Inside Track

BUSINESS & ECONOMY   stock markets Inside Track Instanex gives investors a chance to track the FIIs that control the markets, says SAUMIL SHARMA Instanex CEO Gautam Chand CONVENTIONALLY, WHILE making investment decisions, investors look at the market valuation of companies registered on the stock markets. These valuations are based on the stock issuing company’s performance over a period of time. Till date, financial market indices like S&P CNXNIFTY or BSE tend to be driven by volumes of investment in certain equity issues. So, the common investor has to toil to invest in multiple high growth and profitable companies rather than being able to share a consolidated equity base chosen by highly qualified investors making successful investments in the markets. No longer. Instanex, a specialised investment firm, launched the Instanex FII Index, which tracks the price and performance of the portfolio of listed Indian equity shares owned by such a particular class of investors - Foreign Institutional Investors (FIIs). This innovative market tool is the first of its kind as it is the only index in the world based on quarterly adjusted market capitalisation (FII share holdings) of an investor group or class. "We feel that the Instanex FII Index would be extremely popular with investors as well as with exchange participants and their clients because it is highly correlated to FII flows and will permit investors to take a position more closely linked to FII flows than the Nifty Index”, says Instanex Capital Consultants CEO Gautam Chand. Chand says that Instanex Owner Indices slice the market by investor class rather than the traditional system of market capitalisation or sector. This allows Instanex to observe the investment behavior of different investor classes within the overall market. “Our interest in this Index is due to its representation of the Indian market — with a diversified access to equity investments — done by a largely successful investing class of Foreign Investment Funds. In essence this Index is very beneficial because it combines the benefits of fundamentally sound equity options with the investment choices made by the best investment companies which have many creative minds working behind their investments” , says Bruno del Ama, CEO, Global X Management Company LLC Effectively, this index will enable other investors in the country to replicate the FIIs — the largest institutional investors in Indian markets, with holdings valued at close to $90 billion on May 11, 2009. They account for over three times the value of buy and sell orders on stock exchanges compared to domestic institutional investors. More important, FIIs determine the direction of the market. They are the most successful portfolio investors in India, with 157 percent appreciation since September 30, 2003. New track Retail investors will now easily monitor FII investments in India Photo: SHAILENDRA PANDEY “The advantage of investing in the Instanex FII Index is the higher returns in medium-long term compared to the market. History supports the proposition that the superior performance of the FII index over the market will be sustained”, adds del Ama. Over the past two months FIIs have changed the direction of the Indian markets. On March 5, the Instanex FII Index touched its 2009 low of 184.20, down 16.55 percent for the year. Immediately after that, the index recovered sharply, clearly indicating that FIIs had drastically reduced their selling. GB Bajaj, a strategist, argues that the Instanex FII index is expected to bring about a major change in the way FIIs and domestic investors strategise and plan their equity holdings in Indian markets because of the transparency it brings into the system in terms closely analysing FII equity investment data through SEBI’s provision of information disclosure. “The FII index is based on active rather than passive investment management compared to broad-based indices, and is very specific to the Indian financial market context where FIIs have outperformed other market investors in the long run. With the time and money that these large foreign institutional investors put into research on the Indian markets their investment decisions are more often right and outperform the regular market indices”, says Jerry Moskowitz, MD of FTSE Americas. “Sentiment drives short-term investments, whereas long-term investment is based on the fundamentals of companies and the economy” says Gautam, while commenting on the 36.62% rise in the Instanex FII index since 06 March 2009. He also says that financial markets in India are liquidity-driven where speculators front run the market on future expected FII orders and hope to sell dear to the FIIs. In short, it means fresh FII inflows supporting the index rise. FII are always buying or selling but what makes this index workable? Instanex’s findings show that over 1,500 registered FII that manage 5,000 accounts have shown largely homogenous choices of stocks and are consistent in their stock selection over the past five years. Very specific to the context of Indian markets, it is noteworthy that FIIs have broadly similar investment patterns which enabled Instanex to create such an index, which might not be true for any other market. “In my opinion there exists no other such index or such a trend in any other market to form a dynamic index based on particular investor class behaviour”, adds del Ama. India is attractive to FIIs due to the steady growth its economy had registered   Moskowitz responds by saying “FIIs investing in India buy      and sell the same securities and if the market as a whole  starts to follow similar investments then FIIs may face falling  returns on their investment choices, resulting in change of  investment strategies. However, this would need a fundamental shift in the investment patterns of FIIs, changing the regular type of compensation and restructuring the tracking of markets” IT’S NOT a given that the Instanex FII index will always outperform the broad base indices, argues Moskowitz, adding that markets in the US and Europe have never proved any such trends and more often than not retail investors have outperformed institutional investors in these markets. “In case of Indian markets the underlying assumption is that institutions like pension funds consistently make the right decisions using the research depth they can achieve into the market”, adds Moskowitz Experts show mild concern that policy or regulatory changes in the long run may affect the fortunes of the Instanex FII index but such cases would arise only if the FIIs choose to play a different ball game altogether. The dynamism of this index due to its self-adjusting quarterly cycle will allow it to closely follow the sectorial shifts in foreign investment in equity markets. With optimism, Girish Bajaj comments that “the future of this index is bright and it shall become extremely popular with introduction of ETFs and other by-products like options and futures. Importantly, it shall provide a good indicator of the direction in which the market is expected to move, challenging the existing tactical strategy of various investor groups”. Overall, the introduction of the new index seems to be promising for domestic investors in the current times. WRITER’S EMAIL  saumil.08@gmail.com

From Tehelka Magazine, Vol 6, Issue 20, Dated May 23, 2009

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A Conventional Intervention

BUSINESS & ECONOMY

A Conventional Intervention

The RBI initiates an economic stimulus, hoping its policy rate change will induce commercial banks to increase lending, saysSAUMIL SHARMA Low business The RBI must help resurface credit demand in the markets ALTHOUGH THE IMF and the World Bank have forecast 5.25 percent and 4 percent GDP growth for the Indian economy in 2009-10, the Reserve Bank of India (RBI) still maintains its projection of 6 percent growth in its annual policy statement for this fiscal. And Prime Minister Manmohan Singh seems determined that the Indian economy will be back with a growth rate of 8 percent after September 2009. As a central bank, the RBI has maintained liquidity in the system and sufficiently supported banks and other institutions in the country, but that is only one side of the coin. The ongoing parliamentary election have effectively left the RBI in charge of the economic stimulus India requires during this crucial period. It, therefore, needs to take on a commercial bank’s role while conditions of lending and credit still face difficulties. For the economy to grow at a higher level, counter-cyclical lending by commercial banks is necessary and the RBI will have to directly oversee timely policy changes according to market conditions. Following the global financial meltdown, the RBI resorted to adjusting the Cash Reserve Ratio (CRR) and undertook Open Market Operations to maintain sufficient liquidity. In its annual policy report for 2009-10, it issued a rate cut of 25 basis points in the repo and reverse repo rate, to make them 4.75 and 3.25 percent respectively, indicating a need for commercial banks to ease their lending rates. The annual report notes that in the last two quarters, the RBI has reduced its lending rates by 400 basis points but the reduction in the range of the Bank Prime Lending Rate (BPLR) was only 125-225 basis points (for public sector banks), followed by 100-125 basis points (for private sector banks) and 0-100 basis points (for five major foreign banks). The polls have left the RBI in charge of the economic stimulus India now needs Clearly, the recent monetary easing by the RBI has not been fully reflected in the reaction of commercial banks towards lending rates, partly because of a lag between policy change and market implementation. For the past two quarters, most conventional monetary controls exercised by the RBI, although necessary for handling liquidity issues, have been focused on conventional ways to exude or absorb money flows. There hasn’t been much unconventional monetary management to create ease in credit conditions. And this, in turn, is impacting the economy in one way or the other. Consider this. The declining growth in the credit market and fall in credit demand has also tended to deteriorate financial assets: for instance, non-performing assets (NPAs) of commercial banks have ballooned. According to a recent report by the Credit Rating Information Services of India Limited (CRISIL), the slowdown will drive the gross NPA valuation in the banking sector to a projected five percent of total bank advances by end March 2011 — from just 2.8 percent in end March 2008. “The increase in NPAs will be driven by delinquencies in corporate loans; this asset class accounts for about 56 per cent of banks’ advances,” points out Raman Uberoi, senior director, CRISIL, adding that deterioration in the asset quality of corporate loans will be the result of slowdown in demand, lack of access to funding at reasonable rates, movements in foreign exchange rates and a lengthening working capital cycle. OBVIOUSLY, THE vicious cycle of credit losses starts with difficulties in credit availability to a market that requires lending. This results in an eventual loss of demand in asking credit to facilitate economic activity. This loss of demand is a reflection of low confidence of the market in raising credit from institutions, while business volumes and profits are trickling. As a result, India — for some strange reason — faces a peculiar situation where the RBI’s efforts have genuinely created an ease of liquidity in the market but commercial banks — both stateowned and private — have found it increasingly difficult to pursue renewed credit lending while corporate profits have continuously declined. The distortion of credit cycles in the market is underlined by the RBI’s report which states that business confidence is low and credit demand needs to be driven. Currently RBI’s liquidity support has helped in bringing some stability to financial markets and maintaining sufficient foreign reserves to handle the balance of payments. What is still lacking, however, is a bold statement to bring self-assurance to credit markets and resurface lost credit demand. It’s a crisis of confidence that needs a courageous central bank to make a leap into the unknown.

From Tehelka Magazine, Vol 6, Issue 18, Dated May 09, 2009

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Too Rusty At The Edges

BUSINESS & ECONOMY   iron ore Too Rusty At The Edges Extreme spot market dependencies have struck India’s iron ore industry, with prices hammered to a global low, says SAUMIL SHARMA Rough ride: Mining operations in Orrisa THE BURGEONING Chinese steel industry has kept the Indian iron ore market buoyant in the past. But a slowdown in the world economy has led to a fall in infrastructure growth — and adversely impacted the demand for steel in world markets. After mid-2008, the sudden valleys in the demand graph of the global steel market sent shock waves into the iron ore sector, effectively knocking out spot prices. “The Indian iron ore market is hit because of grossly undervalued spot prices. Mines are selling at a loss or marginal profits”, says SB Chauhan, advisor to the Federation of Indian Mineral Industry (FIMI). Other sector watchers agree that the outlook for 2009 is grim. “Small operators in India are likely to be severely hit because of depressed spot prices. They may find it difficult to continue operations because the demand revival emerged with buyers looking for price stability and shifting focus to long-term contracts”, says Magnus Ericsson, senior partner, Raw Materials Group, Sweden. Revival of the Chinese market will hopefully bail out the small operators from India During 2007-08, iron ore miners in India enjoyed much higher spot prices compared to long-term contract prices because of considerable demand from Chinese importers. While only a handful of Indian iron ore companies like MMTC (a government of India enterprise) held long-term iron ore contracts with Japan and South Korea, most private mine-owners engaged in spot cargo shipments. “Under normal circumstances spot prices will always earn a premium over contract prices, but imbalance of supply-demand created a unique trend reversal with long-term prices higher than spot prices,” argues Chauhan. This transformed an extremely profitable Indian industry in 2007-08 into a break-even or loss-making one in 2008-09. The Indian government stepped in, supporting the sector by adjusting the ad valorem export duty on iron ore fines to nil and iron ore lumps to 5 percent in the interim budget announced in February 2009. The duty cuts have helped, but only marginally: Chinese buyers are asking for an import price of $50 to $55 per metric ton of ore. “Today, it is increasingly difficult to sell iron ore fines at even $50 per metric ton FOB (free on board) at Indian ports”, says an Indian trader. These price levels are about 40 percent of the 2008 iron ore prices at their peak. Exports in 2007-08 were 104 million tons; by March 2009, volumes touched 100 million tons. Ericsson argues that if 2007-08 had seen iron ore prices suddenly shoot up by 75-95 percent, a sharp fall to 40-50 percent of peak levels would bring prices back to early 2007 prices — at which point supply-demand dynamics would be in balance. High domestic freight charges in India are an added disadvantage. “Rail freight charge is a major problem as transport cost constitutes 50-70 percent of the final Indian prices,” says Chauhan, maintaining that the 2003 freight hike from the 120 class category for iron ore to the highest freight bracket of 200 Class is completely unjustified. Global prices are controlled by the Big 3 — BHP Billiton, Rio Tinto and Vale. Unfortunately, India falls out of the longterm contract league of the Big 3 and faces the brunt of pressure from buyers such as the Chinese. Even the slightly lowered sea-freight rates have not helped Indian miners shore their business. For the iron ore barons, the once rich vein seems to have petered out.

From Tehelka Magazine, Vol 6, Issue 17, Dated May 02, 2009

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Cleaning Up Coal

BUSINESS & ECONOMY   Coal               Cleaning Up Coal Coal gasification is an alternative extraction technology that can significantly green the Indian power sector, says SAUMIL SHARMA WITH HEIGHTENED concern for global warming at last taking centrestage — unlike his predecessor, George Bush, US President Barack Obama agrees the issue needs immediate tackling — all major world economies are obliged to look for environmentally sustainable ways of energy sources to meet growing demand. India and China, now the world’s biggest emitters of the greenhouse gases that account for a quarter of coal-combustion related global emission, need to be proactive in containing their emission levels. This means making their energy sector both clean and green. Green coal : A gasification plant in the United States. Clean Coal Limited has plans to work with Coal India It’s not an easy task. Current energy consumption levels in India are heavily dependent on conventional coal mining, making it the most important energy source in India. About 70 percent of total electricity generation in India uses coal. It is also the most carbon-intensive fuel. The sector, therefore, continues to bear the blame for the maximum emission of greenhouse gases and for polluting water under and over the surface. While it is hard to replace the need for coal, it is possible to develop and promote alternative technologies to produce cleaner fuel from the abundant coal deposits in the country. A good beginning is already on the cards, with power sector reform initiating the new paradigm of extracting fuel in ways other than conventional coal mining. A US firm specialising in technical expertise and management of an alternative coal extraction process — Underground Gasification of Coal (UCG) — has now proposed a pilot project in Jharkhand. Negotiations between a set of companies under the banner Clean Coal Resources (CCR) and the Jharkhand Government are set to start soon after the Lok Sabha elections are over. The two parties will be looking to work out the operational details of the proposed project and a possible collaboration with the public sector, Coal India Limited, or its subsidiaries. Seventy percent of electricity in India is from coal, the most carbon-intensive fuel UCG is an alternative technology for producing synthesis gas, or syngas. It exploits deep coal deposits that cannot be extracted by conventional coal mining techniques — by drilling holes, namely ‘injection’ wells and a ‘production’ well. The former is used to send oxygen steam to facilitate the combustion of coal deep beneath the surface, It leads to an exhaust of mixed gas composition, which comes out of the production well and is processed into syngas, which is further stored or channelled through pipelines. Graham Chapman, CEO of Clean Coal Ltd, strategic alliance partner of CCR, says: “We have identified our target countries by assessing the prevalence of coal resources that are difficult to mine and a requirement for power, which India meets.” After negotiating a workable project and successful testing of the pilot phase, CCR will move to commercial installation, generating enough syngas for supporting gas-fired power plants generating 300- 400MW of electricity. An estimated 46 percent of the coal deposits in India are concentrated in the Damodar river basin in Jharkhand, making it an attractive location for such an initiative. The state also offers a commercially viable market for syngas because it has many coal-fired power plants in the same belt. Coal gasification is greener in every way than open cast and underground mining A big advantage of the UCG technology is that conventional mining can continue at shallower deposits, while UCG can be applied to deeper portions of the same field. UCG was originally a development in the oil and natural gas industry for the production of synthetic natural gas. The technique has been incorporated in the research and development phase by Indian energy firms like Reliance Industries Limited (RIL) and Oil and Natural Gas Corporation (ONGC). Major breakthroughs in coal gasification techniques have proved that it’s a viable alternative technology. THE ICING on the cake is that it’s greener in every way than both opencast and underground coal mining. UCG pilot projects have shown positive results with 95 percent recovery of coal resource, more than 75 percent energy recovery, and a consistent calorific value of syngas. Even better for environmentalists, even in the process of commercial testing, no groundwater or surface contamination has been reported. Explaining the hazards of conventional mining in Jharkhand, onsite environmental researcher Nitish Priyadarshi quotes in a study: “Exploi - tation of coal by underground and opencast mining has lead to a great environmental threat in this area. Besides mining, coal-based industries like coal washeries, coke oven plants, coal fired thermal power plants, steel plants and other related industries in the region also greatly impart towards degradation of the environmental quality, vis-a-vis human health.” The presence of abundant deposits of coal and low mining cost has made non- OECD (Organization for Economic Cooperation and Development) countries highly dependent on coal as the main source of energy for generation of electricity. India has about 51.8 billion tons of estimated available coal reserves for UCG, which make this alternative technology investment in India commercially attractive in the long term. Surveys have been carried out and a pilot plant is under construction by an ONGC-state consortium in Gujarat. As a part of the Indian alternative energy policy, an Indo-Australian collaboration in UCG was announced in January 2009 and coal blocks in India are being allotted for UCG pilot and commercial projects to foreign and Indian companies. After multiple phases of R&D in UCG, other countries too, such as Australia, Vietnam, Japan, Indonesia, China and Mongolia, are now moving on to commercial installations of pilot projects. Uzbekistan has a successful running UCG coal-fired Angren power plant operating a dedicated 100MW steam turbine. In India’s specific case, although its coal deposits have low calorific value, the country’s dependence on coal as fuel has been increasing rapidly in the last decade. Conventional coal mining has therefore come under severe strain. The effect of coal mining in terms of environmental degradation and health issues among both residents and the workforce in coal mining areas has been severe. Almost half a million people (mostly unskilled labour) work in this sector, and it produces approximately 500 million tons of coal per year. In a time like the current global recession, it is essential that India promotes investment in the green sector to bolster growth and create stronger ties with the developed world. But it is also a fact that the government has allowed 100 percent foreign direct investment in the power and the mining sector in India. In such a situation, what will be important is how the government regulates the revenue generated out of large-scale foreign investment in the sector. A policy shift in energy, towards cleaner fuels, or towards cleaner use of fuels such as coal, will certainly help temper the environmental impact — both within the country and on the planet.

From Tehelka Magazine, Vol 6, Issue 16, Dated Apr 25, 2009

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An Endless Spiral

BUSINESS & ECONOMY   cashew An Endless Spiral Global recession has forced a retreat for Indian cashew processors, says SAUMIL SHARMA IT’S IRONIC that, during a general global recession, the Indian cashew manufacturing industry has a supply shortage — and cannot meet demand. But that’s where the good news ends: the reason is that the sector was over-producing in the last quarter of 2008. At a time when global demand fell by 5-10 percent, cashew production had a serious overcapacity problem. Says Kalbavi Prakash Rao, president, Karnataka Cashew Manufacturers’ Association: “The surplus was sucked up by the domestic market, but now the market is under supply pressure.” Vicious cycle Workers at a cashew processing factory Since October 2008, fear of uncertain demand patterns in the US, European, and Japanese markets triggered a retreat of forward contracts, leading to a large surplus of cashews. It was only the peaking of local demand (festival gifting) that helped pick up this surplus. “India’s fortunate to have a domestic industry which peaks during this season,” says Shashi Varma, Cashew Export Council. Unstable export conditions made manufacturers veer away from producing at the risk of potential losses, and suddenly the supply capacity has fallen below demand levels. “Kerala Cashew Development Corporation is researching to shift focus to Russian and Chinese markets, as US exports have badly deteriorated,” says Dr. Retheesh, managing director, KCDC India imports 50 percent of the raw cashew required by processing units in the country. Varma agrees that “advance purchase was made at higher than parity prices, making it difficult for Indian manufacturers to continue producing at current price levels of processed cashews”. Extreme climatic conditions further troubled an industry already under the gun. Half-way through an underperforming Indian season, which winds up in mid-May, a grim outlook for African and Vietnamese supply has induced an acute uncertainty. Another blow is a 10 percent labour decrease in the labourintensive industry. Because of such a combination of reasons, cashew processing factories are shutting down. The future of Indian cashews, at present, seems to rest with the home market.

From Tehelka Magazine, Vol 6, Issue 15, Dated Apr 18, 2009

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Losing Leverage

BUSINESS & ECONOMY   Losing Leverage A European recession weakens India’s influence in trade talks with the EU, says SAUMIL SHARMA NINETEEN MONTHS into a spiralling global financial crisis, India and the European Union (EU) are discussing withdrawing impediments to cross-border trade. The negotiations held in New Delhi last week were the sixth round of talks for a Free Trade Agreement (FTA). India has a fifth of its trade with the EU while its share in EU trade is a mere two percent Despite the interest to reduce trade barriers, the EU is under economic and political pressure to solve structural imbalance issues and maintain a stable Euro. And amid the corrective actions to restore the strength of European Integration, the matter of free trade and reaching out to foreign markets is not seen to have universal appeal. The global economic crisis has resulted in weak economic indicators and falling demand for goods and services in the last quarter of 2008 and early 2009 for major European economies. Imports by the EU shrank by 7.8 percent in December 2008 on a year on year basis. Recently, French carmaker Renault moved its production back to France. Some European banks have reserved certain percentages for domestic lending only. Italy’s fiscal deficit is more than 100 percent of its GDP. Wealthy European nations like Germany are facing pressure to take the brunt of reckless spending by other EU economies. With the EU following the pattern set by the US and UK in trying to euphemise protectionism with tax reform measures and employment reservations, India should read the tea leaves. Since the inception of the EU-India FTA proposal, the central issues have remained the same — goods, services, and investment. Manab Mazumdar, director at FICCI for WTO issues expected negotiations to be under the rubric of NTB (non-tariff barriers) and TBT (Technical Barriers to Trade). “These talks are expected to achieve expeditious resolutions on greater direct market access by removal of the structural barriers,” he says, adding New Delhi must take a clear stand on the ‘‘pressure points’” As India holds the WTO recognition of “Special and Differential Treatment”, it wants a preferential case of average goods and services tariff (the average is only about two percent for the EU and 17 percent for India), claiming the incentive for its developing country status. In terms of volumes, India has close to a fifth of its trade with the EU, while the Union has only two percent of its trade with India. Indian negotiators are already aware of their poorer position in terms of bargaining power. Expectations were built on India’s leverage position with nine percent GDP growth in 2007, and the world economy has drastically changed since. Although India still remains an attractive location for EU foreign investment, that’s in the long term. The prognosis for this round of negotiations look decidedly grim.

From Tehelka Magazine, Vol 6, Issue 14, Dated Apr 11, 2009

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