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Deccan Chronicle Holdings (DCHL) was a regional company publishing the Telugu daily Andhra ...

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Apples & Oranges

During 1994-96, over-extended bank credit, trade deficit, rising inflation and property ...

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Warming Up?

When the market was rising, it was not because of strong fundamentals alone. The crash too is devoid of any fundamental logic. Somewhere in between, lies value. How do you go about understanding it? Debashis Basu explains

Every bull market needs the fuel of money to keep going. The Indian bull has been fuelled almost entirely by ‘foreign institutional investors’ (FIIs). This magazine has taken the position that what we believe to be FIIs are not necessarily foreign, or institutions or investors. There is plenty of serious money that has come in. But to think that serious long-term money is pulling the index down by 400 points one day and pushing it up by 400 points another day is silly. This money is short-term speculative money, seeking returns all over the world in a variety of assets. The wild swings of late February and early March created by this speculative money have forced into the open three key issues that every serious investor must confront.

Issue 1 - Volatility: At the time of writing this article, the Sensex has just closed at 12,885. Exactly a week ago, it was 12,938. The market is down by just 50 points. But, within the week it fell by 4% and then rose 5%. The number of days on which it moves by 2% a day and 3% intra-day is making records. India is among the most volatile markets in the world today. This kind of volatility has not been witnessed since the days of Harshad Mehta and, for a very brief while, in 1999-2000, during the tech boom. Where is so much money coming from? What kind of returns are they seeking? What drives FIIs today and what will drive them away?

Issue 2 - Returns: Exactly a year ago, the Sensex was at 10,574. One year later, it is 12,885. It has risen 22%. Those who believe that 9% economic growth will automatically translate into a perpetually rising market may eventually be right. What they are wrong about is timing. When you buy makes an enormous difference to your returns. Do fund managers know when to buy? During the same period that the Sensex moved up by 22%, equity diversified mutual funds earned an average return of 9%. They have underperformed, no matter what the economic growth rate. Returns never rise in a linear fashion. Sometimes they fall and stay low for extended periods.

Issue 3 - Economic Growth: An 8%-9% growth is our birthright. Well, that is the consensus now. Maybe the consensus is right. After all, with the services sector now dominating the economy, and growing fast, we can indeed grow at 8% easily. But that growth may soon turn out to be at a much higher cost than we imagine. The enormous inflation in wages, property and services and various state-level taxes and levies are not things that worry us. But they are going to hit us soon. Let’s look at the first and third issues, which will guide us on what to do about the second.

The Land of Rising Liquidity To go back to the first issue, we will have to look east. Your prosperity and rising share prices start in Japan. Financial markets are now interlinked. Money can easily flow from the US to Japan to India to China and so on. Of course, true to our hypocritical attitude, we pretend that India’s currency is not convertible. But anybody with a label of FII can have a free run on the Indian market. They can bring in money through the tax havens whenever they want to and take it out at will -- no questions are asked. As far as foreign investors in the stock market are concerned, the rupee is a convertible currency. Also, while the government runs almost a police state for Indian citizens (PAN, MAPIN, TIN, MIN, KYC) and looks forward to extracting every ounce of tax from them, it exempts overseas investors from any scrutiny and, virtually, any taxes. The result of these two factors (easy tax regime and no questions asked about the quantum and source of FII money) is that the Indian market is now floating in the high seas of global speculative finance. It is affected by all major speculative trends. One of the most important of these When the market was rising, it was not because of strong fundamentals alone. The crash too is devoid of any fundamental logic. Somewhere in between, lies value. How do you go about understanding it? Debashis Basu explainstrends recently has been the ‘yen carry trade’.

The trade goes like this. Japanese interest rates are very low now. Large global speculators can borrow Japanese yen at an interest rate of 0.5%. Virtually any security in the world pays more than that. The safest of the currencies, the US dollar, pays 5%+. So, to borrow in yen and invest in dollar is an easy one-way bet. The spread between the two is the return earned for carrying the trade, and hence, the trade is called carry trade. The bet will pay off as long as the yen does not go up or dollar does not depreciate much and so long as the spread remains. Now, if the bet is placed on money borrowed at a low interest rate (from where else but Japan), the returns are multiplied manifold.

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