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Thursday, January 31, 2013

Japanese industrial output points to recovering economy.

Japan's industrial production recovered to rise 2.5% on month in December vs -1.4% in November, although the growth was below consensus of +4.1%. With the companies surveyed for the report expecting more gains in January and February, the data adds to other metrics which indicate that the economy could be rebounding from its recent slump.

German unemployment unexpectedly drops but so do retail sales.

German unemployment has unexpectedly fallen for the first time in 10 months in January, declining 16,000 to 2.92M vs consensus for a rise of 8,000. The jobless rate dropped to 6.8% from 6.9% in December. "The German labor market is in a good position," says SocGen economist Anatoli Annenkov. However, retail sales cratered 4.7% on year in December, far worse than forecast and representing the largest decline since May 2009

Facebook shares fall despite earnings beat.

Accelerated growth in Facebook's (FB) mobile ad sales helped the company's Q4 earnings beat expectations, with EPS coming in at $0.17 and revenue jumping 40% to $1.59B. However, net profit slumped 79% to $64M, due to increased spending and charges related to employee shares. Overall ad sales climbed 41% to $1.33B, with mobile making up 23% of the figure. That's up from 14% in Q3, although the growth didn't meet heightened expectations, which could be one reason for the stock sliding 5.6% premarket.

Deutsche Bank Q4 net loss €2.17B due to massive charges.

Deutsche Bank (DB) swung to a Q4 net loss of €2.17B from a profit of €147M profit last year and vs consensus for a loss of €311M. Earnings were hit by a €1.9B goodwill impairment charge for restructuring and the creation of a non-core unit to sell €125B in assets. DB, which is being investigated for interest-rate manipulation, is also taking €1B in litigation charges. Shares were +1% premarket

Jobs Report Sets Dollar Up For Decline

The greenback was near its weakest level in over a year to the Euro, and dropped as against the Yen, on news that the Fed will continue purchasing treasuries and mortgage bonds.

The Fed decided yesterday to keep purchasing securities at the rate of $85 billion a month and left unchanged its decision to hold its target interest rate near zero, for as long as unemployment remains above 6.5% and while inflation remains below 2.5%.

As a result, I foresee that this position will remain a Dollar-negative factor until we can see improvement in data.

That news may be a while off though, as data about U.S. applications for unemployment insurance payments, due out today, is forecast to show a rise by 21,000 to 351,000 for the week ended 26th January.

Most economists are forecasting that the jobless rate has held steady at 7.8% in January.

The Dollar earlier fetched $1.3579 per Euro, near its weakest level since November 2011, and was down by 0.1% to 90.97 Yen. The Euro was still at a strong level at 123.52 Yen.

The Yen had risen against most of it major counterparts after Asian stocks halted a two day advance.

What we are likely seeing is consolidation after recent gains in the Dollar-Yen.

Earlier today, Japan's Trade Ministry had said that industrial output had risen by 2.5% in December from November, when it had dropped by 1.4%.

This poses a challenge to Prime Minister Shinzo Abe who is seeking to boost growth in an effort to end more than a decade of deflation.

While market perceptions on economic growth remain tepid and inflation expectations remain low, we could see the Yen continue to remain under pressure overall for some time to come.
Ever since the 2008 financial crisis broke out, the world economy has treaded a very fragile and capricious path. There is overall sense of gloom and pessimism. In fact, many have taken to predicting the next big crash, the next big crisis. Will it happen in 2013? Or 2014? Will it be the Eurozone or the US?

With the global economy going through a tough patch, many have been banking on China to prop up global economic growth. What many are not expecting is a full blown financial crisis in China, the emerging economic superpower. We came across an interesting article that discussed this possibility. Though it would be difficult to pinpoint exactly when the bubble would burst, there are some indications that things could eventually get there.

One must remember that the Great Depression struck the US just before it emerged as a global superpower. Could China's fate be similar? While the economy has been growing at a rapid pace, its debt burden has been bulging. In fact, its non-financial debt as a percentage of GDP is close to reaching the same levels that the US had scaled just prior to the 2008 financial crisis. It's already at the same level where Japan was prior to the 1990 banking crisis. If this indicator is anything to go by, China could be heading towards a major disaster. It seems like it's only a question of time.

Wednesday, January 30, 2013

Yen Down As Stocks Up, Dollar Weakest In A Year

The Yen declined against most of its major peers as Asian stocks rose again today and on expectations that Japan will expand monetary stimulus.

The Bank of Japan (BOJ) could maintain a more dovish policy for longer and this together with a rise of the MSCI Asia Pacific Index (MXAP) by 0.7% earlier today, is underpinning Yen weakness.

In fact, the Yen is poised for a 4.6% drop versus the Dollar in January.

Earlier in the month, the BOJ doubled its inflation target to 2% and had also agreed to open-ended asset purchases set to start in 2014.

I foresee that the Yen will still weaken further in the medium term.

Earlier today the Yen dropped 0.2% to 90.90 per Dollar and lost 0.2% to 122.68 per Euro. The Dollar traded at $1.3491 to the Euro.

The Dollar was near to its weakest level in over a year versus the Euro, ahead of data that is expected to show that U.S. job gains and growth have slowed.

The Federal Open Market Committee is set to release its policy statement today and are expected to show that the nation's gross domestic product gained at its weakest rate, 1.1%, for the three months through December, since the first quarter of 2011.

Federal Reserve officials will finalise policy today, following minutes of their December meeting that showed that participants were evenly divided between those advocating that it would be appropriate to end its third round of asset purchases, QW 3, around mid-2013 and those who want the purchases to continue beyond that.

Expectations are that data will show that companies added 165,000 jobs in January, 50,000 less than in December.

So while it's clear that the U.S. economy continues to show signs of weakness, current perceptions are set to keep the Dollar under pressure.

Spain's recession deepens.

Spanish preliminary Q4 GDP fell a greater-than-expected 0.7% on quarter, signalling that the country's recession is deepening after the economy shrank 0.3% in Q3. As the impact of more severe austerity took effect, GDP contracted 1.37% for the whole of 2012. In particular, a rise in VAT in September helped further undermine consumer spending. Spanish shares were -0.2% at midday in Europe

Euro hits 13-month high.

The euro has risen above $1.35 for the first time in 13 months and was +0.5% at $1.3556 premarket. The recent spike in the currency has been helped by confidence that the eurozone crisis just may be over, monetary easing in other parts of the world, and the repayment by banks of cheap ECB loans. However, there has been concern about the euro's rise. "The danger is European policy makers allow a spike (in euro and market rates)...With the Fed and the Bank of Japan still easing, the euro is clearly the path of least resistance."

GDP forecast to slow sharply.

GDP data for Q4 is due out this morning, with economists estimating that growth slowed from 3.1% on year in Q3 to 1.1%, which would be the weakest in almost two years. The softening is attributed to falling inventories and declining exports. The data will come ahead of a FOMC policy announcement later, when the Fed is expected to maintain its asset buying at $85B a month and keep its commitment to hold interest rates close to zero until unemployment drops to 6.5%.

Can Inflation Indexed Bonds[IIBs] replace Gold?

If we thought only Indians were obsessed with gold, we have been proven totally wrong. Even the inflation afflicted Vietnamese have shown a strong inclination towards the yellow metal. The government has been exploring various means to wean Indians off this gold obsession as it has been adversely impacting the current account. Soon after raising the import duty on gold, the RBI has come up with another solution.

No doubt investors flock to gold as the metal is an excellent hedge against inflation. Hence, the Reserve Bank of India's attempt is to divert attention to inflation-indexed bonds (IIBs). These bonds will offer investors an alternative to gold without hurting the economy's current account deficit. What neither the government nor the RBI realise is that a lot of the gold is bought by investors in semi-urban and rural areas as well. These are people on whom the sophistication of IIBs will be completely lost. Hence it is very unlikely that such bonds will do much to allay the government's 'gold fears'.
Data source: Business Standard

The Reserve Bank of India (RBI) in its monetary policy yesterday cut the cash-reserve ratio (CRR) and repo rates by 25 basis points (0.25%). But at the same time it made very clear the various risks that the Indian economy faces. While inflation is certainly one of the key risks, the other equally worrying factor is the current account deficit (CAD). Indeed, as today's chart of the day shows, CAD (as a % of GDP) has been continuously increasing over five consecutive quarters from July-September 2011 (2QFY12) to July-September 2012 (2QFY13). This is bound to have an adverse impact on the stability of the country's exchange rate at a time when domestic growth has also been slowing down. What is more, the rise in imports has largely been on account of fuel and gold imports. This is of more worrying to the RBI, than had the high CAD been on account of import of capital goods. 

Tuesday, January 29, 2013

Euro Steady vs US Dollar But Expected To Rally Further

The Euro stabilized close to an 11-month high against the US Dollar during trading on Tuesday and now looks set to extend gains over the next few days.

The outlook looks rosy for the Euro thanks to growing investor confidence and an all round optimism surrounding the Euro Zone.

Most analysts believe that the Euro could stall temporarily but expect traders to interpret any upcoming dips as opportunities to enter the market long.

Earlier today, the Dollar dropped against most of its 16 major peers. Investors are divided on whether the Federal Reserve will announce a change to its asset buying program after its two day meet on Wednesday.

Many expect that that the Fed will reiterate, that quantitative easing will continue for some time to come and that optimism for a strong Dollar will fade.

According to minutes of the U.S. central bank's December meeting, officials had started debating an end to the bank's unprecedented bond buying, as early as this year.

The minutes showed that participants were almost evenly divided between those advocating an end to the purchases in mid 2013, and those who want same to continue for a longer period.

Should it be that hopes for an early end to QE3 turn out to be unfounded, we can expect broader Dollar selling pressure to take hold.

The U.S. Conference Board's index of U.S. consumer sentiment, a measure of confidence among U.S. consumers, is now expected to have declined this month to 64, from a 65.1 reading in December. The data is due out today.

The Dollar earlier stood at $1.3458 per Euro and rose by a slight 0.1% to 90.90 Yen. The Yen dropped by 0.1% to 122.35 per Euro.

The Yen's decline is attributed to a rise in Asian stocks and lower demand for currencies of nations with low yields.

The Yen has fallen by 6% this month, while the Euro and Dollar have gained 2.2% and 0.2% respectively.

A report is due out today by the GfK SE (GFK) in Germany, which is expected to show a rise in confidence about Germany's economy.

I expect the Euro's strength to continue as against the Dollar in the weeks to come, as signs start to emerge of a strengthening Euro region economy.

Toyota back on top.

Selling 9.75M vehicles in 2012, Toyota (TM) reclaimed the title of world's largest automaker from General Motors, which sold 9.29M. It's a bounce back from the 2011 earthquake and a number of recalls which "dinged" Toyota's reputation. Key were U.S. sales which climbed nearly 500K to 2.1M cars, the highest level since 2008. Going forward, sales in China could be a challenge thanks to the on-going political tensions due to the island dispute

Yahoo shares boosted by climbing revenue.

Yahoo (YHOO) rose 2.5% in premarket trading after the company beat expectations by posting a 2% revenue increase in Q4. The results aren't as robust as Google - which reported a 22% jump in revenue - but they do signal a business at least holding steady instead of deteriorating. "While the road to growth is certain, it will not be immediate," says CEO Marissa Mayer.

Chinese Stocks enter bull market.

The Shanghai Composite rose 0.5% overnight, bringing its gains since December 3 to 20%, a threshold signalling bull market to some. Helping stocks has been not just the idea that the slide in economic growth has bottomed, but Beijing's efforts to funnel investment dollars - both domestic and overseas - into common stocks. The latest is a Taiwan media report suggesting individual Taiwanese will be allowed to invest in Chinese shares.

Fed asset purchases seen topping out at $1.14T.

Ben Bernanke's latest QE program is expected to end in Q1 of 2014, according to the median estimate of a Bloomberg survey. By then, say the respondents, asset purchases - a mix of Treasury's and MBS - will have reached $1.14T. The FOMC begins a 2-day meeting today, with economists expecting little more than a renewed commitment to current policy.
In a bid to tame the bulging fiscal deficit, the finance ministry had set an ambitious PSU divestment target of Rs 300 bn for the fiscal. But the gloom that persisted through most part of the year stalled many such plans. In the year so far, the government has managed to garner merely Rs 96 bn. Now, finally when the market sentiment has improved a bit, it is trying to hasten the stake sale in six companies before the end of the current fiscal. A fresh round of divestments is set to start off next week with the offer for sale of Oil India Ltd (OIL). The other five companies whose stake sale is slated to be done within the next couple of months are National Thermal Power Corporation (NTPC), Nalco, Steel Authority of India Ltd (SAIL), Minerals and Metals Trading Corporation (MMTC) and in Rashtriya Chemicals and Fertilizers (RCF).
What do you think is the lesser of the two evils, a special tax on diesel powered passenger vehicles or an increase in diesel prices? If you think it is the latter, well, the entire auto industry seems to be in total agreement with you. As per reports, manufacturers of diesel run vehicles have welcomed the Government's decision to allow oil marketing companies to raise diesel prices. This could well be a negative for cars run on diesel. However, the overall auto demand in the country is unlikely to get affected. Simply because buyers could start moving back to petrol. And with most manufacturers in the country having both petrol as well as diesel capacities, they would continue to benefit from India's car growth.

A special tax on diesel run cars however would further increase the price gap between petrol and diesel cars. And this poses great risk to the huge investments that diesel manufacturers have made in diesel engine capacities. Not to forget the uncertainty it puts in mind of auto companies keen to set up capacities in the country.

RBI cut both CRR and Repo rate by0.25%

With inflation slowing, the Reserve Bank of India (RBI) finally bit the bullet and turned its focus towards ebbing growth in the Indian economy. The central bank gave India Inc a bounty of New Year's gifts even as it cut the country's GDP growth forecast. The RBI revised GDP growth target for FY13 downwards for the second time, from 6.5% initially, to 5.5% now. Thus, in order to revive sentiment, the central bank cut both the cash reserve ratio (CRR) and the repo rate by 0.25%.

These rates now stand at 4% and 7.75% respectively. The CRR is currently at its lowest level since December 1974 and the cut will release an additional Rs 180 bn of liquidity into the system. In order to spur loan book growth towards the end of the fiscal, banks may now start cutting lending rates. But, further monetary policy movement will depend on the government's stance. Recent government reforms especially the diesel price deregulation has staved off near term risks on the fiscal front. However, sustained fiscal consolidation is needed in order to create room for further monetary easing. Well, all eyes should now be on the Annual Budget due at the end of Feb.

Monday, January 28, 2013

Renewed EU Economic Confidence Helps Lift The Euro

 The Euro remained steady near last weeks 11-month high against the US Dollar during early trading on Monday as economic confidence in Europe continues to rally.

The Euro's stability has been aided by Euro Zone banks that are repaying more than expected with regards to emergency loans borrowed from the ECB and the perception that the ECB's monetary policy is not as strict compared to the US Fed Reserve.

The Dollar was stronger against most of its 16 major peers ahead of a two day policy meeting of Federal Reserve officials on Tuesday.

The Dollar strength is partly due to traders thinking more long term about the U.S. recovery and for now, it seems to me that confidence is rising as regards the U.S. economy. For many, the Fed could be reaching the final point of its quantitative easing programme.
Minutes of the Fed's December meeting have shown that officials started to debate on an end to bond purchases early in the year. So called quantitative easing tends to debase the Dollar.

It's now expected that the Fed could indicate, in its March and June policy meetings, a readiness to begin to scale back, or end, its current round of quantitative easing. Such an occurrence would provide major support to the Dollar.

The Commerce Department is due to publish data today that many economists expect could show that demand for U.S. goods, like machinery and electronics, likely has risen by 2% in December following a more modest 0.8% gain in November.

The Dollar climbed 0.1% to 91.03 Yen while the Euro remained virtually unchanged at $1.3464. The Euro gained 0.2% to 122.56 Yen.

 Meanwhile the Japanese Yen dropped to a 2-1/2 year low against the US Dollar on growing expectations of additional Bank of Japan monetary easing.
The Euro was close to its strongest level in nearly a year, as economists have predicted a rebound in German consumer sentiment.

GfK SE (GFK)'s consumer-sentiment index for Germany, Is expected to be at 5.7 in February. The same index had dropped to 5.6 in January. The company is due to release the figures on Tuesday.

Japan forecasts 2.5% growth.

The government in Japan estimates GDP will increase 2.5% for the fiscal year which begins in April, higher than its previous outlook for 1.8% growth. Strong export outflows and higher capital spending from the government are both expected to provide boosts.

European stocks mixed with oil companies a concern.

Stocks in Europe are having a tough time gaining any traction after falling oil prices added pressure on the shares of major oil companies. The tepid start to the week in Europe runs counter to Asia where a positive earning outlook for Chinese firms provided a boost for markets in China, Hong Kong, and Taiwan. In China, financial stocks rallied after regulators announced that they will increase the number of stocks they allow margin-trading and short-selling in by over 75% to 500 stocks.

The government has proposed to set up National Investment and Manufacturing Zones[NIZM]

The Indian economy is in bad shape. The economic growth has slowed down considerably. Investments have dried up. Thus in-order to step up investments and kick start the growth process, Commerce and Industry minister Anand Sharma is trying to woo investors by hard-selling the National Manufacturing Policy (NMP). If implemented properly, NMP would take the share of manufacturing up from 16% to 25% of GDP and would create 100 m skilled jobs in one decade in India. Under the NMP, the government has proposed to set up National Investment and Manufacturing Zones (NIZM). These will be mega industrial zones with world class supporting infrastructure. The government is offering a host of incentives like exemption from capital gains tax and a liberalised labour and environment norms to promote these zones. 12 of these NIZM had already been notified, which would not only be transformative but is an investment in the future of the country.
Under budgeting for various subsidies has always been amongst the Government's favourite activities. Thus, subsidies on fertilisers are no different. It is believe that the actual subsidy may overshoot the budgeted one by a whopping Rs 40,000 crores. And to make matters worse, the country is staring at a huge stockpile of unsold fertilisers. Just to put things in perspective, we started the current financial year with unsold fertiliser inventory to the tune of 3 m tonnes. However, we could start the next financial year with record high stocks of close to 8 m tonnes! Of course, erratic monsoon was one of the reasons the unsold inventory shot up. But the Government's move to cut nutrient-based subsidy rates has also played a big role in bringing about this state of affairs. Sadly, nobody was prepared for this and people have no idea of what to do about it. Clearly, disposal of such a huge stock may eventually result into a further burden on the exchequer.
How about investing in IPOs for 3 months? With zero downside, the lure of speculating in primary market is set to get irresistible. But is that what market regulator Securities and Exchange Board of India (SEBI) is looking for? It seems the regulator is taking rather harmful steps in its attempt to lure investors to primary markets. The so called solution of 'safety net' makes things no less risky for retail investors.

Now it is true that over 60% of the IPO issuances between 2008 and 2011 performed badly. In many cases it was due to steep pricing of the issue. In others it was due to disappointing fundamental performance of the listed companies. But since investing is about buying fundamentally sound businesses at reasonable valuations, the concept of 'buying back shares in the event of a fall' is meaningless. It defeats the very principle of price discovery. Hence SEBI's proposal that issuers should compulsorily offer safety net to IPO investors seems ridiculous. That too if the share price falls more than 20% of the issue price within 3 months of listing! We believe market speculators will hardly miss an opportunity to speculate on such IPOs. If promoters fail to compensate investors in the event of heightened volatility, confidence of retail investors in capital markets will be quashed for good. Instead of making such absurd promises, we believe that the SEBI could do with some initiatives to ensure better corporate governance amongst companies.
The Goods and Services Tax (GST) has been seen as a welcome move as it was a comprehensive levy of tax which would do away with various other taxes prevalent in India. But its implementation has been delayed. This is hardly surprising. Given the difference in taxes levied in different states, getting a consensus was always going to be a challenge. But now the Centre and the states are looking to reach a compromise. And if that happens, GST could be launched in April 2014. The main point of contention appears to be the compensation to be doled out to states for central sales tax. For the transition to the GST, the states had cut CST to 2% from 4% as part of a gradual phase-out of the tax. But since there was no further progress on implementation from the centre, no further payments were given out. And so the states were contemplating raising the CST again. Getting all the states to arrive at a solution may not be that simple. And there is the possibility that implementation first will take place in a handful of states with the rest of them following suit. Whatever the case, the government needs to iron out these differences soon. Especially if it is serious about setting in motion its reforms process. 
Source: Financial Express

Despite the sluggish global economy there is one commodity that has seen bumper production. The commodity is steel. As shown in the chart, after facing a lull in 2009, the world steel production has been on a rise since. In 2012 the worldwide crude steel production hit a record high with production hitting 1.55 bn tons. This is despite the tougher markets that steel producers all over the world have been complaining about. Steel prices remained depressed for most part of the year. Steel manufacturers were also hurt by the fall in steel demand as well as higher input prices. 

Has the era of high inflation come to an end?

A few weeks ago the data for inflation was released by the government. On the face of it things looked so much better than what they had been a year ago. The inflation measured by Wholesale Price Index (WPI) fell to its three year low to 7.18%. The core inflation fell to 4.2%. This has led many to believe that the Reserve Bank of India (RBI) will reverse its hawkish approach. This means they expect RBI to start rolling back the interest rates. But is inflation really down? Has the era of high inflation come to an end? Unfortunately no.

The WPI and core inflation have certainly come down in recent times. But the inflation measured by the Consumer Price Index (CPI) stubbornly continues to be high at 10.56%. This is the index that measures the incidence of inflation on the common man. More alarmingly, this rate has actually gone up in December 2012 as compared to the month ago figure of 9.9%.

As per a leading daily, the reason for this mismatch is that while bumper crops have helped ease the wholesale inflation, mismanagement on the distribution side has hurt the consumer inflation. The reason behind this is the bottleneck on the supply side. This curse still continues to keep inflation high. Unfortunately till something concrete is done to ease the situation on the supply side, inflation would continue to remain high. Much higher than the government's target limits of 4 to 5%.

Experts and government officials have been blaming the RBI for quite some time for causing the slowdown in the economy. They have said over and over again that RBI needs to cut down interest rates to boost investments. Only then will the supply side issues get sorted. But interestingly the CPI inflation has not come within the government's target range all the way since February 2006. This implies that the problem is not something that was triggered by the RBI's decision to turn hawkish. The problem is more structural in nature. Only way to solve this is to press the accelerator on policy reforms. Otherwise inflation is not really going to come down. Yes we may have some random readings of lower rates for some months. But the overall trend would remain high. It is high time that the government pays heed to this. 

Fed balance sheet tops $3T.

The Fed's prodigious bond-buying has pushed its balance sheet to above $3T, with total assets rising $48B in the past week to a record $3.01T as of Wednesday. The balance sheet is now more than triple its size on September 10, 2008, the week before Lehman Brothers collapsed.

Japan stays stuck firmly in deflation.

Japanese core CPI came in as expected at -0.2% on year in December vs -0.1% in November, with the figure falling despite a 2.9% climb in fuel, light and water charges. The drop in prices was the seventh in eight months and indicates the challenge that Japan faces in climbing out of deflation and reaching its new 2% inflation target.

U.K. economy returns to contraction.

U.K. preliminary Q4 GDP fell a greater-than-expected 0.3% on quarter versus +0.9% in Q3. The economy is now 3.3% smaller than at its peak in Q1 2008 and has only recovered about half the output lost during the financial crisis. "Britain is now half way to a triple dip-recession after this disappointingly weak performance.

EU banks to repay €137.2B in cheap loans.

European banks can begin paying back their LTRO loans on Wednesday next week, and the ECB expects €137.2B to be returned. It's a fairly significant portion of the more than €1T lent out considering that the loans were for three years; the availability of cheaper sources of funding is probably a major reason for the repayments.

Positive German Ifo helps boost stocks.

Germany's Ifo index of business confidence has risen to its highest level in seven months, increasing to 104.2 in January from 102.4 in December and topping forecasts for 103. The expectations and current conditions indexes have also increased as the country's economic outlook improves amid signs that the eurozone debt crisis is fading, for the moment. The buoyant sentiment helped boost European shares and send the DAX to a five-year high

Windows 8 fails to spark Microsoft back into life.

Microsoft (MSFT) experienced a mixed FQ2 as it introduced its new Windows 8, which helped increase revenue at the company's OS unit by 24% to $5.88B. However, Microsoft's net profit slipped 3.7% to $6.38B, EPS of $0.76 just about topped expectations, and revenue edged up 3% to $21.46B but slightly missed consensus. "Business PCs are growing faster than consumer, emerging markets are growing faster than developed," said CFO Peter Klein. Shares were -1.6% premarket.
Fuel price hike was not the only dampener for Indian households in recent days. The government's attempt to curb gold buying was an equal disappointment for many. The move to raise import duty on gold was essentially meant to ease off the pressure on current account deficit. Of late the yellow metal was seen as the single biggest culprit for India's deficit problem. But it seems Indian households are not the only ones disappointed with such a move. Our counterparts in Vietnam face a similar predicament. Thanks to gold's inflation hedging properties and importance in social functions, the metal has increasingly found favour. More importantly lack of trust in equities and low interest rates has made other investments relatively unattractive. Gold on the other hand has had an impressive run in recent times. In fact in the past 10 years investments in gold have outperformed investment in equities. The 30 year story of gold and Sensex is however skewed towards the latter. Thus try as they might, governments in India and Vietnam will not be able to wean investors off gold. That is until other asset classes like equities and debt find more favour.
The Indian IT Services sector is known for delivering quality services at affordable prices. This is turn has helped the sector to grow to a nearly US$ 100 bn industry today. However, the global crisis has dampened the demand for the sector in recent times. Companies are now fighting for market share as the size of the market is not increasing. This has led to intense competition amongst the IT vendors. As a result companies have come under pressure to protect their margins. Accordingly, companies have been forced to find out innovative ways of cutting costs.

Many companies are now employing less experienced and cheaper software engineers to execute projects. This in turn ensures that the costs are lower but has had an adverse impact on the quality of work being delivered. Interestingly the companies are getting away with this to a large extent. According to a leading IT Services Company, European clients are more conscious about high quality rather than costs as compared to their US counterparts. Therefore a reason why lower quality has not really hurt the Indian IT companies could be lower demand from Europe due to the crisis. But eventually lower quality is bound to come back and haunt the Indian IT companies. Compromising quality is actually the best way to lose a client. It would be best for IT companies to clean up their work. Otherwise the stable to improving margins may just be a short term trend.
Every stock has some sort of governance premium embedded in it. For instance, companies like Infosys, which have strong management and good governance practices, command a higher premium. However, there are some companies, typically in the infrastructure and real estate space that command lower premium because of shady governance practices. And it is worthwhile to note how market reacts when that premium erodes. Take the case of IVRCL Infrastructures and Housing Development Infrastructure Limited (HDIL) for example. Both these stocks lost about 20% in trade. HDIL lost ground after one of the promoters sold stake in the company to acquire land. It should be noted that the company had huge debt on its books and high percentage of pledged promoter shares. IVRCL tanked after news of the murder of an NHAI official who was overseeing a road project being built by the company. In both the cases management clarification did nothing to support the stock price later. Market had lost faith in their governance by then and the stocks were duly punished.

The above episodes show the importance of good governance. A failure in that regard could result in a free fall irrespective of valuations. Thus, apart from financials, management quality and corporate governance should be one the key factors investors should watch out for while investing.
Since the global crisis began, all the US and European central banks have done is to support big quantitative easing programs by printing more and more money. This coupled with low interest rates and big debt burdens have put the future of their respective currencies at risk. Japan does not appear to have learnt a lesson from this. Otherwise what would explain the Bank of Japan's move of adopting a massive new quantitative easing program. This includes considerable purchases of government bonds and other assets and doubling of the central bank's inflation target to 2%. The problem is that excess printing of money results in depression of a currency. This makes it less attractive to others. The Japanese do not seem to be worried about this as they are hoping that a weaker currency will lead to better exports. That is fine if one country chooses to do so. But if this action has a domino effect and more than one country resorts to devaluing currencies, the problem only gets compounded. That is why, the Bundesbank is worried that Japan's new stimulus measures are bound to lead to currency wars. And has rightly criticized Japan for the same.
The Government seems to be on a roll with regard to fuel price reforms. After partial decontrol for diesel, it's the turn of gas prices. Close on the heels of the Rangarajan Committee's report, natural gas prices are likely to see more than two fold hike soon. The new gas pricing will be an average of global hub prices and cost of imported LNG. It may apply from 2013 itself on all domestically produced gas except cases where it is either governed by the Production Sharing Contract or the government had previously fixed tenure for the same.

The move is a double edged sword. It will mean rising bills for users, especially power and fertilizer sector that have been using subsidized gas. Still, for companies like Oil and Natural Gas Corporation Ltd. (ONGC) and OIL India, it will be nothing less than a game changer. The domestic gas sector is tracing a backward path because of fixed domestic gas pricing that has led to unviable economies in the segment. A better gas pricing will incentivize investment in domestic gas sector. While high gas prices will fuel inflation in the beginning, with proper implementation, they can prove to be a win-win scheme for all stakeholders in the long term.

Wednesday, January 23, 2013

New optimism for Europe

The Euro found support earlier today after economists predicted that contraction in manufacturing and services in the currency bloc would slow.
This followed the release of a report on Tuesday which showed that German investor confidence has climbed to its highest level in 30 months.
Markit Economics is set to release data of a composite index, which is based on a survey of purchasing managers in manufacturing and services, on Thursday. This is expected to show a gain to 47.5 in January from 47.2 in December. Any reading below 50 signals contraction
Any signs that the Euro-zone recession is easing, albeit at a slow pace, are sure to be positive for the Euro. In fact some, economists are now expecting even stronger signs of growth in the European economy by mid-2013.

European Central Bank President Mario Draghi announced on Tuesday, that in his view the "darkest clouds" over the Euro region have receded. This he said, was due to decisive policy steps that were taken in 2012
In the U.K., Prime Minister David Cameron is set to promise a referendum to decide on whether the U.K. should leave the European Union. This has seen the British pound trade close to its weakest level to the Euro since February, at 84.06 pence per Euro.

The Yen rose for the third consecutive day on speculation that Japanese consumer price data, due for release on Friday and expected to show a 0.2% decline in December from November, is set to add to evidence that the Bank of Japan's (BOJ) monetary stimulus is failing to stoke inflation.

The BOJ had raised its price gain target to 2% on Tuesday and also announced that open ended asset purchases will start in 2014.

The Yen was earlier higher by 0.5% to 88.23 per Dollar and climbed by 0.6% to 117.43 per Euro.
As a result of the Yen's strength, the Euro was forced lower against the US Dollar. The greenback however, failed to capitalize after stronger than expected German economic sentiment data was released on Tuesday.

Transfer Pricing: The “Bright Line test” can be applied to disallow the excessive AMP expenses incurred by the assessee for the benefit of the brand owner

L.G.Electronics India Pvt. Ltd vs. ACIT (ITAT Delhi Special Bench) 

L.G. Electronics Inc, a Korean company, set up a wholly owned subsidiary in India (the assessee) to which it provided technical assistance. The assessee agreed to pay royalty at the rate of 1% as consideration for the use of technical know how etc. The Korean company also permitted the assessee to use its brand name and trade marks to products manufactured in India on a royalty-free basis. The AO, TPO & DRP held that as the Advertising, Marketing and Promotion (“AMP expenses”) expenses incurred by the assessee were 3.85% of its sales and such percentage was higher than the expenses incurred by comparable companies (Videocon & Whirlpool), the assessee was promoting the LG brand owned by its foreign AE and hence should have been adequately compensated by the foreign AE. Applying the Bright Line Test, it was held that the expenses up to 1.39% of the sales should be considered as having been incurred for the assessee‘s own business and the remaining part which is in excess of such percentage on brand promotion of the foreign AE. The excess, after adding a markup of 13%, was computed at Rs. 182 crores. On appeal by the assessee, the Special Bench had to consider the following issues: (i) whether the TPO had jurisdiction to process an international transaction in the absence of any reference made to him by the AO? (ii) whether in the absence of any verbal or written agreement between the assessee and the AE for promoting the brand, there can be said to be a “transaction“? (iii) whether a distinction can be made between the “economic ownership” and “legal ownership” of a brand and the expenses for the former cannot be treated as being for the benefit of the owner? (iv) whether such a “transaction“, if any, can be treated as an “international transaction“? (v) whether the “Bright Line Test” which is a part of U. S. legislation can be applied for making the transfer pricing adjustment? (vi) whether as the entire AMP expenses were deductible u/s 37(1) despite benefit to the brand owner, a transfer pricing adjustment so as to disallow the said expenditure could be made? (vii) what are the factors to be considered while choosing the comparable cases & determining the cost/value of the international transaction of AMP expenses? (viii) whether, if as per TNMM, the assessee’s profit is found to be as good as the comparables, a separate adjustment for AMP expenses can still be made? (ix) whether the verdict in Maruti Suzuki 328 ITR 210 (Del) has been over-ruled/ merged into the order of the Supreme Court so as to cease to have binding effect?
2012 was a year full of worries. It seemed like the Eurozone was on the verge of a major disaster. China seemed headed towards a hard landing. The US was on the brink of a 'fiscal cliff'.

2013. The change of calendar has suddenly changed the global sentiment. Stock indices across of the world have been rallying upwards. Of course, there was some relief in the form of a delayed fiscal cliff. The Chinese slowdown was not as bad as anticipated. But does that indicate things are getting better? Apparently not! Swiss economist Klaus Schwab believes that the risk of a global collapse is still very much there. Unemployment is still quite high in many developed economies. People are losing faith in government and corporate leaders. The Eurozone and Japan are in recession. The US is struggling with its debt ceiling. Any major shock from these vulnerable stocks could send the global economy in a downspin.

Labour issues continue to haunt the Indian auto industry.

Just when one thought that troubles at Maruti Suzuki were over, it is now Hero Motocorp which is at the receiving end. In the case of the latter, workers at the company's Gurgaon plant are demanding bigger wage increases and retirement benefits. Talks with the management do not seem to have worked out. And so these workers have decided to go slow on production as a means of protesting. Labour issues took a violent turn at Maruti Suzuki's Manesar plant last year when an employee was killed and several workers went on a rampage. As a result, there was a lockout declared at the plant and production halted. Not surprisingly, this adversely impacted Maruti's overall performance. Hero Motocorp is also bound to bound to suffer in this regard. What has made matters worse is the timing of these issues. The auto industry in the past several quarters has been struggling on account of slowdown in GDP growth, firm interest rates and fuel prices. Thus, a quick resolution to these labour issues has become all the more important.

BSNL has decided to offer VRS to one lakh employees.

After the telecom war began in India, the state owned companies like BSNL began to bleed. More so after the recent 3G and Broadband Wireless Auction (BWA). Procuring spectrum led to a huge outgo which deteriorated their financial health. Over staffing was another issue which hurt the bottom-line. As a result, BSNL has decided to offer voluntary retirement scheme (VRS) to 1 lakh employees. It may be noted that salary burden constitutes 48% to the BSNL's operating cost. If the employees opt for VRS it may come down considerably. Also, these employees have an average age of 50 years and do not have the requisite skill set. Thus, relieving them is a better option for the company.

It is interesting to note that the profits of BSNL have been declining continuously since 2004-05. Now, it hardly poses any threat to major telecom players. It has lost market share and is suffering from operational inefficiencies. Also, the telecom landscape has changed considerably now. Call rates have been commoditized and there is stiff competition in the market. Thus, recovery happens to be far off for BSNL. May be, it's high time for the company to consider winding up rather than operate in losses. Nevertheless, it is considering various plans like monetizing its tower assets and lease out the network for revival. But we don't think that will be sufficient to re-gain the past glory.

China's Economic comparison is not irrevelant as FM believes.

Comparing apples to oranges? Well, that is how our honourable Finance Minister sees comparisons between India and China. According to him economic comparisons with India's oriental neighbour are irrelevant! As reported by a business daily, while courting queries from Hong Kong investors, the FM responded to that effect.

Now, we must acknowledge that at least he got the facts right. Most of China's economic statistics point in the opposite direction to India's. Fiscal surplus, burgeoning forex surplus and export of capital are yet foreign concepts to India's economic policy makers. Notwithstanding a few corporate overseas investments, India is still largely dependent on import of capital or FDI (foreign direct investment). Hence it is true getting close to China's economic stature is a distant dream for India. Not that we should ape the economy or its policies blindly. But a healthy comparison, however disillusioning, is necessary we believe.

Exactly why we do not agree with the FM on his views about India - China comparison. Comparing India's fiscal and forex positions to economies that are worse off is no solution. That the US and Euro zone are doing no better cannot be a consolation for India! And hence, however remote, benchmarking with China's economic achievements is a must have for India's policy making.

Further it is not just China's positives that count. We need to take lessons from the nation's failures as well. China is criticized for lack of corporate financial transparency and limited regulation on banks. This was a lesson that India took to heart. Large Indian corporate and banks today find more favour amongst global investors particularly for this reason.

Another factor that makes comparison with China inevitable is the similarity in demographics. Here too India has some warning signals to pay heed to. As per China's National Bureau of Statistics, the percentage of its working population started falling 2011 onwards. This is nothing but an early warning signal about impending change in demographic profile. For India, such a change is still in the distant future. But could nevertheless derail India's consumption story.

Thus India has not one but many cues to take from China. Turning a blind eye to the similarities and dissimilarities is not a solution. Hope the FM is listening!

S. 50C does not apply to transfer of FSI & TDR

ITO vs. Prem Rattan Gupta (ITAT Mumbai)
The assessee owned a plot of land admeasuring 2244.18 sq. mts of which 2110 sq. mts was acquired by the Municipality for development purposes. The assessee was entitled to receive TDR/ FSI in lieu of the land acquired. The assessee sold the development rights to the said property for Rs. 20 lakhs and computed capital gains on that basis. However, for purposes of stamp duty, the property was valued at Rs. 1.19 crores. The AO held that the value of the property as adopted by the stamp duty authorities had to be taken as the consideration u/s 50C for purposes of capital gains. This was reversed by the CIT(A). On appeal by the department to the Tribunal, HELD:
S. 50C applies only to the transfer of “land or building” and not to the transfer of all “immovable property“. Accordingly, though FSI and TDR is “immovable property” as held in Chedda Housing Development vs. Babijan Shekh Farid 2007 (3) MLJ 402 (Bom), it is not “land or building” and so cannot be the subject matter of s. 50C. The property acquired for development (in lieu of which the FSI/TDR was granted) also cannot be considered even though the property continues to stand in the assessee’s name in the property records. The property should be valued by the DVO net of the land transferred to the Developer by the assessee after considering the acquisition made by the Govt & the Municipal Corporation and also excluding the value of TDR or additional FSI included in the consideration shown in the Development Agreement.

Global unemployment seen topping 200M.

The number of unemployed worldwide is forecast to rise by 5.1M this year to over 202M, the UN's International Labour Organization says in its annual report. It's worth pointing out that the ILO has cut its jobless figures down each year, although that's because of an increase in the number of people leaving the labor market. Since before the financial crisis in 2007, the total "jobs gap" is 67M.

GOP will look to extend debt cap tomorrow.

House Republicans will attempt to pass a measure tomorrow that would extend the debt ceiling until May 19 by allowing the government to borrow what it needs to meet its obligations rather than by specifying a dollar amount for the limit. The Treasury would also be allowed to top up its emergency borrowing capacity, effectively pushing the debt deadline into the summer

German investor confidence jump.

Germany's ZEW index of investor economic sentiment has surged to its highest level since May 2010, jumping to 31.5 in January from 6.9 in December and coming in way above consensus of 12. The six-month outlook has also improved and the upbeat sentiment could boost investment, although the situation with Germany's trading partners is still considered to be weak.

BOJ moves to end deflation in Japan.

As expected, the Bank of Japan has bowed to huge political pressure and announced further easing measures designed to pull the country out of deflation. The BOJ doubled the inflation target to 2% and said it will start Fed-style open-ended asset purchases of ¥13T ($144.77B) a month, but only starting in January 2014. The delay in the new program helped cause Japanese stocks to close -0.3%.
It happened once way back in 1979. Even then the US lawmakers dilly dallied before raising the debt ceiling. But things are very different now. And the unthinkable 'debt default' by the US in 2013 could have far bigger repercussion than 3 decades back. For one, there is far greater foreign ownership of US Treasury bills. China can vouch for that. Secondly, the US economy is far more vulnerable to recession. This makes the risk of a creditor exodus more real and is damaging prospect for global economy. Most importantly, the US is carrying a much larger debt burden today than it ever did. It is struggling to refinance more than US$ 4.6 trillion worth of debt that becomes due for repayment within two years. Thus envisaging a debt default by the US is not as easy as it sounds in academic terms. A default of such proportion could trigger a wider paralysis in the global financial system. Hence for this to materialize, investors need to be prepared for a financial crisis lik e the one seen in 2008.
 India's infrastructure is in need of a major overhaul is a fact well known. That is why the government has set a target of US$ 1 trillion in the next 5 years to make this happen. Hence, getting funding for the same has also become important. In this regard, SEBI in its latest move has tweaked rules to induce fund flows into infrastructure. Essentially, the regulatory body has widened the definition of strategic investors. This now includes Foreign institutional investors (FIIs) and non banking financial companies (NBFCs). foreign institutional investors (FIIs) have been major participants in India's equity markets. Thus, this is obviously something that SEBI wants to capitalise on. This means that FIIs can now put in money into infrastructure development funds (IDFs). This move is also expected to improve the marketability and saleability of the latter. That said, FIIs have also been notorious for huge capital outflows during times of a global downturn. The outbreak of the global financial crisis is a testimony to the fact. Thus, whether these investors would choose to put in money from a much longer term perspective remains to be seen. 

Monday, January 21, 2013

S. 50C does not apply to transfer of immovable property held through company

Irfan Abdul Kader Fazlani vs. ACIT (ITAT Mumbai)

The assessee held shares in a company called Kamala Mansion Pvt. Ltd. The company owned flats in a building known as Om Vikas Apartments, Walkeshwar Road, Mumbai. The shares were sold by the assessee for Rs. 37.51 lakhs and capital gains were offered on that basis. The AO & CIT(A) held that by the sale of shares in the company, the assessee had effectively transferred the immovable property belonging to the assessee and that it was an indirect way of transferring the immovable properties being the flats in the building. He accordingly ‘pierced the corporate veil‘, invoked s. 50C and computed the capital gains by adopting the stamp duty value of the flats. On appeal by the assessee to the Tribunal, HELD allowing the appeal:

S. 50C applies only to the transfer of a “capital asset, being land or building or both”, “assessed” by any authority of a State Government for stamp duty purposes. The expression “transfer” has to be a direct transfer as defined u/s 2(47) which does not include the tax planning adopted by the assessee. S. 50C is a deeming provisions and has to be interpreted strictly in accordance with the spirit of the provision. On facts, the subject matter of transfer is shares in a company and not land or building or both. The assessee did not have full ownership on the flats which are owned by the company. The transfer of shares was never a part of the assessment of the Stamp duty Authorities of the State Government. Also, the company was deriving income which was taxable under the head ‘income from property’ for more than a decade. Consequently, the action of the AO & CIT(A) to invoke s. 50C to the tax planning adopted by the assessee is not proper and does not have the sanction of the provisions of the Act.

Japanese Yen Moves Off Recent Lows As Traders Book Profits

The Japanese Yen recouped losses incurred last week as it moved away from a recently hit 2-1/2 year low versus the US Dollar during trading on Monday.

The move was brought about by traders looking to take profit just in case easing measures expected from the Bank of Japan meeting falls short of market expectations.

The Yen's expected to remain steady, that is until the Bank of Japan's policy decisions are released after the 2-day meeting comes to an end on Tuesday.
The Yen has really felt the pressure during the past month, having lost 5.9% to the Dollar. Speculation that the BOJ, which is under pressure from new Prime Minister Shinzo Abe's government, is to boost stimulus in an effort to pull the economy out of its third recession since 2008, has seen the Yen take a beating recently.
Most economists do expect that the BOJ will expand its asset purchases by as much as 10 trillion Yen ($112 billion). Abe has recently called for such a spending package and he wants the central bank to double it's 1% target to 2%, in order that consumer price gains can counter entrenched deflation.

Technical indicators are suggesting that the Yen's decline may have been overdone.

For instance, the Yen's 14 day relative strength index to the Dollar on Friday stood at 26. Traders use the 30 level as a signal that an asset's price has fallen too far, or too fast, and could reverse course when below that level. As against the Euro, it stood at 29.

While a correction is anticipated, I still expect that the mid to long term trend may have shifted to its weakness.
International events are playing their part also, with Chinese ships having entered Japanese territorial waters near disputed islands today. Japan purchased the uninhabited islands, known as Senkaku, late in 2012 and this has resulted in the disruption of more than $300 billion worth of trade between these two countries.

The Yen had risen by 0.5% to 89.61 per Dollar earlier today, off its weakest level since June 2010. The Yen gained 0.5% to 119.37 per Euro.

The Dollar remained little changed since the Friday close, at $1.3323 per Euro.

In the U.S. reports are due out, which could show that gains in U.S. home sales have risen.

Sales of existing homes have likely climbed by 1.2% to a 5.1 million annual rate last month. This would be the strongest figure since November 2009. The National Association of Realtors is due to publish the stats on Tuesday.

Yet another report, due out later in the week, could show that new home sales have picked up to a 385,000 annual pace this month, and if so, that would represent the best showing in almost 3 years.

Tuesday will see the release of a report by the ZEW Centre for European Economic Research in Germany. The gauge aims to predict economic developments 6 months in advance and is expected to have risen to 12 in January from 6.9 in December. This would then be its strongest level since April 2012.

For many analysts, it appears that the Eurozone economic downturn could be close to bottoming out, as signs of stabilization in Euro area data start to emerge. It follows then, that we could see the EUR/USD rise in the months to come.
What is one of the important long-term determinants of productivity and economic progress? The answer is research & development (R&D). The next question that would come to mind is-How does India fare on this parameter? An article in First post says that India has globally topped the growth in R&D investments. During 2012, R&D investments at Indian companies grew at a staggering rate of 35.1%. China ranked second with a growth of 28.1% during the same period. Does this mean it is time to raise the toast?

Consider the following facts before you decide. India total investments in R&D are very meagre. If you compare with other major economies, India is way behind in terms of the quantum of people employed in the field of research. While IT firm Infosys may be the highest R&D spender among Indian companies, on a global scale it ranks 329th. In fact, merely 14 Indian companies rank in the global list of top-1500 entities in terms of their annual R&D investments.
Since the dawn of the global crisis, the Indian IT industry has come under pressure. And it was but natural for this to happen because the industry depends on the developed world for a large part of its revenues. So if the client countries and hence client industries are in trouble, they are obviously not going to award huge deals at premium pricing. For a while the IT companies were optimistic that things would revive when the crisis turned. But now they have learned to work under circumstances that can only be called the new normal. Companies have come to accept that deal sizes are going to be smaller. Pricing is going to get competitive. As a result expecting premium pricing on every deal is not going to work. Interestingly as per Economic Times, the industry is going to see outs ourcing deals worth US$ 50 bn come up for renewal in 2013. This is nearly half the total size of the entire Indian IT industry. This will evoke a new era of competition in the sector at least for this year. Companies that are willing to be flexible and deliver superior quality will emerge as winners. The rest will have to take a backseat. 
What do you think of a stock that is trading at a very lofty PE multiple of around 54x? You won't touch it with a 10-feet pole, right? The quality of the firm doesn't matter. Investing at that high a PE is surely asking for trouble. And what if we tell you that the earnings of the firm have absolutely no scope for growth? Well, the decision of not investing can't come easier than this, can it? However, there's a portfolio manager out there who's still bullish on a security with fundamentals similar to what we just outlined. Except the security is not of a listed entity but the US 10-yr treasury.

As per the gentleman, who works for none other than bond giant PIMCO, despite such prices, there is no bubble in the US treasury market. He believe that factors like risk averseness and Fed's mandate to keep interest rates suppressed is providing support to the bond market and keeping bond prices high. To be fair to PIMCO, they do seem well aware of why bond prices are high and that much of this is Fed induced. However, they seem to be banking upon their ability to predict when exactly the cycle will reverse. This is hardly the best strategy as per us. The moment something appears expensive and being supported artificially, one should immediately move out of it. Timing the market seldom works on a consistent long-term basis.

Greece is not out of woods yet.

Whether to bail out Greece or not was a big question for European policy makers. Since the country was reeling under debt with no structured plan to reduce the same euro zone partners were apprehensive in lending out support. However, leaving Greece alone to fend for itself would have created further trouble. On the other hand, lending money for bail out was also not feasible (for the fear of no recovery) as there were lack of reforms and no strict austerity measures. Despite that, Greece has received billions of dollars as bail out from the member nations. That's because if no help was extended then Greece would have had to exit Euro Zone. And this could have had serious repercussions on other member nations. But it seems that bail out which continued for long requires further doses of additional liquidity.

Recently, International Monetary Fund (IMF) estimated that Greece would face a financing gap between 5.5 bn to 9.5 bn Euros in 2015 and 2016. And this gap is most likely to be filled by the member nations. Other help is also extended in the form of lowering interest rates on the loans already given out. The Greek debt buyback program is also being considered. Thus, while EU is taking all the steps to extend support to the ailing country it remains to be seen whether the Greek government is able to re-install fiscal sanity in years to come. If not, the trouble may deepen further.      
The government has decided to hike diesel prices by Rs 0.5 each month, for the next 18 months. This will lead to a Rs 9 increase in per litre diesel prices at the end of this period. This move is aimed at ending the under-recoveries of the oil marketing companies. With these price hikes, concerns over higher inflation levels have started looming. Planning Commission Deputy Chairman Montek Singh Ahluwalia is of the view that it should not be a problem. His argument is that while diesel prices may be higher, this would lead to less disposable income levels. And therefore leading to lower demand for other products - thereby reducing their prices. All this would help towards curbing inflation levels over the long term.

We do not buy Mr. Ahluwalia's argument given that diesel price hike would increase prices of nearly all commodities - including the essential ones whose demand cannot be easily lowered (food in particular). Given that the RBI monetary policy review is planned in the next few days, this statement seems to be an indirect message sent across

Geithner blames greed not fraud for crisis.

Outgoing Treasury Secretary Timothy Geithner has explained in a leaving interview with the WSJ why he's uncomfortable with accusations that bankers haven't been punished enough for the financial crisis. "A huge part of what happened across the system was just a mixture of ignorance and greed, or hope over experience, and not illegal. Most financial crises are not caused by fraud or abuse."

IEA: Oil market "crouching tiger, hidden dragon."

Describing the oil market as a "crouching tiger, hidden dragon," the International Energy Agency has increased its 2013 consumption outlook by 240,000 bpd to 90.8M bpd. The IEA cited an expected rise in demand from a recovering Chinese economy as a main reason for the new forecast, which comes as OPEC, and Saudi Arabia in particular, cuts production. However, the agency is not worried about the kingdom's reduction in output.

BOJ to mull QE

The Bank of Japan will reportedly consider making a Fed-like open-ended pledge to purchase assets until it reaches a new inflation target of 2%. At a policy meeting next week, the BOJ is also expected to increase its asset-buying by ¥10T ($112B), and it might discuss other measures. The intensifying speculation about further easing from the BOJ helped weaken the yen earlier and send Tokyo shares sharply higher.

Chinese economy re-accelerates.

China's GDP rose 7.9% on year in Q4, slightly beating forecasts and topping Q3 growth of 7.4%. The re-acceleration confirms that the government's stimulus policies and a boost in trade have started to pull the economy out of its slowdown, although the full-year growth of 7.8% was the lowest since 1999. Still, stronger-than-expected industrial production and retail sales in December suggest that the economy is decently positioned for 2013.
Air India has become synonymous with a troubled airline. Just when things were appearing to improve somewhat, a new problem has put a spoke in its wheels. It is reported that the state-run airline had to ground its six Boeing 787 Dreamliner's yesterday. Apparently, regulators and airlines in Europe and South America have also grounded the Dreamliner. This was after doubts were raised about the plane's batteries.

It is worth noting that the 787 Dreamliner has a list price of US$ 207 m (approximately Rs 11.2 bn). The aircraft is said to be fuel-efficient as it uses weight-saving composite materials. It has been touted as an important breakthrough in the way aircrafts are designed and built. Air India had been pinning all its hope on the 787 Dreamliner for its turnaround. The carrier has 27 Dreamliner's on order. The deliveries had commenced in September 2012. Subsequently, it reported profits at the operating (EBITDA) level in November and December. This recent glitch is the last thing that it may have asked for. Given that its turnaround depends on this Dreamliner, it would only be hoping that the problem gets sorted as soon as possible.
Project approval, environmental issues and land acquisition have been major hurdles for long. Infrastructure projects have contended with these since last couple of years. Notwithstanding the resultant delays and cost escalations, the government has articulated ambitious plans. Building 20 kilometres of roadways a day was just one of them. But it seems a late realization has dawned upon the government regarding another issue. Public private partnership plans for funding large infra projects have made no headway. Banks have backed off from many of these projects due to asset liability mismatches. Infrastructure funding companies too are very selective. Hence many projects are at the mercy of private equity funds. There too raising equity has not been easy for most players.

NHAI in particular has highlighted this problem in road building projects. The body managed to award just 1,000 km of roadway contracts this financial year. This was against a target of 9,500 kms. But there too firms have exited citing lack of funds. Hence '20 kilometres of roadways a day' is a distant dream for India for the time being. 
Responding to threat of rising fiscal deficit and a possible rating downgrade, the Government seems to be biting the bullet bit by bit on diesel prices. The Government has empowered oil companies to hike diesel prices in a phased manner. It's a brave step indeed. The oil companies have responded with a hike of 50 paisa per litre. But will this euphoria last? Let us see the finer points.

The diesel currently incurs around Rs 9.6 per litre of under recoveries. In comparison, small price hikes will be a drop in the ocean as far as curbing fiscal deficit is concerned. While oil companies have been authorized for time to time price hikes, there is no clarity on the amount and time frame for the same. Few years back petrol was fully decontrolled. Yet, oil companies incurred losses on it as they hardly ever raised prices without government permission. With 'regulated' price hikes expected on diesel, we would rather be conservative on follow up action. Especially because this will have cascading impact on various sectors resulting and can lead to inflation spiralling.
The telecom sector had witnessed a bumper period till recently. Most of the gains seen by the companies were driven by the increasing subscriber base. But in recent times this growth seems to be fading away. The total number of subscribers (for GSM only) has been declining in recent months. In the month of December 2012, total subscriber base declined by 6.6 m. One reason behind this decline is market saturation as penetration rates have crossed 70%. But the bigger reason for the decline is people discontinuing the practice of keeping multiple connections. As tariffs have reached rock bottom, most operators have cut back on offering freebies along with new connections. As free minutes and other such goodies have been cut down, subscribers prefer to cut back on the number of connections that they have. 

Consumer regulator to outline new mortgage rules.

The Consumer Financial Protection Bureau is today due to unveil rules that will require mortgage servicers to improve their efforts to ensure that struggling borrowers are able to keep their homes. Among other things, lenders will have to assess homeowners for all loan-assistance options and not those "that are most financially favourable for the servicer."
Gone are the days of guaranteed big bonuses for investment bankers. Since the global financial crisis in 2008, pay checks of investment banks had come under the scanner especially when these banks were considered as one of the main culprits behind the crisis. Since then bonuses have not surged the way they did in the heydays of 2006 and 2007. What is more, in a very subdued economic environment, lower bonuses are actually being doled out by investment banks to bolster profits.

Goldman Sachs is one such example. In the fourth quarter result season, Goldman Sachs not only put the brakes on bonuses but also cut pay by 11%. This has led the bank to report profits which are at the highest level in 3 years. Same has been the case with JP Morgan's investment bank where the CEO's bonus was halved. As a result of which this bank was also able to report a growth in profits. While business sentiments appear to be improving gradually, most of these investment banks are increasingly focusing on managing expenses through reducing pay or going in for job cuts. Whether this trend will sustain in the coming years remains to be seen though.
Data Source: World Gold Council

In a development that created huge flutters in the gold market, German central bank is pulling some of its gold reserves out of the foreign banks. However, it will do it slowly, relocating 300 tonnes of gold from New York to Frankfurt and an additional 374 tonnes from Paris to Frankfurt by 2020. This amounts to around 1/5th of its official gold holdings as identified by the World Gold Council. As today's chart shows, in US$ terms, Germany's gold holdings stood at a little over US$ 200 bn. While India is way behind at US$ 33 bn, unofficially, it is easily one of the largest holders of gold.

Eurozone inflation unchanged.

 Eurozone inflation stayed unchanged in December, coming in an expected +2.2% on year. That's above the ECB's target of just under 2%. Excluding energy and unprocessed food, inflation was +1.6%, also as forecast.

December prices seen unchanged from November.

U.S. inflation data for December is due out this morning, with economists expecting that CPI will come in flat on month vs -0.3% in November. Core CPI is seen at +0.2% vs +0.1%. However, "any signal that things may be heating up could bolster the case for an end to quantitative easing sooner rather than later," says FXStreet contributing analyst Richard Lee.

Car sales in Europe hit a ditch.

European new-car registrations slumped 16.3% on year to 799,407 vehicles in December, the sharpest decline since October 2010, as high unemployment and an unwillingness by banks to finance consumer purchases took their toll. For 2012, EU sales fell 8.2% to 12.05M, the steepest annual drop since 1993. GM (GM) and Ford (F) registrations in Europe cratered 27% each in December, although those of Hyundai (HYMLF.PK) and Kia (KIMTF.PK), with their affordable cars and long warranties, climbed 10.5% and 6.8% respectively.

Eurozone divided over strength of euro.

The ECB's Ewald Nowotny has moved to downplay fears about the strength of the euro after Eurogroup Chairman Jean-Claude Juncker said last night that the currency "is dangerously high." The exchange rate isn't a matter of major concern, said Nowotny, while he doesn't expect a longer-term increase in the currency against the dollar. The euro fell against the greenback following Juncker's comments but recovered to +0.1% midday in Europe.

JPMorgan's net profit surges 54%.

JPMorgan Chase's (JPM) Q4 net income jumped 54% to $5.7B as EPS of $1.39 beat consensus but a revenue increase of 10% to $24.4B missed forecasts. JPMorgan has also released internal reports about its $6.2B Whaling Loss. Shares were -0.2% premarket.

Sunday, January 20, 2013

The debt ceiling has again come to haunt the US. For those unaware of the term, the debt ceiling, as imposed by the Congress, refers to the debt level that the US can carry at any given time. While the Republicans have been opposing the idea of raising the debt ceiling yet again, the idea of having a trillion dollar platinum coin issued was doing the rounds. Fortunately, better sense seems to have prevailed and the idea has been rejected. So the next alternative appears to be selling the huge sovereign gold deposits. The US Treasury has about 261.5 million ounces of the yellow metal. At the current gold price, that could raise over US$ 440 bn. But even this idea has been dumped by the US Treasury Secretary Tim Geithner. Selling gold would appear like a fire sale. As per him, this would affect US' reputation and have adverse global implications.

It is worrying that the US policymakers are refusing to acknowledge the magnitude of the crisis that their economy is facing. If you are unable to service and repay your loan, what would you do? Sell some assets, maybe gold, and repay the loan right? But governments tend to take a different course. They make the debt cycle so vicious that they keep borrowing debt to service old debt.

But there are other reasons, too, why selling gold may not solve the US debt ceiling crisis. This is because the US government currently borrows about US$ 100 bn of debt every month. So selling the Treasury gold would cover up just over 4 months of the debt obligations. So it remains to be seen what new trick US policymakers come up with to further postpone the impending crisis.

China IPO Market has almost dried up.

Why does anyone invest in an asset? The answer as you rightly guessed is to earn returns. But what if you are unable to earn returns on your investment? Such is a dilemma being faced by private equity (PE) firms in China. The PE firms typically invest in private companies and look to cash in on their investments when the companies go public. And this strategy worked well till recently as China and Hong Kong were the epicentres for mega IPOs. But given the gloomy stock markets in China, IPO activity has almost dried up. As a result PE firms are finding it increasingly difficult to realize returns on their investments. The tougher part is that most of them are nearing their usual investment horizon of 5 to 7 year period. As a result they are getting all the more jittery as the date to return cash to their investors gets closer. However till IPO activity picks up again PE firms are left stranded. Unlike other countries China does not have secondary market for transactions that fall within the purview of mergers & acquisitions. This means that one PE firm cannot sell its stake in a company to another PE firm with ease. In the current environment the need to develop this market has become increasingly important. Till that happens PE firms do not have much choice but to sit and wait for IPO activity to pick up again. 
Data source: RBI, JP Morgan presentation

One of the major concerns for Indian government is to cap fuel subsidies. After all, the same is a major contributor to India's fiscal deficit. But one look at global oil prices and consumption levels tells us that India is relatively better off. Not just in terms of prices but also per capita consumption levels. However, the only way to make more energy available for economic growth is to look for new sustainable resources. Something that the US has been successfully doing with shale gas.

BOJ gets even more pessimistic about regions.

The Bank of Japan has downgraded its economic assessment for eight of the country's nine regions for the second consecutive quarter. "Many regions said their economies were moving on a weak note or weakening due to the continued slowdown in overseas growth," the BOJ noted.

Fitch reiterates warning over U.S. debt.

Fitch has again warned it will formally review the U.S.'s AAA rating if the debt ceiling isn't raised, although the agency believes that the risk of a default "remains extremely low." Even if the U.S. averts a default, however, Fitch could still downgrade the country later in the year if Washington fails to formulate a medium-term plan to cut the deficit and restore confidence.

Rio to boost iron ore production as prices surge.

Rio Tinto (RIO) intends to expand its iron ore mine in the remote Australian region of Pilbara to 360M metric tons a year by mid-2015 from 290M by the end of 2013. In 2012, Rio's overall production rose 4% to 253M tons, slightly above its guidance of 250M tons. The company is benefiting from an 80% recovery in iron-ore prices since September as Chinese steel mills re-enter the market on an improving economic picture.

Eurozone crisis hits Germany as GDP contracts in Q4.

The eurozone's woes finally hit Germany's economy in Q4, when GDP contracted a preliminary 0.5%, which was greater than expected and marked a deterioration from +0.2% in Q3. In 2012 as a whole, German growth fell to 0.7% from 3% a year earlier, with the Federal Statistical Office saying that exports were "once again the main driving force" for the country's expansion. The data, along with fears about the U.S. debt ceiling, helped depress sentiment in global markets, and U.S. stock futures fell pre-market.
We love to buy gold because we believe that gold prices always keep increasing. To some extent, the reverse also holds true. Our immense appetite for the yellow metal is an important factor affecting gold prices. India has been the leading importer of gold, accounting for over 20% of the global demand. So, if India's demand for gold falls drastically, it does have some impact on the prices as well.

Our unabashed fondness for gold doesn't go down well with the policymakers. This is because India mainly relies on imports to meet its gold demand. And this in turn weighs down on India's current account. In the quarter ended September 2012, India's current account deficit stood tall at 5.4% of GDP. Moreover, it is said that in some months gold accounted for half of the deficit. As such, policymakers and the RBI have been finding ways to curb India's gold imports. Last year, the import duty on gold was increased to 4%. The Finance Minister is now suggesting that this be further increased to 6%. But critics say that this would increase the black market trade in gold.

Recently, creation of gold-backed financial products is under consideration. This would possibly help mobilise the huge unproductive stock of the yellow metal in the country. Overall, we think it is difficult to wean Indians off their thousands of years of love affair with gold.
* Dec 2012 data for India, Russia, Eurozone, Nov 2012 data for the others
Data Source: The Economist
With the consumer price index coming in higher for India in December 2012, how does the country fare when compared to its peers? Not too well we believe. As today's chart of the day shows, consumer prices have remained the highest in India when compared to its peer China, although both have grown faster than most. However, China enjoys a trade surplus as against a trade deficit for India.
India has two indices to measure inflation and currently both of them are telling a different story. The latest wholesale price index (WPI) has gone down from 7.24% to 7.14%. But this is in contrast to the consumer price inflation (CPI) index which crossed the double digit mark in December 2012 to reach 10.56%.

The fall in WPI has been perceived as an encouraging sign and so there are increased expectations that the Reserve Bank of India (RBI) will cut rates in its next monetary policy. So far the central bank has been in no mood to oblige on account of high inflation. So it will be interesting to see what its next move will be when the inflation indices throw up such contrasting data.

The woes on the CPI front do not end here. Despite the higher numbers, there are many factors that have not been reflected in the December data on account of the lag effect. This means that the impact of these will be felt in 2013 so that consumer prices could rise much more this calendar year. For starters, it does not take into account the recent hike in railway fares which will show up in either the January or February numbers. Then there is the proposed hike in diesel prices, the increase in minimum support prices (MSP) and increase in wages. The latter more so in the aftermath of the violence at Maruti's plant at Manesar.

Assuming that growth does not pick up, all these indicators point to an increased possibility of stagflation (i.e. inflation and low growth) in 2013. For growth to ramp up, the government needs to ramp up productive spending towards areas such as infrastructure, education and the like. But for now its hands are tied as the fiscal deficit data shows. What is more, it has not been able to stick to its targets for bringing this deficit down. And with elections around the corner, the motivation to drastically bring down subsidies is low. While it may look to reduce this deficit by increasing taxes, that would be another dampener on consumption as purchasing power reduces. Thus, we would not be surprised i f 2013 turns out to be another challenging year for the Indian economy.

Monday, January 14, 2013

Interest earned by a mutual association from deposits placed with member banks is not exempt on the ground of “mutuality”

M/s Bangalore Club vs. CIT (Supreme Court)

The assessee, a mutual association, claimed that the interest earned by it on fixed deposits kept with the bank (which was a corporate member) was not taxable on the basis of mutuality. The AO rejected the claim though the CIT(A) and Tribunal upheld the claim. The High Court reversed the Tribunal and upheld the stand of the AO. On appeal by the assessee to the Supreme Court, HELD dismissing the appeal:
For a receipt to be exempt on the principles of Mutuality, three conditions have to be satisfied. The first is that there must be a complete identity between the contributors and participators. The second is that the actions of the participators and contributors must be in furtherance of the mandate of the association. The third is that there must be no scope of profiteering by the contributors from a fund made by them which could only be expended or returned to themselves. On facts, though the interest was earned from banks which were corporate members of the club, it was not exempt on the ground of mutuality because (i) the arrangement lacks a complete identity between the contributors and participators. With the funds of the club, member banks engaged in commercial operations with third parties outside of the mutuality, rupturing the ‘privity of mutuality’, and consequently, violating the one to one identity between the contributors and participators, (ii) the surplus funds were not used in furtherance of the object of the club but were taken out of mutuality when the member banks placed the same at the disposal of third parties, thus, initiating an independent contract between the bank and the clients of the bank, a third party, not privy to the mutuality & (iii) The Banks generated revenue by paying a lower rate of interest to the assessee-club and loaning the funds to third parties. The interest accrued on the surplus deposited by the club like in the case of any other deposit made by an account holder with the bank. A façade of a club cannot be constructed over commercial transactions to avoid liability to tax. Such setups cannot be permitted to claim double benefit of mutuality.

S. 158B: Despite TDS & Advance-tax, income is “undisclosed” if ROI not filed by due date

ACIT vs. M/s A. R. Enterprises (Supreme Court)

A search u/s 132 was conducted on 23.2.1996 when it was detected that though the assessee had taxable income for AY 1995-96 it had not filed a ROI and the due date (31.10.1995) had lapsed. The AO issued a s. 158BD notice directing the assessee to file a return for the block period. The assessee claimed that as it had paid advance tax on the income for AY 1995-96, the income could not be said to be “undisclosed“. The AO rejected the claim though the Tribunal and High Court accepted the assessee’s claim on the basis that payment of Advance Tax itself necessarily implies disclosure of the income on which the advance is paid. On appeal by the department to the Supreme Court, HELD reversing the Tribunal and High Court:
S. 158B(b) defines the expression “undisclosed income” to mean that income “which has not been or would not have been disclosed for the purposes of this Act”. The only way of disclosing income on the part of an assessee is through filing of a return and therefore an “undisclosed income” signifies income not stated in the return filed. It cannot be said that payment of Advance Tax by an assessee per se is tantamount to disclosure of total income. There can be no generic rule as to the significance of payment of Advance Tax in construing intention of disclosure of income. This depends on the time at which the search is conducted in relation to the due date for filing return. If the search is conducted after the expiry of the due date for filing return, payment of Advance Tax is irrelevant in construing the intention of the assessee to disclose income because it is a case where income has clearly not been disclosed. The possibility of the intention to disclose does not arise since the opportunity of disclosure has lapsed. If search is conducted prior to the due date for filing return, the opportunity to disclose income by filing a return still persists. In such a case, payment of Advance Tax may be a material fact for construing whether an assessee intended to disclose. An assessee is entitled to make the legitimate claim that even though the search or the documents recovered show income earned by him, he has paid Advance Tax for the relevant assessment year and has an opportunity to declare the total income, in the return of income, which he would file by the due date. Hence, the fulcrum of such a decision is the due date for filing of return of income vis-à-vis date of search. Also, because Advance Tax is based on estimated income, it cannot result in the disclosure of the total income assessable and chargeable to tax. The proposition that payment of Advance Tax is tantamount to disclosure of income would be contrary to the very purpose of filing of return. On facts, as the assessee had not filed the ROI by the date of search and the due date had lapsed, the income found was “undisclosed” even though advance-tax thereon had been paid. Similarly, as TDS is also computed on the estimated income of an assessee for the relevant FY, it does not amount to disclosure of income, nor does it indicate the intention to disclose income if the ROI is not filed.