The Need For Transformation

Western Union was the first true blood communications empire in the world, having started in the year 1851 as “New York and Mississippi Valley Printing Telegraph Company”. In the years to follow it was to dominate the “communications” business with its stranglehold on the telegraph business which grew to it being the first American communications company having its own fleet of geosynchronous communication satellites. Despite its early success and continual evolution including the launch of the first disposable prepaid phone card Western Union is no longer in the communications business and has transformed itself today as a financial services company, one of the biggest in the world today.

In the words of the Oxford dictionary, transformation is “a marked change in form, nature, or appearance”.

In a continually changing world where “Change is the only Constant”, the transformation of organizations from where they were; to where they need to be is a reality being faced daily. Transformation is a requirement for growth, a requirement for sustenance, or even a requirement for survival. Transformation is about having a fresh perspective to changing business circumstances. These changed circumstances are brought about by:

·         Technological changes
·         Change of dated working practices and processes
·         The need to bring about cost efficiency
·         Challenges brought about by mergers and acquisitions
·         Economic environment
·         Government legislation/initiatives

Transformation of companies is happening all around us. A good case of an organization undergoing transformation is that of CMS. For many CMS has been known as the IT services company present in the hardware area, providing services such as hardware maintenance support etc. How many know that this organization has been slowly transforming itself into a Cash Management services company? After its acquisition of Securitrans, CMS now accounts for 60% of the cash management business for ATM’s in India. Dig deeper and you would see that at the heart of this transformation lie two of the reasons listed above for transformation:   

1.       Economic Environment. India has about 100,000 ATM’s as per a report of London Based RBR Consulting, (a firm specializing in Banking Retail, and ATM Research). This figure is expected to grow to 400,000 by 2017.

2.       Government Initiatives. The RBI has decided to allow non-banks to service and setup ATM’s paving the way for White Label ATM’s or WLATM’s. In the words of Rajiv Kaul, CEO CMS, “Over the next 3 years state run banks would add 65000 ATM’s, Private bank’s 20000 and WLATM’s would be another 50000”.

Most ATM’s require about Rs. 10 lakh cash replenishment every alternate day, or about 15 Crore a year ($ 3 million a year). With about 400,000 ATM’s by 2017, the cash replenishment required could be as high as $1,200,000 million a year, or $ 1200 Billion a year. Just imagine the Cash Management fees, which at even 1% could be as high $ 12 billion. Is that not enough reason for transformation?

Opportunities in UID for the Banking and IT Industry

There has been a lot of discussion regarding the UID project and the scope of opportunities which exist for the IT industry in general. I would like to present some opportunities in the IT sector resulting from certain financial and banking growth activities which would be occurring. It is important to look at a number of policies and acts of parliament and the convergence thereof to see the potential for large business applications in the very near future. However to understand this opportunities one needs to see the following:

The Unique Identification Authority of India (UIDAI), was established in February 2009 to own and operate the Unique Identification Card (UID). It is an agency of the Government of India. This authority will aim at providing a unique number to all Indians based on simple biometrics.

The Mahatma Gandhi National Rural Employment Guarantee Act or NREGA is an act passed by Parliament aimed at enhancing the livelihood security of people in rural areas by guaranteeing hundred days of wage-employment in a financial year to a rural households. The outlay for this program is about Rs. 40,000 Crore (About $ 9 Billion) for the year 2010-2011.

One of the aims of the UID project is to enable payments to beneficiaries of NREGA and to avoid embezzlement of funds. Now of course the immediate potential application is to merge telecom applications to provide a means of transferring those monies to beneficiaries. A greater attraction could be to offer complete banking solutions to an untapped population of close to a quarter of a billion living in the rural areas, without access to these facilities..

This is made possible by seeing an RBI directive in 2010. The RBI (Reserve Bank of India) has been stressing on banks to increase their reach in rural areas by a policy of “Inclusive Growth”. By its letter dated 28th September 2010, RBI/2010-11/217, DBOD No. BL.BC.43/22.01.009/2010-11, the RBI has specifically extended the scope of Extension of Banking Services through the use of Business Correspondents or agents to act as banking counters. The RBI is offering incentives in the form of reimbursements for each account opened. By using these BC’s there is huge growth opportunity for banks through the following:

a) They get a cheap source of funds for their banking operations.
b) They get partly reimbursed for the administrative cost they incur while the verification is already ensured by UID.
c) They get to fulfil their corporate social responsibility by reaching out to the rural masses.

The benefit for the IT industry lies in the following:

a) Immediate application development for payment gateways, verification systems and other systems.
b) IT Infrastructure development for these BC (Banking Correspondents). India has about 638,000 villages as per the census of 2001. So even if 10% of Indian villages were to have a BC, we are talking of installing close to 63000 such Banking Counters.
c) It costs more than 1 lakh rupees per month to maintain an ATM. Even if it costs one lakh per year to maintain a BC, we are talking of a huge market in maintenance and support.

The vision is there, what we need to do is ensure the successful implementation of all these directives, which has huge business potential and at the same time could help make a huge difference to society.

Will the Double Dip actually be a V+U recession?

Since the collapse of Bear Stearns on March 16 2008, the world has been in a financial crisis, with the terms recession and depression freely doing the rounds. The only debate has been to its shape, whether this is a V, U, or W shaped (double dip). Whatever the prognosis, the situation is still volatile and would likely to remain so for some time to come.

Of a world GDP of approximately $ 57 Trillion, the US with 1$ 4.5 and the EU with $ 16.44 are the two most important players. The situation in the US is not very rosy where the unemployment figure is at 9.7% as per the Bureau of Labour Statistics. Added to that is the fact that GDP growth has been lower than expected for the 1st Quarter of 2010, while the fiscal deficient is in excess of 10% and US national debt is reaching 75%. To add to the woes the recent drop in the stock market reflects poor investor sentiment on account of lower than expected growth for the 2nd quarter.

The EU is also facing similar pressures and as per the European Economic Forecast - Spring 2010, the EU GDP growth will be depressed for the 1st three quarters of 2010. The employment rate is expected to fall by 1% this year, putting greater pressure in the unemployment rate. The fiscal deficient would be as high as 6.8% throughout the EU, and a debt to GDP ratio of 78.7%. The recent crisis in the EU over Greece may just be a play on future crisis yet to come from the UK, France, Spain and Italy.

Further hampering a climb out from the recession with deficit’s and debts reaching record levels; Governments do not have the stomach for more stimulus packages. The lack of political will for more stimulus packages is more due to the alarming rise of Dept to GDP. Greece with a debt of 115%, unemployment at 9.2% and deficit at 12% caused a global crisis. If seen in the light of the fact that Greece’s economy represents just 2% of the EU, economy, what are the dangers posed from a nation like Italy which has a debt of 115%, unemployment at 8% and an accepted fiscal deficit of 6% (some say a lot higher), and represents 12% of the EU GDP?

Consumer spending in the US shows very weak sentiment. Retail figures for May 2010 in the US show a 1.2% drop. New home sales for May 2010 have plunged 33%. Along with a drop in Auto Sales this represents a continued scenario of return to recessionary economics.

Another factor likely to affect the world economy in 2010-2011 is a potential crash in World Agricultural prices. As per the FAO the Food Price Index has consistently been falling from 174 in Jan 2010 to around 164 in May 2010. Although highly tentative the forecast of rice production alone is estimated to see an increase of more than 4% in 2010-2011.

The BRIC economies of Brazil, Russia, India and China represent about 8.6 Trillion GDP, or close to 16 % of the world GDP. An expected drop in agricultural prices may greatly impact the BRIC economies where close to 39% of the labour force and 10% of GDP is based on agriculture, unlike the developed economies where only about 0.7 % (US), 4% (EU) labour force is agriculture dependent. Drop in agricultural prices would affect the Chinese and Indian economies substantially though for different reasons.

So when the first stage of the recession started in 2008, we saw the developed economies of the US and EU hit badly while the BRIC economies (barring Russia) less severely hit.

George W Bush famously said “In an economic recession, I'd rather that in order to get out of this recession, that the people be spending their money, not the government trying to figure out how to spend the people's money.”

The problem is there is very little money either with Governments or the people to spend. With less funds available and return to recessionary pressures the second coming dip may not be a V curve but actually a U curve.

Is the Economic Recovery a Mirage and have we missed an opportunity for Reforms?

“What is more mortifying than to feel that you have missed the plum for want of courage to shake the tree?” - Logan Pearsall Smith

There have been a lot of noises that the worst recession since the great depression is over. This comes on news such as that from the Bureau of Economic Affairs, which states that the US GDP grew by 2.2% for the 3rd quarter of 2009.(http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm) while the estimates for the 4th quarter are as much as 4%. Of course to many this might be a great indicator that the economy is recovering.

However along with this apparent growth is the fact that there has been no let up in job losses, albeit at a much lower rate. Even assuming the fact that the official records do not reflect complete figures of unemployed, such as those who have stopped looking for jobs, etc, the current unemployment situation at 10% (http://www.bls.gov/news.release/empsit.nr0.htm ) is still quite high. “Traditional” sentiments state that unemployment figures start to trend down a couple of months after the recovery process begins. However the so called recovery has been on now for 9 months, with 6 straight months totally in the black. We have yet to see unemployment figures going south.

Perhaps one reason for all the positive noises coming out is because some of the big banks are miraculously repaying the loans given to them by the government. The markets were bad for the last couple of quarters, till the middle of 2009, yet Investment banks could repay government loans to the tune of billions of dollars. So just, think; housing, automobiles, manufacturing, trade, and employment all head south, but the financial institutions are making money. It’s kind of funny.

If you go more deeply you may see some of the reasons. These banks could repay the TARP loans because of TARP itself. Look at it this way, the US government has pumped in excess of a trillion dollars in stimulus funds. The US Government paid AIG money, which paid Goldman Sachs money who repaid the loan given to it by the US Government. In all the exchange of money, what productivity has actually happened? Now also look at the fact that four institutions AIG, Freddie Mac, Fannie Mae and GMAC have received in excess of 600 billion from the US government and they may not be in a position to repay anytime soon.

However since banks like Goldman Sachs and Citi are now moving towards being free of the TARP induced controls, there are chances that we could see a return to the speculative scenario we had earlier. Over leveraging is still widespread, and has not been controlled. On the 27th of November just an announcement by the Dubai government on the potential delay in debt repayment was enough to cause global markets to crash. So if the economy is improving, why no confidence? Is it because the banks know a thing or two more about their actual health?

The whole approach of all governments have been one of containment, of effects and not associated with removal of causes for the economic recession. So we could probably see a recap of this crisis soon. I feel that we have actually patched up and postponed the full implications.

We have seen two successive governments, one republican and the other democrat throw hundreds of billions of dollars at the crisis, but no one has keenly looked at the regulatory precautions such as the “Glass Steagall Act” act enacted in 1933 to control wild speculation.

There are no efforts at bringing about systematic safety valves into the money system. We may therefore yet hear with regret the words of H. Jackson Brown, Jr, “Nothing is more expensive than a missed opportunity.”

Fighting Food Inflation with Tight Monetary Policy is Counter-Productive

“Clearly now going forward, the accommodative monetary stance will have to be reassessed” Usha Thorat, RBI Deputy Governor, Dec 2, 2009

The above emphasis was also shared by R Rangarajan, Chairman, Prime Ministers Economic Advisory Council. This is in response to shooting up of food prices in recent times. This has clearly worried the Government of India as food inflation has been up 17.4% in the third week of November 2009, and the Government is under pressure in the Parliament. To fight this menace, a tighter monetary policy is being considered.

What Does Tight Monetary Policy Mean?

It is a course action undertaken by a Central Bank (RBI in India) to constrict spending in an economy that is seen to be growing too quickly, or to curb inflation when it is rising too fast. The usual policy is to "make money availability scarcer" by raising short-term interest rates. This raises the cost of borrowing and effectively reduces its attractiveness.

However one question is how many people use borrowed money to buy food? In cases of tightening economic situations most families will first stop on luxuries, then some basic household necessities and the last would be food expenditure. So you will see the Construction Industry (housing), Auto Sector, textiles, tourism being hit first, causing acute financial pressure on the economy.

So by the time the scarcity of money causes families to restrict a demand for food, the whole economy would have gone for a spin (downward). The fact that the food prices have been shooting up has been know for many months. Earlier the Government was highlighting low Inflation, showcasing only 0.7% in April while the commodity price for food was shooting up. Long term solutions are needed, not knee jerk reactions.

As I had written in my previous article in May, India’s economy is dependent on the Monsoon, and correspondingly to the Agriculture sector.

http://sunilmohal.blogspot.com/2009/05/indian-economy-set-to-buck-negative.html

The Government has limited options:

1. Being Politically correct, Tighten Monetary Policy, and tank the economy. However the food prices would remain high till the next crops come in, and the purpose is defeated.

2. Being politically incorrect, but economically correct, do nothing, wait for the next harvest to come in, and hope the economy does not tank.

3. Focusing on long term solutions, like

a) Creating Food Storage facilities. Currently India looses Rs. 58,000 Crore (About $ 13 Billion) annually on food wastage, as per MrSubodh Kant Sahai in speech in Parliament in March 2008.
b) Better Pesticide usage. "It is estimated that India loses approximately 18% of the crop yield valued at Rs 90,000-crore ($ 20 Billion) due to pest attacks each year," as per a CARE Ratings report.

c) Better irrigation to increase crop yields.

"Leadership is, among other things, the ability to inflict pain and get away with it - short-term pain for long-term gain."- George Will

With the Recession near ending, wither employment?

“Fed Views Recession Near End”.

These headlines have been appearing in the media for the last couple of days. Alongside this almost celebratory tone most economists are seeing green shoots in the economy amidst a general impression that the recession is on the ebb.

Yes the economy, that is businesses and large organizations are stabilizing and are returning to the black. Key indicators all point to that (refer my previous article of July 30th). While there were job losses in July, the job losses have almost halved from the figure of 650,000 jobs lost per month before May 2009. This seems to be another indicator that recovery is around the corner.

So with the recession “near at end”; a question does arise as to when the unemployment figures will drop?

Before proceeding to this question one needs to understand the current scenario. I would like to briefly touch upon the unemployment figures for July in the US which was 14.5 million or 9.4% of the work force. This has been almost unchanged for the second consecutive month. This is paradoxical as it would mean that there no job losses, while the job losses were to the tune of about 330,000 in July.

http://www.bls.gov/news.release/empsit.nr0.htm (*)

We have 330,000 jobs lost in July 2009, but the unemployment rate remains static at 9.4%. So what is the story? About 2.3 million persons were marginally attached to the labor force in July. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey. (*) So if we add that figure to the unemployment figure which is 14.5 million, the actual unemployed total stands at around 16.8 million or 10.8% of the workforce.

This is an indicator the unemployment situation is graver then reflected.

“The world, indeed, is like a dream and the treasures of the world are an alluring mirage! Like the apparent distances in a picture, things have no reality in themselves, but they are like heat haze.” - Buddha

There is a feeling amongst many; that companies are not hiring because they want to be on firmer footing and consolidate themselves before they revert to hiring. Is that the whole truth, or is there another scenario(s) at hand?

A point which has been overlooked is the impact of the whole sale merger of companies in such areas as the BFSI (Banks, Financial Services and Insurance) Sector, the Pharma sector etc. These mergers have shut down many jobs, most of them permanently. So while companies are stabilizing on their balance sheets, the benefit to the labor force in terms of enhanced employment is a question mark.

The road to higher employment is going to be a very long and rocky one and to revert to 4-5 % unemployment levels will take years. Since many of the old job opportunities are less likely to emerge, skill up gradation and skill enhancement is of the utmost importance.

“When you are asked if you can do a job, tell 'em, 'Certainly I can!' Then get busy and find out how to do it.” Theodore Roosevelt, 26th US President

This November, Black Friday to signal a new dawn

The Legend of the Phoenix, from the ancient Greeks has it that the mystical bird when it completes a life-cycle, burns to ashes and then from these ashes arises a new young bird resplendent in all its glory of gold and color.

Last year between Aug 19 and Aug 22, 2008 I had written about the impending retail crash, which would cause a crash in retail sales leading to what would be a “Red Friday”.

http://sunilmohal.blogspot.com/2008/08/ides-of-march.html
http://sunilmohal.blogspot.com/2008/08/no-man-is-island.html

I further opined in February 2009 that we would see some signs of recovery by October 2009. Taken in the context of the situation at the beginning of the year I would like to quote a few words from Anne Lamott; “Hope begins in the dark, the stubborn hope that if you just show up and try to do the right thing, the dawn will come.”

Much has happened in the last one year. There has been widespread pessimism and predictions of an “Apocalypse” in the economy. In the next couple of articles I would like to share my opinion of the way things are headed, with the thought that the dawn is almost upon us.

1. New home sales have surged 11% in June 2009, over the previous month. Of course one should be careful in what one reads from this, as the median price range has fallen. However the flip side is that builders had 281,000 houses on the market last month, down 4.1 % from May. This is the lowest since February 1998. This should see a surge in construction activity. In fact as per the US Dept. of Commerce US steel production showed an increase of13.5% from 3.8 million metric tons in April to 4.2 million in May.

2. Car sales continue to drop, but it appears that the bottom has been reached. Ford plans to increase production by 16% in Q3.

3. The U.S. Census Bureau announced on July 14th advance estimates of U.S. retail and food services sales for June, were $342.1 billion, an increase of 0.6 percent (±0.5%) from the previous month. Though we see that there is a month on month increase, there is a difference of 9% from June 2008.

4. Most Banks have shown improved performance for almost 2 quarters now showing that the worst in the banking sector seems to be over. Here again, we need to read this with caution as some of the implied profits is due to one off sales or accounting changes.

5. The Job market has continued to show a decline but the numbers of people being laid off are showing signs of declining. http://www.bls.gov/news.release/empsit.nr0.htm

While a lot of people may think “When things are bad, we take comfort in the thought that they could always be worse. And when they are, we find hope in the thought that things are so bad they have to get better.”, I am of the belief that this year “Black Friday” will definitely bring some cheer in retail figures.

The Phoenix will rise…

The Indian Economy set to Buck the Negative Trend

For the last couple of months there has been conjecture, discussions debates and what have you, about the state and direction of the Indian Economy. Most parts of the world are undoubtedly in the throes of a major recession, but what of India?

Is the worst behind us? While thinking of this I am reminded of the lines by Alex Tan “Perhaps our eyes need to be washed by our tears once in a while, so that we can see Life with a clearer view again.”

So does it mean that we are on the path of recovery? Consider the following:

1. Car & Motorcycles sales are up by 2% in March 2009, compared to March 2008, whereas in most parts they have fallen from 10-30%.
2. The largest housing lender, HDFC has shown loan approvals during the year 2008 -2009 at INR. 49,166 crores (About $ 10.39 Billion at currency rate of 1$ = 47.3 INR) as compared to INR 42,520 crores ($8.98 Billion) in the financial year 2007-2008 representing a growth of 16%. Actual Loan disbursements during the year were up 21%.
3. While the inflation rate has more or less remained stagnant at 0.7% for week ending April 25 2009, the Commodity price for food items has gone up from a level of 125 in March 2009 to about 130.2 in April 2009 (http://indexmundi.com/commodities/?commodity=food-price-index)
4. The export / import balance in March 09 of $-4.9 Billion is the lowest differential in the last 2 years. (http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx).
5. Foreign Exchange Reserves saw a huge decline between April 2008 (314 Billion) to 252 Billion in October 08, but since then these figures have been seeing a remarkable steadiness so much so that these reserves stood at 251.9 as of Feb 2009 (http://rbidocs.rbi.org.in/rdocs/Bulletin/DOCs/MAYBULCS44.xls).
6. Retail sales seem to be picking up.

Besides the above facts and figures there are some other key indicators. India’s Export earning at about $ 165 Billion as a %age of GDP is low. Of the export earning IT/ITES is about $ 60 Billion, which has not headed south, so even if one would see a negative change for the remaining the worst case scenario is not more than a couple of Billion. Similarly with remittances which had been about $ 27 billion as per the World Bank in 2008, likely to drop, we can see another negative growth of a couple of a Billion Dollars. In a trillion Dollar economy a few Billion dollars less is not going to have a major impact.

We also have the following positives:

The formation of a stable government in India in May 09 has already seen a fantastic rally in the stock markets, so much so that an upward change of 17% in the first few minutes on opening of the stock markets after the election results were declared forced the markets to shut down. While there might be minor corrections in the days to come, it would still show a very healthy position vis a vis other stock markets. This has brought in huge foreign investment back in the stock markets.

Finally we have to realize that 60% of the Indian economy is still dependent on Agriculture and it is ultimately the rain gods and not Wall St. which is the biggest driver. If the Monsoon is good or even average, then there is no looking back.

I think this festive season on Oct-Nov should see a visible rebound with the turbulence of the last couple of months behind us, so in the words of Ramsay Clark “Turbulence is life force. It is opportunity. Let's love turbulence and use it for change.”

Banking Results Hide a Grim Truth

“When a thing is funny, search it for a hidden truth.” George Bernard Shaw

The recent quarterly results given out by the banks has brought great cheer worldwide, with stock markets rallying and suddenly there is a talk that the depression (not recession as claimed by politicians) is about to see its imminent end.

When I see the good cheer all around on these positive notes I find it difficult to reconcile with some facts regarding the US economy. Why should we take that as the bell weather of the world economy? Well there is no escaping the fact that the US GDP is actually 25% of world GDP. Any positive there would rub on everywhere else and the reverse holds true as well. Therefore there are certain facts which are difficult to overlook:

1. Unemployment figures have risen to 8.5% in March 09 and are expected to reach 10.3% in Oct 09 as per the http://forecasts.org/unemploy.htm.

2. Retail sales per the US Census http://www.census.gov/marts/www/marts_current.html) are heading south month on month, year on year.

3. Car sales are heading south as well and are in fact down by about 36% from march 08 (http://www.motorintelligence.com/m_frameset.html).

4. New House sales in the US have shown a slight pick up in February 09 as opposed to Jan 09, but are still at 41% lower than Feb. 08 as per the website http://www.census.gov/

(http://72.14.235.132/search?q=cache:TV7nXG0Tz88J:www.census.gov/const/newressales.pdf+new+home+sales&cd=2&hl=en&ct=clnk&gl=in)

The fear on rising credit card defaults is adding to a sense of concern. So where is the profit coming from? Is it that existing mortgages are being refinanced to take advantage of the low mortgage rates?

Another important aspect not commented upon is that the “American Recovery and Reinvestment Act of 2009” which seemingly had a $ 787 Billion for the stimulus, actually has a 37% component or $ 288 Billion tax rebate. Now this is a one time rebate which will put a couple of hundred dollars per person on the table which may help in some minor family expenses, but what effect will it have on the economy? Will this sum help to pay an installement or two on a mortgage, thus postponing the inevitable, which is more default?

It seems as if we are postponing current challenges for a future date when we could see another round of great losses.

“Three things cannot be long hidden: the sun, the moon, and the truth.” Buddha

Effects of BRIC on World Economy

The BRIC grouping refers to Brazil Russia India China. This term was first coined by Goldman Sachs in about 2001. In the year 2008 the economies of the G7 stood at about $32.96 Trillion vs $ 8.87 Trillion of the BRIC, which is about 26% size of the G7. However, economists often talk of the economies of the BRIC countries in terms of PPP, or Purchasing Power Parity to demonstrate the relative strengths of these economies. Thus for the same period 2008 in PPP terms the G7 stood at about $29.1 Trillion vs $ 15.37 Trillion for the BRIC , which is about 52% size of the G7. A table highlighting the figures along with export import figures is given below:

What is the PPP theory? This is a theory which equalizes purchasing power of currencies in the home currency for a given basket of goods or services. This is used to calculate relative living standards. For example the average doctor’s fee paid for a single consultation in India would be lower then for a similar consultation in the US. Similarly the rent of an apartment in India would be lesser then that in the US. So the PPP will factor in the lower cost of services and adjust to show the relative strength as per the local currency. So if the factor of conversion is 3, then it would mean that a person earning $1000 in India is as well off as a person earning $ 3000 in the US.

The problem with this theory is to decide which basket of services to select. Should it be food, medical costs, transportation, or entertainment etc? This is because the proportion of relative cost would be different in different countries for different services or products. So the consultation fees for a doctor in the US might be 3 times costlier then that in India. However if one was to buy say, a Sony 42inch LCD screen, the cost would probably be the same, in fact it may even be more in India as the local taxes would be higher in India.

Now look at the ratio of exports of the BRIC vs G7 in dollar terms and PPP terms. The effects of lower exports in PPP terms would be perceived to be lower. However in trade you need to pay in actual dollar terms and not some relative terms. In the present economic crisis the slow down of exports would in effect probably hit the BRIC countries more especially China and Russia. So their ability to have a positive impact on the world economy instead of being more may actually be less. Russia would be hard hit by drop in Oil prices while the Chinese economy is already facing huge factory closures due to drop in exports to the US and European markets. Negative exports would have implications for imports as well further dampening global trade.

So I believe the BRIC groupings effects on international trade been exaggerated and the resultant effects on powering the world economy in this economic downturn is misleading. Part of this is due to the illusion of PPP calculations.

Why L&T should have stake in Satyam

Presidents Obama’s federal stimulus package of $ 815 Billion was cleared by the House of Representatives yesterday. It is expected that the Senate should clear it sometime next week. Of this amount about $ 500 billion plus would be spent by the US government on four key areas, all of which would have huge components of IT expenditure.

So why does it makes sense for L&T to have a stake in Satyam?

The single largest new investment in national infrastructure since the creation of the federal highway system in the 1950s is planned in the US from Government spending from the stimulus package.

In the coming months, by Q3 2009, the US would see development of Infrastructure to create jobs and revive the economy. The sudden upsurge in development of infrastructure would need skilled engineers and companies with the necessary tools to provide those services. There would be a shortage of people in the US and companies would be hard pressed to provide services.

L&T is a global company with extensive experience in infrastructure like roads and bridges. In today’s economy Information Technology is a tool to enhance efficiency in areas like designing, project management, GIS. Satyam would help strengthen areas in the L&T fold to form a strong product mix.

It has been commented upon by none other than Carlos Ghosn that the “frugal engineering skills” of Indian companies can affect cost savings of upto 15% in development costs.

If L&T can show effective cost savings for potential clients through the combination of L&T skills in Infrastructure and Satyam skills in IT, it would be ideally placed to reap business opportunities.

Thus despite all the negatives of Satyam at the present moment, the potential rewards are huge. If L&T does not acquire Satyam outright, it would atleast be able to leverage synergy by being the largest stockholder.

Economic Meltdown - A Statician’s Dream / Everyones Nightmare

"A Single death is a tragedy; a million is just a statistic”

Joseph Stalin

In these times of crises, only the dark side would appear in our minds.

The demise of Lehman Brothers last week was projected as a great tragedy and rang alarm bells all across so much so that that AIG was bailed out by an 85 Billion package. However what may be less known is that since late 2006 more than 286 Mortgage companies have gone bust while since mid 2007 about 81 hedge funds have been liquidated.

Now the US government is in with a 700 Billion bailout package which will essentially convert private debt into public debt, or about 2,200 dollars for every person in the US. This would have been probably allright and considered a necessary evil, if the maths added up and we actually knew what the debt was. The problem is we really do not know with all types of fancy financial instruments being used to show profits in boardrooms.

I have been provided some very insightful information by Mr. Louis F Hill, Chairman of Rockwood Capital Management, Inc. He has shared the following:

In October 2007, Bill Gross, of Pimco, estimated $ 250 Billion losses in US sub-prime mortgages. Then in January 2008, the G-7 Finance Ministers estimated there would be $ 400 Billion Losses in US mortgages. This increase was caused by the realization that the mortgage mess had spread beyond just the sub-prime class. By April 8th 2008, The IMF estimated there would be $ 564 Billion losses in US residential mortgages. Please note, that the headlines for the IMF numbers were reported higher ($ 945 Billion) because of their inclusion of $ 380 Billion in commercial real estate losses. So what is the scale of the SIV’s (Structured Investment Vehicle) involved with residential mortgages? If mortgages were the only holding in these vehicles, we could estimate that the SIV’s debt exposure would be 10 times the latest estimate or $ 5.64 Trillion.

The Bank of International Settlements reports there are more than $ 500 Trillion dollars of derivatives in 2007 and $ 600 Trillion in 2008. Credit default swaps were estimated at $ 58 Trillion in 2007 and $ 64 Trillion in 2008. So the mortgages in the SIV’s, at the $ 5.64 Trillion level, are a small part of the total numbers derivative instruments in existence.

In the past six years, Stephanie Pomboy of Macromavens estimates 500% more credit has been created outside of the banking system than within it. This means that those financial products are essentially unregulated.

To understand one of the issues one needs to get an idea of what a CDS or Credit Default Swap is.

“A credit default swap is like an insurance policy. It can be used by a debt holder to insure against a default under the debt instrument. There is no requirement to actually hold any asset and is not generally considered insurance for regulatory purposes”

Now if we have created enormous amounts of credit outside the banking system, which are unregulated then, I guess all the numbers will become just that; Statistics, which would cause enormous hardships to people who will also become statistics in government records.

Back to the housing fiasco, some idea of statistics is below:

Bank seizures in the first half of the year increased by 154 percent to 370,179 from the same period in 2007. while a record 1.2 million homes were in foreclosure during the second quarter of 2008. That represents 2.8% of all outstanding loans, up from 1.4% of all loans during the same period a year ago, according to a report released Friday by the Mortgage Bankers Association (MBA).

During the three months ended June 30, 2.9 million homeowners, or 6.4%, were behind on their payments, up more than 25% from last year.

This brings us to the question:

Is the 700 billion bailout like putting a band-aid on a bullet wound, would it be enough?

Linkedin Debate:

http://www.linkedin.com/answers/financial-markets/equity-markets/MKT_EQU/329558-564729

Economic Meltdown - Kangaroo Banks

There is no calamity greater than lavish desires.
There is no greater guilt than discontentment.
And there is no greater disaster than greed.

Lao-tzu (604 BC - 531 BC)

The current economic meltdown is due to our inability to differentiate between our needs and greed and the various interest groups getting acts passed in congress.

The Glass-Steagall Act (GSA) was enacted in 1933 after the collapse of the stock markets in 1929 leading to the Great Depression. This was done to ensure that a clear distinction was made between commercial banking and Investment banking. Regulatory barriers were created and banks were given a limited period of time to choose their lines of business to prevent all sorts of conflict of interest. This also ensured that Banks would be limited in their ability use depositor’s money for underwriting issues.

One of the main reasons the GSA was passed was that it was felt that commercial banks had become too-speculative. In the period leading to 1929 the banks had become very greedy. They issued doubtful or unsound loans to companies in which the banks had invested and then encouraged clients to invest in that stock. (Does this ring a bell in the form of sub-prime mortgages?)

The GSA was further strengthened by the Federal Reserve Board in 1956. A new act stated that underwriting insurance was not a good banking practice and needed to be delinked from banking operations.

The GSA was a strong barrier to fiscal irresponsibility and excessive speculation. Somehow this important legislation was overturned by the Gramm-Leach-Bliley Act (GLBA). The full name was the Gramm-Leach-Bliley Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338 (November 12, 1999). This is an act of the United States Congress which repealed the Glass-Steagall Act.

The ostensible reason was to open competition among banks insurance companies and financial services companies. The distinction between commercial banks and brokerage firms has since thinned.

If in a country we have the executive wing acting as the judiciary and dispensing justice, we call it having “Kangaroo Courts”. The reason these are separate functions is to ensure proper checks and balances. The passing of the Gramm-Leach-Bliley Act blurred the distinction between commercial banks and Investment banks in a manner similar to the executive and judiciary in Kangaroo courts.

I would like to give a short story taken from the Panchtantra, a series of stories in the manner of Aesops Fables taught in India to drive home some wisdom. This particular story explains how excessive desire can be ruinous.


The Brahmin and the Pot of Flour

Long long ago there was a Brahmin, Rama Raju known for his miserliness. Every day he would save the flour earned from his begging in an earthen bowl. This he tied above his bed.

One day he returned home very tired and went to sleep and began dreaming. He dreamt that there was a famine in the country and that he had fetched a huge some of money from the sale of his flour. He used it to buy goats whose milk he sold at huge margins eventually having a large herd. From this he bought cows etc to become a very rich man. He then dreamt that he got a beautiful bride with whom he had kids. These kids who were very naughty would not listen to him. One day he to discipline them he picks up a cane and starts waving in the air.

In his now disturbed sleep the Brahmin actually picks up a cane and waves it and by chance hits the pot of flour which crashes onto the ground. The Brahmin wakes up to see his dreams shattered.

“Moral of the story, Castles built in air will come crashing down”.

The Coming Retail Crash - No Man is an Island

No man is an island, entire of itself; every man is a piece of the continent, a part of the main; if a clod be washed away by the sea, Europe is the less...any man's death diminishes me, because I am involved in mankind...

John Donne

My last article on the Ides of March has elicited some offline queries. One of the themes was that the collapse of the housing industry should not cause such a catastrophe that the US economy on the whole should be hit hard enough to cause a Red Friday.

Not being an economist provides me the liberty of looking at things from a simpler viewpoint. My retort to the gentleman was as follows.

Could you imagine all the primary and secondary industries connected with the housing industry? Do you know that the construction industry shed about 557,000 jobs from the period Sept 2006 to July 2008. My view is that if there is slump in construction it would lead to reduced demand for the following:

1. Cement Consumption reduced by 2.2% in 2007 and is expected to reduce by 10% in 2008.
2. Steel consumption domestically is seeing reduction in demand as 30% consumption is for the construction industry and 20% for the auto industry.
3. Similarly requirements for fittings, fixtures, electrical items, plumbing, are some of the other areas to be hit causing job losses for plumbers, electricians, transporters etc.

Some of the statistics as per Bureau of Labor Statistics, US dept. of labor give the following details:

1. Employment in retail trade lost 211,000 jobs since March 2007
2. Motor vehicle and parts dealers saw a decline of 35,000 jobs since January 2008.
3. Temporary help services has seen a decline by 185,000 jobs since Jan 2008.

The one industry which has seen huge increase in demand for manpower is the mining industry which includes oil and gas.

Overall there has been a loss of 463,000 jobs in calendar year 2008 as of July 2008.

Therefore the decline in basic industries like Housing and the auto sector would not be causing limited damage but damage across the economy. Not only is there less money to spend, there is a negative belief as well which would lead people to put of purchases. Therefore John Donne’s statement is apt, that things do not happen in isolation, we are all interconnected. While the Friday after Thanksgiving may not be such a catastrophe, it would definitely bring no cheer.

The Coming Retail Crash -Ides of March

In Shakespeare’s Julius Caesar, the soothsayers warning "Beware the Ides of March," displayed a sense of foreboding. The ides of March in Julius Caesar was the 15th of March, a day of bad luck and evil.

Is November 28th going to be a newer version of the Ides of March? A new Ides of November?

Why do I state a specific date as the new of Ides of March? Well this is going to be the date of this years Black Friday, ie the Friday following Thanksgiving. The Friday following Thanksgiving (the 4th Thursday of November) is traditionally the start of the Christmas shopping season. Stores throughout the US see a sudden boom in sales and the period of loses (red on the account books) are wiped out. This is the period in which retailers are back in the black.

All the signs of a slow down are there but, is it a tip of the iceberg?

1. Unemployment is up to 5.7% as of July 2008 and expected to rise to 6.5%
2. Mortgage defaults are up almost 100% over the same period in 2007.
3. Housing prices are down by up to 20% causing greater fear and recession.
4. Fuel consumption is down 2%. Americans are driving 4% less then they were last year (one of the highest drops since 1942). This not just due to high oil prices but the sheer inability to pay.
5. The auto industry is in a tailspin with plans to close down assembly lines for gas guzzlers and companies reporting losses of tens of Billions.
6. Freddie Mac and Fannie Mae which between them refinance 5 Trillion dollars, of housing loans are between them in a not so good shape.

The latest worry is that the average American is using his credit card to shore up the weekly spending on basic necessities like groceries; sums in a tight market which would be difficult to repay leading to more defaults. In fact this trend seems to be happening. There just seems to be not enough money in the home front.

So with such a dire situation what will happen to Black Friday? Will it be a Red Friday?