verdict: Subscribe for Listing Gains. Re-enter at Rs. 325 – 350 range.

1. This issue is highly overvalued but RELIANCE brand and ADA’s financial wizardry will see it through.
2. ADA to protect his equity/ reputation in the market will make sure that at least during the first few days market price would be higher than issue price.
3. I would suggest retail investors to wait till last day before putting in money. Check the subscription figure on NSE website. Put in money only after retail section has been subscribed at least 1 time and issue over all has been subscribed 5 times. Remember FII’s can withdraw their money at the last moment, if subscription figures are below expectations as they did in Cairn India issue.
4. Apply under full price option. Dont go for part payment option. It would provide an opportunity to sell out at the time of listing itself. Otherwise would be stuck with the stock for more than a month.
5. Sell on listing, making as much listing gain as possible. At least free your capital.
6. If you are compulsive Reliance shareholder re-enter the stock at around Rs.325-350 range. I can bet it will touch that level atleast once between listing date and completion of installation of 28000 MW