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Thursday, May 30, 2013

Mid-Day Report: Markets Stay in Consolidations, US Data Missed


Markets continue to engage in consolidation today. While Nikkei dropped another -737 pts to close below 14000 at 13589, European equities pared initial loss and turned positive quickly.
US futures also point to mildly higher opening. Data from US saw Q1 GDP revised slightly lower to 2.4% while price index was revised low to 1.1%. Initial jobless claims rose more than expected to 354k in the week ended May 24. Continuing claims rose 63k to 2.99m in the weekended May 18.
Dollar pared initial loss and recovered into US session. Yen was also mildly lower. But most major pairs are stuck in range and we'd expect more consolidations ahead.
Italy sold EUR 3b in 10-year bonds today with average yield at 4.14%, up from last month's auction at 3.94%. Demand was down slightly with bid-to-cover ratio at 1.38 times, comparing to prior 1.42 times. It also sold EUR 2.75b in five year bonds with yield at 3.01%, up from prior 2.84%. Overall, the sale met maximum target and is see as solid by markets.
Confidence data from Eurozone showed slightly more than expected improvement in May.
Economic confidence rose to 89.4, industrial confidence improved to -13.0, consumer confidence rose to -21.9, services confidence rose to -9.3. Swiss GDP rose more than expected by 0.6% qoq in Q1.

“Due date” in s. 36(1)(va) for payment of employees’ Provident Fund, ESIC etc contribution should be read with s. 43B(b) to mean “due date” for filing ROI

CIT vs. Kichha Sugar Company Ltd (Uttarakhand High Court)

The assessee collected employees’ Provident Fund contribution for payment to the provident fund authorities. However, the amount was not paid to the provident fund authorities within the “due date” specified in the Provident Fund Act though it was paid before the due date of filing the return of income. The AO assessed the amounts received as income u/s 2(24)(x) but refused to allow a deduction u/s 36(1)(va) on the ground that the amounts were not paid within the prescribed “due date“. The CIT(A) and Tribunal allowed the assessee’s claim for deduction u/s 43B(b). The Department filed an appeal in the High Court claiming that s. 43B did not apply to employees’ contribution. HELD by the High Court dismissing the appeal:
S. 2(24)(x) provides that the amounts of employees’ contribution to PF etc collected by the employer shall be assessed as his income. S. 36(1)(va) provides that the said employees’ contribution shall be allowed as a deduction if paid within the “due date” specified in the relevant legislation. S. 43(B)(b) provides that any sum payable by the assessee as an employer by way of contribution to any provident fund etc shall be allowed if paid before the due date of filing the ROI. The “due date” referred to in s. 36(1)(va) must be read in conjunction with s. 43B(b) to mean the “due date” of filing the ROI. The AO wrongly proceeded on the basis that the “due date” in s. 36(1)(va) is the due date fixed by the Provident Fund authority, whereas read in the context of s. 43B(b) it is the “due date” fixed for filing the ROI.
Note: The same view is taken in AIMIL 321 ITR 508 (Del) & Bharati Shipyard 132 ITD 53 (SB)(Mum). However, the ITAT Mumbai has refused to follow this law in LKP Securities on the ground that s. 43B applies only to “employer’s contribution

Chinese debt increasingly inefficient.

China's broadest measure of credit rose 58% to a record 6.16T yuan ($1T) in Q1, but that debt has become less effective: each $1 of credit added 17 cents to GDP, down from 29 cents last year and 83 cents in 2007. "Less efficient and more highly leveraged borrowers...(are) tying up credit that could be used to generate more growth," says former Treasury economist David Loevinger. The solution is to boost the more profitable private sector.

Japanese shares plunge again.

A late sell-off in an already weak market caused the Nikkei (EWJ) to close -5.2%, taking the index's losses since the volatility began late last week to over 14%. Fears about the end of the Fed's QE program and the market undergoing a correction are cited as reasons for the turbulence, as well as the falling dollar-yen (FXY), although the equity-currency relationship seems to have become reciprocal.
The Ministry of Finance had issued guidelines for minimum public shareholding for all listed companies - 25% for private companies and 10% for public companies. For private sector, the deadline to meet these is June 3, 2013 and this is only a few days away. For public companies, the same is August 8, 2013. As reported by the Economic Times, these offers for sale (OFS) are believed to be worth about Rs 135 bn. Of this, more than 70% will be done by private players. While the daily also reported that the flood of OFS' could dampen the on going market rally - on account of market liquidity going towards subscribing to these - it should naturally not be a cause of concern for a long term investor such as yourself. In order to make their respective OFS' comfortably subscribed, promoters would be pricing them lower to the market prices. As such, one could use these opportunities to buy into good companies. All this, provided that valuations are not out of your comfort zone!
The slowdown in China and weak global economic prospects may have hurt the prices of every other metal. But the correction in price of gold finds its roots in speculative trends rather than fundamentals! As per an article in Global Economic Trend Analysis, Hedge funds are least bullish on gold in more than five years. The 30% correction in the price of the precious metal has led to money managers cut their long positions on gold. But that is far from having an impact on the fundamental demand supply dynamics of gold. With neither the US nor Japan giving a clear signal of ending the monetary easing, liquidity is here to stay. Needless to say, jobless economic recovery and steep inflati on will only make the currency r isks seem more real. Hence if not as a hedge against inflation, do make sure that you own some gold if you already don't. Having to brace your portfolio against currency risk is no longer a risk for fund managers but retail investors as well. And gold can very well help you with that!
High inflation has been a big roadblock to India's growth in recent years. And one of the key drivers of this high inflation has been rising food prices. Who is the real culprit for this? You think the real reason is poor monsoons last year? You couldn't be further from the truth if you think so. The real culprit appears to be none other than the UPA government. And the problem at hand is not food shortage. But a problem of plenty!

Let us explain. The Food Corporation of India (FCI) buys rice and wheat from farmers at the minimum support price (MSP) set by the government. These food grains are then distributed by the government through various programmes via the public distribution system. Apart from this, the government also procures food grains to maintain buffer stocks. These buffer stocks are kept so as to be in a position to deal with any unexpected shock that could disrupt supplies. There is a minimum buffer level that is needed. This is understandable.

Here's the irony... What happens when you're hoarding too much buffer stock? You end up creating an artificial scarcity in the market. As per an article in Business Today, the government has been hoarding more than twice the minimum food grain buffer needed. Sometimes as high as three times! The result is that despite the abundant supply, food inflation has been persistently high.

Wednesday, May 29, 2013

Germany suffers largest jobless rise in 4 years.

 As expected, Germany's unemployment stayed unchanged at 6.9% in May, although the number of people without a job rose by a greater-than-forecast 21,000 to 2.96M. That's the biggest monthly increase for over four years as the economy feels the effects of the eurozone crisis and long winter.

OECD cuts global outlook.

 The OECD has reduced its world economic growth outlook to 3.1% for this year and 4% for 2014 from prior forecasts of 3.4% and 4.2% respectively. In its twice-yearly Economic Outlook, the organization predicted that the U.S. will improve and that Japan will rebound, while the recession-hit eurozone will fall further behind. The OECD also warned that the withdrawal of QE by central banks could cause spikes in bond yields and harm the world economy.

Morgan Stanley to raise $1-3B property fund.

Morgan Stanley's (MS) Msref real-estate department reportedly intends to raise a new $1-3B global property fund and hopes that China Investment Corp., which owns 6.4% in the bank, will become an anchor investor. However, Morgan Stanley might have problems attracting other potential backers, such as Calpers and the New York State Common Retirement Fund, both of which have been burned by placing their money with Msref.

U.S. Treasurys stabilize following blood-letting.

U.S. bond prices were higher premarket following the carnage yesterday, when the 10-year yield rose 15 bps to a 13-month high of 2.16%. Maybe more troubling for those borrowing short and lending long was a 12 bp jump in the 5-year yield to 1.01% (its up from 0.65% in a month), and a 4 bp pop in the 2-year yield to 0.28%.
Of late, a lot of fraudulent ponzi schemes have come to light. Lakhs of Indian investors have lost their hard-earned money. Here's some more worrying news... Recently, MD & CEO of Amway India was arrested for alleged money laundering and breach of trust. For starters, Amway is India's largest multi-level direct selling company. In the direct selling system, products are sold directly to consumers through a network of sales agents.

With this recent arrest, the scanner is now on direct selling companies. Are they similar to other ponzi schemes? Apparently, the fault lines separating the two may be diminishing.

One of the biggest problems in a country like India is lack of investor education. Gullible investors are often duped into putting their money into questionable schemes. Inspirational success stories are told. Big promises are made. Investors are assured of mindboggling returns. Then of course, reality gives them a rude shock. And people realise they have lost a lot of money.
There have been debates going on for a while as to whether the six large 'too-big-to-fail' US banks have had an advantage over their smaller counterparts in terms of lower borrowing rates. Analysts of Goldman Sachs - one of the six TBTF banks - recently released a report reasoning why this TBTF logic is flawed. But an interesting article in Bloomberg counters most of the arguments. On an overall basis, the key question is whether these TBTF banks are borrowing at rates lower than they otherwise would. And not necessarily in comparison to the smaller banks; all this given that they have backing from the government. Let us take up an example. Companies' debt instruments are given various ratings. What the author of the article is suggesting is that one should not be comparing a company having 'AAA' rating with one having a relatively lower rating of 'A'. Instead, within companies having 'AAA' ratings, can a particular company get more of an advantage just because it is funded or backed by the government? Looking at it from this perspective, we believe it surely does weaken the analysts' stand.

S. 115AD: FII’s securities transactions’ profits not assessable as “business profits’

Platinum Investment Management Ltd vs. DDIT (ITAT Mumbai)

The assessee, a Foreign Institutional Investor (“FII”), suffered a loss of Rs. 41 crore on account of derivative transactions. The AO & CIT(A) relied on the AAR Ruling in Royal Bank of Canada 323 ITR 380 and held that as the said loss arose out speculative transactions, it had to be treated as a business loss and could not be set-off against STCG. On appeal by the assessee to the Tribunal HELD allowing the appeal:
Under the policy of the Central Government and the SEBI (FII) Regulations, 1995 a FII can only “invest” in securities and cannot do “business” in securities. S. 115AD also provides that all income arising to a FII from securities, whether from their retention or from their transfer, is taxable as a capital gain. This is also the view expressed in Press Note F. No. 5(13)SE/91-FIV dated 24.03.1994 issued by the Ministry of Finance. If the Revenue is permitted to make a distinction between the securities held by a FII by classifying them as a capital asset or as stock in trade, s. 115AD will become otiose. The result is that all income arising to a FII, including from dealings in derivatives has to be assessed as capital gains. The contrary view of the AAR in Royal Bank of Canada cannot be followed (LG Asian Plus Ltd 46 SOT 159 followed)
Note: In ABC Equity Fund 250 ITR 194, Fidelity Advisor Series VII 271 ITR 1, General Electric Pension Trust 280 ITR 425, Fidelity Northstar Fund 288 ITR 641 and Royal Bank of Canada 323 ITR 380 contrasting views have been taken on the issue

Tuesday, May 28, 2013

Dollar Climbs As Data Due, Yen Down

 Earlier today, the Dollar climbed against most of its major counterparts ahead of U.S. data due that is forecast to show that consumer confidence has improved while home prices have also risen.
The Conference Board's index of U.S. consumer sentiment, due out today, is expected to have climbed to 71 in May, it highest level in six months, from 68.1 in April.
Also due out today is the release of the S&P/Case-Shiller index of property values. This is expected to sow that values in 20 U.S. cities have risen by around 10.2% in March from March 2012. This would be the highest rise since April 2006.

As a result, after the close of markets in the U.S. and U.K. yesterday for public holidays, the Dollar Index, which Intercontinental Exchange Inc. uses to track the Dollar against the currencies of six major U.S. trading partners, earlier added 0.2% to 83.889.

The rise came amid the prospects of improving U.S. fundamentals which could spur the Federal Reserve to taper off its monthly bond purchases of $85 billion.
With many economists of the view that the pace of Fed purchases is unsustainable, tapering is expected to begin in the fourth quarter of 2013.

Earlier the Dollar rose by 0.9 percent to 101.86 Yen and by 0.2% to $1.2904 per Euro. The Yen dropped by 0.7& to 131.42 per Euro.

The Yen had snapped a three-day gain against the Euro, after the Bank of Japan (BOJ) had estimated that deposits it holds in custody for financial companies are set to rise to a record 72.4 trillion Yen ($711 billion) today.

Japan's current-account balance is a part of the monetary base and the BOJ plans to double it within two years. Its aim is to purchase more than 7 trillion Yen of government bonds each month in order to end 15 years of deflation.

It's clear to me that Japan's monetary easing will continue to underpin the Yen's decline, and many analysts expect further Yen weakness as economic indicators improve in the U.S. and other countries.


Ireland mulls ending 'Double Irish' tax break.

 Ireland is reportedly looking at closing the "Double Irish" loophole that allows multinational companies to keep their tax bills low by funnelling their profits through two linked Irish subsidiaries. Apple (AAPL) is one beneficiary, and another is Google (GOOG), which enjoys what's called a "Double Irish Dutch sandwich" whereby its Irish operations make tax-deductible payments to a Bermudan subsidiary via a Dutch affiliate.

Japanese stocks regain footing, Europe up.

 Japanese stocks regained their footing today after a number of sessions of volatility as a weakening yen helped support exporters and as large constituents recovered from heavy selling on Monday. Asian shares in general rose, inspiring their counterparts in Europe in the absence of any major news. U.S. stock futures were also looking good premarket ahead of consumer confidence and manufacturing data.

Yen Strengthens For Third Day.

The Yen rose against the Dollar today as concerns mounted that the Bank of Japan (BOJ) is struggling to control the rise in Japanese government bond (JGB) yields.
Following a statement by BOJ Governor Haruhiko Kuroda yesterday, to the effect that Japan could cope with rising interest-rates as yields on JGBs rose for a third week, the Yen strengthened against most of its major counterparts.
Having reached 1% Yields on Thursday, the highest in a year, today Japan's 10-year government bonds were at 0.85%.

Some BOJ board members, according to minutes of the last policy meeting in April, have attributed greater bond volatility to the central bank's debt purchases. The BOJ's aim is to meet a 2% inflation target.

Some analysts are recommending that investors watch for a selloff in Japan's currency and bonds.

The Yen has lost 17% over the past six months, after Prime Minister Shinzo Abe pledged to end 15 years of deflation.

The Yen earlier today rose by 0.2% to 101.08 per Dollar and by 0.1% to 130.86 per Euro. The Euro was little changed at $1.2947.
Today the markets in both the U.S.A. and U.K. are closed due to public holidays.

The Aussie dropped against most of its major counterparts earlier today after China's president, Xi Jinping, signalled tolerance for slower growth.

Concerns were raised amongst investors that a deceleration of China's economy will lead to reduced demand for commodity exports.

In fact, the slowdown in Chinese demand could persist in the near term and so could likely continue to weigh on the Australian Dollar.

The Aussie was little changed at 96.55 U.S. cents and touched NZ$1.1886, its weakest level since January 2009.

Public and Private debt;Then and now.

Data Source: Wall Street Journal

Today's chart of the day displays the debt to GDP ratio of major global economies. This ratio indicates the health of a country's balance sheet. The higher the debt level, the more difficult it would be for the sector (public or private in this case) to repay and service the debts. Evidently, over the years, the debt to GDP ratios have worsened for US, UK and Japan.
Looking at the chart, it is clear at first sight that since 1990 there have been major fluctuations in debt to GDP across the world. Emerging markets particularly have seen a major change, more so in private debt figures. From having access to cheap capital in the early 90s, the latter half of the decade saw the debt levels going down post the 1997 financial crisis. However, the boom period post the millennium, led the private players to continue taking on more debt given the access to cheap capital. As for developed markets, majority of this period saw an increase in private debt on the back of the housing boom. Public debt of these economies continues to be an area of concern. This has increased all the more over the past few years as governments have been making attempts to fuel growth in their respective regions.
The Japanese economy has witnessed two long decades of stagnation. In a bid to revive economic growth, the Japanese Prime Minister has taken some extreme and highly risk steps. As we have said earlier, the Bank of Japan has pledged to double its monetary base.

Ever since the announcement, the financial markets have gone topsy-turvy. Excessive money supply tends to inflate asset prices. As a result, the Japanese stock markets have gone rallying. On the other hand, the Japanese yen has fallen sharply against the US dollar.

Will these measures lift Japan's economy? For one, theoretical expectations do not often translate to real outcomes. Moreover, such high-risk gambles as Japan's monetary stimulus come at a huge price. And they could have unintended far-reaching repercussions.

Some signs are already there. Interest rates on 10-year government bonds have gone over 1% for the first time in a year. Ideally, money printing should result in suppression of yields. But some recent comments by the US central banker raised hopes of retiring the QE3 program. This severely impacted Japanese markets.

The Japanese government is overburdened with debt. As such, a sustained increase in interest rates would severely jeopardise its finances. Any major financial shock arising out of such a situation would ruin the Japanese economy.

Sunday, May 26, 2013

German businesses stay confident amidst the economic gloom.

Germany's Ifo index of business confidence rose to 105.7 in May from 104.4 in April and topped estimates of 104.5. The increased positivity follows two consecutive declines and comes despite the EU recession, and as a second reading of Q1 GDP confirms that Germany eked out quarterly growth of 0.1%.

Eurozone composite PMI hits three-month high.

The preliminary Markit composite PMI for the eurozone printed at 47.7 in May which, albeit still squarely in contraction territory, is still a three-month high. Both services and manufacturing "saw an easing in the rate of decline" but employment dropped for the seventeenth straight month. Ultimately, "the eurozone's second recession in five years looks set to drag into a seventh successive quarter," Markit's chief economist  said. Individually, Germany's flash PMI came in at 49.9, showing weakness across the currency bloc continues to weigh on the region's largest economy

Singapore Q1 GDP revision shows expansion.

Singapore revised Q1 GDP up to show a 1.8% Q/Q expansion (seasonally adjusted, annualized) versus an advance estimate of a 1.4% decline. On a Y/Y basis the economy expanded 0.2%. The Ministry of Trade and Industry said "economic growth … is expected to improve gradually over the course of the year." The Singapore ETF (EWS) is up 19.8% Y/Y.

Contraction: PMI dips below 50 in China.

 Manufacturing activity is shrinking in China as the HSBC flash PMI fell into contraction territory for the first time in seven months in May, dropping to 49.6 from 50.4 in April, missing expectations. HSBC didn't mince words in an appeal to Beijing: "The cooling manufacturing activities in May reflected slower domestic demand and ongoing external headwinds. A sequential slowdown is likely in the middle of Q2, casting downside risk to China's fragile growth recovery. Moreover, the further signs of labor market slackness call for more policy support. Beijing still has fiscal ammunition to do so."
Lower inflation numbers, reforms and lower subsidy on fuel have hardly appeased the rating agencies. On the contrary, they have issued additional warnings about an impending rating downgrade for India. One that will not just push India to the 'junk' status but also keep away foreign investors. Indian corporate hoping to raise cheaper funds abroad will also then have to shell out much more.

As per SEBI, Foreign institutional investors (FIIs) have poured in US$ 18.8 bn into Indian stocks and bonds so far this year. This is nearly 30% higher than last year. What is it then that the rating agencies fear but FIIs do not?

The problem lies in the government's attitude towards addressing India's deficit problems. The economy has been sporting uncomfortably wide fiscal and current account deficits for a while now. The December quarter current account deficit at 6 .7% of GDP was at record levels. Rating agencies suspect that with elections on the cards, the government will dole out sops that will make the deficits wider. Besides, the election spending will also take the government's focus away from reform measures.

Thus, the rating downgrade risk may not be turning away the FIIs yet. But as per an article in Wall Street Journal, the rating agencies believe that it is only a matter of time before the FIIs retreat.

Thursday, May 23, 2013

Employees’ PF/ ESI Contribution is not covered by s. 43B & is only allowable as a deduction u/s 36(1)(va) if paid by the “due date” prescribed therein

ITO vs. LKP Securities Ltd (ITAT Mumbai)

In AY 2008-09 the assessee collected employees’ contribution to the Provident Fund and ESIC but did not pay it within the due date prescribed by the relevant legislation. The amount was, however, paid before the due date of filing the ROI. The AO assessed the said amounts as income u/s 2(24)(x) but declined to grant a deduction u/s 36(1)(va) as the amount had been paid after the due date. The CIT(A), relying on Alom Extrusions 319 ITR 306 (SC) and AIMIL 321 ITR 508 (Del) held that the amounts had to be allowed as a deduction u/s 43B as they had been paid before filing the ROI. On appeal by the department to the Tribunal, HELD reversing the CIT(A):
S. 43B covers only the sums payable by way of contribution by the assessee as an employer, i.e., the employer’s contribution to the PF and ESI funds. It does not cover the employees contribution. While the employer’s contribution is allowable u/s 37(1), the employees’ contribution collected by the employer is deemed to be his income u/s 2(24)(x) and is allowable as a deduction u/s 36(1)(va) only if it is paid to the relevant fund by the due date as prescribed in the relevant legislation. Even if one assumes that s. 43B(b) applies to s. 36(1)(va) payments, a deduction would not be admissible because the s. 36(1)(va) payments are not ‘otherwise allowable’ if they are paid beyond the “due date”. The decisions in Vinay Cement 213 CTR (SC) 268 & Alom Extrusions 319 ITR 306 (SC) are not an authority on the point that employees’ contributions are also covered by s. 43B. Though in AIMIL 321 ITR 508 (Del) it was held that employees’ contribution to EPF and ESI funds are covered by s. 43B, it cannot be followed because (i) the Court moved on the premise that employees’ contribution is subject to clause (b) of s. 43B and did not notice the condition in s. 36(1)(va), (ii) the decision by the tribunal, which was approved by the High Court in AIMIL was rendered without considering the decision of the Special Bench in ITC Ltd& (iii) it is inconsistent with Godaveri (Mannar) Sahakari 298 ITR 149 (Bom). Accordingly, AIMIL cannot be followed and the deductibility of employees’ contribution has to be seen only with reference to s. 36(1)(va) (together with grace period) (Bengal Chemicals & Pharmaceuticals (included in file) & ITC Ltd 112 ITD 57 (Kol)(SB) followed)
 Note: In Bharati Shipyard 132 ITD 53 (SB)(Mum), Desh Rakshak Aushdhalaya 313 ITR 140 (Utt), Lakhani India 324 ITR 73 (P&H) & Lakhani Rubber Works 326 ITR 415 (P&H) it has been held that employees’ contribution is also covered by s. 43B

Bernanke Testimony Keeps Dollar Down

Earlier today the Dollar remained pressured against the Euro ahead of Federal Reserve Chairman Ben S. Bernanke addressing Congress. Speculation ahead of the address is that the U.S. has not recovered fast enough for the Fed to reduce monetary stimulus.
It seems to me that Bernanke isn't hawkish, and it's likely then that he will err on the side of caution and continue with the Fed's monetary easing policy. He testifies today to the Joint Economic Committee. The Federal Open Market Committee (FOMC) will then also release minutes of its last policy meeting later in the day.

The Market seems likely then to respond to Bernanke's remarks by selling the Dollar.

The Fed has been purchasing $85 billion a month in Treasury and mortgage debt in an effort to drive borrowing costs down and also to drive growth.

 The purchases should continue mainly because markets indicators point to improving financial conditions and that purchases could be adjusted depending on how the economy changes.

Any U.S. pullback from monetary easing is likely to trigger a rise in bond yields according to South Korea's central bank chief, Kim Choong Soo.

"If the U.S. begins to exit from quantitative easing policies, the world will be facing interest-rate risks" Soo said to various heads of banks today in Seoul.
The Dollar earlier traded at $1.2910 per Euro and at 102.61 Yen. The Yen slipped 0.2% to 132.48 per Euro.

The Yen's decline versus the Euro can mainly be attributed to Bank of Japan (BOJ) policy makers having retained their monetary-base target.

At the end of its policy meeting the BOJ today confirmed a plan to double the monetary base over the next two years. They will expand the supply of money in the economy by 60 trillion Yen ($585 billion) to 70 trillion Yen a year.
India has had a trade deficit with China for long. The reason is fairly simple to understand. China is an export powerhouse. Also, since its currency is pegged and kept artificially low, Chinese goods get competitive advantage across the world. However, during the recent visit of Chinese premier to India, both the countries decided to take steps to reduce this deficit. But it seems that this is unlikely to happen. The reason being India's exports to China majorly comprise of iron ore and iron sand. And considering the slowdown in the Chinese real estate market the demand for these Indian raw materials has declined. As a result, India's exports to China have declined. On the other hand, Chinese exports have been on an increasing trend. During the first four months of this year, Chinese exports increased 3.6% YoY. This has resulted in widening of the deficit. Considering that China's export basket is wide and India is dependent on Chinese products, the only way to reduce the deficit for India is to try and increase its exports to China. And this can be done by manufacturing goods that meet Chinese demand. 
Japan has become an area of big worry of late. The reason being its extravagant quantitative easing (QE) program. The Bank of Japan has pledged to double its monetary base. The money printing is bigger than even the one unleashed by the US Federal Reserve.

Japan's QE plan has sent asset prices soaring. While the Japanese yen has plunged, the stock markets have been soaring. But the rise in asset prices has been quite uneven.

We came across an interesting article in the Wall Street Journal that highlights this fact. For instance, the shares in real estate investment trusts (REIT) have shot up quite a lot. During the first four months of 2013, the Tokyo Stock Exchange REIT index was up 43.5%. This was higher than the 35.5% gain delivered by the broader index. Among others, the central bank of Japan was a buyer of listed property investments.

Now here is the worrying part. While REIT prices have soared, the underlying property prices haven't moved much. The activity in the physical property market has been lacklustre. Prime office vacancy rates are still hovering around 8%. Apartment prices in Tokyo are still 22.8% below their level in 2000. As per the article, the sector is trading at a hefty premium to the underlying property assets. How will that gap close? Either property prices will have to rise. Or REIT prices will have to tumble. Certainly, a very risky environment for investors!

BOE minutes show King still favors QE expansion.

 Minutes from the Bank of England's latest policy meeting show the committee's vote to keep rates unchanged was unanimous while three out of nine members (including Mervyn King) voted to increase the size of the central bank's asset purchases by £25B. Sterling (FXB) moved 0.44% lower against the dollar following the release to a multi-week low.

BOJ faces rising bond yields.

The Bank of Japan elected to steer (largely) clear of what many view as a no-win situation Wednesday when Governor Haruhiko Kuroda didn't use this week's policy meeting statement to jawbone government bonds higher (JGBL), although he did pledge flexibility in asset purchases at the post-statement news conference. Surging yields have underscored concerns that the BOJ's purchases could suck liquidity from the bond market, stoking volatility, but rising yields can also be interpreted as a sign investors expect Kuroda will be successful at reflating the Japanese economy. However, acknowledging this is somewhat counterintuitive as "the whole aim of QE is to keep bond yields down," one economist told CNBC, adding that the BOJ is "damned if they do, damned if they don't." Ultimately, the BOJ left monetary policy unchanged, sounded generally optimistic about the prospects for the economy, and noted that some evidence suggests inflation expectations are rising.

Tuesday, May 21, 2013

Monti confident in Italian government, bonds.

 Italy's former technocratic leader Mario Monti doesn't agree with George Soros and others who say the stability in the Italian bond market (ITLY, ITLT) is merely the proverbial calm before the storm. Monti said Tuesday that the ECB is better equipped now than previously to handle disruptions in the sovereign debt market and noted that in his opinion, the steep decline in yields on Italian sovereign debt is sustainable. Monti also predicted that another election is not imminent in Italy as electoral law reform will take at least six months to complete

Goldman lifts S&P targets.

Goldman Sachs lifted its forecasts for the S&P 500 (SPY) Monday, as it expect the index to gain 5% by year-end to 1,750, 9% to 1,900 in 2014, and 10% to 2,100 in 2015. The rationale: expectations of above-trend real GDP growth beginning next year coupled with P/E multiple expansion to 16x. Furthermore, dividends should rise ~30% over the next two years, bolstering the bank's claim that dividend-paying equities are one of the only places investors can look to for income-generation.

Inflation below forecasts in U.K.

 Inflation in the U.K. rose just 2.4% in April, a seven month low and down from 2.8% in March. Economists were expecting a reading of 2.6%. Core inflation came in at 2%, the lowest level in three and a half years. Some economists now say consumer price increases may peak at 3% this summer rather than the forecasted 3.5% and note that inflation may hit the Bank of England's 2% target by H1 2015.

India's growth estimates for 2014

Source: Financial Express
PMEAC - Prime Minister Economic Advisory Council
NCAER - National Council of Applied Economic Research
ADB - Asian Development Bank
IMF - International Monetary Fund

Through the dawn of the global crisis, India had been able to dazzle the world with its stellar economic growth. But things have changed. High inflation rates, RBI's hawkish policy and lack of policy reforms led growth to dip. The fiscal year 2013 saw growth come in at less than 6%. Though the outlook for 2014 is better; however, it is not much better. As shown in the chart the various forecasts for India's growth range from 5.8% to 6.7%. Not one thinks that India can grow at over 8% like it had done in the past. Things have definitely improved when compared to where we were last year. Inflation has eased off. This has made RBI adopt a more liberal stand and roll back interest rates. The government seems to be working on reform s albeit in a small manner. But a lot more needs to be done. Most importantly the government needs to work towards restoring investor confidence in the country. Only that will help boost investments which are needed to spur growth.

Monday, May 20, 2013

Yen now too weak?

The Yen earlier climbed, as against a majority of its 16 major counterparts, after Amari said on Sunday that there's speculation the Japanese currency's past strength has "been corrected a lot."

He went on to say that "If the Yen extends losses a lot, people's lives will be negatively affected. It's our job to minimize that."

In fact, over the last 6 months the Yen has dropped 20% and was near its lowest level in more than four years to the Dollar.

Amari's remarks, that essentially create the impression that the worst of the losses were now over, had spooked the market.

The Yen earlier rose as much as 1.1%, at 102.67 per Dollar and by 0.5% to 131.90 per Euro. The Dollar stayed virtually unchanged at $1.2848 per Euro.

The Dollar has been boosted recently by speculation that the Federal Reserve will signal that it will gradually scale down its easing policies.

Last Thursday Fed Bank of San Francisco President. John Williams, had said that faster economic growth and gains in the job market could prompt the central bank to ease off its bond buying over the months to come.
At the moment, the Dollar does seem to have the upper hand over other currencies from the perspective of fundamentals.

Fed Chairman Ben S. Bernanke is due to speak to the Joint Economic Committee of Congress on Wednesday. The same day, the minutes of the bank's most recent policy meeting will be released.

What risk? Yields fall for Italy, Slovenia.

 Is risk aversion yesterday's news in the eurozone? A report out of Italy showing industrial orders rose 1.6% in March (handily beating estimates and reversing a 2.5% decline in February) helped push the spread between 10-year German bunds (BUND) and comparable Italian government debt (ITLY) to its narrowest level since January at one point on Monday, as investors pared safe haven bets. Meanwhile, yields on Slovenian 10-year bonds fell slightly early on, defying Fitch's downgrade. Of course, the ratings agency is still "far behind the market's assessment of Slovenia's creditworthiness," one economist said, adding that as long as S&P maintains its A- rating, Slovenian banks can still pledge their government bonds as collateral in ECB liquidity operations.

Report questions financial stability of independent Scotland.

 If Scotland were an independent state, its banking sector would have assets totalling 1250% of GDP, a U.K. government report said, throwing the financial risks inherent in a 2014 referendum on Scottish independence into stark relief. By contrast, Cyprus' banks had assets equivalent to 700% of economic output before the country's financial sector was hit by a devastating crisis. Such an "exceptionally large banking sector" would be vulnerable to financial shocks, and taxpayers may be at great risk if the central government didn't have the capacity to deal with the fall out, the U.K. says. Scotland's Finance Secretary called the report "a feeble attempt to undermine confidence" in an independent Scotland.

Curtailing rising property values proves difficult in China.

 New home prices in China rose 4.9% from a year ago in April, a faster Y/Y pace than the 3.6% growth witnessed in March. In Beijing and Shanghai, prices rose 10.3% and 8.6% respectively. The data underscore government concerns regarding property inflation and suggest that last month's 13% decline in home sales transaction value was an anomaly tied to developers' rush to supply homes in March ahead of property curbs rather than an indicator that the sector is cooling. On a M/M basis, home prices rose 1% in April. The Chinese Real Estate ETF (TAO) is essentially flat YTD, but up ~43% over 12 months.

Sun rises on Japanese economy.

The Japanese economy is slowly improving, the government said Monday, pointing to evidence that exports and factory output are beginning to show signs of life. The upgraded economic assessment is the first upbeat report in two months. Additionally, Reuters Tankan survey showed a sixth consecutive month of improving manufacturer sentiment in Japan, as exporters cheered the weak yen. The index printed at 7, the first positive read in more than a year. The country's Economics Minister said the stage is set for a "V-shaped recovery." The rosy outlook was enough to boost the Nikkei 1.47% on the session to a fresh five-and-a-half year high.
Following a recent scam involving, Kolkata-based Sharada Group, the reputation of the entire investment industry has been tainted. So much so that Members of Parliament (MPs) are pressing for a blanket ban on schemes that offer unrealistically high returns. This scam is an important lesson for all of us. When someone offers high rate of return and that too guaranteed, ask till you are fully satisfied about the possibility. High rate of return is possible only when there is a high degree of uncertainty. Certainty of returns can only offer low rates of return comparable to the return on fixed deposits of banks. Otherwise, an investor who gets lured by high return on investment often puts the return of his investment in great danger. What should one do as an investor? Managing our investments is not just our need, it is also our responsibility. If one understands the role of investments in one's life, the focus automatically gets diverted on the life-time needs of money a nd all the short-cuts are forgotten.
Rating agency Standard and Poor's (S&P) has warned that there is more 30% chance of India's sovereign rating being downgraded to junk status in the next 12 months. This is threat that is bigger to the Finance Ministry more than any other. For it will completely seal the prospects of economic recovery. For one, the junk status will dramatically raise the overseas cost of borrowing for Indian companies. Secondly, it will also adversely impact the country's image as a foreign investment destination. As per an article in Mint, international institutional investors have already invested over US$ 17 bn in India so far this year. The downgrade in rating will be a huge setback to them.

Although S&P's credibility and reputation in terms of quality of its ratings has hardly recovered since the 2008 subprime crisis, the 'junk status' threat is something that India cannot afford to ignore.
If you're wondering what will be the fate of the Euro in the near future, a couple of Deutsche Bank analysts might have an answer for you. They are of the view that there are strong chances that the common Euro zone currency could depreciate significantly. This of course sounds counterintuitive at first. If economic scenario in a region is improving, then the currency should rise and not fall, isn't it? But take your mind back to the crisis of 2008-09. Here, during the crisis, the US dollar shot up but then fell later as risk of crisis abated and investors diversified into other assets. Thus, exactly similar could happen with the Euro. Here, the Euro went up as investors rushed to safe haven when risk of economic contagion increased. But now with situation imp roving, people will move out of Euro and thus, make it fall. But is it fair to assume that a second event will pan out in exactly the same way as the first one? Even if the underlying currencies and the economies involved are different. We don't think so. And precisely the reason why we don't like to predict things in the short run. This is not to say that long term predictions are always correct but certainly have a greater chance of proving themselves correct if analysed properly
Data source: SEBI 
Indian corporates' liking for overseas capital is well known. Not only is the capital abundant in foreign markets but it is also cheap. This is because interest rates in foreign markets are lower than in India. But interest rates are relevant when it comes to borrowing via debt. Apart from debt which comes in the form of foreign currency convertible bonds and external commercial borrowings (ECB's) corporates can also raise equity capital from foreign markets. This comes in the form of American Depository Receipts (ADRs) and Global Depository Receipts (GDRs). Raising capital via this mechanism enables foreign investors to participate in India story without taking any currency risk. On the other hand, listing in overseas markets gives the subject company a global platfor m.

Considering the recent slowdown in overseas markets the appetite of raising money via ADRs and GDRs has dried up. It can be seen from the chart that in all the 4 quarters of FY12 money raised via both these instruments was higher than in FY13. In fact, in 4QFY13 not a single Indian company managed to raise a penny via these instruments. It is not that Indian corporates have sufficient liquidity and they don't need to raise capital. The reason for dying faith in these instruments is that foreign investors are a bit circumspect about putting their money in India right now. Hence, Indian companies are unwilling to raise capital via this mechanism. We feel that unless the global environment improves such a dry spell is likely to continue.  

U.S. economy reaches escape velocity, poll shows.

A worldwide poll of investors, analysts, and traders conducted by Bloomberg shows more than two thirds believe the U.S. economic recovery is "sustainable," while only a little over a quarter of those surveyed see a return to recession within the next two years. Key drivers of the upbeat forecast include increasing energy independence, rising home values, and "a pause in partisan budgetary battles in Washington" (there's agreement in Washington?). Housing, it seems, is the main talking point: "Anyone who isn't long real estate housing is a moron," Axiom Management's Stan Jonas is quoted as saying.

In China, wages grow at healthy pace.

 Real, inflation adjusted wages at nonprivate Chinese companies (state-owned and public enterprises) grew 9% in 2012, up from 8.5% in the previous year, while real wages in the private sector rose 14%, China's statistics bureau said Friday. On a nominal basis, wages grew at a double-digit pace even as the pace of economic growth decelerated. While the data show the country is continuing to push towards establishing "a normal wage increase system," manufacturers could feel the heat should wage growth continue to outpace economic growth going forward.
Will Iran come to the rescue of the beleaguered Indian auto industry? It might well be the case. As per an article in the Economic Times, Iran has agreed to source automobiles and pharmaceuticals from India. This is in exchange for payment of oil imports.

Prior to this, the trade balance was considerably skewed towards Iran. So while India exported goods worth US$ 3.4 bn in FY13, imports were much higher at US$ 11.6 bn. That is not all. India has also been having problems making dollar payments to Iran. This is on account of the sanctions imposed on the latter by the developed world. Hence, this form of barter appears to have found favour among both.

For Iran too, this is beneficial because so far they had been importing automobiles from the European Union (EU). Automobiles and pharmaceuticals were two of the bigger components of the export basket adding upto US$ 18.4 bn and US$ 14.6 bn respectively in FY13. How big an opportunity it is for the Indian auto and pharma industry remains to be seen.  

Thursday, May 16, 2013

Data Drives Euro Down

Ahead of a report likely to confirm that inflation in the Euro region was the slowest in three years, the Euro dropped near to a six-week low.
The Euro slid on speculation that the Euro area's annual inflation rate has dipped to 1.2% in April, the lowest level since February 2010, down from 1.7% in March.
Today the European Union's statistics office in Luxembourg is forecast to confirm the expectations.
Furthermore, the European Central Bank (ECB) is set to ease policy after data had shown that the region's economy has extended its recession to a record sixth quarter.

This puts more pressure on the region's leaders to spur growth.

Data released yesterday had shown that Gross domestic product (GDP) in the Euro area had contracted 0.2% last quarter. German's economy had grown by 0.1%, well below the 0.3% most economists had forecast.

Under the circumstances I expect the Euro to continue its downward trend.

The Euro was lower by 0.1% at $1.2874 and dropped 0.2% to 131.56 Yen. The Dollar remained virtually unchanged at 102.18 Yen.

The Dollar Index (DXY) was earlier just 0.4% away from its highest level since July at 83.794.
Data is also expected out from the U.S., government today that could show that initial jobless claims have probably risen by 7,000 to 330,000 for the week ended May 11.

The Yen had advanced following reports that showed that Japan's economy had expanded more than expected.

This, despite a report that showed that Japanese investors were net buyers of foreign bonds for the week ended May 10th.

A separate report showed that Japan's economy had expanded by 0.9% in the first quarter, above a forecast 0.7% rise.

Demand for physical gold solid in Q1.

 Prior to April's sharp sell-off in gold futures and the SPDR Gold Trust (GLD), demand for physical gold was robust, as Q1 witnessed the first increase in U.S. demand for gold jewelry in seven years. Overall, jewelry demand rose 12% worldwide in Q1 and demand from China rose 19% to a record 185 metric tons. In terms of bar and coin sales, demand was even stronger, rising 22% in China, 52% in India, and 43% in the U.S. Meanwhile, gold held by ETFs fell 177 metric tons, showing outflows were apparent even before the sell-off. Ultimately, the data show the fundamentals of the gold market are intact, despite moves in the "non-physical market," the World Gold Council said.

Japanese economy grows, but capex is weak.

The Japanese economy grew 3.5% (annualized) in Q1 as rising stock prices made consumers more willing to spend, a partial confirmation of the effectiveness of Prime Minister Shinzo Abe's economic policies. On the other hand, capex fell 0.7% Q/Q on expectations of a 0.7% increase, proof the corporate sector is still skeptical regarding fiscal and monetary authorities' ability to wrest the country from the grip of deflation. The weak read on business investment weighed on Japanese stocks as the Nikkei fell 0.39% — the index did hold the 15,000 level.
The Eurozone has been testing several things to get itself out of the mess that it is in. It has invoked austerity measures. It is printing money like there is no tomorrow. But nothing seems to be helping. As per the Financial Times, the recession has just been prolonged. The data states that the 17 bloc nation has registered yet another period of recession. This makes it the longest period of recession since the Euro currency came into existence. Unemployment soared to 12.1%. France is back into recession. Italy and Spain are not doing any better. Even Germany has shown very little improvement.

The Eurozone needs to take harsh measures if it wants to come out of this mess. It has made terrible mistakes in the past and appears to be paying the price now. Unfortunately all it is doing to deal with the crisis is giving temporary pain relief pills to the economy. All these pills do is to postpone the disaster to another date.

Distressed assets weigh on PSU bank stocks

Stock price decline calculated between 31 Dec 2012 and 15 May 2013;
*Indian Overseas Bank; ** Oriental Bank of Commerce
Owing to the slowdown in the economy, several businesses are facing tough times and struggling under the weight of debt. The loan books of PSU banks have already been under pressure on account of rising non-performing assets and loan restructuring.

As per an article in the Economic Times, the worst is not over yet. PSU banks are expected to continue to witness significant loan restructuring for yet another quarter. Two major PSU banks, Bank of Baroda and Union Bank of India are expecting to restructure loans to the tune of Rs 48 bn in the June ending quarter. United Bank of India witnessed a whopping 80% drop in net profits in the quart er ended March 2013 due to bad loans and squeeze on margins. Overall, the banking sector has been significantly affected by the slowdown in the economy.

Today's chart of the day shows PSU bank stocks that have witnessed a steep decline in their price in the year so far.

Germany avoids recession, revises down Q4 GDP data.

 Unlike its less economically fortunate eurozone core compatriot France, Germany managed to avoid falling into recession in Q1, albeit by the narrowest of margins. The German economy expanded by 0.1% during the quarter, less than the 0.3% growth economists expected, as harsh winter weather, falling exports, and lackluster investment took their toll. Germany's statistics office also revised down its GDP data for Q4, saying the economy shrank by 0.7% during the period, more than the 0.6% contraction previously reported. The data come on the heels of ZEW's investor confidence reading which showed persistent worries about the state of the eurozone economy writ large continue to weigh on sentiment.

CBO slashes deficit estimate.

The federal deficit will narrow to $642B in the fiscal year ending in September, the CBO said Tuesday — a meaningful improvement from February's projection of $845B. The revision comes courtesy of higher tax receipts and dividend payments to the Treasury from Fannie (FNMA.OB) and Freddie (FMCC.OB). The government can now skirt the federal borrowing limit until October or November. The CBO sees a deficit of 3.4% in FY14 and 2.1% in FY15, before the figure begins to rise anew on increased spending.

French economy slips into recession.

 France slid into recession during Q1 as the French economy contracted 0.2% Q/Q after shrinking by the same amount in Q4. With unemployment at record levels and President Fran├žois Hollande's popularity at all-time lows, the country faces an uphill battle to right the ship as it struggles to bring its deficit in line with the EU-mandated 3%, while simultaneously restoring growth. Economists project a 0.2% contraction for the full year and a survey of French citizens shows just 11% believe Hollande can bring down the jobless rate by year's end.
After three years of staying consistently high, wholesale price index (WPI) finally fell below 5% in April 2013. This means that inflation is now within the comfort zone of the Reserve Bank of India (RBI). Inflation so far had been a big headache for the central bank. As a result of which it was not comfortable cutting interest rates. This is even when economic growth had considerably slowed down. With this latest piece of development, there are once again increased hopes that the central bank will bite the bullet and cut rates in its next monetary policy meeting. With commodity prices easing, there was some breather on the food inflation front as well. This slumped to 6.1% from 8.7% a month ago. Similar was the case with non-food manufacturing inflation, which slowed to 2.8% in April from 3.5% a month ago. This is after the international prices of iron ore and steel dropped. However, a lot will depend on how this trend pans out in the coming months. Further, the consu mer price inflation data will also play an important role in determining the central bank's further actions. 

Tuesday, May 14, 2013

Fed's eye on upcoming data

Today, profit-taking knocked the Dollar off a five week high. The Fed's Quantitative Easing (Q.E.) exit strategy is now focused on upcoming data. New talk of negative rates keeps Euro in check.
The Dollar was down from a five-week high today as against a basket of major currencies. Traders were locking in gains as they focused on data due out later in the week, that potentially might affect the U.S. Federal Reserve's policy.
The Dollar index dropped by 0.3% to 83.015 off from Friday's five week high of 83.438.

As against the Yen, the Dollar slid 0.3% to 101.56 Yen, while the Euro gained 0.35% to $1.3018.

Should upcoming U.S. economic data be strong, then I expect the Dollar to pick up its recent momentum again.

Speculation that a Financial Times report that claims that hedge funds are no longer wary of a collapse in the Euro, could have exaggerated price moves.

Nevertheless, the Dollar has been underpinned by data that shows that U.S. retail sales had unexpectedly risen in April, as households bought building materials, automobiles, and various other goods.

The rise in retail sales and relatively strong job growth recently, have boosted expectations that the U.S. Federal Reserve could scale back its asset-buying programme later in 2013.

The focus is now on industrial production stats tomorrow and housing starts and consumer prices on Thursday. Friday will see the release of consumer sentiment data.

Market players will then be focusing on comments from Fed speakers later in the week.
Should that occur, this would mean that banks would be charged for parking spare cash that they do not lend. In turn, this would create incentives for investors not to hold Euro cash.

Spain's 12-month borrowing costs hit 3-year low.

Spain sold €3.034B of 12-month T-bills at an average yield of just 0.994% Tuesday, the lowest rate in more than three years as borrowing costs continue to fall on investors' apparently unshakable faith in the ECB's willingness to backstop Spanish and Italian sovereign debt. Yields on comparable notes hit 5% last June. Meanwhile, core inflation in Spain fell to 1.9% in April, below economists' projections and the lowest level in eight months, as the country's economy continues to stumble

German investor confidence subdued.

 ZEW said its index of investor and analyst expectations crept up to 36.4 this month from 36.3 in April, missing economists' forecast of 40. The below-consensus reading was largely attributed to a generalized sense of anxiety regarding the economic situation in the eurozone as a whole, underscored by the ECB's recent rate cut. "The problem is that [Germany] seems to be the only big EU economy growing," said a senior economist at Citigroup, quoted by Bloomberg.

U.S. oil boom fuels non-OPEC supply growth.

 Thanks to U.S. shale oil, demand for OPEC crude will remain largely unchanged over the next five years, the IEA said in its semi-annual report. "Output growth from North America dominates the medium-term growth profile," as U.S. liquids production should increase by 2.8M barrels per day by 2018, accounting for half of non-OPEC growth during the period. Total U.S. output five years from now should reach 11.9M barrels per day, or around 20% of the projected total of 59.3M barrels per day of non-OPEC supply
The Economic Times has reported that the Ministry of Power is seeking advice of regulator Central Electricity Regulatory Commission. This is towards tackling fuel availability for certain projects. It is believed that existing power capacities of 37,680 MW and upcoming capacities of 28,000 MW could benefit from the outcome. One outcome being discussed is a provision for passing on the additional costs to customers.

A few years ago, through the process of competitive bidding, power producers signed power purchase agreements. These were done keeping certain factors in mind. The factors included assurance in terms of coal supplies; largely to be made by Coal India (CIL). However, CIL has been unable to meet its obligations. This has led power producers to resort to importing coal. Such coal is costlier by about 40% as compared to domestic coal. With fuel prices moving up, it's the power producers who have been impacted as their project viability has come under question. Passing on costs is a difficult and lengthy process and one that the government does not prefer considering that the eventual impact would be on the final consumers.

On an overall basis, it does indicate the sticky situation the government is in. While on one hand, there are concerns relating to power shortage and possibly systemic failures. But without appropriate pricing, power produces may not want not add capacities. Either way, it does seem that the consumers who be bearing the cost burden.
The Credit Guarantee scheme has been a very popular form of shadow banking in China. How it works is that company A acts as a guarantor of company B's loans. In turn, some subsidiary of company B acts as a guarantor for company A. If either of the company went bust, banks would end up calling loans for every company in the chain. Since these companies too might have guaranteed loans for others, more companies get into trouble. This therefore ends up becoming a viscous cycle of loan defaults. As per Money news, rating agency Moody's has cited a warning signal on China's thriving shadow banking system which poses systemic risks. The nation's financial industry has expanded by more than 67% over the past two years. But the same has been on the back of many compromises on asset quality. While the rating agency has just pointed at the tip of the iceberg, we will not be surprised if a full-fledged financial crisis shows up in due time.

India's trade deficit widens.

India's appetite for (now cheaper) gold (GLD) drove the country's trade deficit 70% wider in April as precious metals imports more than doubled Y/Y. The deficit came in at $17.8B last month, up from $10.31B in March as higher import taxes on gold failed to arrest voracious demand from the world's biggest consumer. The country's trade secretary called the figures "surprising."

Libor replacement on the horizon.

 Libor may be replaced by a new system next year. FT says discussions are centered around a dual-track system wherein a survey-based approach (the old model) would operate concurrently with a transaction-based index (the new model). Presumably, such an approach would retain the stability of the traditional model, while incorporating an element of objectivity.

Broken record: Nikkei rallies, yen falls.

 The yen (FXY) continued its slide early Monday, falling to a new four-and-a-half year low against the dollar (before recovering), helping the Nikkei (NKY) post another triple-digit gain on the session, rising 1.2% to 14782, its highest level since January 2008. The weak yen comes on the heels of the G7's reportedly amicable meeting over the weekend, at which officials were generally supportive of the BOJ's policies and reiterated that Japan's goal is to fight deflation not engage in the targeting of exchange rates.

In China, economy sends mixed signals.

Chinese industrial output growth printed at 9.3% in April, up from a seven-month low of 8.9% in March but still a whisker below economists' expectations of 9.4%. Investors were watching the data closely for signs of weakness after last week's trade data aroused suspicion for being too good to be true. Traders also got a read on the Chinese consumer as the National Bureau of Statistics said retail sales in the country grew 12.8% last month, matching forecasts. Despite the news, consumer discretionary stocks fell. Ultimately, investors once again came away with mixed feelings regarding the state of the Chinese economy.

Monday, May 13, 2013

G-7 Chiefs say they'll let Yen slide

The Yen weakened beyond 102 to the Dollar for the first time in four and a half years, after Group-of-Seven (G-7) finance officials said that for the moment, they'll accept a slide in the Yen.
The past weekend, G-7 finance ministers and central banker officials again confirmed their commitment made in February, not to target exchange rates.
The policy makers went on to say that they had examined Japan's policies and current strategy and that they will be monitoring its impact on currencies.

By granting tacit approval for Japan's policies, it seems likely to me that the trend of a weakening Yen is set to continue and even gather momentum in the next few days.

The Yen weakness has also been advanced by the release of a report which showed that Japanese investors have become net buyers of foreign bonds.

Earlier today, the Yen traded at 101.59 per Dollar, up slightly from 102.15 which was a level unseen since October 2008. The Yen traded at 131.86 per Euro, while the Dollar remained virtually unchanged at $1.2981 per Euro.
The Dollar had gained ground against most of its major counterparts after Treasury 10-year yields had risen to their highest level in nearly seven weeks. The rise comes ahead of a speech on monetary policy, by Federal Reserve Bank of Philadelphia President Charles Plosser, on Tuesday.


India's coal production below target.

Source: Financial Express
The fiscal year ended March 2013 saw coal imports sky rocket. India's coal imports rose by almost one third to 135 m tones during the year. A big reason for this was the slowdown in domestic output. This is the fifth year in a row when domestic coal output did not even meet the target output set by the country's largest coal producer, Coal India. As against a target of 464.1 MT for FY13, it achieved only 452.2 MT as production. Unless the company is able to start adhering and meeting its targets, the country's power producers will not have much choice but to import coal. Let us not forget that imported coal is much more expensive as compared to domestic coal. 

Moody's doesn't see corporate bond bubble.

 Don't panic, Moody's said in a report Friday, there's "no strong evidence that recent [corporate debt] issuance levels presage a damaging correction." The notion that a bubble is building in the corporate bond market isn't reflected in credit spreads which, for both investment grade (LQD) and high yield (HYG, JNK), are closer to long-run averages than they are to alarmingly tight. Furthermore, the ratings agency said a surge in issuance reflects the "disintermediation of the banking sector" and noted that the proportion of total corporate liabilities comprised of debt securities "hasn't significantly increased over the past two years." We can all rest easy now.

Margin debt hits pre-crisis levels.

 NYSE margin debt hit $379.5B in March, a 28% Y/Y increase as investors borrow money to buy into what has become a famously resilient rally. The concern is that a steep sell-off could snowball if leveraged investors are forced to unwind positions to meet margin calls. Borrowing to buy shares is of course one sign of unbridled optimism, although some believe levering up makes sense in the current environment. The last time margin debt hit $380B: July 2007, the same month S&P and Moody's marked the beginning of the crisis by downgrading hundreds of RMBS.

ArcelorMittal posts loss, but results improve from Q4.

 ArcelorMittal (MT) posted a net loss of $345M or -$0.21 per share for Q1 on revenue of $19.752B, and while both figures were worse than Q1 2012, the results were an improvement over the previous quarter. CEO Lakshmi Mittal said the economic environment "remains challenging," but sounded upbeat about the company's performance in the face of a soft market. The world's largest steel maker said EBITDA (which, like the profit and revenue picture, improved slightly from Q4), should continue to improve sequentially and will likely come in above $7.1B for the full year.

Dollar rises above ¥100, Nikkei Soars.

For the first time since April of 2009, the yen (FXY) fell through the 100-level against the dollar, helping the Nikkei rally nearly 3% on the session and almost 7% on the week. Japanese equities (EWJ) are now trading at levels last seen in January of 2008. Japanese capital flows data finally showed what many had been waiting for since BOJ Governor Kuroda's shot across the bow at deflation: an outflow, as Japanese investors became net buyers of foreign bonds.
Amidst slowdown in global markets, India's exports are in a sort of downtrend. In fact, in FY13, exports fell 4.4% YoY as the demand from overseas markets remained muted. However, it seems that a revival is on the cards this year. The government is confident that exports will increase by 10% YoY this year. However, exporters are confident that the growth figure could be in the region of 20-25% YoY. And there are many reasons for this optimism. The US economy is already showing some signs of revival. It may be noted that US is the largest market for India's clothing exports. Thus, a revival there indirectly helps India's exports. However, European Union is still a cause of concern. Nonetheless, India's dependence on Europe has declined in recent times. Also, increasing exposures to countries like Africa and Latin America that are relatively less impacted by the global slowdown is likely to help boost exports. Overall, it seems that in FY14 export growth is likely to be strong. This should help curb current account deficit provided gold and crude prices do not increase. 

Thursday, May 9, 2013

Transfer Pricing: All related transactions cannot be considered for PLI determination

CIT vs. Stratex Net Works (India) Pvt. Ltd (Delhi High Court)

The assessee’s parent company, Digital Microwave Corporation USA, supplied equipment to Indian customers for which the assessee received commission. The said equipment was covered by warranty and the service relating thereto was provided by the assessee. The assessee also undertook installation of the said equipment and provided annual maintenance. The assessee claimed that while the receipt of commission and the provision of warranty service were “international transactions” with the AE and subject to transfer pricing regulations, the installation& maintenance service was an independent transaction and could not be considered while computing the PLI for determining the ALP. The TPO rejected the claim and held that in computing the profit level indicator of the international transactions involving warranty services and commission income, the operating revenue and operating costs of the installation/commissioning and maintenance services had to be taken. The CIT(A) & Tribunal upheld the assessee’s claim. On appeal by the department to the High Court, HELD dismissing the appeal:
The department’s argument that the installation, commissioning & maintenance services were intricately connected with the international transactions of warranty support services and commission income and that their operating cost and operating revenue had to be considered while computing the profit level indicator is not acceptable because the installation/ commissioning and maintenance agreements were independent agreements unconnected with the transactions of warranty support services and commission income. This is shown by the fact that while the equipment was supplied to 40 customers by the AE, only three of them availed of the installation services from the assessee. Also, a corroborative circumstance for construing the transactions of installation/commissioning and maintenance as domestic transactions was that the TPO had made no adjustment in respect of these transactions. The transactions pertaining to the installation/commissioning and maintenance services were also not deemed international transactions u/s 92B(2) because none of the conditions stipulated therein of a prior agreement existing between the customers of the assessee and the AE have been established as a fact. Moreover, there is no finding that the terms of the transaction of installation/commissioning as well as maintenance had been determined in substance between the customers and the assessee by the AE. In the absence of such finding, it cannot be deemed that the transaction of installation/commissioning as well as provision of maintenance services by the assessee to its domestic customers in India were international transactions falling within s. 92B(2).

Pound at 3 Month High,

Earlier today the Pound touched a three month high to the Dollar ahead of a Bank of England (BOE) Policy meeting today.
Today's gains for the Pound against the Dollar is mainly attributed to speculation that the BOE is likely to refrain from expanding monetary stimulus when it holds a policy meeting today.
Should the BOE puts off additional easing today, we could see gains continue for a little while longer.

The BOE's Monetary Policy Committee seems likely to keep the target for its program of bond purchases (otherwise known as quantitative easing) at 375 billion pounds ($583 billion). In a recent meeting in April, most of the panel had said that the monetary policy was already "highly stimulatory."
Sterling earlier traded at $1.5538 while the Euro traded at $1.3159. The Yen climbed by 0.3% to 98.72 per Dollar and by 0.3% to 129.90 per Euro.

The Euro had held its biggest gain in three weeks as a Spanish bond auction was set for today. Spain will auction debt maturing in 2016, 2018 and 2026.

This will follow Portugal's first 10-year debt sale in 2 years, following its bailout in 2011, which saw investors submit bids for 10.2 billion Euros ($13.4 billion) of the nation's 10-year notes.

German data is due out on Friday which could show that exports from Germany had risen by 0.5% in March following a 1.5% drop in February. On Wednesday a report had shown that the nation's industrial production had grown by 1.2% in March from 0.6% in February.
The Yen's climb was mainly attributed to Asian stocks having earlier erased gains, with the MSCI Asia Pacific Index of shares having slid by 0.3%.

With confidence remaining low that we could see further strong readings on the U.S. economy, it seems that the Dollar-Yen could remain constrained in the near term.

S. 40(a)(ia) TDS: Special Bench verdict in Merilyn Shipping is not good law

CIT vs. Sikandarkhan N. Tunvar (Gujarat High Court)

The assessee, engaged in the business of transport contractor and commission agent, incurred expenditure of Rs. 8.74 crores on payment to contractors where no TDS was deducted. The AO & CIT(A) held that the expenditure had to be disallowed u/s 40(a)(ia). On appeal, the Tribunal, relying on Merilyn Shipping & Transports 146 TTJ 1 (Viz) (SB) held that as the said amount had already been paid and was not “payable” as of 31st March, the disallowance u/s 40(a)(ia) could not be made. On appeal by the department to the High Court, HELD reversing the Tribunal:
In Merilyn Shipping 146 TTJ 1 (Viz) (SB) the majority held that as the Finance Bill proposed the words “amount credited or paid” and as the Finance Act used the words “amounts payable“, s. 40(a)(ia) could only apply to amounts that are outstanding as of 31st March and not to amounts already paid during the year. This view is not correct for two reasons. Firstly, a strict reading of s. 40(a)(ia) shows that all that it requires is that there should be an amount payable of the nature described, which is such on which tax is deductible at source but such tax has not been deducted or if deducted not paid before the due date. The provision nowhere requires that the amount which is payable must remain so payable throughout during the year. If the assessee’s interpretation is accepted, it would lead to a situation where the assessee who though was required to deduct the tax at source but no such deduction was made or more flagrantly deduction though made is not paid to the Government, would escape the consequence only because the amount was already paid over before the end of the year in contrast to another assessee who would otherwise be in similar situation but in whose case the amount remained payable till the end of the year. There is no logic why the legislature would have desired to bring about such irreconcilable and diverse consequences. Secondly, the principle of deliberate or conscious omission is applied mainly when an existing provision is amended and a change is brought about. The Special Bench was wrong in comparing the language used in the draft bill to that used in the final enactment to assign a particular meaning to s. 40(a)(ia). Accordingly, Merilyn Shipping does not lay down correct law. The correct law is that s. 40(a)(ia) covers not only to the amounts which are payable as on 31th March of a particular year but also which are payable at any time during the year.

Spain's borrowing costs fall at auction.

Spain sold €4.57B of debt at auction Thursday, above its target. Three- and five-year bonds yielded 2.247% and 2.789% respectively while a note due in 2026 yielded 4.336% — borrowing costs dropped for all the maturities auctioned compared to the last time comparable debt was sold. Bid-to-covers were 2.34 for the three-year, 2.24 for the five-year, and 1.62 for the 2026 bond.

Unemployment ticks lower in Australia.

 Headline numbers obscured rising unemployment in resource-rich Western Australia, where the mining industry (which accounts for 20% of the country's GDP) is suffering from weaker economic growth in China and a stubbornly high aussie (FXA). The jobless rate in Western Australia rose to 5.25% in April from 4.8% in March, hitting its highest level since 2010 and rising more than a full percentage point YTD. Meanwhile, the headline unemployment figure, which of course includes data from Victoria, New South Wales, and Queensland, printed at 5.5% for April, down from 5.6% in March.

Junk bond yields hit record lows.

 For the first time ever, the yield on junk bonds (HYG, JNK) has fallen below 5%. The Barclays U.S. Corporate High Yield index fell to 4.97% earlier this week, capping a more than 100 basis point compression YTD, as investors' insatiable appetite for income in a stingy ZIRP environment has fuelled robust demand for relatively riskier assets. Despite the sharp decline in yields, the spread to Treasurys is still well off historic lows at 4.06%.

Bank of England keeps rates, QE unchanged.

 In keeping with consensus expectations, the Bank of England left rates unchanged at 0.5% Thursday and resolved to maintain the size of its asset purchases (£375B). Some say recent economic data including upbeat industrial output readings, suggest the British economy is on the mend. The BOE's policy committee has been divided of late regarding the need for more QE.

In China, consumer prices rise, producer price deflation persists.

 Consumer prices rose 2.4% in China during April, up from 2.1% in March and slightly above economists' estimates, although still well below the government's 3.5% target. Producer prices — now in their fourteenth straight month of decline — fell 2.6%, a steeper drop than expected. Stocks in Hong Kong and Shanghai fell 0.14% and 0.6% on the session following the data.

South Korea central Bank cuts rates.

 In a surprise move, the South Korean central bank cut interest rates by 25 basis points Thursday, calling economic activity in the eurozone and emerging markets "sluggish" and "weaker than initially expected." The cut took the base rate to 2.5%, its lowest level in two years and when combined with recent fiscal policy designed to bolster growth, should help "accelerate the recovery and increase the upside of Korea's GDP," one economist told the NY Times. South Korean stocks (EWY) rose 1.18% and the won fell 0.34% against the dollar.

S. 43(5): Loss on foreign currency forward contracts by a manufacturer/ exporter is a “hedging loss” and not a “speculation loss”

CIT vs. Friends And Friends Shipping Pvt. Ltd (Gujarat High Court)

The assessee, an exporter, entered into forward contracts with Banks to hedge against any loss arising out of fluctuation in foreign currency. The forward contract provided that the assessee would buy some quantity of dollars at a particular rate to cover export bill payment. The contract gave delivery option dates and the assessee had the option to cancel the contract and pay the loss to the Bank. The assessee suffered a loss of Rs. 15 lakhs on such cancellation. The AO & CIT(A) held that the loss constituted a “speculation loss” u/s 43(5) and could not be allowed as a deduction. On appeal, the Tribunal upheld the assessee’s claim. On appeal by the department, HELD dismissing the appeal:
Though the assessee is not a dealer in foreign exchange, it entered into forward contracts with banks for the purpose of hedging the loss due to fluctuation in foreign exchange while implementing the export contracts. The transactions in foreign exchanges were incidental to the assessee’s regular course of business and the loss was thus not a speculative loss u/s 43(5) but was incidental to the assessee’s business and allowable as such. The fact that there may have been no direct co-relation between the exchange document and the precise export contract cannot be seen in isolation if there are in fact several separate contracts with the bankers (Soorajmull Nagarmull 129 ITR 169 (Cal) & Badridas Gauridu 261 ITR 256 (Bom) followed; M. G. Brothers 154 ITR 695 (AP) distinguished)

Wednesday, May 8, 2013

Transfer Pricing: In computing ALP, interest& abnormal costs to be excluded

Marubeni India Pvt. Ltd vs. DIT (Delhi High Court)

The assessee rendered marketing support services to its foreign AE for which it earned a commission. The assessee claimed that in determining the ALP, the interest earned by it on short-term deposits arose from a core treasury function and had to be included in the operating profit and the expenses incurred by it on closure of business were ‘abnormal’ and had to be excluded from the operating profit. The TPO, CIT(A) and Tribunal (144 TTJ 474) rejected the assessee’s contention. On appeal by the assessee to the High Court, HELD:
(i) The question whether a particular activity of the assessee such as the interest generating activity should be taken into consideration in the determination of the ALP is a question which needs to be decided considering the nature of the business of the assessee and its’ “business model”. The Tribunal rightly held that as the earning of interest income was only the result of investment of surplus funds and was not a primary income-generating activity, the interest income had to be excluded from the “operating profit” for purposes of determination of ALP;
(ii) It is not possible to lay down a formula that would be applicable universally to determine whether a particular expenditure or cost incurred by the assessee is a normal or abnormal item of expense in cases relating to transfer pricing. If the assessee is compensated for its service on the basis of cost plus 10%, the question may arise as to whether the compensation paid for closure of the Indian units can be considered to be normal or abnormal cost, because the compensation would directly depend or vary according to the quantum of the costs. But if the assessee is being compensated by a fee or commission which has no connection with the costs incurred, such costs would be treated as abnormal. On facts, as the assessee was being compensated by way of a commission of fees by the AE and not on cost plus basis, the compensation paid in connection with the closure of the Indian units represents abnormal costs which have to be excluded for determining the ALP.