Indian stocks to open sideways: Wednesday Market Preview

Fears of the European debt crisis spreading has made investors jittery

The Indian stock market is likely to open sideways on mixed global cues. Moody’s downgrade of Ireland’s credit rating to junk resulted in Wall Street finishing trade lower on Tuesday, in the red for the third day in a row. However, showing some resilience the  Asian pack opened in the green on Wednesday on bargain hunting after recent losses in the market, which made stocks cheaper. The SGX Nifty was 16 points higher at 5,542 compared to its previous close of 5,526.

The domestic market was severely mauled yesterday by the deepening Euro debt crisis and a couple of negative domestic factors such as poor Infosys results and a decline in the manufacturing index. After opening lower, the indices were knocked down through the day and lost more than 1.5% by the close of trading. Earlier, the Sensex opened 187 points down at 18,534, while the Nifty opened at 5,557, lower by 59 points from its previous close.

The drop in the indices was worsened by the first quarter results of Infosys that were below expectations. Slower-than-expected industrial output numbers for May that were announced around noon, dampened sentiments further. Industrial output, measured by the Index of Industrial Production (IIP) rose by just 5.6% from a year earlier. April's industrial output growth was also revised downwards to 5.8% from the earlier 6.3%, the government said. The growth in April-May was just 5.7% compared to 10.8% a year ago.

The weak market appeared to revive briefly on the news of the much-awaited Cabinet reshuffle, a little before noon. At about this time, the indices hit their intra day high, the Sensex at 18,589 and the Nifty at 5,580.

The market did not revive after that and as the European markets re-opened weak, the Sensex hit an intra-day low at 18,326 and the Nifty fell back to 5,497. At the close the Sensex had lost 310 points to 18,412 and the Nifty 90 points to 5,526.

On Monday, we mentioned that the Nifty may find support at 5,525. Yesterday, the Nifty broke this support but ended above it. We could see a pullback rally, subject to global events.

The fears of the European debt crisis spreading to Italy and Spain after Moody’s Investor Services downgraded Ireland’s credit rating to junk territory had investors and policymakers worried. The ratings agency said that Ireland will need more funds before it can return to capital markets. Earlier US indices were in the green after minutes of the 21st-22nd June Federal Open Markets Committee meeting suggested that there was still space for more stimulus to boost the economy.

IT stocks Novellus Systems fell 4.02 and Microchip Technology plunged 12% after they provided weak earnings outlooks late Monday.

In economic news, US trade deficit surged in May to its highest level in more than two-and-half years. Also, farm-machinery stocks slid after the US Department of Agriculture trimmed its consumption outlook for corn this year, while raising corn-production forecasts.

The Dow declined 58.88 points (0.47%) to settle at 12,446.88. The S&P 500 shed 5.85 points (0.44%) at 1,313.64 and the Nasdaq fell 20.71 points (0.74%)at 2,781.91.

Markets in Asia were up in early trade on Wednesday as data that just came in suggested that the Chinese GDP stood at 9.5% in the second quarter from 9.7% in the year-ago period. However, European worries kept investors on their guard.

The Shanghai Composite gained 0.69%, the Hang Seng surged 0.92%, the Jakarta Composite climbed 0.59%, the Nikkei 225 added 0.01%, the Straits Times gained 0.27%, the Seoul Composite was 0.46% higher and the Taiwan Weighted rose 0.44%. On the other hand, the KLSE Composite slipped marginally into the red down 0.01% in early trade.

Back home, a meeting of the Empowered Group of Ministers (EGoM) headed by finance minister Pranab Mukherjee to consider limiting supply of subsidised domestic LPG cylinders to 4-6 per household in a year, has been deferred. The EGoM meeting was slated for 1630 hours on Tuesday but had to be deferred due to the Cabinet reshuffle.

The panel was to consider recommendation of the Task Force on Direct Transfer of Subsidies on Kerosene, LPG and Fertiliser.


DGH, RIL reply to CAG issues on KG-D6 field

Sector regulator says production sharing contract allows companies to revise plans, costs

Reliance Industries (RIL) as well as the oil ministry and sector regulator, the Directorate General of Hydrocarbons (DGH) today gave a detailed point-by-point reply to the observations of the Comptroller and Auditor General (CAG) on the country's largest gas field, KG-D6.

Besides Reliance, Cairn India and the UK's BG Group have also replied to audit observations on the Rajasthan oilfields and the Panna/Mukta and Tapti fields, respectively, at the Exit Conference called by the CAG before it finalises its report, PTI quoted sources privy to the meetings as saying.

DGH director-general SK Srivastava in a separate session with the CAG said the production sharing contract (PSC) allowed companies to revise costs and plans for developing oil and gas finds. This is by incorporating new inputs like the one done by Reliance for its KG-D6 fields where costs went up from $2.4 billion initially, to $8.8 billion, in two phases ($5.2 billion in phase-1 and $3.6 billion in phase-II).

The initial cost produced in 2004 was for producing a maximum of 40 million standard cubic metres per day (mmscmd), but in the revised plans Reliance doubled output to 80 mmscmd. "Financial estimates were best estimates at that point of time for the broad work programme considered in development plan and were used for techno economic evaluation only," DGH said.

The CAG had in its draft report accused the oil ministry and the DGH of turning a blind eye to the cost increase which would lower the government's profit take from the field.

Sources said that the DGH disagreed with CAG's assumption of adverse impact on government's financial take from the project, saying "cost for the purpose of computation of government take is determined based on actual expenditure incurred and duly validated by audit, and is not based on development plan estimates".

"Any expenditure qualified by audit will be disallowed as contract cost," it said, and added that RIL's actual expenditure on phase-1 of KG-D6 gas field development was $5.6 billion till March 2011. The second phase of drilling is scheduled to commence shortly.

A Reliance team headed by its executive director PMS Prasad pointed out that "the draft CAG report had found nothing to suggest that Reliance indulged in gold-plating, that is Reliance placed orders on its own affiliates at inflated costs or that payments made to vendors came back to Reliance."

According to sources, RIL stated that "using the benefit of hindsight, CAG cannot question the technical and operational judgements of the operator that were in effect the best possible judgements at that time, based on the best information available. Benchmarking the project with similar ones the world over validates the fact that KG-D6 remains the most cost-effective project."

Reliance said there was "no malafide intent" on its part in making any "economic, commercial or operational decisions". The company said "reasonableness of costs incurred cannot be established on the basis of hindsight. Any increase in investment only increases the risk exposure of the operator without giving any additional benefits."

The company presented a nearly 250-page reply to the CAG draft audit, while DGH's response was nearly 180 pages long.

Sources said that the private operators criticised the CAG for exceeding its brief and converting the special audit into a performance audit. Any audit has to be done under the production sharing contract which provides for the legal regime under which the companies have to operate. If audits like that done by the CAG were to go beyond the contract, there would be no legal protection left for the companies, they said.

The sources said that while RIL officials took almost 100 minutes to explain their point of view, Cairn representatives gave their explanation in less than 30 minutes. BG also took a similar amount of time.

The CAG had in its draft report of 7th June stated that the oil ministry and its technical arm, the DGH, had favoured private firms like RIL and Cairn India by allowing them to retain entire exploration acreage, turning a blind eye to the increase in capital expenditure and giving additional area in violation of the production sharing contract.

Sources said DGH urged CAG to focus in its final report on accounting issues with quantification, so as to ensure that revenue and expenditure reported in the books of accounts reflect a true and fair view in line with the accounting principles.

Also, procurement of goods and services should be viewed in the light of the common commercial practices prevailing in the private sector that distinguishes the performance of private sector and may not be unduly shadowed by the systems and procedures of a PSU, it said.

On pure technical issues, the CAG audit should rely on the judgement of the technical arm of the oil ministry for drawing conclusions in view of the fact that exploration and production complexity is not easily comprehensible. "The CAG's final comment should encourage enhanced inflow of private and foreign capital and technology," the DGH stated.

CAG may take two months to finalise its final report which would be tabled in parliament.


Warning signs of the deepening euro zone crisis have been inexplainably ignored

Global markets slide on fears of debt default spreading to Italy, Spain; warning signals were available some months ago

Global markets today suffered one of their worst beatings in recent months on mounting fears of a likely default by Greece and that the debt crisis is spreading to Italy and Spain. Shares across Europe dropped nearly 3% to two-year lows, Asian markets were also hit earlier in the day, and it appeared likely that the story would be repeated in the US markets too.

While to some the IMF has been surprisingly silent on bailouts for these debt-ridden European economies and Euro zone finance ministers are now talking about a rescue fund to help Greece but have fixed no timing, it seems that early warnings about this developing situation that could devastate financial markets all over again have been ignored.

Over a month ago, Porter Stansberry, financial advisor, warned that Italy was the next big global problem. In an article headlined "This is the biggest threat to your financial future" published on The Daily Crux web site, Mr Stansberry wrote, "Credit default swaps on Italian sovereign debt are at record levels and moving higher. Currently it costs €250,000 per year to insure €10 million worth of Italian bonds. I expect these prices to continue to increase, making it much harder for Italy to get the estimated €250 billion it needs to finance its annual deficit and roll over the €170 billion in principal that will come due in the second half of this year."

"And... none of these debt estimates includes the growing likelihood of a major bailout for UniCredit, Italy's largest bank. UniCredit is Europe's largest lender to Eastern Europe, where JPMorgan estimates credit losses will total €40 billion this year. When you see in the news that Hungary's currency is plummeting, you can bet UniCredit's losses are growing," Mr Stansberry elaborated.

Today, on the Italian bourses, UniCredit fell by over 7% before turning higher aided by a ban on short-selling by Italy's regulator and news that the government had sold its targeted €6.75 billion of 12-month bills in a bond auction.

UniCredit is the successor bank of Kredit-Anstalt, whose failure in 1931 overwhelmed European governments, forcing Austria, Germany, and England off the gold standard.

Mr Stansberry stated emphatically: "As I told my subscribers in March, I think history is about to repeat itself: Roughly 75 years after its collapse set off the banking crisis that ended the gold standard and destroyed the world's financial system, Kredit-Anstalt (now known as UniCredit) is once again the largest bank in Eastern Europe. I believe it will soon fail again, setting off another global banking crisis."

The investment advisor explained that one aspect about European sovereign debt that most investors around the world failed to understand is that Europe's banking regulators have allowed the banks to own European sovereign debt with zero reserves because the banks argued these were "risk-free" assets. The easiest way for European banks to "lever up" and increase their returns on equity was to borrow large amounts of slightly higher-yielding sovereign debt, from places like Greece, Spain, Portugal, and Italy. This allowed nations privileged access to credit, and it also allowed banks to take on much more leverage than they could have otherwise afforded. "Now, with credit default swap prices rising on these sovereign credits, the truth of these credit risks is coming out," he wrote.

In another note to investors on 20th June, Mr Stansberry wrote that he expected the Spanish and Italian economies to collapse in the next six months. "I expect this next 'down leg' in the world's markets to be more severe than the crisis of 2008, because the balance sheets of the Western democracies are now less prepared to manage the losses.

Describing the history of UniCredit again, and how the failure of its predecessor Oesterreichische Credit-Anstalt—the largest bank in Eastern Europe before World War II—was responsible for kicking off the Great Depression, Mr Stansberry said he was convinced that the failure of UniCredit now would presage the next global monetary collapse.

Today, as the UniCredit stock continues to weaken, there could be a run on the bank and the losses would be too large for Italy to manage without a huge international bailout. "UniCredit has borrowed $300 billion from other European banks. And Italy's government already owes creditors more than 120% of GDP. There aren't any easy solutions to this problem," the investment advisor wrote.


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