I remember the two bullies who studied with me in high school. They intimidated poor souls like me quite often; had no shame in forcefully taking nice goodies from our lunch boxes, flick our chocolates, force us to let them copy from our assignments and what not. Absolute rascals; but they were good athletes. They bought honour to the school in every district and state championships and so they were darlings of the faculty. Every once in a while they got caught for their transgressions; will get few raps on the knuckles, may be few days of suspension and then they were back in action. I am sure many of you would have had similar experiences.
I remembered these bullies when I was reading comments by Hank Paulson (US treasury secretary July 2006- Jan 2009) in 2006. “If you look at the recent history, there is a disturbance in the capital market every four to eight years; savings and loan crisis in the late ‘80s and early ‘90s, the bond market blow up of 1994 and the crisis that began in Asia in 1997 and continued with Russia’s default on its debt in 1998. I was convinced that we were due for another disruption” (Referred in his book “On the brink”). He was proved right within few months.
The same book also refers to a remark by John Mack CEO of Morgan Stanley in 2008 on the cause of the melt down. “Greed, leverage and lax investor standards; we took conditions for granted and we as an industry lost discipline”
This is not just the cause of 2008 melt down; it is the cause of many melt downs. Such behaviour appears to be normal in this line of business. Take a look the civil case filed by Securities and Exchange Commission (SEC) against Goldman Sachs in April 2010 charging ‘fraudulent misconduct’. This is not just an isolated incident as we can see from the following.
“NASD fines Citi, Merrill, Morgan Stanley $250,000 each” The America's Intelligence Wire July 19, 2004” (i)
“On June 6, 2007, the NASD announced more than $15 million in fines and restitution against Citigroup Global Markets, Inc., to settle charges related to misleading documents and inadequate disclosure in retirement seminars and meetings for BellSouth Corp. employees in North Carolina and South Carolina.” (ii)
“Merrill Lynch & Company said yesterday that it would pay $100 million in penalties to New York and other states and change the way it pays stock analysts to end an investigation that its chairman said had damaged the firm's reputation. “ (iii)
Citigroup Inc. agreed to pay a $70 million fine for practices in its Baltimore consumer finance unit, including raising the cost of loans to poor and credit-starved customers by requiring them to have unnecessary cosigners” (iv)
“Morgan Stanley, the second-largest U.S. securities firm by market value, was fined $10 million by the Securities and Exchange Commission because it failed to guard against insider trading for at least eight years. The fine was the biggest ever for a violation of surveillance rule” (v)
These are just a few samples. Do a Google search with the word ‘fine’ along with the name of any of the large investment banker; you will be surprised at the frequency of serious transgressions which are not just fines on technical violation but fines on substantive charges. We will wonder aloud “Will we ever learn?”
Compounding such practices is the frequent roll out of complex financial products which are often too complex for the investors to understand. Hank Paulson’s (who has been the CEO of Goldman Sachs before taking over as the Treasury Secretary) reference on the proliferation of product innovation is quite blunt on this. “In theory this was all to the good. But there was a dark side. The market became opaque as structured products grew increasingly complex and difficult to understand even for sophisticated investors”
This is why we need innovative regulation to match with the innovations in market place. In his blog post on regulating the new financial sector, Prof. Willam Buiter has given a very interesting suggestion “the same rigour used by US FDA for pharma and medical products should be insisted for introduction of financial products to broader market does not look out of place in the context of the recent history”.
We also need to think innovation in the checks and balances that we build in the system. Quoting Paulson again; “The regulatory structure, organised around traditional business lines had not begun to keep up with the evolution of the markets”.... it had led to counterproductive competition among regulators, wasteful duplication in some areas and gaping holes in others”
We in India have few important lessons to learn from all these.
To prevent run-away innovation that is rash and irresponsible, we need to put in place the right regulatory establishment to avoid the same kind of mistakes that has been laid bare in front of us. If we expect responsible behaviour and self regulation collectively from the guys running financial markets we are asking too much. We have not seen such industry wide responsible behaviour anywhere in the world.
Regulation does not mean micro-management of day-to-day functioning. Regulator’s role is to set the rules of the game and keep a watch whether the players are playing as per the rules. He also has to keep a look at the impact of changing structure of the game and modify the rules. If I give an example, the rules of T20 is not exactly the same as in the case of test cricket though both are cricket. To make this possible the regulators will have to be able to attract people who have the right experience, the right domain knowledge and most importantly the right attitude who can establish appropriate processes and use the modern technology tools and match or better industry strengths. This is the challenge of governance.
One of the major suggestions on regulation we often hear is to curtail all innovations; I don’t agree with this. We have enormous potential for modernising the markets with innovative products. If we say that we will be insulated from the turmoil on account of lack of market sophistication, we are not being very bright. It is like saying that I never fell because I never rode. A sophisticated market is a prerequisite for growth. In this journey we will make mistakes; and these mistakes will trigger better controls and that is the democratic process of growth. To go into hibernation is not the solution. Look at our favourite sport, cricket; from leisurely five day test matches we have progressed to one day internationals and now to 20 over matches keeping pace with our life. Notwithstanding, the controversy of IPL, the innovations have only improved the game on multiple dimensions.
“ We should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change, one that will allow us to more effectively deal with the inevitable market disruptions and one that will better protect investors and consumers.” Hank Paulson
(i) http://www.accessmylibrary.com/coms2/summary_0286-22046900_ITM
(ii) http://en.wikipedia.org/wiki/Citigroup
(iii) May 2002, New York times http://www.nytimes.com/2002/05/22/business/100-million-fine-for-merrill-lynch.html
(iv) Washington Post, 2004
(v) Bloomberg 2006
Showing posts with label Capital Markets. Show all posts
Showing posts with label Capital Markets. Show all posts
Tuesday, May 25, 2010
Monday, July 27, 2009
Will we ever learn?
Last week I was chatting with one of my friends who is based in New Jersey. He is a senior executive of a multinational bank and a key player in the high-stake game of Wall Street. (Like many members of this club, he often pretends to know all the answers and I am willing to listen to him!) The topic of discussion turned to recent financial market turmoil and how the survivors are surviving. The record quarterly profit of Goldman Sachs and huge bonus they plan to payout naturally popped up.
“The turmoil has kicked out many players. The bailout package has ameliorated extreme trauma of the remaining few. Now with reduced competition to feed the demand, the surviving bankers are up to their same old tricks. They even enjoy better margins these days” My friend explained to me. I was a bit surprised. So soon? Is the memory so short? Don’t we learn some lessons? Is it just a cynical remark of a jealous banker?
I logged onto the net to see what more renowned experts had to say on this. The following quote from Paul Krugman in the article "The Joy of Sachs” he wrote in the New York Times summarised it all. (Do take the pain to read the whole article. It is illuminating.)
“First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.
Second, it shows that Wall Street’s bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away.
Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely.”
This brought to my mind a completely contrasting story. The story of Darbary Seth of Tata Chemicals. Soda Ash, the chemical that his company produced and marketed was under price control and one day the government removed the price control. Instead of trying to take advantage of the freedom that this decontrol offered and increase price, he actually reduced the price. To the surprised colleagues and frustrated competitors he quipped, “When there is decontrol, we should have self control”
These are two ends of the spectrum. On one end we see the corporate governance that limits itself to being technically correct and compliance to the letter of the law. On the other end we see a visionary leadership who recognizes the larger role played by every business enterprise. The world around us is a mixture of both and what lies in between. The balance keeps shifting from one extreme to another. Sometimes the crisis, that was triggered by the excesses lead to stronger shareholder activism and trigger correction mechanisms as new acts and regulations.
In the last few years the pendulum appears to have been more to the side of ‘profit at whatever costs’. More so in the areas of financial innovation or rather the how these innovations were exploited.
How do we ensure that the balance tilts more towards more responsible corporations? Is there a need to bring about some regulatory intervention? Will it help?
I agree the rules cannot be the solution. But when the financial innovations significantly expanded product options and as Krugman noted “directed vast quantities of capital into the construction of unsellable houses and empty shopping malls which increased risk rather than reducing it, and concentrated risk rather than spreading it” there appears to be a definite case for some tweaking of regulations to ensure that the checks and balances are built with no/ minimum conflicts of interest. (Refer to my posting Checks and Balances - Who checks and Who balances” for some thoughts on this)
Don’t get me wrong. I am not advocating a return to license and control raj. My limited point is that we need to strengthen our institutional framework further and the regulators should improve the quality of their team so that they can clearly discern what is right and what is fair and don’t let the political expediency rule their judgement; especially when the market participants get caught in a spiral of short-termism and incentive structures that could be disastrous to the society in the long term. On the other hand a little more of introspection in the board rooms and among managers could also help.(Take a look at "Devastation of world financial markets - A case of Policy Reversals in India?” for some different perspectives on this)
“The turmoil has kicked out many players. The bailout package has ameliorated extreme trauma of the remaining few. Now with reduced competition to feed the demand, the surviving bankers are up to their same old tricks. They even enjoy better margins these days” My friend explained to me. I was a bit surprised. So soon? Is the memory so short? Don’t we learn some lessons? Is it just a cynical remark of a jealous banker?
I logged onto the net to see what more renowned experts had to say on this. The following quote from Paul Krugman in the article "The Joy of Sachs” he wrote in the New York Times summarised it all. (Do take the pain to read the whole article. It is illuminating.)
“First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.
Second, it shows that Wall Street’s bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away.
Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely.”
This brought to my mind a completely contrasting story. The story of Darbary Seth of Tata Chemicals. Soda Ash, the chemical that his company produced and marketed was under price control and one day the government removed the price control. Instead of trying to take advantage of the freedom that this decontrol offered and increase price, he actually reduced the price. To the surprised colleagues and frustrated competitors he quipped, “When there is decontrol, we should have self control”
These are two ends of the spectrum. On one end we see the corporate governance that limits itself to being technically correct and compliance to the letter of the law. On the other end we see a visionary leadership who recognizes the larger role played by every business enterprise. The world around us is a mixture of both and what lies in between. The balance keeps shifting from one extreme to another. Sometimes the crisis, that was triggered by the excesses lead to stronger shareholder activism and trigger correction mechanisms as new acts and regulations.
In the last few years the pendulum appears to have been more to the side of ‘profit at whatever costs’. More so in the areas of financial innovation or rather the how these innovations were exploited.
How do we ensure that the balance tilts more towards more responsible corporations? Is there a need to bring about some regulatory intervention? Will it help?
I agree the rules cannot be the solution. But when the financial innovations significantly expanded product options and as Krugman noted “directed vast quantities of capital into the construction of unsellable houses and empty shopping malls which increased risk rather than reducing it, and concentrated risk rather than spreading it” there appears to be a definite case for some tweaking of regulations to ensure that the checks and balances are built with no/ minimum conflicts of interest. (Refer to my posting Checks and Balances - Who checks and Who balances” for some thoughts on this)
Don’t get me wrong. I am not advocating a return to license and control raj. My limited point is that we need to strengthen our institutional framework further and the regulators should improve the quality of their team so that they can clearly discern what is right and what is fair and don’t let the political expediency rule their judgement; especially when the market participants get caught in a spiral of short-termism and incentive structures that could be disastrous to the society in the long term. On the other hand a little more of introspection in the board rooms and among managers could also help.(Take a look at "Devastation of world financial markets - A case of Policy Reversals in India?” for some different perspectives on this)
Thursday, April 23, 2009
Checks & Balances - Who checks and Who balances
Integrity in reporting of accurate matrices for measurement of risk and return of traded instruments and checks and balance that ensure this reporting are critical requirements for any decent financial market. But when we follow the events that have been unfolding the world over, it appears that there is still some way to go.
The most critical issue with respect to the Satyam saga in India has also been this. The company had good people, a respected client base, history of high quality delivery and a profitable and growing business. But the owners milked the company for their personal greed and misreported the financial status. The behavior of the venerable audit firm Price Waterhouse as the company auditor has raised questions about how independent were these independent outside auditors.
This is not a one-off incident. Neither is it something peculiar to India or doings of some small time firms. Enron, WorldCom, and Xerox are recent history.
Arthur Anderson was accused of improper audits in financial scandals in a number of cases in USA and had to go in for settlement in many of them. Enron was the icing on the cake, which took the audit firm along with it to extinction.
SEC took action against KPMG with respect to violation of anti fraud provisions with its audit of Xerox. E&Y was also accused by SEC of violating independence rules.
This problem was not just with respect to collusion by independent auditors in perpetuating financial frauds. It has been pointed out that one of the root causes of the collapse of world financial markets in the recent past has been the failure of credit rating agencies in reflecting the true nature of risks associated with many structured products that have been rated by them.
Why do we see such irresponsible behavior from a large cross section of professionals and professional organizations? When we go a little deep into the reasons behind this, we see that the one of the main reasons has been the failure of the checks and balances in avoiding conflicts of interest.
There are two serious contributors to this conflict of interest with respect to the independent auditors. One is the extent of multi-disciplinary non-audit related services these firms offered to their clients like legal, consulting services etc. Realizing the conflicts associated with such practices we have seen a number of regulatory restrictions on such multi-disciplinary offers.
The other issue is that the audit firm is selected and their remuneration is fixed by the company management. Robert Prentice, professor of business law at the McCombs School of Business after exploring literature in psychology, decision theory, behavioral finance, and behavioral economics has suggested that auditors works are significantly affected by ‘self serving bias’. Based on behavioral experiments, Professors Bazerman, Loewenstein and Moore suggests that because of the subjective nature of accounting, and the close financial and personal ties of auditors and corporate managers, even the most honest and meticulous of auditors can unintentionally distort the numbers in ways that mask a company’s true financial status. They have also referred to a study of 139 auditors employed at large U.S. accounting firms in which half of the participants were asked to assume that they were auditors hired by the company while the other half were asked to assume they were hired by another company that conducts business with the audited company. With respect to five given ambiguous auditing vignettes, auditors who were hypothetically hired by the audited company were on the average 30% more likely to find the financial reports complied with GAAP
Same is the case with incentive structure in the credit rating agency. The agency is paid by the entity who is getting its instruments rated and not by the investor who uses this rating for their investments. The criticality of these ratings are quite high because the regulators of capital market, banking , pension funds and mutual funds use these ratings to specify the asset quality mixture that brokers / banks / pension funds were allowed to hold. As Frank Partnoy a professor at the university of San Diego school of law observed “rather than selling opinions to investors, the credit rating agencies were selling licenses to borrowers”.
While stronger regulatory oversight can address these issues, more efforts are needed to develop models where the incentive structures would ensure better checks and balances.
Models suggested by Professor Joshua Ronen of New York University and Peter K M chan of US SEC are thought provoking in this direction.
The basic structure of Prof Ronen’s Financial Statement Insurance (FSI) may be described as follows :
‘Instead of appointing and paying auditors, companies would purchase financial statement insurance that provides coverage to investors against losses suffered as result of misrepresentation in financial reports. The insurance coverage that the companies are able to obtain is publicized, along with the premiums paid for the coverage. The insurance carriers then appoint and pay the auditors who attest to the accuracy of the financial statements of the prospective insurance clients. Those announcing higher limits of coverage and smaller premiums will distinguish themselves in the eyes of the investors as the companies with higher quality financial statements. In contrast, those with smaller or no coverage or higher premiums will reveal themselves as those with lower quality financial statements. Every company will be eager to get higher coverage and pay smaller premiums lest it be identified as the latter. A sort of Gresham's law in reverse would be set in operation, resulting in a fight to quality’.
The model suggested by Peter MK Chan is as follows:
‘The interests of auditors with those who have the greatest interest in accurate financial reporting and the investing public should align, making use of advances in Internet technology. The companies should be required to make available over the net significant amount of raw financial data on a real-time basis. Using these raw data the investor-hired auditors should be able to perform meaningful audits or reviews of corporate financial data. Regulations should also be directed toward ameliorating any negative effects associated with such increased access, including regulations designed to reduce litigation risks. The market will take care of the rest’.
I am not trying to analyze the pros and cons to the above proposals nor do I suggest that one of the above be adopted. The simple point I am making is that we should modify the regulatory framework to ensure that the checks and balances are built with no/ minimum conflicts of interest. And today is a good time to debate, indentify and implement such reforms, as we are in a world which has been rudely awaked to the risks of these conflicts of interest. Strike when the iron is hot.
The above is not just a case of public policy. It is also a lesson for any entity who is actively involved in defining or refining business processes in any organization.
The most critical issue with respect to the Satyam saga in India has also been this. The company had good people, a respected client base, history of high quality delivery and a profitable and growing business. But the owners milked the company for their personal greed and misreported the financial status. The behavior of the venerable audit firm Price Waterhouse as the company auditor has raised questions about how independent were these independent outside auditors.
This is not a one-off incident. Neither is it something peculiar to India or doings of some small time firms. Enron, WorldCom, and Xerox are recent history.
Arthur Anderson was accused of improper audits in financial scandals in a number of cases in USA and had to go in for settlement in many of them. Enron was the icing on the cake, which took the audit firm along with it to extinction.
SEC took action against KPMG with respect to violation of anti fraud provisions with its audit of Xerox. E&Y was also accused by SEC of violating independence rules.
This problem was not just with respect to collusion by independent auditors in perpetuating financial frauds. It has been pointed out that one of the root causes of the collapse of world financial markets in the recent past has been the failure of credit rating agencies in reflecting the true nature of risks associated with many structured products that have been rated by them.
Why do we see such irresponsible behavior from a large cross section of professionals and professional organizations? When we go a little deep into the reasons behind this, we see that the one of the main reasons has been the failure of the checks and balances in avoiding conflicts of interest.
There are two serious contributors to this conflict of interest with respect to the independent auditors. One is the extent of multi-disciplinary non-audit related services these firms offered to their clients like legal, consulting services etc. Realizing the conflicts associated with such practices we have seen a number of regulatory restrictions on such multi-disciplinary offers.
The other issue is that the audit firm is selected and their remuneration is fixed by the company management. Robert Prentice, professor of business law at the McCombs School of Business after exploring literature in psychology, decision theory, behavioral finance, and behavioral economics has suggested that auditors works are significantly affected by ‘self serving bias’. Based on behavioral experiments, Professors Bazerman, Loewenstein and Moore suggests that because of the subjective nature of accounting, and the close financial and personal ties of auditors and corporate managers, even the most honest and meticulous of auditors can unintentionally distort the numbers in ways that mask a company’s true financial status. They have also referred to a study of 139 auditors employed at large U.S. accounting firms in which half of the participants were asked to assume that they were auditors hired by the company while the other half were asked to assume they were hired by another company that conducts business with the audited company. With respect to five given ambiguous auditing vignettes, auditors who were hypothetically hired by the audited company were on the average 30% more likely to find the financial reports complied with GAAP
Same is the case with incentive structure in the credit rating agency. The agency is paid by the entity who is getting its instruments rated and not by the investor who uses this rating for their investments. The criticality of these ratings are quite high because the regulators of capital market, banking , pension funds and mutual funds use these ratings to specify the asset quality mixture that brokers / banks / pension funds were allowed to hold. As Frank Partnoy a professor at the university of San Diego school of law observed “rather than selling opinions to investors, the credit rating agencies were selling licenses to borrowers”.
While stronger regulatory oversight can address these issues, more efforts are needed to develop models where the incentive structures would ensure better checks and balances.
Models suggested by Professor Joshua Ronen of New York University and Peter K M chan of US SEC are thought provoking in this direction.
The basic structure of Prof Ronen’s Financial Statement Insurance (FSI) may be described as follows :
‘Instead of appointing and paying auditors, companies would purchase financial statement insurance that provides coverage to investors against losses suffered as result of misrepresentation in financial reports. The insurance coverage that the companies are able to obtain is publicized, along with the premiums paid for the coverage. The insurance carriers then appoint and pay the auditors who attest to the accuracy of the financial statements of the prospective insurance clients. Those announcing higher limits of coverage and smaller premiums will distinguish themselves in the eyes of the investors as the companies with higher quality financial statements. In contrast, those with smaller or no coverage or higher premiums will reveal themselves as those with lower quality financial statements. Every company will be eager to get higher coverage and pay smaller premiums lest it be identified as the latter. A sort of Gresham's law in reverse would be set in operation, resulting in a fight to quality’.
The model suggested by Peter MK Chan is as follows:
‘The interests of auditors with those who have the greatest interest in accurate financial reporting and the investing public should align, making use of advances in Internet technology. The companies should be required to make available over the net significant amount of raw financial data on a real-time basis. Using these raw data the investor-hired auditors should be able to perform meaningful audits or reviews of corporate financial data. Regulations should also be directed toward ameliorating any negative effects associated with such increased access, including regulations designed to reduce litigation risks. The market will take care of the rest’.
I am not trying to analyze the pros and cons to the above proposals nor do I suggest that one of the above be adopted. The simple point I am making is that we should modify the regulatory framework to ensure that the checks and balances are built with no/ minimum conflicts of interest. And today is a good time to debate, indentify and implement such reforms, as we are in a world which has been rudely awaked to the risks of these conflicts of interest. Strike when the iron is hot.
The above is not just a case of public policy. It is also a lesson for any entity who is actively involved in defining or refining business processes in any organization.
Saturday, March 28, 2009
Optimism amidst Gloom – Opportunities for Value Investment
The Capital market is always choppy and wavy, like the high seas. That is the nature of the beast. There is no moment of rest. Each trough spreads its share of gloom, negativity and suicides and each crust bring with it euphoria, splurges and binges. We have seen many across centuries; Tulip Mania of Amsterdam 1637, South Sea Bubble 1720, Wall Street Crash 1929 and again in 1987, Harshad Metha driven boom in India 1992, South East Asian melt down in 1997, internet boom and bust around the world of 2000 and now the mayhem in world financial market.
I was looking at an article that I had written in 2003, when the sentiments were down after the tech bust, 9/11 Iraq war, Enron, Worldcom and Arthur Anderson scams. The BSE Sensex was around 3000. Paul Krugman’s observation in Fortune in September 1998 that ‘never in the course of economic events-not even the early years of economic depression- has so large part of the world economy experienced so devastating a fall from grace” looked relevant in 1998, 2003 and even today.
My article was an expression of my optimism that what goes down will come back. Since then we have gone up and now come down again. The Sensex in the region of 9,000 – 10,000. At this stage I feel it is relevant to feel optimistic again. I wanted to pen my thoughts about it and I realized that I don’t need to write a new article again. Just a few edits of my old article. And that is what I have done. For the sake of convenience, continuity and a bit of wry humor, I have retained the original parts in (bracketed small font) that I have edited out and marked the additions in italics. This is how it goes.
With (war clouds looming large) the world of financial markets having experienced a worldwide melt down, the world of investment seems to be in a state of limbo. Adding to this woe has been a spate of poor corporate performance (in developed) around the world, few high profile bankruptcies and accounting scams which have literally pulled the rug from under the leg. All in all the general perception seems to be in hoarding money in cash or near cash equivalent or park in yellow metal.
Let us take a look at it from a different perspective. I believe that this is the time for investors who are looking for value opportunities. A time to pick up shares at real good value. To get some good returns in medium term you don’t have to be even adventurous in terms of investing in speculative and high risk ventures. Just look for few well established and well performing conventional companies. The chance of disappointment is really low. What gives me this confidence? The same reason the prices are down today; the uncertainty around us. It has been always seen that at times of uncertainty the investor looks for a high risk premium and it translates to a lower price for stock. This means that the investor is willing to pay a relatively lower price, compared to times when the uncertainty is low, to buy a piece of the same company. Today we are surrounded by innumerable of factors of uncertainty, which leads to depressed prices.
There is certainly a very high probability that at least some sources of this uncertainty will get sorted out in the near future. This means that general level of depression will certainly pass and this has to convert to better valuations. We have seen this in all markets at all times. Look at what happened after the Gulf war in the US market. The markets have produced above-average gains following U.S. involvement in the World Wars, the Korean War, Vietnam and the Gulf War.
From the general let me venture in to specifics. Let us look at what can be one of the winning markets for the coming year. One of the winners definitely will be the Indian Market. The factors in favor are just too many.
Indian economy in general has been on a high gear. With a GDP growth of around (5%) 6.5% in 2009 compared to an average of about (2%) 3% for the world as a whole India has been one of the fastest growing economies in the recent past. Even the projections for the coming couple of years seem to be in the same direction.
Corporate Sector in India has been performing outstandingly till last year. The current year has witnessed the aftershocks of the worldwide melt down. (When the general results from the corporate sector around the world has been filled with more bad news than good, Indian corporates have been showing a different color.) Indian companies in the earlier era of protected markets had significant inefficiencies inherent in them. Now that they have been exposed to global competition, they have tightened their belts and released significant gains. (During half year ended in September 2002 the net profit of the Indian corporate increased by more than 50%. In the third quarter ended in December 2002, the results of the major 679 companies which released their results shows that the sales has increased by 70% and net profit has increased by 15%.) CMIE expects aggregate profit after tax (PAT) of listed Indian corporates to rise by 77.3 per cent in 2009-10.The detailed analysis by CMIE is given at the bottom of this article
The foreign exchange reserves have been growing at a quicker pace. For the first time after 1978 the year 2002 showed a surplus in the current account. With more than $ 290 (72) billion in foreign exchange in September 2008 Indian government has now allowed Indian citizens to buy and own foreign assets out of their rupee earnings in India.
(The external debt situation has also reduced significantly to 21% from a peak of 39% in March 1992. This has resulted in debt service ratio improving from 27% in 1992 to 17% in 2002). As per Ministry of Finance Press Release India’s total external debt stock at end September 2008 stood at US $ 222.61 billion, which is marginally lower than the level of US $ 223.81 billion at end June 2008. The ratio of foreign exchange reserves to total external debt as at end September 2008 stood at a comfortable level of 128.6 per cent.
(Realizing the reversal in the Rs /US$ exchange rate Indian companies are today taking un-hedged US$ denominated loans.)The recent depreciation of the Rs on account some capital flight has given some jitters to such companies. In fact these companies have been lobbying to get teh accounting standards modified so that they will not have to show the marked-to-market losses in their annual report.:-)
Even infrastructure sector has improved in an encouraging fashion. The telecom cost which was one of the most expensive in the world has seen price reduction of more than 50% since the complete decontrol of this segment. Today in spite of recession it is one of the fastest growing segments in India and one of the most attractive by world standards. Roads and Ports are getting significant investment.
With so much to go for India is an excellent bet for investment in medium term. Although I have been in the Industry for a long time I am normally very conservative and very guarded. But I have very little reservation in being bullish on India in the near future.
Corporate India’s PAT to grow by 77.3% in 2009-10 - CMIE clarifies
CMIE expects aggregate profit after tax (PAT) of listed Indian corporates to rise by 77.3 per cent in 2009-10. This robust profit growth projection is based on the expectation of the petroleum products sector returning into profits from the March 2009 quarter. The losses incurred by the petroleum products sector had eaten away more than a third of the aggregate profits made by the rest of the Corporate India during April-December 2008. Benefiting from the fall in the crude oil prices, we expect the petroleum products sector to make net profits of Rs.11,225 crore in 2009-10 as against the net losses of Rs.56,533 crore estimated for 2008-09.
The aforementioned profit figures are exclusive of prior period and extra-ordinary income. CMIE always uses PAT figures exclusive of P&E as it enables meaningful inter-period comparison.
We have excluded Rs.60,967 crore received by the petroleum products companies during April- December 2008 from the government in the form of oil bonds. The oil bonds are not with respect to the sales made during the quarter in which they were received. It is a reimbursement of the loss suffered by the petroleum products companies.
We expect the petroleum products sector to show a major turnaround at the PAT (net of P&E) level in 2009-10. This will have a major bearing on the overall profit performance of Corporate India as the petroleum products sector contributes 25-30 per cent to the aggregate net sales.
Excluding the petroleum products sector, the rest of the Indian corporates (listed on Indian bourses) are expected to report a 22.7 per cent rise in aggregate PAT in 2009-10. The healthy order-book positions of the construction companies and the machinery companies are expected to help them report robust sales growth. Sharp rise in sales, softening of interest rates and fall in commodity prices, particularly metals are expected to help the construction and machinery sectors to report 40- 50 rise in PAT in 2009-10. A gamut of other sectors such as commercial vehicles, wires & cables, tyres & tubes, plastic products and polymers are also expected to benefit from the fall in input (commodity) prices and low interest rates.
Non-financial services such as hotels, health services and LNG storage & distribution are also expected to report over 20 per cent growth in PAT in 2009-10. The hotels sector witnessed a fall in income and PAT in the December 2008 quarter because of the fall in occupancy rate following the terror attack and slowdown in the global market.
We expect the sector to show an improvement in income and PAT growth in 2009-10 backed by improvement in occupancy and hike in room rates. Similarly, the health service sector is also expected to report a healthy growth in profits backed by capacity
additions and higher average revenue per customer. Doubling of capacity by Petronet LNG and the additional transmission volumes of gas from the KG basin of Reliance are expected to help the LNG storage & distribution sector report a healthy income growth in 2009-10. This coupled with the lower raw material prices is expected to help the sector to report a 47.4 per cent rise in PAT in 2009-10.
We expect the profit performance of the banking segment in 2009-10 also to be healthy. The sector is expected to report a 28.3 per cent rise in PAT owing to continuation of healthy over 20 per cent growth in credit, lower operating expenses and lower provisioning levels compared to 2008-09.
Finally, it is not unusual for Corporate India to report very high or very low profit growth. In 2002-03 and 2003-04, PAT had grown by 70.2 and 76.0 per cent, respectively. In 1994-95, PAT had more than doubled (104.2 per cent) in a single year.
I was looking at an article that I had written in 2003, when the sentiments were down after the tech bust, 9/11 Iraq war, Enron, Worldcom and Arthur Anderson scams. The BSE Sensex was around 3000. Paul Krugman’s observation in Fortune in September 1998 that ‘never in the course of economic events-not even the early years of economic depression- has so large part of the world economy experienced so devastating a fall from grace” looked relevant in 1998, 2003 and even today.
My article was an expression of my optimism that what goes down will come back. Since then we have gone up and now come down again. The Sensex in the region of 9,000 – 10,000. At this stage I feel it is relevant to feel optimistic again. I wanted to pen my thoughts about it and I realized that I don’t need to write a new article again. Just a few edits of my old article. And that is what I have done. For the sake of convenience, continuity and a bit of wry humor, I have retained the original parts in (bracketed small font) that I have edited out and marked the additions in italics. This is how it goes.
With (war clouds looming large) the world of financial markets having experienced a worldwide melt down, the world of investment seems to be in a state of limbo. Adding to this woe has been a spate of poor corporate performance (in developed) around the world, few high profile bankruptcies and accounting scams which have literally pulled the rug from under the leg. All in all the general perception seems to be in hoarding money in cash or near cash equivalent or park in yellow metal.
Let us take a look at it from a different perspective. I believe that this is the time for investors who are looking for value opportunities. A time to pick up shares at real good value. To get some good returns in medium term you don’t have to be even adventurous in terms of investing in speculative and high risk ventures. Just look for few well established and well performing conventional companies. The chance of disappointment is really low. What gives me this confidence? The same reason the prices are down today; the uncertainty around us. It has been always seen that at times of uncertainty the investor looks for a high risk premium and it translates to a lower price for stock. This means that the investor is willing to pay a relatively lower price, compared to times when the uncertainty is low, to buy a piece of the same company. Today we are surrounded by innumerable of factors of uncertainty, which leads to depressed prices.
There is certainly a very high probability that at least some sources of this uncertainty will get sorted out in the near future. This means that general level of depression will certainly pass and this has to convert to better valuations. We have seen this in all markets at all times. Look at what happened after the Gulf war in the US market. The markets have produced above-average gains following U.S. involvement in the World Wars, the Korean War, Vietnam and the Gulf War.
From the general let me venture in to specifics. Let us look at what can be one of the winning markets for the coming year. One of the winners definitely will be the Indian Market. The factors in favor are just too many.
Indian economy in general has been on a high gear. With a GDP growth of around (5%) 6.5% in 2009 compared to an average of about (2%) 3% for the world as a whole India has been one of the fastest growing economies in the recent past. Even the projections for the coming couple of years seem to be in the same direction.
Corporate Sector in India has been performing outstandingly till last year. The current year has witnessed the aftershocks of the worldwide melt down. (When the general results from the corporate sector around the world has been filled with more bad news than good, Indian corporates have been showing a different color.) Indian companies in the earlier era of protected markets had significant inefficiencies inherent in them. Now that they have been exposed to global competition, they have tightened their belts and released significant gains. (During half year ended in September 2002 the net profit of the Indian corporate increased by more than 50%. In the third quarter ended in December 2002, the results of the major 679 companies which released their results shows that the sales has increased by 70% and net profit has increased by 15%.) CMIE expects aggregate profit after tax (PAT) of listed Indian corporates to rise by 77.3 per cent in 2009-10.The detailed analysis by CMIE is given at the bottom of this article
The foreign exchange reserves have been growing at a quicker pace. For the first time after 1978 the year 2002 showed a surplus in the current account. With more than $ 290 (72) billion in foreign exchange in September 2008 Indian government has now allowed Indian citizens to buy and own foreign assets out of their rupee earnings in India.
(The external debt situation has also reduced significantly to 21% from a peak of 39% in March 1992. This has resulted in debt service ratio improving from 27% in 1992 to 17% in 2002). As per Ministry of Finance Press Release India’s total external debt stock at end September 2008 stood at US $ 222.61 billion, which is marginally lower than the level of US $ 223.81 billion at end June 2008. The ratio of foreign exchange reserves to total external debt as at end September 2008 stood at a comfortable level of 128.6 per cent.
(Realizing the reversal in the Rs /US$ exchange rate Indian companies are today taking un-hedged US$ denominated loans.)The recent depreciation of the Rs on account some capital flight has given some jitters to such companies. In fact these companies have been lobbying to get teh accounting standards modified so that they will not have to show the marked-to-market losses in their annual report.:-)
Even infrastructure sector has improved in an encouraging fashion. The telecom cost which was one of the most expensive in the world has seen price reduction of more than 50% since the complete decontrol of this segment. Today in spite of recession it is one of the fastest growing segments in India and one of the most attractive by world standards. Roads and Ports are getting significant investment.
With so much to go for India is an excellent bet for investment in medium term. Although I have been in the Industry for a long time I am normally very conservative and very guarded. But I have very little reservation in being bullish on India in the near future.
Corporate India’s PAT to grow by 77.3% in 2009-10 - CMIE clarifies
CMIE expects aggregate profit after tax (PAT) of listed Indian corporates to rise by 77.3 per cent in 2009-10. This robust profit growth projection is based on the expectation of the petroleum products sector returning into profits from the March 2009 quarter. The losses incurred by the petroleum products sector had eaten away more than a third of the aggregate profits made by the rest of the Corporate India during April-December 2008. Benefiting from the fall in the crude oil prices, we expect the petroleum products sector to make net profits of Rs.11,225 crore in 2009-10 as against the net losses of Rs.56,533 crore estimated for 2008-09.
The aforementioned profit figures are exclusive of prior period and extra-ordinary income. CMIE always uses PAT figures exclusive of P&E as it enables meaningful inter-period comparison.
We have excluded Rs.60,967 crore received by the petroleum products companies during April- December 2008 from the government in the form of oil bonds. The oil bonds are not with respect to the sales made during the quarter in which they were received. It is a reimbursement of the loss suffered by the petroleum products companies.
We expect the petroleum products sector to show a major turnaround at the PAT (net of P&E) level in 2009-10. This will have a major bearing on the overall profit performance of Corporate India as the petroleum products sector contributes 25-30 per cent to the aggregate net sales.
Excluding the petroleum products sector, the rest of the Indian corporates (listed on Indian bourses) are expected to report a 22.7 per cent rise in aggregate PAT in 2009-10. The healthy order-book positions of the construction companies and the machinery companies are expected to help them report robust sales growth. Sharp rise in sales, softening of interest rates and fall in commodity prices, particularly metals are expected to help the construction and machinery sectors to report 40- 50 rise in PAT in 2009-10. A gamut of other sectors such as commercial vehicles, wires & cables, tyres & tubes, plastic products and polymers are also expected to benefit from the fall in input (commodity) prices and low interest rates.
Non-financial services such as hotels, health services and LNG storage & distribution are also expected to report over 20 per cent growth in PAT in 2009-10. The hotels sector witnessed a fall in income and PAT in the December 2008 quarter because of the fall in occupancy rate following the terror attack and slowdown in the global market.
We expect the sector to show an improvement in income and PAT growth in 2009-10 backed by improvement in occupancy and hike in room rates. Similarly, the health service sector is also expected to report a healthy growth in profits backed by capacity
additions and higher average revenue per customer. Doubling of capacity by Petronet LNG and the additional transmission volumes of gas from the KG basin of Reliance are expected to help the LNG storage & distribution sector report a healthy income growth in 2009-10. This coupled with the lower raw material prices is expected to help the sector to report a 47.4 per cent rise in PAT in 2009-10.
We expect the profit performance of the banking segment in 2009-10 also to be healthy. The sector is expected to report a 28.3 per cent rise in PAT owing to continuation of healthy over 20 per cent growth in credit, lower operating expenses and lower provisioning levels compared to 2008-09.
Finally, it is not unusual for Corporate India to report very high or very low profit growth. In 2002-03 and 2003-04, PAT had grown by 70.2 and 76.0 per cent, respectively. In 1994-95, PAT had more than doubled (104.2 per cent) in a single year.
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