Grexit and Its Effects on the World Economy

The exit of Greece from the Euro Zone, nicknamed as GREXIT, is the currently trending topic of the global economy. Grexit is looking almost inevitable at this point of time as far as the talks between the Greece Ministers and its creditors are considered. Amidst all the events, we will take a look at how the world economy might be affected and how Indian markets might react.

Let us start with a small recap on how this situation of a default by a country actually arose in Greece. Has it happened all of a sudden? Or has it been an effect of a long-term sustained stressed situation? So here is whats been happening in Greece in brief right from 2008, the year popularly known as the year of Sub Prime Crisis. Although it has no direct correlation with the current situation in Greece.

Just when the world was recovering from the global slowdown of 2008, with the fear of default and in the hope of getting assistance, Greece announced that it was understating its deficit burden from quiet a long time. The news came as  a complete surprise to the markets and while analyzing this situation the world started questioning the ability to payback its debt obligations. Greece had a debt to GDP ratio of around 146% by 2010. Due to which the Greece bonds were declared as Junk bonds( precisely non investment grade bonds), which prohibited them from accessing the bond markets.

karikatur für tribüne- skeptische blicke

In this adverse situation, the International Monetary Fund (IMF), the European Central Bank (ECB) and European commission(EC) came to rescue with a proposal for Greece to initiate a revival. IMF, ECB and EC, together popularly known as the Troika, extended a loan of 110 Billion Euros in its first lot, and another pack of 130 Billion Euros. Although this assistance came with certain conditions like cutting down Govt debt, structural reforms and privatization of Govt Assets. These severe austerity measures were not taken well by the public. However, this continued for a year and then finally a premature election was called for in Dec 2014 since the public wanted a new govt to handle the situation. The new Govt in power refused to accept the measures suggested by the Troika for its revival against a huge sum of 240 Billion Euros. From that time onward, there has been immense political uncertainty, which is indicating that the Euro Zone might probably let go off Greece.

Currently Greece is left with two bad choices to make and its been left to them to choose whichever might lead to lesser repercussions. Following image might just give a brief idea of the condition:

grexit-comic

In case if Grexit happens, then the stock markets might see turmoil for at-least a medium term period since many companies in various countries have immense dependency of their revenues from the Euro Zone. Before we look at what would happen to Indian Markets, let take a look at what would happen in general on the event of a default. Grexit would mean distress in the euro zone, depreciating euro against the major currencies. Dollar would strengthen immensely over this event, thus putting further downward pressure over rupee. Apart from currency markets aspect, it might even lead to FIIs outflow since the emerging markets as a whole would become risky and the investors might want to invest in safer assets such as US Treasuries, especially in the short-term. Greece on the other hand might be locked out of the international markets. The crisis doesn’t end there, Greece will have to adopt its old currency, drachma, which will lead to its devaluation on default but the debt will still have to be repaid in terms of Euros, leading to further distress.

Indian Stock Markets on the other hand, might become the favorite destination to invest in the long-term, looking at the simultaneity of Euro Zone crisis, the US showing slow recovery, China showing slowdown, Shanghai Index correcting almost 20% being over valued from the past year and IPOs woes, and all time high forex reserves with RBI to control currency movements. Anyway the markets would not be affected to the extent of correction of 2008 phase since there are not many un-hedged exposures from the corporates. The only issues might be a few companies being exposed to the weak Euro as a part of their revenue generation and the new 30 IPOs lined up to enter the markets. However, in this decisive time it will be interesting to see if Greece handles the situation wisely or will choose to default.

Next up might be something on markets, in case Greece defaults on its 1.5 Billion euro payment to IMF.

Thank you. 🙂

Strategic Debt Restructuring – RBI’s Aggressive Stance On NPAs

Growing Non Performing Assets(NPAs) have been a greater concern in Indian Banking sector from the past few years. NPAs are those assets in which borrower has failed to make interest or principal payments for 90 days or 3 months in a row. Non-performing assets are problematic for financial institutions since they depend on interest payments for income. Troublesome pressure from the economy can lead to a sharp increase in non-performing loans and often results in massive write-downs. Thus the banks have to set aside a specified amount as per RBI norms to cover those losses in-case they crystallize, which are known as provisions. The provision is hence not used in lending purposes putting further downside risk on banks’ profitability and increases the overall cost.

RBI in its recent announcement has said “NO” to these increasing costs and has suggested a wonderful measure called as Strategic Debt Restructuring. RBI has now allowed the banks to take 51% or more stake in the defaulting companies after restructuring of their loans for the first time. The move is aimed at resolving the stress in the banking system and the current level of slippage. The NPAs of the Indian Banking sector has been rising amidst weak economic conditions. The current Gross NPA of the Indian banks stands at around 4.4% levels but has been estimated to rise sharply in the coming years, to around 5-6 %. ICRA and Crisil have estimated the numbers to be 5.9% and 4.5% respectively. Heres how the banks been performing and how much does each category of bank contributes to the credit and the NPAs levels. The scenario even post 2013 has remained the same with the PSBs contributing highest in the growing NPAs while Pvt Banks keeping them highly muted.

Fullscreen capture 6142015 92809 AM.bmp

There were many measures taken by the RBI to reduce the levels. One of the important steps was introducing the 5/25 loan restructuring scheme. SDR is another way of reducing NPAs. Following are the steps as to how SDR will work:

Fullscreen capture 6142015 95115 AM.bmp

The overall process seems to be a wonderful move to reduction in NPAs. Selection of the right and competent promoters, non availability of secondary markets to sell stake according to SEBI rules, provision costs being reduced only on sale of stake and the chance of non sale-ability of certain companies will be the barriers in real-time implementation process. Apart from these, there are a set of conditions in Joint Lenders Forum (JLFs). Without fulfilling those it will not be able to take the NPAs off its balance sheets. RBI has done the needful to give banks the extra powers to fix its balance sheet, but its depends on banks’ performance in deciding if NPAs will be reduced thus reducing costs and provisions or will it change adversely increasing costs further. Although banks might face problems in implementing the same under current conditions, it is a positive leap towards a better and a more robust banking structure.

Thank you. 🙂

Nasty Correction Amidst Rate Cut

Generally a rate cut by monetary authorities of India, the RBI, is seen as a sign of growth in the future and the markets show bullish trends. But this time something completely opposite happened. A simple logic can be there was a rate cut leading to reduced arbitrage for the FIIs and thus FIIs pulling out funds and thus markets fall. Although, all of that I said is true but there is a lot more to that.

RBI in its second monetary policy decided to reduce its key policy rate, the repo rate, by 25 bps to 7.25. This decision was implemented in the view of reduced inflation and weak corporate earnings numbers. It just took the amount of scope it got to cut based on inflation and Equilibrium interest rates as well.

07fii

There are various reasons to the 350 -400 points fall in the broader index, nifty, most important being the FIIs selling out. The sell off has also caused some volatility in the rupee movement making rupee weaker and less of a denomination to invest in. Although India has been a favorite avenue for investment, the fundamentals do not signal the same. Nifty tanked by around 350-400 points over the week from Tuesday post RBI action to reduce the repo rate.

Fullscreen capture 662015 124323 PM.bmp

Fullscreen capture 662015 124329 PM.bmp

Markets have been really skeptical about the controversy between the corporate earnings numbers and the GDP rate, the two being significantly negatively correlated at the moment. It is actually important to note that GDP is calculated as the cumulative value addition by about 5,00,000 companies in the new method of calculation, which constitutes both the organised and the unorganised sector. Unfortunately, the numbers of the unorganized sector, which has contributed to most part of the GDP, are not published on the MCA21 website (Ministry of Corporate affairs). This results into a negative sentiment if the country is really growing at the so-called fastest rate.

On the other hand, the MAT issues have been settled on the equity part of it but the treatment of interest and royalties from debt investments by FIIs is still an unresolved one. It has created a barrier for debt investments in the coming months.

GST, India biggest tax reform post independence, is still facing problems from the states regarding the compensation against the losses. It was proposed in the Constitutional Amendment Bill that the states will be compensated 100% of their losses for the first three years, 75% in the fourth and 50% in the fifth. States on the contrary are demanding for a 100 % loss compensation for the entire period of 5 years. Lets hope that the GST issue gets resolved soon to pump up the Indian markets soon.

Another signal that RBI gave on the 2nd of June, which led to a sell off in the markets, was the reduction in chances of further monetary easing in the near future. RBI has cautioned the markets with three important key points which it will consider before further monetary easing. Those are the effects of increasing crude oil prices, the likely El Nino effect and the upward pressure on the inflation due to the reduced forecast by IMD.

Going forward, the GOI will have to take some serious steps in the areas of PDS and be accommodative to help RBI contain its inflation target of 6% by Jan 2016. But so far the fear of crude oil prices rising seems to be subdued atleast till Dec 2015. OPEC on friday in its meet decided to keep pumping oil at least till its next meet in Dec. This is a good sign for the Indian economy since oil prices might witness some downward pressure.

Considering the given conditions, further the markets might show some mid term bullishness looking at the oil prices and US slowdown persisting. EL Nino will be a factor to look for in the coming months. Growth for the corporate sector will start picking up in the next two quarters. Banking sector remains in a shaky position amidst rising NPAs and lower profitability and especially no CRR cut is going to hurt the commercial business.

Thank you. 🙂

RBI D Day – A Cut or Status Quo

The Reserve Bank of India on June 2, 2015 will announce its Second Bi-Monthly monetary policy. This policy is a tough one for the RBI to decide because of the various effects of the world economy and the domestic conditions. Question is, will there be a rate cut or a status quo. There are various factors that are likely to be considered by Dr. Rajan to decide on the policy action. Lets take a look at the information based on which probably we can foresee the trend of the policy action due tomorrow.

First and the foremost important factor for the same is the retail inflation. CPI ( Consumer Price Index) has seen a decline since Nov 2013 from 11% levels to the current 4-5% levels. WPI( wholesale Price Index) on the other hand showing deflationary trend. The biggest concern for India since the past 2 years was the rising food inflation. Food inflation, lately, has moderated to 5.4% from highly uncomfortable level of 14.45 % during Nov 2013. Inflation is thus showing consistent downfall and has been averaging at 5.5% which is well below the RBI targets of 6% inflation by Jan 2016. The RBI is focusing on the use of CPI alone post apt recommendations of the Urjit Patel Committee. There are chances that WPI might not be picture after a certain amount of time. But it must be acknowledged that FIT (Flexible Inflation Targeting ) has started showing its positive effects.

While on the industrial growth side, India has shown disappointment so far including the disappointing Q4 earning of 2014-15. IIP (Index of Industrial Production) continues to be anaemic which shrank to 2.10% from 5-6 % levels.Firms’ net profit growth has failed to recover despite rate cuts in the previous reviews. Net profit growth has been hovering around 6.5% from the past 4 years in the Indian economy. While the interest costs as a percentage of net sales, which is of major importance for the domestic companies, has seen a steady increase every year. These conditions suggest that although we are growing at 7.3% annually, there is a hint of slowdown in the industrial sector (organized Industrial sector to be accurate).

On the BFSI sector side of it, the commercial credit growth has shown a continuous downfall from 16% to around 10.5% in two years time. This condition seems to be horrifying for the banks and its performance on the NIM(Net Interest Margin) and NII(Net Interest Income) aspects. Deposit growth has been subdued as well.

FII fund flows into Indian markets have also been declining amidst the delays in the structural and tax reforms. Markets have been witnessing high volatility in the recent past, with its IV(Implied Volatility) well over 20%, which is not a good sign. Value of rupee has also shown a downward trend against the dollar thus increasing the value of import burden.

Liquidity conditions in the economy also seem to be comfortable looking at the prevailing call rates. RBI has made sure that enough liquidity is available in the system without compromising on the rupee value. Call rates have been consistently steady at 7 – 7.5% levels, indicating comfortable levels of liquidity, and well within the repo operation window of 6.5%(rev Repo rate) to 8.5%(MSF Facility rate). This liquidity comfort is thus indicating greater probability of a rate cut tomorrow.

US Fed on the other hand has been indicating signs of increasing their interest rates in the Sept FOMC meet. But looking at the US Govt statement on Friday 29th June, where they reduced the forecast of 0.2% annual growth to a shrinking growth of 0.7% due to weak Q1 growth, it looks tough for the Fed to increase rates in the near future. Thus giving RBI the scope of easing its monetary policy.

All the factors of inflation easing, commercial credit growth declining, pressure on NII, negative fund flows from FIIs, subdued corporate earnings, steady liquidity conditions and the increasing cost of interest are signalling towards a rate cut.

All the above factors are a guidance about the direction of the repo rate. There is one factor which is being considered by all central bankers for decisions on the operational rate cutting. This factor will ultimately determine the size of the rate cuts going forward depending on the economic conditions. The factor is popularly known as the Equilibrium Real Interest. This is the move of central bankers towards discretion as to what is should be the ideal rate for a certain economy. ERI is the rate which is considered acceptable by the central bankers over and above the inflation levels which is right for the economy to grow. RBI considers ERI should be 1.5% to 2%. Current inflation averaging at 5.5% and considering an average ERI of 1.75%, it might be apt that the ideal rate would be 7.25% in the current configuration.

images

Considering all the factors of magnitude and direction of the repo rate, RBI in its Second Bi Monthly Policy might cut repo rate by 25 bps to 7.25% or even 50 bps if Dr. Rajan decides to surprise the markets yet another time. It is unlikely that RBI will maintain status quo looking at the factors in play. CRR and SLR on the other hand might not be disturbed at the moment since the liquidity condition seems comfortable. The effects of the monsoons and the EL Nino is still an unanswered issue which can be only witnessed in the near future. Presently, some rate adjustments are certainly due in India as well as US, but its likely that the RBI will step on the gas first to spur growth as well as contain inflation.

Thank you 🙂