Sunday, October 30, 2011

(This is from today's Deccan Chronicle / Asian Age) FIGHTING INFLATION Protect returns from inflation Oct 30, 2011 - By R. Balakrishnan . .. The government is finally admitting that inflation is a problem that is likely to stay with us for some time and that it expects relief only by 2013. But the government also chooses to tell us that the ‘real’ interest rate is ‘positive’. Yes, if we believe that inflation is less than the post-tax interest return of around seven to eight per cent, we get on most fixed income (fixed deposits, bonds etc) options. For the individual investor, inflation is a post-tax impact. Hence, I will knock off the tax component of the interest income. At this juncture, the RBI has completed its 13th consecutive fiddling with upping interest rates. This would erode the value of my existing investments in fixed income paper. There is also a possibility that if inflation stabilises somewhat, there would be a hike in diesel prices, which would once again lead to an all round price hike. So, there is a constant fear of having to pay higher prices for the same goods. At the same time, investment confidence seems to be lower. This means that output may not grow much. Are we poised to enter a period of ‘stagflation’? Stagflation means rising prices with no growth in supply. This is scary. Suddenly, I find that there is no ‘real’ return but actually a painful erosion of wealth that is taking place. My daily expenses are galloping at a rate higher than the return I can get from fixed income investing. The broad market indices seem to be faring even worse. I keep reading about how quality US stocks are available with a dividend yield of five to six per cent. I do not see any Nifty or Sensex stock giving me that kind of a return, yet. So, should I put my money in to global stocks? The temptation is high. Global stocks would mean that I also take on the risks of the strength and weakness of the Indian rupee. Presently, the Indian rupee is at a low point. How low will it go? I think that as the world economy slips, the relative strength of the rupee should be higher. In other words, I am likely to get fewer rupees for a dollar. Will the global stocks appreciate enough for me to get a return that sufficiently protects the rupee return? The government does permit an annual limit of $200,000 per individual to be invested in any global market. This is a substantial limit (almost a `1 crore per head). Yes, gold has given positive returns, but how far will it go? Yes, gold and equities ought to have an inverse relationship. If economies do well, we would like to own equities and enjoy the growth. So I do not have to ‘run away’ to buy gold. Of course, there are many other commodities like copper or silver where also one can invest. So many worries are due to uncertainties caused by global economic turmoil, Indian economic slowdown and inflation. In the domestic markets, I will stick to companies which have high consumer driven growth. Consumer non-durables and couple of private sector banks that do not have the PSU culture and have consistent grow-th, clean balance sheets and low level of problem loans. In fact, even some of the large NBFCs look good. Unfortunately, we cannot have a play on food prices due to absence of producing companies in the listed place. That would be the place where I want my money to be. Depleting res-ources, increasing activism and rising prices are a potent combination for sharp gains.

Saturday, October 29, 2011


The Greek can continue their wayward ways. The write off of half the sovereign debt is proof that the world want's to pretend that all is well. Lend the Greek more money. They can buy more stuff produced in China and elsewhere. If you call their bluff, make them default, then their buying could grind to a halt. Not very good. How wonderful! Mortgage finance all over again. Lend so that they can buy. Lend more and they buy still more. Finally when they cannot repay, write off some. The balance? Well, we will reschedule it for tomorrow. Now, there is clear hope for the other PIGS that they can continue with their wanton borrowing and not worry about default. No one is going to take them to the poorhouse. So what does it matter whether the credit rating is C or D? Investment bankers in search of bonuses ensure that sovereign paper can be placed with some sucker or the other. You hold my hand, I hold yours and we play ring-a-ring-a-roses. Germany is worried. To Euro or not to Euro? How long will they continue to pay for the excesses of their euro brothers? UK is breathing easy. No PIGS to bail out. Of course, their bankers will want to get in to a piece of the action. The famed "City" paychecks have got thinner. Play East India Company all over again. China is watching and wondering. How long can they keep their riches to themselves? If their buyers go bankrupt, what happens to the factories that keep shipping goods under every label? Publicly they say that they will lend only to Germany. But, if Italian paper or Spanish paper comes floating around, with everyone having had their fill, it is a Hobson's choice. Banks who bought the lovely Euro paper, now find that they will need a Basel III and IV to bring capital adequacy to the levels which the Japanese originally wanted (zero). The funny regulations will make you take a hit if there is a default. But, if you take a forced hair cut (there ought to be a better term for a 50% robbery) then the accounting rules let you remain healthy. If you have terminal cancer, all will be well if we change it's name to 'flu'. That is what the banks are doing. John Maynard Keynes had famously said : "If I own you a pound, I have a problem: but if I own you a million, YOU have a problem". India has a big lesson to learn. Default is fashionable and in fact if we default, we get better terms from the world. There is no need to pledge gold with someone to meet some stupid financial commitment. After all, the investment banker who made money when he arranged for the loan, is now looking for another fee when he restructures the loan. And if we default, we can cut our external debt by half! Think about it. Greek have a new anthem. Courtesy Bobby McFerrin- "Don't worry, Be Happy..."

Tuesday, October 25, 2011

Selling a college

A business house was faced with a dilemma of whether to keep its business or give it up to the bankers who were ready to hang it. The business house also used to run an engineering college with high capitation fees. The sick unit was being eyed by a rogue politician. Finally, the businessman 'sold' his college at ten years estimated capitation fee to the politician. The politician got a college. The businessman retained his 'sick' unit, squared off his loans cheap and is trying to revive the company. And all of them lived happily, except the bankers who wrote off debts and now have to give new debts that will again go bad. Thus, the cycle of business goes on. One fine day, the college administration will change for the worse. The reputation of the college would take a beating. Unless of course, the politician realises that running a good college is more important than the business of politics, which is ephemeral. Students and faculty are on tenterhooks , wondering if the reputation of the college may be negatively impacted. Let us wait and watch.

Of SBI and other PSU's

(This is from the latest issue of Moneylife. Was written before the downgrade of SBI ) If I own one hundred percent of a company, it is completely my prerogative to what I please with the company I own. However, the moment I invite someone else to become a part owner, then I have no right to do anything that does not enhance shareholder value (in other words, there is no right to do any act which results in the shareholder suffering a loss in value). We have our PSU Banks, where the main shareholder / promoter continuously and consistently destroy value. Right from appointment of a CEO to forced lending money to sectors from which there is no hope of recovery, the main shareholder has been abusing the other shareholders who have foolishly piled on board. I call them foolish, because their expectation that the government will get out of business, is a long way from happening. Of course, investors and brokers say that ultimately privatisation will happen. So, buy it today in anticipation of freedom tomorrow. My thoughts are the opposite. Let freedom happen. Then we can take a call. No one really knows the health of the PSU banks. Each time there is a problem, the RBI bails them out by changing the accounting standards. Investments are categorised in to nebulous buckets called “Hold to Maturity”, “Available for Sale” etc., If there is a valuation problem, it is simply re-labelled. Norms for recognition of bad debts keep changing. Loan re-scheduling is common. Banks like SBI do not recognise pension liability, and instead account for it as and when paid! And our wonderful members of the Institute of Chartered Accountants sign the balance sheets of banks without any qualifications! Their job is to make a comment if there is divergence with generally accepted accounting practices. They cannot keep quiet if there is a deviation and not comment simply because the RBI permits it. The auditors have been appointed to opine if the books are true and in conformity with accounting standards. The rules of the RBI are merely a labelling exercise for the banks. Our RBI thinks that by changing the name of the disease, the state of health is changed! I am also amazed at how a bank like SBI with its few thousands of branches gets audited at all. And to top it all, SBI has a list of auditors, most of whom are not known (whether they have the size and skill sets to audit a bank is another question) who come together and one auditor signs everything! The audit process at SBI should surely be amazing. We all know that SBI owns a few subsidiaries. From the schedule, I can neither make out the number of shares that SBI holds or the value/cost of its investments in different subsidiaries. Banks do not give a list of the investments they hold. Apart from the SLR investments, the banks have a lot of investments that are lumped together in one line. So, how does an analyst make sense of it at all? Automation and technology have made visits to the banks redundant. In this, the private sector banks have clearly taken the lead and they have also learnt to do what it takes to keep the affluent customer happy. Private Banks have dedicated relationship managers, who are there to help you out with virtually anything to do with your account. Many private banks also help out by sending people to your home / office if the relationship is commercially significant. Here is where a bank like State Bank of India has no hope. It will be left with the poor un-remunerative customers in the big cities. The cream of the affluent are unlikely to give the bank a look see unless there are compelling circumstances. Of course, the fact that the government of India uses SBI as its main bank enables SBI to be the largest bank without any effort or a business strategy. All PSU’s, state and central treasuries keep SBI in the pink of health by keeping large balances in the current account. This is evidenced by the high CASA (Current Account and Savings Account Balances that carry no to low interest as opposed to fixed deposits) of nearly 50% that SBI enjoys. It also shows the incompetency of the PSU’s and government departments in keeping money idle and enriching the bank. Private sector today does not keep money idle. They keep money in liquid funds, even if the surplus cash is for a couple of days at a time. So, here we have inefficient government machinery feeding the inefficient banks. In addition, SBI is always at the forefront of any politically inspired financial giveaways, which no self respecting private sector bank would do. Any bank which has issued shares to the public has no right to give away anything for free. We always see SBI at the forefront of all political drama when it comes to loan waivers or opening of branches in unviable locations. The interesting thing that is going to happen is of the merger of the subsidiary banks. Logically, one would expect a huge amount of cost savings, reduction in headcount as well as selling of surplus real estate. It is not happened yet and given that SBI is a bank that even has a union of ‘officers’ it is unlikely to materialise. So, the large ‘hidden’ values are not getting unlocked at all. The bank continues as inefficiently as ever. It is only because of freebies in the form of high CASA, assured government business etc, the Return on Equity (probably the only measure of how shareholder money is used) is in double digits, though below the large and efficient private banks. The other thing that I look at is the “executive” pay at the PSU Banks. If someone is good, why should he work for that pay? Is he driven by a sense of public service? It is time that the pay for senior executives is on par with private sector. In the absence of parity, I am afraid that either an idiot will run the bank or the corrupt will. This factor is compounded by the presence of unions (including unions for officers” – the management team!) which will not allow one officer to jump ahead of another. I have worked in nationalised banks and have friends who still work. There is a set of people who work hard but cannot make any decisions. There is set of people who shirk work and don’t care a damn about anything and the management of the bank cannot do a damn about them. Then there is a set that lines their own pockets by selling out to businessmen who see corruption as an easy way out. Of course, the CEO is subject to all kinds of political pressures in lending decisions. None of the PSU banks have a long term strategy for business and the CEO generally gets appointed at the fag end of his career. His decision making would be screwed up. If he is honest, he is worried about his pensions and will play it safe. If he is corrupt, then he will go berserk and lend to all kinds of sectors. He simply will not be allowed to execute a ten year vision plan. In short, is it worth investing in to the shares of the PSU outfits, simply in the hope of their being unshackled? R Balakrishnan

Saturday, October 15, 2011

Shattered Accounting

(This was published in the latest issue of Moneylife) There is a body called the “Institute of Chartered Accountants of India” (ICA). It is supposed to set standards for fair accounting, transparency in communication of financials to anyone who reads an audited annual report, apart from being obliged to make written comments on any aspect that they find unreasonable or not satisfactorily explained. In law, they are supposed to be appointed by the shareholders. In practice, it is the promoter who appoints and at every AGM there is a routine resolution that is approved by the shareholders. The shareholder is not given any information about the audit firm, its capabilities or its size. The shareholder in reality, has no control or clue about who his auditor his. Over the years, there has been total laxity and dilution in accounting standards in India, in the guise of ‘conforming’ to International Standards. I have been analysing balance sheets over time and I can see the disclosure standards falling dramatically. Let me start with subsidiary companies. In the past, the annual report would have the full accounts, with schedules, of the subsidiary companies. Today, it is missing. If the company is somewhat liberal, it may put up the subsidiary companies’ accounts on its websites. This presumes that every shareholder has internet access. However, unless you sit down with a detailed paper report in your hand, the net does not allow one for a friendly read or enable you to move from page to page, quickly. Companies have abused the internet to upload accounts in various formats that are difficult to read and engage in cross references. Now, one understands that there is a move to make reporting in one uniform language, but it seems unlikely that things will get any better. Why not continue with the practice? I see that the companies have managed to lobby the government, in the garb of ‘green’ movement and move to electronic delivery of annual reports. I do hope that this will not be mandatory. I still love the old fashioned printed annual report. To tell you what the disclosure standards have come down to, let me take the annual report of Reliance Industries Limited, one of the most widely followed companies in India. I read from the P&L account that the sales for the year 2010-11 were Rs.248641 crores. However, what product/s the company sold cannot be fathomed from the accounts. There is no schedule that gives the break-down of the sales. Of course one schedule gives “production meant for sale” listing different products and quantities, but no value. Whether it was sold and what it contributed, the accounts do not tell me. Same is the case with purchases. Manufacturing & other expenses were Rs.211823 crores. The explanatory schedule gives one line saying “Raw Material Consumed” Rs.193234 crores! Wonder what it was? The language used is in the singular, so it must be one mighty raw material indeed! A small item of Rs.68 lakh of lease rent is detailed in this schedule but something that is ninety percent, is dismissed in one line! If I go to the balance sheet, it is very impressive indeed. Net worth of Rs.151548 crores! The net block of fixed assets is slightly larger than this. Investments made by the company is Rs.37,651 crore. If I go to the “Consolidated” accounts, this figure drops to Rs.21596 crores. I see that the company has listed 142 ‘related parties’! It will take expert scanning and working to fathom out how much money is invested in any associate, what stake the company has etc., Also, different year end dates for many subsidiaries / associates add to the chaos. There are three pages in small print which give ‘financial information’ of 120 subsidiaries! The print size bothers me and I give up on the balance sheet. I am sure that RIL discloses everything to the research analysts or on its websites. But the fact of the matter is that in 200 plus pages, the financial disclosures that are mandatory, are not enough to tell you what the company does. This is so different from the past, when there would be detailed schedules from which one could work out the unit costs, unit realisations etc., Today, in the name of saving on postage, printing etc, reporting standards have gone to the dogs. About accounting standards, the less said the better. Companies are allowed to follow different standards if they go to a court of law. Even if they do, it should be the job of ICA to qualify and quantify the issue. They rarely do. The balance sheet of Tata Steel also throws up an interesting thing in so far as accounting standards are considered. The notes to the accounts (page 160 of the annual report) show an ingenious accounting of the interest on ‘perpetual ‘debentures. “c) The Company has raised Rs 1,500 crores through the issue of Hybrid Perpetual Securities in March 2011. These securities are perpetual in nature with no maturity or redemption and are callable only at the option of the Company. The Distribution on the securities, which may be deferred at the option of the Company under certain circumstances, is set at 11.80% p.a., with a step up provision if the securities are not called after 10 years. As these securities are perpetual in nature and ranked senior only to share capital of the Company, these are not classi´Čüed as ‘debt’ and the distribution on such securities amounting to Rs 4.54 crores (net of tax) not considered in ‘Net Finance Charges’.” When the company has an option to repay at the end of ten years, how can it not be considered as not debt for the first ten years? Or is the company so sure of its abilities that it assumes the entire amount to be never repaid? And how can the interest on that not be classified as something else? The company distorts its financial cover ratios if it does not include the amount under interest. Who knows? Maybe after ten years, the entire debt can be converted in to ‘other income’! The other thing that is happening in the name of ‘green’ or ‘eco friendliness’ is the emailing of balance sheets. This is a retrograde move. Unless I have a printed annual report, it is impossible for me to analyse a balance sheet. I would have to take a printout of the soft copies in any case. And the companies do print fancy and glossy annual reports for giving to the fund managers and the media. The above are two broad examples of what our disclosure standards are coming to. Balance sheets are getting difficult to read and understand. This is surely not the road to increased transparency. The ICA seems to be on a mission to help promoters to bring in opacity in the only formal communication that is made to the shareholders. And to think that under law, it is the shareholders who appoint the auditors! I would urge that SEBI look in to the accounting (sub)standards that are currently being followed with regard to listed companies. The ICA ought not to be trusted to bring transparency in reporting. R Balakrishnan September 16th, 2011

Thursday, October 13, 2011

The Colour of Money

(GREAT NEWS: WROTE THIS YESTERDAY. TODAY'S PAPER REPORTS THAT PROPERTY SALES THROUGH POWER OF ATTORNEY NOT VALID. MUST LOOK AT FINE PRINT) WITH A LITTLE HELP FROM THE TAXMAN.. The government rules are cleverly drafted with the support of lobbyists who ensure that black money generation and storage is not disturbed. Gold has been a traditional place to park one’s unaccounted money. Gold, diamonds and other items of jewellery have been the eternal favourites of anyone searching for a way to dispose of the bundles of cash. Apart from money under the pillow not earning anything, cash is also unwieldy. Of course, one can buy land, finished property etc., Land can be easily bought under a Power of Attorney from the seller and never registered. It can change hands several times before it is finally registered. This is a convenient way to park black money. It is not too difficult to keep the document in safe custody with a lawyer (hopefully the lawyer will not diddle your successors out of it, should you cease to be) and ensure that the taxman does not get his hands on it. And land is a ‘state’ subject. It is unlikely that any state government will make Powers of Attorney invalid beyond a time limit when it comes to land dealings. If the tax authorities want, they can plug this loophole simply by saying that the last registered name continues to be the owner for all purposes and that powers of attorneys for land sales are not valid without the attorney holder being registered as the legal owner for all purposes. Most of us today find it difficult to invest even a rupee without a PAN card issued by the tax department. The tax authorities require you to have a PAN card reference if you invest more than fifty thousand rupees in mutual funds. Till May 2011, there was no requirement for anyone to show a PAN card for buying gold or jewellery. One could do the entire transaction in cash. Some jewellers would ask for some name/address and you could write anything there. He was more interested in completing the sale rather than finding out about who you were. And dealing in cash had its advantages. No taxes or levies. No income tax on profits that the seller made. If the tax department ever tried to match the gold purchases with the invoiced sales and tax reference numbers, the results would be interesting. If you hold any gold or jewellery, you are supposed to pay wealth tax on it, subject to some exemptions. Wealth tax is wonderful. If you have any assets (gold, jewellery, automobiles, second or third homes etc) in excess of Rs.30 lakh, the government gets one percent of the excess over 30 lakh because you are ‘rich’. Of course, financial assets (stocks, shares, mutual funds etc are exempt from this). Of course your accountants know more than fifty ways to leave your taxman (with apologies to Paul Simon). You can always get ‘gifts’ from friends and relatives on various occasions and if you have some overseas so much the better. You could even ‘buy’ a prize winning lottery ticket! Now, the tax department has cracked the whip. It says that if you purchase jewellery or gold for more than rupees five lakhs (500,000 Rs) in one go, the seller must have a copy of the PAN card of the buyer. The wordings are very clever. It (Sec 114B of Income Tax Rules)says Every person shall quote his permanent account number in all documents pertaining to the transactions specified below, namely (many things are listed) and the operative one here is: payment to a dealer,— (i) of an amount of five lakh rupees or more at any one time; or (ii) against a bill for an amount of five lakh rupees or more, for purchase of bullion or jewellery: The other thing is that you can buy it in CASH. So, if more than five lakh, if possible you could split it in to convenient amounts. Indian gold imports in this fiscal could be anything between 800 and 1000 tonnes. At $ 53,000 per kg, 800 tonnes would be 2,12,000 crores!! This is almost 18% of the total budget of the government or more than one thirds of the tax receipts!! I do not have figures of diamonds, gems etc. Add those and it could be some mind boggling sums. How much of this is money that has evaded the taxman? Less than half? More than half? CASH as a medium of exchange is encouraged by the taxman. The only limitation is that if you have a business expenditure that is more than Rs.20,000 and in cash, it is not allowed as a business expenditure, unless there is a valid explanation. So, there is no bar on CASH SALES by anyone. So, one must compliment our tax authorities for leaving enough room for tax evasion. It also shows that they are serious about black money. Can we ask for more encouragement? We must also give thanks to bodies like the Institute of Chartered Accountants who help prepare draft legislations, the lawyers who ensure loopholes and above all, the politicians who ensure a way out of all difficulties. After all, who wants to pay tax? R. Balakrishnan October 13th, 2011

Sunday, October 2, 2011


(Published in Asian Age / Deccan Chronicle on 2nd October 2011)
In gold the world trusts

Oct 02, 2011 - By R. Balakrishnan



Gold rose 58 times from $19 in 1900 to touch $1,110 in 2010, while the Dow Jones Industrial Average jumped 172 times from $61 in 1900 to $10,500 in 2010.

Today, gold and real estate have become essentials in every investor’s asset creation. But is there a danger that these two asset classes could turn out to be the biggest bubbles in the long run? We all presume that we will be the smart fellow and will bail out before the others. However, mass following, inflation and the action of governments such as constant bail outs and subsidies ensures that these assets keep inflating in value. It is likely that lack of faith in the sovereign as well as inflationary pressures and crowd behaviour could keep these assets on the high for times to come.
Gold is a metal, which has no intrinsic use or value, but it has become a synonym for wealth due to purely emotional or sentimental reasons. In the frenzy of speculative hoarding, it has virtually become a self fulfilling prophecy. If we take the pure extraction cost, it is well under $400 per ounce. However, it has become a store of value and is driven by factors such as the strength of the dollar, the degree of likelihood of an alternative to the dollar as a “safe haven”, the fetish of Indian and Chinese households for the yellow metal and the speculative forces of hedge funds and commodity funds.
The one thing to note is that gold does not follow any predictive valuation model. It is perception and a function of demand, supply, fear, greed and hype. In dollar terms, gold gave negative returns from 1980 to 2006! The quantum leap has come only post 2006.
For Indians, there were some positive returns as the rupee consistently weakened during the entire period. Gold was used primarily as jewellery and as a store of unaccounted money.
A year ago, gold was trading at under $1,300 an ounce. Now it is around $1,700, after breaching $1,800 per ounce and it is now looking volatile. Can it fall further? The key to that lies in whether the global money managers believe in what the US is doing. If faith flows back to the dollar, gold will get sold off or vice versa.
Faith in the US government is perhaps the most important factor that will influence future gold prices. Most governments that have huge trade balances have invested bulk of their surplus money in bonds issued by the US government. The day this faith cracks, there will be a dumping of these bonds, a run on the dollar and a mad rush to gold. Perhaps, there is not enough physical gold in the world to accommodate all the surplus money and hence the governments may not dump the dollar for gold in one go.
For Indians, gold prices are also determined by the exchange rate of the Indian rupee. If global prices of gold fall by five per cent and the Indian rupee depreciate by five per cent, the rupee price of gold will not show any change. So the price of gold in the Indian markets is also a function of the Indian rupee!
Indian demand for gold is a significant price driver for gold. Today, India and China account for nearly 60 per cent of gold demand! An important factor to note is that in spite of the rapid price rise in the last 12 months, the Indian hunger for gold has not declined. In fact, demand for physical gold has also increased due to investment buying through the ETF route.
To sum up, gold has become an important alternative investment thanks to the recklessness of governments. Lack of trust in third parties, perhaps makes gold a good friend. The higher is the mistrust in governments, the higher the payoff in gold and vice versa. Should you continue investing in it? That is your call, depending on how you assess the economic situation and your own investment strategy.