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Thursday, 16 June 2016

Why crude oil prices have started rising again

The collapse of global crude oil prices in 2014 was easily one of the biggest energy stories on the planet. By early 2016, oil had slid to $33 per barrel, a level not seen since 2003. Gasoline was dirt cheap, SUVs were coming back in style, Venezuela was imploding, and the US fracking boom started fizzling. It was a really big deal.

Over the last month, however, prices have started to creep back up again, rising to $50 per barrel this week. We're still nowhere near the levels seen before the recent crash, but it’s a noticeable uptick, with potentially important ripple effects around the world. So what’s going on? And will this rally actually last?

Because oil is so easily shipped and traded around the world, prices (mostly) depend on just two things: global supply and global demand. The best place to get a handle on these two factors is the International Energy Agency’s monthly Oil Market Report. The graph below, from the latest edition, tells the tale:

Oil production and consumption noted in millions of barrels per day. (IEA Oil Market Report)

As you can see, between 2014 and 2016 the world was pumping out far more oil than anyone needed, causing prices to crash. Oil production (the green line) was surging, driven in large part by the US fracking boom, Iraq’s postwar recovery, and Saudi Arabia’s decision to keep its own output high.

Meanwhile, oil consumption (the yellow line) was slowing, held back by economic weakness in China and Europe. All that surplus oil was being stored in inventories (in blue) for later.

But as of mid-2016, production and consumption have started coming back into balance, which is putting upward pressure on oil prices. The IEA lists three important factors here:

1) A few key sources of oil have been cut off due to disruptions. The massive wildfires in Fort McMurray, Alberta, have taken more than 700,000 barrels per day of Canadian oil sands production offline. In Nigeria, militants have stepped up their attacks on oil and gas infrastructure. Violence in Libya continues to hinder oil exports there. And Venezuela’s political situation has deteriorated so drastically, the IEA says, that it may soon muck up oil operations.

The US Energy Information Administration notes that "unplanned global oil supply disruptions" are at their highest level since at least 2011. This has even overwhelmed the fact that Iran has lately added 700,000 barrels per day to world markets after the US and EU sanctions lifted sanctions. The net effect is to push prices up:

Note that some of these disruptions are temporary (particularly the fire-related outages in Canada), but others could prove longer-lasting.

2) Global oil demand is growing faster than expected. In part because oil is so cheap, countries are using more of it. The IEA now expects global oil demand to grow by an extra 1.3 million barrels per day in 2016. Partly that’s due to fast-growing developing countries like India. But, surprisingly, US oil demand is expected to surge this year by about 255,000 barrels per day. Americans have been taking advantage of cheap gasoline to drive more miles this year than ever before.

3) Low prices are starting to cramp the US shale boom. What makes crude oil markets so tricky is that prices depend on production — but production also depends on prices.

Back in the early 2010s, when global crude prices were hovering around $100 per barrel, US energy companies decided it would be profitable to go after costly and hard-to-extract sources of crude, using fracking to get at the oil locked away in the shale formations of Texas and North Dakota. The resulting "shale boom" basically doubled US crude oil production and helped precipitate the global price crash.

But now those low prices are forcing US drillers to cut back, laying off thousands of workers and idling their drilling rigs. US field production of oil has finally started falling in 2016, as the chart below shows. And, overall, the IEA expects US shale production to drop by 500,000 barrels per day this year:

US shale drillers have been trying to fend off this day of reckoning by slashing their costs and making their operations more efficient. But at a certain point, economic reality bites down. The shale wells that they’ve already drilled are rapidly becoming depleted (there’s only so much oil a given well can produce), and it will no longer be profitable to drill new wells. (It costs more to extract shale oil than it does for, say, Saudi Arabia or Kuwait or Iraq to pump oil, which is why US production falls first.)

Now here’s where things get really tricky: As US shale producers cut back, global oil production will fall and oil prices will start rising. But at a certain point, if prices rise high enough, those shale drillers will fire up their rigs again and resume drilling. It’s a complicated game of ping-pong.

No one knows for sure how high prices have to rise to convince US shale companies to start drilling again. Is it $50 per barrel? $60 per barrel? Some companies may feel burned by last year’s short-lived price rally and are wary about jumping back in to drill only to then lose money when prices consequently fall. Others may decide to open up the thousands wells that they’ve already drilled but haven’t yet tapped. And if companies dostart increasing production, how far do prices fall again? Where is the equilibrium?

So if you want to figure out where oil prices will go next, you have to take this all into account. Some of the factors pushing up oil prices right now, such as Canada’s wildfires, are only fleeting. Others, like violence in Libya and the deterioration of Venezuela, seem more likely to stick around for a while. And then there’s the ever-tricky question of how the US oil industry responds to prices. Plus the fact that the world still has some 3 billion barrels of oil tucked away in storage. No wonder oil prices are always so tough to predict.

Tuesday, 14 June 2016

economy

GDP calculation is faulty admits the chief statistician of India

Sainath Gupta 12:41:00

The Chief Statistician of India T.C.A. Anant has admitted that there are “some discrepancies” in the recently released GDP data on Friday and has said that the government is making efforts to minimise them.

Going by figures, the government of India suggests that GDP has grown at 7.9% in the last quarter and it is also the fastest growing economy in the world.

The true story is that discrepancies have soared to Rs 2.14 lakh crore. We recently published an article that says discrepancies cover 51% of the GDP. If discrepancies are removed from the GDP, then the actual GDP would come down to a mere 3.9%. In the previous fiscal, discrepancies amounted to (-) Rs 35,284 crore.

So what are ‘discrepancies’?

GDP is calculated by two methods – a. Income method b. Expenditure method, ideally calculation by both methods should be the same, however, there are always some statistical differences amounting to 0.1 – 1 % and these numbers could be more in the case of developing country. Discrepancies even by a few percentage points is a red flag, to have discrepancies as 51% of GDP is beyond imagination and explanation.

Mr. Anant said that discrepancy occurs because the government compile expenditure estimates along with production figure, which is based on some rule of thumbs, the allocation does not completely explain expenditure side accurately and thus the difference between the two estimates becomes discrepancy, as reported by Deccan Chronicle.

Even if we take this into consideration, few recently published facts completely go against such high rate of GDP.

The factory output measured in terms of Industrial Production (IIP) has shrunk by 0.8 per cent in April this year, the first decline in three months.Capital goods output, which is a barometer of investment, declined sharply by 24.9 per cent in April.The Business Expectations Index (BEI), which is a useful metric for the confidence of companies, has fallen to its lowest level in the last two years.The agricultural sector which also is a key factor for country’s GDP saw a growth of merely 1.2%.

At a time like this, how can the GDP of the country accelerate?

Thursday, 12 May 2016

TAX

India's new Mauritius treaty signals end of shopping for tax havens

Sainath Gupta 17:53:00

MUMBAI, May 11 (Reuters) - India's move to plug suspected losses in tax revenue through Mauritius, a top source of foreign investments into the country, has not sent financial markets into a tailspin as it would have just a few years ago.

But while markets took the move in their stride, analysts warn India is likely to expand its crackdown on tax treaties and make it harder for investors to shop around for new havens.

India will start imposing capital gains tax on investments coming from Mauritius starting next year, after the two countries agreed to amend a three-decade old treaty. funds from Mauritius interested in India will have to weigh paying capital gains taxes that could range from zero to as much as 20 percent versus the expense of setting up a new structure.

Investors say they will wait for final details and consider how it will affect India's tax treaty with Singapore. The rules state any changes to the capital gains exemption provided to Mauritius will lead to changes in the agreement with the city-state.

Mauritius and Singapore account for the bulk of the $278 billion in foreign equity investments since 2000.

Even with capital gains, analysts say shopping around for a new tax haven may not make sense. India will next year toughen the criteria under which offshore funds can claim tax benefits abroad, a key priority for Prime Minister Narendra Modi's government.

"World over, the wind is blowing against tax treaty shopping and treaty abuse. Structures set up only for the purpose of claiming tax exemptions but without adequate substance are no longer likely to work," said Suresh Swamy, a partner at PwC in Mumbai.

Investors were relieved the taxes would only apply to investments starting next year and not affect existing investments. India's main share index .NSEI fell 0.5 percent.

India has become a favourite destination of foreign investors under Modi on hopes of major reforms targeted to revitalise Asia's third-largest economy. Gross foreign investments reached a record $55.5 billion in the year to March 2016, up 23 percent from the previous year, according to brokerage Religare Capital Markets.

The tax changes could hurt short-term foreign investment inflows, but investors say they may still choose Mauritius if it proves cost effective.

"I don't think shifting everything lock, stock and barrel for an existing fund is going to be that easy," said a director for a private equity fund in Mauritius, who declined to be identified given the sensitivity of the subject.

A hedge fund manager who had been considering setting up in Mauritius said his firm would also keep its options open, while exploring other locations such as Delaware or Cayman Islands.

"Ultimately, if Mauritius proves to be a more cost-effective offshore jurisdiction for non-U.S. investors, then I think many India funds will continue to domicile their funds and management companies in Mauritius."

economy

By ‘crying wolf’ Indian Banks have only harmed their own credibility, says Raghuram Rajan

Sainath Gupta 16:16:00

RBI governor

Raghuram Rajan

has said that the bankers may have low credibility because they have "cried wolf too often." However, he appeared in their favour for easing of strict capital control measures so that the growth can be given the required boost.

He was also seen comparing India's situation to that of SMEs in industrial countries, stating that both scenarios need faster growth. He added that the greater demand on banks to hold capital in the post-financial crisis scenario has not come for free.

"It made sense post financial crisis to ask banks to hold more capital. But one of the concerns bankers have been expressing, even if bankers may have low credibility because they have cried wolf too often, that eventually it will... create greater aversion to taking on risky lending.

"We see some of that today. Certainly, as an emerging markcentral bank regulator, I see that foreign banks have stopped opening branches because our credit rating is BAA, which implies higher risk. From that perspective, international banks who are asked to put in money in India feel it is not worth it, because they have to set aside a lot more capital."

ALSO READ:

RBI might cut more rates if inflation falls

Various global agencies have assigned the lowest investment grade rating because of having a high risk profile.

"So we need to ask ourselves, is more capital good or is it likely to impinge on activities banks do. There is a trade-off and this calls for more empirical work as to what the right level of capital is,"

Rajan

added.

Wednesday, 9 March 2016

yuan

Yuan Dominating the Dollar

Sainath Gupta 18:01:00

(Bloomberg) -- China’s yuan, which earned reserve status from the International Monetary Fund last year, enjoys growing prominence as an international currency that will diminish the dollar’s role in trade and transactions over time, according to a U.S. congressional panel.

The yuan “is already on the path to being a reserve currency both in principle and in practice,” Eswar Prasad, a former chief of the IMF’s China Division and now a professor at Cornell University in Ithaca, New York, wrote in a report prepared for the U.S.-China Economic and Security Review Commission.

The rise of the currency, also known as the renminbi, “will erode but not seriously challenge the dollar’s status as the dominant global reserve currency” Prasad wrote in his report to the commission. The body was created in 2000 to review the national security implications of trade and economic ties between the U.S. and China.

While the yuan will be used more widely to denominate and settle cross-border transactions, “the underdeveloped state of China’s financial markets is likely to be the major constraint” on the currency’s rising prominence in international finance, Prasad wrote.

yuan

China's Debt Seen at 283% of GDP by 2019

Sainath Gupta 17:59:00

China’s ratio of debt to its economic size is seen climbing for at least another four years, underscoring the risks facing policy makers as they strive to prevent a deeper slowdown without triggering a credit blowout.

Seven out of 12 economists see the debt-to-gross-domestic-product ratio increasing through at least 2019, with four expecting a peak in 2020 or later, according to a Bloomberg News survey. Debt will peak at 283 percent of GDP, according to the median estimate of eight economists.

Policy makers grappling with the fallout from a credit binge after the global financial crisis are also being confronted by anemic demand for exports and an aging workforce, pushing economic growth to the slowest pace in a quarter of a century. With robust consumption and services struggling to pick up the slack from slowing investment and manufacturing, China’s communist leaders are striving to put a floor under growth to ensure average expansion stays around 6.5 percent through 2020.

"We doubt the debt ratio will peak before 2020," said Julian Evans-Pritchard, a China economist at Capital Economics Ltd. in Singapore. "Our model puts the peak in the debt ratio in 2024, but the ratio could rise further beyond that if Chinese policymakers fail to implement the necessary structural reforms required to improve credit allocation."

Concerns over China’s borrowing came to the fore last week, when a report showed the country’s banks extended a record 2.51 trillion yuan ($385 billion) of new loans in January. The increase in debt could pressure the country’s credit rating, Standard & Poor’s said on Tuesday, less than a week after the cost to insure Chinese bonds against default rose to a four-year high.

Underscoring the delicate balancing act between the desire to keep credit flowing, but not too fast, the central bank will boost the amount of reserves that must be locked away by some banks. The move reinforced the view that the central bank is striving to prevent a repeat of the 2009-2010 credit blowout, said Tim Condon, head of Asian research at ING Groep NV in Singapore.

The tightening of liquidity for some lenders follows the monetary authority’s recent announcement that it would adopt a so-called macro prudential assessment system that uses commercial banks’ required-reserve ratios to help enforce financial stability.

Still, the PBOC is seeking to lower overall borrowing costs to underpin an economy that expanded at the slowest pace in a quarter century last year. To guide market interest rates lower, the PBOC last week provided cash through its Medium-term Lending Facility at 2.85 percent for six-month loans, down from 3 percent.

It is almost impossible to identify a specific debt-to-GDP level or time period that will “tip” the Chinese economy into a financial crisis, Goldman Sachs Group Inc.’s investment management division said in a January report. Comparing the magnitude and pace of the increase in China’s debt-to-GDP ratio to those of other countries, it concluded China’s increase is among the highest in recent history.

"Every major country with a rapid increase in debt has experienced either a financial crisis or a prolonged slowdown in GDP growth," wrote analysts led by New York-based chief investment officer Sharmin Mossavar-Rahmani and Hong Kong-based investment strategist Ha Jiming. "History suggests that China will face the same fate."

The paper compared China to five countries that experienced financial crises since 1990 -- Japan, South Korea, Thailand, the U.S. and U.K. -- and found China’s increase in debt relative to GDP since 2008 was exceeded only by Thailand’s binge from 1990 to 1997.

"Most also had lower levels of debt relative to GDP and, again with the exception of Thailand, were far richer than China at the time of their crises," it says.

Fiscal Room

The risk going forward is that China’s growth targets are still too high and lead to higher fiscal deficits and debt, Standard & Poor’s said last week. The nation’s room for fiscal maneuver will shrink when potential problems such as deteriorating asset quality in the banking sector arise.

While China has a high level of corporate debt, government debt isn’t high, said Wang Yiming, deputy director at the Development Research Center of the State Council in a briefing last week. China’s high savings rate is also supportive of higher investment, which may provide a buffer to a higher debt-to-GDP ratio, said Tommy Xie, an economist with Oversea-Chinese Banking Corp. in Singapore.

At the higher end of the spectrum, respondents Evans-Pritchard and Larry Hu, head of China economics at Macquarie Securities Ltd. in Hong Kong, see China’s debt-to-GDP ratio peaking at about 300 percent of GDP. At the lower end, Nie Wen, a Shanghai-based economist at Huabao Trust, estimates it will peak at 250 percent.

"If China chooses the zombie bank/company mop up and prop up strategy, they will slow not only productivity but current and potential GDP," said Constance Hunter, chief economist at KPMG LLP in New York. "If they choose instead to take the heretofore unrecognized bad debts of the state-owned banks on the government balance sheet, a la Ireland, they will increase government debt but they won’t have zombie banks and they are more likely to see a robust recovery."

Courtesy of Bloomberg

saudi

Abu Dhabi’s Biggest Bank Says Oil Prices May Drop to $20

Sainath Gupta 17:54:00

Oil prices may drop to near $20 a barrel this year as the global glut of crude persists into 2017, Abu Dhabi’s largest lender said.

U.S. benchmark West Texas Intermediate crude should trade in a range between $25 a barrel and $45 a barrel for the rest of the year, “although a very brief spike down towards $20 is possible,” the National Bank of Abu Dhabi PJSC wrote in its Global Investment Outlook 2016 report on Sunday. Prices at the lower end of the range will stimulate demand growth, it said.

“For at least the next few years there do appear to be solid fundamental reasons why oil prices are likely to remain in a trading range,” NBAD analysts wrote in the report. Producers have sold less of their crude this year through forward transactions than in past years, and forward-selling would likely accelerate if prices rallied much above $40 a barrel, the bank said.

Abu Dhabi is the capital of the United Arab Emirates, which holds about 6 percent of the world’s oil reserves. Almost all regional oil exporters are set to register “twin deficits” on both their current and fiscal accounts for last year and this year, NBAD said. WTI prices dropped about 40 percent in the past year.

Repost

Thursday, 3 March 2016

economy

Bank of Japan May Reduce Rates Again, But Not Now

Sainath Gupta 23:43:00

Bank of Japan Deputy Governor Hiroshi Nakaso indicated the central bank is prepared to take its benchmark rate deeper into negative territory, though not immediately.

“We have designed a policy that technically allows us to cut the level further,” Nakaso told reporters in Okinawa Thursday, referring to a minus 0.1 percent interest rate policy the central bank adopted in January. “I can’t say anything concrete at this point” on how low the rate could go, he said.

Nakaso, a career BOJ official tapped by Prime Minister Shinzo Abe as one of Governor Haruhiko Kuroda’s two deputies, also said that financial markets need time to digest the unprecedented negative-rate policy. It took effect Feb. 16.

“Some more time is needed for financial markets to digest the policy and for us to measure the impact of it,” said Nakaso, who is a former director at the BOJ’s markets section.

The BOJ has faced a backlash against the Jan. 29 decision to charge commercial banks on a share of the cash they park at the central bank. The reaction has cast a cloud over the BOJ’s next policy meeting, scheduled for March 14-15.

economy

Russia's Economy Is Tanking, So Why Is Putin Smiling?

Sainath Gupta 23:40:00

With Russia mired in the longest recession in two decades, there hasn’t been a lot of good economic news lately. But there’s one indicator that’s looking up, and it’s the one that matters most to Vladimir Putin: His hard-currency reserves.

The central bank held $379 billion in foreign exchange and gold as of Feb. 19, up $29 billion from lows touched last April, making Russia the only major emerging market with a gain.

While China and Saudi Arabia have spent tens of billions of dollars to shore up their currencies, the central bank in Moscow has gone cold turkey on intervention. Since blowing more than $67 billion in a failed effort to steady the currency at the end of 2014, Russia hasn’t spent a penny to prop up the ruble. In fact, it bought some foreign currency last spring.

“No amount of spending of currency reserves can stabilize the ruble,” Dmitry Tulin, first deputy governor of the central bank, said last month, a few weeks after the currency dropped to new lows. “It’s very easy to fire your whole arsenal quickly, but that would yield only a temporary, Pyrrhic victory.”

That view reflects Putin’s about-face just over a year ago as he decided to husband the Kremlin’s cash at all costs, amid falling oil prices and U.S. and European Union sanctions that largely cut Russia off from western financial markets. The exchange rate, once a top economic priority, would have to be sacrificed as crude plunged. Spending from Russia’s sovereign-wealth funds, the bulk of which count toward the central bank’s holdings, would be conducted in a way that ensured the overall total didn’t drop. There would be no “burning through the reserves,”Putin said when the central bank cut the ruble loose in December 2014.

The economic experiment reflects his conviction that gold and hard currency in the bank are the best guarantee of Russia’s financial independence, according to senior officials who’ve discussed the issue with him. Since he came to power in 2000, Putin has built up reserves from a mere $13 billion and paid off Russia’s debt, which is now one of the lowest among major economies.

“Vladimir Putin recognized the power of reserves in 2008-2009, when thanks to them he survived the crisis without significant losses,” said Alexei Kudrin, who was then finance minister and still meets Putin regularly to discuss economic policy. “To be left with a small amount of reserves now would be difficult, even just psychologically.”

Tuesday, Putin brushed off calls to use the central bank funds to help revive the economy, telling a business group, “Gold and currency reserves are created by the central bank for other purposes, not for financing current economic problems.”

Rebuilding Reserves

Last spring, when the currency staged a brief recovery, the bank moved in to buy $10.5 billion for its reserves, hastily suspending the effort when the ruble resumed its declines. Most of the rest of the gain in reserves comes from banks repaying hard-currency loans from the central bank and fluctuations in exchange rates, the bank said.

But the toll on the ruble has been heavy. The currency has lost a quarter of its value against the dollar since early last year and gyrated by as much as 5 percent per day early this year as oil prices tested the lowest levels seen in years.

“The central bank is ready to tolerate almost any volatility in the rate in order not to spend reserves,” said Oleg Kouzmin, economist at Renaissance Capital.

Central bank officials watch markets closely for signs Russians might be losing faith in the battered ruble, getting daily reports from banks on demand for foreign currency, according to senior officials. So far, the Kremlin has avoided the kind of market panic that other devaluations triggered.

Ruble Pain

But the ruble’s drop has fueled a spike in inflation, reversing years of progress in the central bank’s efforts to rein in price growth. Consumer prices jumped 12.9 percent last year, the biggest calendar-year rise since 2008. The ruble’s drop accounted for the bulk of the increase, given Russia’s dependence on imports of everything from food to industrial equipment, according to the central bank.

While the weaker currency has opened the way for some local companies to compete with lower prices at home and abroad, the sharp swings in the rate complicate life for business.

“This ruble volatility is bad for us,” said Vladislav Korochkin, president of Russky Ogorod, a mid-sized company based near Moscow that sells seeds and plants and imports about half its raw materials. “Nobody believes anymore that it’s possible to predict what the rate will be in six months,” he added.

The volatility worries Putin, too, according to senior officials who’ve discussed the issue with him, but so far it’s a price he’s willing to pay for preserving the country’s financial security. He regularly asks aides for reports on the remaining reserve balances, according to two senior officials who spoke on condition of anonymity.

Russia also keeps most of the money from its two wealth funds at the central bank. But even as the Kremlin draws those down, officials have found a way to keep the overall reserve total up.

Draining Funds

When the Finance Ministry draws from the rainy-day fund to cover the widening budget deficit, the central bank simply shifts the foreign-currency assets to its own account, issuing rubles to the ministry. To hold inflation down, the central bank drains an equivalent amount of rubles from the system by reducing its lending to banks.

“Contrary to the widely held view, spending from the Reserve Fund doesn’t reduce international reserves,” said Ekaterina Vlasova, a former central bank official who is now economist at Citigroup Inc. in Moscow.

Putin personally makes decisions on spending the other wealth fund, which is earmarked for infrastructure and other long-term projects, according to senior officials. So far, about a third of the $71 billion total has been committed, with the rest remaining in central bank reserves.

All told, the $379 billion in central bank reserves includes about $99 billion from two the wealth funds. The money is mostly invested in dollar and euro government debt, as well as Russia’s growing holdings of gold.

Officials have said both the wealth funds could be fully depleted by 2018 unless oil prices recover or the government finds other ways to cover the deficit, such as selling state assets or raising debt. Once the funds are empty, the Kremlin will be forced to make painful cuts in spending or hike taxes in order to keep the budget gap under control.

The central bank, meanwhile, is looking to increase its reserves. After Putin’s mandate to hold onto the cash, the central bank announced plans to boost reserves to $500 billion.

Though that target is more than twice what economic theory suggests would typically be required, “That’s the level we’ve become accustomed to,” central bank chief Elvira Nabiullina said in announcing the goal last year.

If attained, that would be a level not seen since early 2014 and just short of the record set in July 2008. Then, the total was $598 billion, enough to rank third in the world behind China and Japan.

Hitting those figures means the ruble’s wobbles are likely to continue. “The central bank is going to stay on the sidelines in the currency market,” said Vlasova, the Citigroup economist. “The financial authorities are serious about maintaining international reserves in the short term and increasing them over the medium term.”

Sunday, 24 January 2016

economy

Why 2016 will be difficult, but you should not panic

Sainath Gupta 19:21:00

It is less than a month since 2016 began, and the equity markets are already down by close to 6 per cent year to date. With this, the markets have corrected 13 per cent since the beginning of 2015 (13 months). That is good enough a correction to unnerve you a bit, or signal you to average.

It is going to be a rough ride this year, or at least for a good part of this year. China, crude oil and currency are beginning to trouble the world. But then here’s why you should not panic and upset your portfolio.

Why this is not 2008

There are many reasons why it may not be right to compare the current situation to the one in 2008. Given below are some:

First, while commodity is a factor to worry about, the scenario was entirely different in 2008. Commodity cycle was at a peak then, and was only thought to go up. This time around, if anything, commodities have crashed, and are only forecast to go further down south. That means commodity per se cannot be a threat to the net import of developing economies such as India.

Two, too much money, created too quickly and the eventual collapse of speculation in credit and derivatives in the US, besides bankcrupty in parts of Europe were key reasons for the 2008 downfall. This time, the trigger has been China, and that too its primarily slowing economy (we will discuss the China conundrum later), although it may be too early to say whether it will lead to a credit risk globally at a later stage. While a slowing Chinese economy can slow global growth, that alone need not be cause for a crisis. Besides, global growth expectations are themselves moderate, with sufficient cuts in forecasts, as opposed to unrealistic growth expectations in 2007-08. India itself has been steadily seeing earning downgrades, and there seems little optimism in near-term earnings growth. In other words, there is complete absence of exuberance. This means less risk of a bubble.

Three, various banks across the globe have been more actively using their monetary/fiscal tools to combat excess and low liquidity situations, as the case may be, since the debacle in 2008. That will also likely help curtail even a serious situation to snowball into one like 2008.

For India itself, it is among the few emerging markets considered to have a revival, helped by the fallout in commodities, as well as fiscal/monetary adjustments.

Why it will still be a tough year

While the comparison with 2008 may be overdone, we do believe that this is not going to be an easy year; at least for the next one-two quarters. Why do we think so?

What China can do: China is definitely reeling under a slowdown, following years of building over capacities. China now suffers from high savings rates, and the sinking of huge investments into capacities not balanced with productivity, therefore leading to the problem of mounting debt. There are no quick fixes for China’s woes. China’s lasting solution would come from a more open economy and market-driven currency valuation. However, allowing market forces to readjust means capital outflows (not just from China, but from other emerging markets as well), and a depreciation of the Chinese currency, renminbi, which could slowly result in global pain. This is because a depreciating renminbi could make some of the export-oriented nations less competitive. Besides, China is the second largest economy, and a slowdown there would hurt global numbers as well.

What it means for India: Many of the Asian emerging markets are exporters to China, and a Chinese slowdown could hurt them. India is less vulnerable on this count. However, a depreciating Chinese currency could make us less export competitive in our own exports such as textiles or engineered goods. Besides, cheap dumping of Chinese inputs such as steel could send Indian commodity makers into a domestic supply glut and put down corporate profitability.

Crude impact: Two, crude has bottomed to 11-year lows and is no longer driven by fundamentals. Multiple extraneous factors drive the price and removal of sanctions on Iran, and fresh supply of oil will likely not help provide any support to price.

A number of oil producing nations that have taken sharp price falls on what is their main stream of revenue could also see a slowdown in their economy. Besides crude, a number of commodities have also crashed. That means many countries such as Brazil, Russia or South Africa are hit.

As many of these oil nations are also high-importing nations, the countries that export to these regions would also be affected. There is, therefore, this ripple effect. Not that the US markets can be immune to all this as the S&P 500 gets over a third of its earnings from companies in emerging markets.

What it means for India: As mentioned early on, net importers like India get to benefit from lower crude oil prices. However, the problem is that India’s own stock market fortunes are linked to institutional flows. The outflow of sovereign wealth (belonging to oil producing nations) from oil producing nations can mean outflow of money from stock markets, thereby impacting returns. This is what is being currently experienced.

Credit risk

More than China, currency or crude, what ultimately has potential to turn a slowdown or market fall into a crisis is credit risk. Whether it is the Asian Crisis in 1997, or the global meltdown in 2008, credit holds the potential to make or break. So what is the credit risk in the current scenario? The risk with Chinese credit is imminent as its debt to GDP ratio has been mounting at over 250 per cent. And China’s credit problems can impact the world, going by its borrowings as well as its parking of money across economies.

But that is not the only credit risk. Oil producing nations could also see increasing risks in terms of a liquidity crunch. This is already visible in terms of the pull out of the sovereign wealth of gulf nations parked in other emerging markets. Oil producers including the shale gas producers in US have been under a lot of stress to service their debt as oil glut and 11-year low prices keep it hard to generate sufficient cash flows. Bankruptcy or debt restructuring could once again impact the largest sector in every economy – banking.

While this risk is not imminent at present, what we are implying is that it is effectively a credit risk that has the potential to throw the market into a 2008-like scenario. The good news is that countries are now well placed with fiscal and monetary tools to manage their liquidity better than they did in 2008. That means they have better means to curtail meltdowns. And the current scenario may also force the US to go slow on its rate hike path, thus muting the risk of outflow from riskier markets.

What it means for India: The impact on India, from such a credit situation is unlikely to show up in the economy; but rather play up in the markets. This is because, such a credit risk scenario would mean lower investible surplus in foreign institutional players including sovereign wealth money. And Indian markets are driven by foreign flows. That means, our markets may have to, for some time, settle for lower inflows or limited players participating. That would probably also be the time when domestic institutional investors (such as mutual funds) could do some bargain hunting.

Where India stands

As a net oil importer, and as one of the few emerging markets which is witnessing a revival (in pockets), India is certainly better placed to benefit from the crude oil tumble. It will fix the country’s financial problems, and also make it look even better among emerging markets.

Added to this, India is not too export driven and has a sound internal consumption story to play with. The Seventh Pay Commission, the One Rank One Pension and Direct Benefit Transfers can be expected to buttress the local economy, and signs of these are already showing up in corporate performance as well as market data.

No doubt, institutional money will flow out (before they get back into the country) as readjustment of foreign portfolios happen. However, we think such a correction is, in a way, necessary. This is because the markets heated up in the 2014 rally, with just promises of government performance, without being backed by improving corporate fundamentals.

There is more action on the ground today. And on the brighter side, the overvalued pockets on our market are beginning to get more reasonable, providing good entry opportunities. At about 19 times Nifty price earnings ratio (trailing) now, it is quite a bit of fall from the over 21 P/E even at the beginning of this year. We have (see graph below) also seen a steady downgrade in earnings estimate, unlike in 2007-08, where estimates were upped, despite P/E levels of 28 times.

So what will the markets do? Money would be rewarded to quality stocks with good earnings growth thus far, the short-term market correction notwithstanding. On the other hand, markets could be rather unkind to even small disappointments in earnings. That means there would be pockets of opportunities for fund managers to pick and hold.

What you should do

You have two choices – to sit back, watch the show (and not watch your portfolio), and thank yourself few years hence for having stayed there. Or you could hit the panic button, get out, and not just regret, but be poorer for that. We hope you will choose the former and be richer.

If you decide to average, use market falls of over 5 per cent to deploy say 2-3 months of your running SIP amounts (if you have SIPs running), or deploy a third of your surplus into the market. Large-cap or multi-cap diversified funds would be preferred options. We had advocated in September that markets would be volatile, and that investors should consider active averaging until March 2016. We believe the current scenario only provides more opportunities. So note that this will not be without short-term pain. But then, the gain at the end would likely make it worthwhile.

Saturday, 9 January 2016

economy

14 Predictions for 2016 From the Brightest Minds in Finance

Sainath Gupta 14:59:00

Watch for a Worldwide Recession

Ruchir Sharma, head of emerging markets equity and global macro, Morgan Stanley Investment Management

“We are now just one big shock away from a global downturn, and the next one seems most likely to originate in China, where heavy debt, excessive investment, and population decline are combining to undermine growth, while relatively low-debt countries from Eastern Europe to South Asia look better positioned to weather the inevitable next turn in the cycle.”

Fixed Income Faces a Rocky Road

Photographer: Brendan Mcdermid/Reuters/Corbis

Dan Fuss, vice chairman at Loomis Sayles & Co. and co–portfolio manager of the $20 billion Loomis Sayles Bond Fund

Yields on the benchmark 10-year Treasury note will likely rise to 2.6 percent to 2.8 percent by the end of 2016, Fuss says, although he cautions that the current geopolitical turmoil makes forecasting especially difficult. For investors with a bond portfolio in these rocky times, Fuss recommends a mix of Treasuries, investment-grade corporates (with maturities of five to 12 years), and high-yield debt has the best chance of success in 2016. And you’ll need to be especially picky when it comes to high-yield bonds instead of relying on an index fund, he says. “It’s quite clear that high yield has the best value relative to stocks, but there’s a lot more scatter there.”

Know Which Equities to Watch

Thomas J. Lee, managing partner at Fundstrat Global Advisors

“Equities are going to do really well in 2016, especially banks and blue-chip businesses. Banks will benefit from the Fed tightening and will boost their returns on equity as the economy expands. And when you look at blue chips, they’re going to have the ability to generate stronger returns as the economy picks up.”

The EU Faces Its Biggest Challenge Yet

Rebecca Patterson, chief investment officer of Bessemer Trust, which oversees more than $100 billion in assets

The biggest risk for Europe in the year? "It's the refugee crisis," says Patterson. "I think it's the biggest challenge to the European Union yet. The horrible terrorist attacks in Paris increased the risk that the refugee crisis could result in a political and/or policy shift, or simply lead consumers to change their spending patterns. Either could weigh on sentiment around European growth and corporate profits." Patterson is on alert for any such changes but remains overweight European equities and positioned for a weaker Euro, she says. "The Paris attacks sadly shone a light on the European refugee crisis; I assume more investors globally now are thinking more about what millions of immigrants can mean for an economy and respective markets. However, I am still not sure that investors globally have adequately thought through what market spillovers the European refugee crisis could trigger over the coming year."

Expect a Lift

Photographer: Shannon Stapleton/Reuters/Corbis

Jim Caron, a managing director at Morgan Stanley Investment Management

“I believe inflation risk premia will return to the markets. This should provide upward lift for 30-year Treasury yields, possibly toward 3.75 percent. The markets may also be surprised by how slowly the Fed hikes rates in the face of what we think will be an improving economic climate.”

Unicorns Will Have Their Moment—or Not

Alan Patricof, co-founder of Greycroft Partners

“I am concerned about the overexuberance in financing of startups. There are just too many at the moment, and there isn’t enough money to sustain them. I think inevitably we’re going to see more of these unicorns”—startups valued at more than $1 billion—“try the public market, and that will finally tell us whether they can support themselves. By the way, I don’t think there’s enough money around to sustain all of them. We’re going to find out which unicorns can make it.”

The Search for Yield Will Intensify

Russ Koesterich, global chief investment strategist at BlackRock, the world’s largest money manager

“The Fed is going to be less important in 2016,” says Koesterich, who expects Janet Yellen & Co. to raise interest rates incrementally. He predicts global growth will stay sluggish, increasing the thirst for higher-yielding assets. Investors who have relied on high-coupon bonds they bought before the financial crisis are running out of those securities, he says—and there’s little to replace them that’s a slam dunk. “You won’t be able to find income without risk. Asset classes from [master limited partnerships] to high-yield bonds each have their own risks—and none of them are cheap. You’re going to have to have a multi-asset-class, diversified-yield play.”

Get Energized

Barbara Byrne, vice chairman of investment banking at Barclays Capital

“We will begin to see a recovery in the prices of natural resources for largely—and critically important—political reasons. We’re beginning to see sovereign wealth funds decline—Norway, Saudi Arabia. I think we’ll see a reversal on that; countries will not be able to afford fluctuations in their reserves. We’ll probably move to a more stable oil price, which I would say is $60 per barrel. And I think energy assets that are investing in sustainability at the same time that they’re focusing on meeting the needs of the current demands will probably do well.”

Study Latin America

Tulio Vera, chief global investment strategist for the J.P. Morgan Latin American Private Bank

“There’s a ray of sunshine from Argentina,” says Vera. “That’s not only important for the country but also for the region.” While Vera says the investment landscape in Brazil remains uncertain, he sees Mexico continuing to benefit from the U.S. economic recovery, especially in the auto industry. “There will be some very interesting entry points in Latin American assets between now and the end of next year,” he says. “We are getting closer to a re-entry moment for some of these markets.”

Growth Is Coming … in 2017

Joseph LaVorgna, chief U.S. economist at Deutsche Bank

“I’ve got growth accelerating a bit because it seems like there are reasons that the economy should get better, but it’s concerning that 2010 was the best year for growth since before the recession. As I look forward, the message is ‘more of the same,’ with maybe some optimism into 2017 that whoever the U.S. elects president will pursue growth policies, since this economy hasn’t done well.”

Impact Investing Will Target Cancer

Mark Haefele, global chief investment officer at UBS Wealth Management

“The world’s populations are aging, and demand for cancer treatments will only increase,” says Haefele. “Yet the supply of capital for the riskiest stages of development is limited.” Health-care companies tend to focus on later-stage research, providing an opportunity for earlier-stage investors to earn an attractive long-term return—and benefit society. “This type of practice”—known as impact investing—“is likely to become more popular as investors seek to align their portfolios with their social values as well as generating a return,” says Haefele.

China Will Be Just Fine

Yang Zhao, chief China economist at Nomura Holdings, which cut its 2016 GDP forecast to 5.8 percent from 6.7 percent on Oct. 6

“Is there going to be a hard landing in China? I don’t think so. The labor market remains largely balanced; even with 5.8 percent GDP growth, the economy will create jobs, especially in the labor-intensive services sector. And it’s unlikely that China’s financial industry is headed for a crisis because most of the country’s institutions are backed by the government. Should any systematically important financial institutions have any problems, we believe that the government will step up to rescue them.”

Think Like a Millennial

Katie Koch, a managing director at Goldman Sachs Asset Management, which oversees almost $100 billion in global stocks

“The rise of the millennials will have long-term investment implications,” Koch says. “Their spending trajectory is getting steeper and increasing compared to baby boomers, who are decreasing their spending as they retire.” In 2016, Koch is especially keen on Netflix, Nike, H&M, and PChome Online, a Taiwanese e-commerce company, because they prioritize instant information, quick consumption, and healthy living—themes that resonate with the 2 billion people worldwide born from 1980 to 2000.

More of ‘Whatever It Takes’ From the ECB

Erik Nielsen, chief economist at UniCredit

“Expect further divergence between the Fed and the ECB, with the former hiking rates a couple of times next year and the latter expanding its balance sheet more than it has presently announced.”

Thursday, 16 June 2016

Tuesday, 14 June 2016

Thursday, 12 May 2016

Wednesday, 9 March 2016

Fiscal Room

Thursday, 3 March 2016

Rebuilding Reserves

Ruble Pain

Draining Funds

Sunday, 24 January 2016

Saturday, 9 January 2016

Watch for a Worldwide Recession

Fixed Income Faces a Rocky Road

Know Which Equities to Watch

The EU Faces Its Biggest Challenge Yet

Expect a Lift

Unicorns Will Have Their Moment—or Not

The Search for Yield Will Intensify

Get Energized

Study Latin America

Growth Is Coming … in 2017

Impact Investing Will Target Cancer

China Will Be Just Fine

Think Like a Millennial

More of ‘Whatever It Takes’ From the ECB

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