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World Bank warns India

Looking at the deficits and finances of the central government will make one wince, writes Dr Bhaskar Dasgupta.

india Updated: Aug 04, 2003 15:37 IST

The India Babble

So the Sensex was rather confused this week. Monday was slightly up, Tuesday went down, Wednesday powered up, Thursday went up in the morning and then dropped sharply which continued on Friday and the week ended up at 3647.

Monday had a good dose of optimism coming from the world markets and encouraging news about Zee Telefilms and the public sector banks, which look like getting rationalised as well as benefiting from softer interest rates. Then the bad news came from Mastek on Tuesday about its results, which dragged down the new economy stocks and on top of that, profit taking hit the old economy stocks making it a very volatile day indeed.

The foreign institutional investors were a bit hesitant as well and I am slowly coming to the realisation that all this foreign institutional interest is good, but comparatively speaking, given the disparity in relative investment amounts
between domestic institutional investors and foreign investors, the market reacts disproportionately to the trading patterns of the foreign institutional investors. Anyway, the market over-corrected next day after the massive selling pressure of Tuesday and hoped for a good reporting session. Thursday took fright from the global markets and it continued on Friday because of Wipro's under expectation results.

The World Bank raised a warning against India's deteriorating public finances, and with due cause, the public self-congratulatory plaudits notwithstanding. Looking at the deficits and finances of the central government will make one wince and if one dares to look at the state government finances, gruesome ulcers are one very likely outcome. Given the forthcoming elections, I cannot see the situation improving. As it seems like the NDA government (in some shape or form) will be returned to power, I guess we can sacrifice the next 2-3 years of potential reforms on the altar of political expediency. Just look at the halving of farm loans to 9 per cent for loans up to Rs 50,000. Guess who is going to take the hit - the poor PSU's. Disinvestment is off the cards as well till the elections.

The RBI is getting concerned about rising levels of arbitrage flows coming from NRI's into the non-resident external deposit accounts and it has decreed that that the interest payable on fresh NRE deposit accounts should not exceed 250 basis points above the dollar Libor of corresponding maturities. But I am afraid this will not do the trick, even considering transaction costs, the rate of return on these deposits is higher than US deposit rates.

Next week? I think there will be volatility again, the optimism has been hyped up too much and I suspect that the corporate results will not be that good to justify all this hype and there will be corrections!

The Babble in the Ivory Towers
A paper by Houweling et. al. of the Tinbergen Institute on how to measure corporate bond liquidity is a good analysis on how to deal with the knotty area of corporate bond risk, specially in these days of depression and volatile bond markets. The authors create a comprehensive liquidity model using various data variables such as yield, coupon, volatility etc.. Their first finding is that liquidity risk is well captured by the markets and is priced into the price of the bonds. The highest liquidity risk premium's on the corporate bonds were explained by the age of the bonds and the yield dispersion.

While the author's concentrate on the euro-denominated corporate bond market, the results seem to be applicable across most other bond markets as well. Surprisingly enough, most of the research on corporate bonds in the world has been carried out on the US markets and not enough on the other major markets around the world. Previously, most of the studies have concentrated on using end of day prices or some other bond characteristic. Unfortunately, given that most of the corporate bond trading is over the counter, publicly available prices are necessarily thin in non-US markets. This causes a lack of good analytics which can give bond investors some heads up on bond investment decisions.

Details of this paper and past columns are available on http://beady.blogspot.com

The World Babble
It wasn't as good this week, I am afraid, the NASDAQ was almost 4 per cent down, as was the DOW and S&P500, not by as much but still in negative territory. Even the National Bureau of Economic Research's announcement that the recession had officially ended in November 2002 didn't give a fillip, surrounded by the mild pricking of the corporate results expectations bubble. Microsoft, one of the bell-weather stocks missed its earnings target, but did better later in the week when it reported that it has a better than expected sales forecast.

Similarly, IBM took a dive after reporting its results. Big Blue did match expectations, but the hype was that it will exceed results and it was pretty sobering for the market to see that the next quarter will be challenging, what with the summer months holidays and all. Nokia and Ericsson gave gloomy signals as well, although Ericsson was slightly more upbeat and the market recognized it as such. Even Alan Greenspan's promise to be more "accommodating" by keeping rates low and sagely expressing his optimism that the recovery is here to stay was not able to perk up the markets. The bond market was all over the place after his comments with US Treasuries yields hitting 4 per cent and prices falling sharply. Mind you, all this is good for the emerging market bond market.

The other big news was that Sandy Weill, the head honcho of Citigroup is going to step down as CEO, but remain as the Chairman for 3 more years. For people in the know, nothing will change, Sandy is too forceful and too dominating a character to become an elderly statesman only interested in the board meeting lunches and nodding off. The last year has been a horrendous one for Citigroup, what with all the legal suits flying around, but Citigroup earnings figures have held up tremendously.

The foreign exchange market is taking stock of the slow but steady good economic news coming out of the USA and the dollar has recovered significantly from the highs it reached against the Euro and is trading around $1.12 to the Euro. One should bear in mind the deficit which is hanging over the nation's finances, how long will the foreign investors keep on purchasing US securities and funding the US deficit? As I mentioned last week, if the Chinese Yuan is revalued, then all bets are off and one can seriously expect a massive meltdown over in Asia, not to mention the impact on USA. Right now, Europe is shouldering all the pain of revaluation. Sterling went down a bit as well, after expectations that there will be further rate cuts after comments by the governor of the Bank of England on the possibilities of future deflation.

Euro stocks tried to buck the trend but didn't really work, the FT Eurotop 300 ended up about 11 points below the start of the week at 858. Blame the tech sector for it. While saying all that, the earnings have not really been that bad, both in Euroland as well as in the USA, but it's the puncturing of the hype and hope bubble, which is causing the volatility and despondency around the place. The Footsie 100 followed the US markets and ended up roughly at the same level as the start of the week at 4073. The Nikkei 225 was in defensive mode as well, steadily trending down and ended up at 9527.

Gold is still hovering around in a tight range around the $344 per ounce level, the market is without much support as people are waiting to see the end of the reporting season to figure out how to play the yellow metal for the coming quarter. On the US economic front, there were a slew of results which gave a cautious support to the view, that the economy is improving, albeit on a middling basis. Retail sales rose by 0.5 per cent in June, the consumer prices index increased by 0.2 per cent last month after being flat and down over the previous couple of months respectively.

Manufacturing output moved up by 0.4 per cent in June while inventories were cut by 0.2 per cent in May. Finally, jobless claims dropped by 29,000, but are still stubbornly high. Till capacity is cut (almost a quarter is sitting idle!) and unemployment drops significantly, the economy will keep on moving in neutral with short sharp jerks around the place. This, combined with another heavy reporting week coming up will mean that the markets will remain volatile and may well drift lower.

(Dr Bhaskar Dasgupta writes a weekly Monday round-up on markets and indicators. He holds a Doctorate in Finance and Artificial Intelligence from Manchester Business School and works in London in diverse capacities in the banking sector.)

First Published: Aug 04, 2003 15:37 IST