The looming recession

It’s been a long time since I blogged. My heartiest apologies to my loyal readers! The reason is quite apparent from the title I believe. According to most of the analysts & self proclaimed experts the recession is already here & it is here to stay for a considerable long time before it gives way to some growth. There had been many financial follies that our Harvard Princeton & IIM grads committed while creating a all gorging monster called derivatives that almost wiped out $3 trillion out of the world economy. This financial blunder is compared to the great depression of the 1930s. Could this be the apparition of the old & painful time that has come back from the underworld to haunt us for coming years?

Well let us first have a look at the reasons why we are facing this situation. The very base of this problem is faulty valuations of the assets held. It all started with the housing bubble in California. The root of this bubble lies with faulty policies brought forward by the No. 42 (read Bill Clinton – a ‘Democrat’ of course – republicans need not be happy for electing the worst ever president, the successor No. 43 ‘Dubya’) & his supporter the so called legendary Alan Greenspan – ex-Fed chief. They came together in a conspiracy of reducing the interest rates to such a historic low that anyone & everyone on the streets of US was capable for getting a housing loan. Obviously the demand for houses started increasing to an unreasonable level. People still kept buying such expensive houses & banks kept offering loans for buying such houses, both considering that they have backing of a very stable asset ‘The House.’
Now comes the time for the financial innovators. These loans offered by banks are converted into Mortgage backed CDOs (Collateralised Debt Obligations). They were securitised by the companies like Fannie Mae & Freddie Mac into resalable assets. These assets were bought by investment bankers like Lehman Bros & Merrill Lynch. Add to that another innovation called ‘Derivatives’, which itself has no value of its own but trades on some other asset like the paper money mentioned above. All of the institutions mentioned above are now liquidated. The correction of the prices started when general people realised that the houses they were buying or holding were not worth the prices they were quoting. So the base of all these financial innovation & great boost to global turnover was removed. The huge castles of cards built over such base had to come crashing down.

Other culprits to the disaster are the rating agencies world over, as all these assets were rated as ‘very safe’ before selling them to next buyer. So all the buyers were also under the misconception that their investments were also ‘very safe’. The valuation models followed by the rating agencies & the investment bankers need to be revisited to avoid any reoccurrence of such disaster in future.

In my opinion the even though the current crisis is very serious & the extent of losses booked are very huge; the biggest difference between the great depression & now is the role knowledge & information technology & media will play in resolving the problem. The biggest problem in recession has always been the public perception & sentiments. So far the media has been disgusting in helping the people out. When the prices were rising to a ridiculous level, they were not bothered to inform people about it. Now as the recession is round the corner, the only thing that can help prevent that is the public sentiment & spending that will boost the consumption in economy. If you read the articles in any of the financial periodicals, you’ll lose your appetite; forget about spending your hard earned money in the market.

In the end if anyone asks for my opinion about the whole situation, I’d say that there is problem in the global market & the recession is not here yet but it will be here. But if all knowledge works in the right direction then it won’t be here to stay for a longer time. I believe we have gathered enough knowledge & are equipped enough to come out of it. Particularly the BRIC nations will be the first ones to rise out of it. Now only the time will tell, how good an analyst I am!

Review - Union Budget 2008-09

This year’s budget was expected to be populist one as we are going into election before the next budget. And to certain extent the FM Mr. P. Chidambaram has lived up to it. The Highlights of the expenditure planning are as follows.

• National Rural Health Mission 15% increase in allocation

• Outlay of Rs. 16534cr for health care

• Initial allocation of NREGS Rs. 16000cr for all 596 rural districts; may be increased if necessary.

• Bharat Nirman allocation Rs. 31280cr

• LIC to cover woman SHG’s (Self Help Groups) linked to banks.

• Irrigation outlay Rs. 20000cr vs. Rs. 11000cr

• Waiver of debt schemes – for marginal & small farmers: complete waiver of loans – could be reimbursement to PSU banks – it would amount to 4% of all loans of banks: positive for PSU banks as some written of losses due to prudential norms will recover & NPA’s could be reduced by 0.5 – 1% – Amount of Rs. 60000cr total agri-loan waiver – needs to be done by June 08

• Addressing the demands of Anganwadi workers the basic pay to teaching staff increased from Rs. 1000 to Rs. 1500 & cleaning staff from Rs. 500 to Rs. 750

• 5 more UMPP bidding to be opened

• Exchange traded FOREX derivatives to be introduced

• Defence allocation Rs. 1.05 lakh cr up 10% from Rs. 96000cr

• Rs. 55000cr revenue deficit 1.4% vs. 1.5% previous year

• Fiscal deficit 3.1% vs. 3.3% previous year

Lot of emphasise is laid on expenditure to bring social justice just as was expected. But not much is being said about capital expenditure on infrastructure & to improve quality of education. 3 additional IIT’s & few IISc’s are planned but nothing about Management Schools.

The revenue side has been a boost as there was record collection on Direct as well as Indirect tax receipts. So little was done to tamper with the same.

Customs

• No change in peak rate

There was lot of hue & cry about possible custom duty & CVD cut to boost the supply side to reduce the cost push inflationary pressures but the budget has turned out to be total failure from that perspective. Same mistake is being repeated from last year. Also there was expectation that duty on crude would be reduced to cope up with fuel price pressure but that also did not come. So no relief for inflation from fiscal policy point of view. Monetary policy alone would not be enough to curb it, so it’s a failure on control of inflation parameter.

Excise

• Cut in excise for Buses, chassis, small car, 2/3 wheeler to 12% from 16%

• Cut in excise on Pharma products 8% from 16%

• Bulk Cement 400/ton

• CST 2% from 3%

Attempt is made to give a fillip to lagging auto industry. Also to cover the price limits put on pharma products. This move will surely achieve that.

Direct tax

• Slab changed till Rs. 1.50 lakh - nil, Rs. 1.5 – 3 lakh – 10%, Rs. 3 – 5 lakh – 20%, above Rs. 5 lakh – 30% & above 10 lakh add surcharge

• Women Rs. 1.8 lakh threshold

• Senior citizen Rs. 2.25 lakh threshold

• Corp rate surcharge unchanged

• Section 80D applicable for expense on policies of parent/s Rs. 15000

• Section 80IB – construction of Hospitals – 5 years haven, Construction of Hotels in Heritage sites recognised by UNESCO

• Short term capital gains tax increased to 15% from 10%

• Commodities transaction tax introduced

• DDT (Dividend Distribution Tax) 15% unchanged

• DDT waiver for subsidy passing profits to parent co. to avoid double taxation provided the parent is not subsidy to any other co.

• Bank transaction tax withdrawn

• STT (Securities Transaction Tax) unchanged

• STT on options premium only

Direct tax part lives up to populist budget. This would again put a demand pull inflationary pressure on economy as there will be more disposable income in the hands of individual which is boost to consumeristic tendency of the young generation.

There are many negative factors for the capital markets though. STT was expected to be reduced which was not. STT should have been removed from Options & Futures which not exactly materialized. DDT still not removed which still is sort of double taxation. There was expectation that the FM will try to boost the dull capital market condition but there was little he added to it. Few things are good as no DDT chargeable to earnings transferred from subsidy to parent company, with not enough clarity on additional clause. The banking transaction tax is removed, which was not fair in the first place; so correction of mistake. Scrap of TDS on debt instruments: this move is a boost to debt markets in the country.

In all, this budget could be termed as populist neutral budget which is precursor to elections. The FM is living up his wish to keep the budget as a non event. Wait for the year when you are not much concerned of this article.