Saturday, April 28, 2012

Take stock of risks

This article was originally published in Postnoon on April 20th, 2012

Srikanth kept mulling over his conversation with Prof. Nicky the entire week. He reached the conclusion that he falls in the category of people who not only have the appetite to take risk, but also have the ability to do so. Equipped with this self realisation, he walked over to Prof. Nicky, who was looking at a piece of paper very carefully.As Srikanth got closer, Prof. Nicky looked up from the piece of paper and gestured to him to look at the graph on the paper.

Prof. Nicky: Hey come on Srikanth. Look at this!

Srikanth: What is this Professor?

Prof. Nicky: Remember that I was telling you that every asset class has its own risk profile?

Srikanth: Yes I remember!

Prof. Nicky: Ah good! So if somebody has the appetite and the ability to take risks, where does he invest his money?

Srikanth: That’s what I came to ask you. I have realised that I fall in that category.

Prof. Nicky: There are various asset classes like real estate, commodities etc. in which such people can invest. However, one of the most popular classes of risky assets is equities. Equities imply owning a share in the assets, liabilities and profits of a company. When a company grows, more money is required for it to expand. The original promoters may not have that money. Hence they approach the public to buy the shares of the company. That’s where the term “investing in shares” comes from!

Thus equities have the benefit of being very liquid, that is, they can be bought and sold easily on the exchanges like the NSE and the BSE. The other aspect of equities which attracts investors to them is the potential to make huge returns. If you look at the graph, you can see that the benchmark NIFTY index has given close to 13.8% returns on an annual, compounded basis over the last ten years. In other words, if you had invested `1000 in the stocks of Nifty in April 2002, you would have `4,645 now. This is a return of 365% over a 10-year period. This is more than what you would earn if you had invested in fixed deposits or other savings schemes like Kisan Vikas Patra or Post Office Saving schemes!

Srikanth: Really? So why do the equities give a higher return?

Prof. Nicky: They give a higher return because they need to compensate the investors for the higher risks associated with equities. It is like demanding a higher salary if your job is more stressful.

Srikanth: Where is the risk? You just now said that an investor can earn as much as 365% over a 10 year period!

Prof. Nicky: Now that is how a lot of people tend to think and that is why they end up losing money. You would make so much money if you invested in April 2002, and if you remained invested till April 2012. But what if you invested in September 2007 and then had to sell around September 2008?

Srikanth: looking more closely at the graph now, gave a gasp, “Oh My God! I would have lost more than 50% of my money in that case”!

Prof. Nicky: Exactly. And that is the risk. You do not know where the market is going to go tomorrow. The share prices depend upon the performance of the company, the economic, political and technological factors, the future prospects of the company and many more! When there are so many uncertain elements in running the company, it is very difficult to know exactly how much return you will get after a given period.

Historically, the equities have performed better than the other risk free investment tools like Government Bonds or saving schemes and Deposits. For those who can take this risk, it might be worth it! So go ahead boy, invest in equities, choose the companies wisely, and keep your fingers crossed!

Friday, April 27, 2012

The business of deposits

This article was originally published in Postnoon on April 27th, 2012

I, Prof. Nicky, had a tet-e-tet with Laxmiamma three weeks back. I was curious to know if she had taken heed of my advise and started investing. So I strolled out of our lush campus and walked into the nearby GPRS quarters. It is in one of these quarters that Laxmiamma had been hoarding her cash every month since the past 10 years in the hope of collecting enough money to release her pawned jewellery.

Laxmiamma was genuinely happy to see me and did not waste any time before showing me the account opening kit which she had got from her bank. She was the proud owner of a bank account now, which came with an ATM card and a cheque book.

She did not waste any time in offering her famous Irani chai and shooting her questions to me. So while enjoying the chai, I answered her primary question related to the difference between a savings account, a Fixed Deposit and a Recurring Deposit.

A Savings Account is meant for saving money, as the name suggests, from your income. The money deposited can be withdrawn any time and you can deposit money into the account as many times as you want. It is generally like a temporary parking place for the surplus funds that you have. Earlier, the banks used to pay a very small interest on the amount in this account. However, the recent deregulation of savings account interest rates by RBI has resulted in the bank giving as much as 6-7% interest.

Laxmiamma: I have opened my account by putting an initial deposit of `5,000/- Should I put my entire savings in the past 10 years into this account then Prof. Nicky?

Prof. Nicky: You could do that. But, you will earn more if you deposit your savings into a Fixed Deposit. The interest that the Banks offer on this account are usually much higher. Though the catch is that, you are expected to keep your money with the bank for a fixed tenure. The interest rates vary according to the tenure and, currently, may range from 7% to 10%.

Laxmiamma: But what if I have a medical emergency and need the money urgently?

Prof. Nicky: Hmmm… you can withdraw the deposit if you wish to. However, the bank will usually impose a penalty of 0.5% to 1% for doing so. Different banks have different rules regarding it.

Laxmiamma: So I will keep my past savings as a Fixed Deposit with the bank. But can I do a fixed deposit of my monthly future savings too?

Prof. Nicky: Once again, you could do that. But it will be a hassle for you to do it every month. If you have an online banking facility, then it is easy. But since you do not have that facility, you will need to fill up the fixed deposit form every month. Instead, you can do a Recurring Deposit of your monthly savings.

Laxmiamma was awed at all the facilities that the banking system offers. She asked, “How do I do that?”

Prof. Nicky: You can fill up a form similar to the Fixed Deposit form and instruct the bank to take out a fixed amount of money every month from your savings account, and put it into a Recurring Deposit. The bank will do it every month, for as many months as you instruct them to do it in the form. You will not need to remind the bank. You only have to ensure that you have that money in your savings account. For a Recurring Deposit, you need to be reasonably certain about the amount of money that you can save every month. The interest rates are similar to those in the Fixed Deposit.

Laxmiamma: So what you are telling me is that all three, Savings Account, Fixed Deposit and Recurring Deposit are going to be useful to me!
Prof. Nicky: Exactly! Can you please get me another cup of the chai?

Wednesday, April 18, 2012

FY13 guidance: Heed the warning

This comment was first published in The Free Press Journal, April 14th, 2012

Infosys has never shied away from making tough statements. The events of today are somewhat a replica of what happened on April 15th 2009 too. In that year too, Infosys cautioned the markets about the uncertain economic climate globally and predicted a 3.1-6.7% lower revenues for the next financial year. The share prices dropped on that day by as much as 7.7%.

Similarly, today the markets sent the share price of Infosys spiralling downwards, by more than 9%. Principles of Accounting teach us to be conservative. Given the market scenario today; Eurozone uncertainty, Currency volatility, customers becoming more cost conscious due to the experiences of the past couple of months, all support the guidance given by Infosys.

There are calls by certain analysts who think that TCS should be taken as the benchmark for setting the Industry outlook for the next year rather than Infosys. When a good meaning friend warns you of an impending danger, you have the choice of either analysing the situation and taking heed of the signals that point towards the danger. Or you can change your friend!

Momentum and Overreaction in Indian Capital Markets

This article was first published in the Free Press Journal, April 16th, 2012

Refuting one of the most famous theories in Finance, the Efficient Market Hypothesis (EMH), Momentum and Overreaction are two phenomena experienced in different degrees in different markets across the globe.

Momentum refers to a phenomenon wherein the past winners continue to be winners and past losers continue to be losers in the short run, typically three months to one year period. Overreaction or reversal anomaly is that the losers in the past outperform the past winners and past winners turn into losers in the long-term, a period of three to five years.

Studies in the developed markets like the US, UK, Australia and Japan, and developing nations like Turkey and Brazil, have shown that due to the presence of either momentum or overreaction, or both phenomena, significant abnormal returns can be earned by the investors using simple strategies. The support for momentum is weaker in the emerging countries than for the developed countries. Also, Asian countries are found to exhibit weaker momentum than the European and American countries.

While both momentum and overreaction can be attributed to factors like size, risk, macro-economy, data mining biases, liquidity, etc. none of them are conclusive. Another strand of literature relies of the investor psychology to explain the two trends.

Investor Psychology

Psychological characteristics of investors might explain the reasons that could be behind over-reaction or momentum. Indian investors being more emotional in nature, psychological aspects may be very important in explaining the market trends.

One of the most popular investor characteristic is “overconfidence”. Overconfidence makes the investors overreact to any news. If there is good news about a stock, the investors will drive the prices up by buying more, and will continue to keep buying for some time due to overconfidence. According to this logic, the momentum will be higher in Bull markets.

On the other hand, momentum may also be a symptom of underreaction. That is, prices adjust too slowly to news. The underreaction of stock prices due to news (for example, earnings announcements) may cause the momentum, since a slow diffusion of information among investors could make the path to the ‘correct’ value of the stock longer than expected. But, for longer periods, an overreaction of stock prices may occur due to extrapolation of a series of good or bad news, especially if investors are overconfident.

Underreaction could also be a result of either the conservative nature of the investors or lack of confidence. The conservatism bias suggests that individuals underweight new information in updating their expectations. If investors act in this way, prices will tend to slowly adjust to information, but once the information is fully incorporated in prices, there is no further predictability in stock returns. Investors, who lack confidence and hesitate in making a decision, would also underreact to information, causing the prices to take longer to reach their correct value, hence exhibiting momentum.

It is also found that bad news generally have the effect of making the prices more volatile than good news. Also, people act faster on good news than on bad news, as they are averse to losses. They do not mind realizing profits, but dislike realizing losses, hence keep postponing them. Both small as well as professional traders have been found to hold their losing portfolios longer than their winning ones. This could be interpreted as negative feedback strategy with respect to past returns, which could lead to reversals in prices.

Studies have pointed towards other factors like self-attribution self-deceptions, emotion-based judgments, framing effects, and mental accounting, to explain the momentum and overreaction trends.

In a study which was published in the International Research Journal of Finance and Economics, my peers Chakrapani Chaturvedula and Nikhil Rastogi from IMT Hyderabad and I studied 156 months NSE listed stocks data for indications of momentum and overreaction effects.

Momentum in NSE, India

We find that momentum strategy of buying the winners and selling the losers results in significant positive returns for the interval of 3 months for all categories of stocks, low cap, mid cap and large cap (Table 1). However when we take the higher intervals like 6 months and 12 months, there is no momentum in small cap and medium cap stocks. But, for large cap stocks, it persists for all the intervals up till 12months. This result is surprising since these stocks are tracked more by the analyst and so information should be quickly incorporated into the prices resulting in no momentum for this category of stocks. The result is also in contrast with many previous literatures, which points towards existence of momentum in small cap, rather than large cap stocks.

Overreaction in NSE, India

Table 2 shows the results for Overreaction after accounting for size. We find no evidence of over-reaction for the small and the large cap stocks while we consistently find it in the case of mid cap stocks. Our results for the large cap stocks are not at all surprising as the large cap stocks are widely tracked by analysts and any new information would get disseminated very fast. However, the absence of over-reaction in small cap stocks is very surprising because small cap stocks, by virtue of being less traded and having slower dissemination of information than large or medium cap stocks, was expected to show signs of over-reaction.

The evidence for overreaction is present only in mid-cap stocks. This is supported by the under-reaction hypothesis. What we can say is that in India, stocks under-react to new information initially, thereby exhibiting momentum in the short run. But, mid-cap stocks over-react in the long run.

Saturday, April 14, 2012

I'll Do it my Way

The book by Christina Daniels is a peek into the 'Incredible journey of Aamir Khan'. Aamir Khan has been making intelligent and trendsetting movies since Lagaan and has made many enjoyable movies even before that. As someone who appreciates his work, I am thankful to Christina for taking up this task of telling Aamir's story, through interviews with people who have worked closely with him. I admire him a bit more now, because the book highlights facts which often get lost due to the over the board publicity tactics of many other actors. I realised only after reading the book, that ALL Aamir movies have been huge hits, meaningful and intelligent since Lagaan in 2001. That's like a Don Bradman of Cinema.

Know risks before the plunge

This article was originally published in Postnoon on April 13th, 2012

On my way to ISB on Monday, I saw a motorcyclist speeding on the Gachibowli road hit a car taking a u-turn. The car was damaged and the motorcyclist suffered good deal of injuries. On enquiry, the rider said that he was in a hurry to meet his sister who was not well.

This got me thinking about the risks people take in their lives. Even though we read about accidents due to speeding very frequently, we still drive fast to save a few minutes. A cricketer tries to hit a six with every ball, taking the risk of getting caught on or near the boundary.

An investor faces similar risks. In order to earn higher returns, investors often take risks which may not be compatible with either their risk appetite or risk taking ability.

Taking a sip of the coffee, Prof. Nicky asks Srikanth, “Have you watched the movie 3 Idiots?”

Srikanth: Of course. Who hasn’t?

Prof. Nicky: Do you remember the scene where ‘Virus’, summoned Raju and Farhan to his office and told them to leave the company of Rancho?

Srikanth, proudly: I remember the entire movie, dialogue by dialogue. I’ve watched it 23 times.

Prof. Nicky: And how many times have you read Yasaswy’s book on investments?

Srikanth, descending down to the earth: Uhhh… Prof. I was about to start reading it the coming weekend… I Uhhh… thought… uhhhh…

Prof. Nicky: Ok. Coming back to 3 Idiots. So what was ‘Virus’ trying to explain to Raju and Farhan by comparing the income of their families with that of Rancho’s?

Srikanth: Ummm… I guess he was trying to tell them that they cannot afford to be thrown out of the course as passing and getting a good job was very important for them. Their families were not as well to do as Rancho’s.

Prof. Nicky: Exactly. This means that they do not have the risk taking ability, even though they have the appetite. Generally youngsters, with lesser responsibilities, single status, have more appetite to take risk.

Srikanth: But an investor wants returns. How are all this connected to returns?

Prof. Nicky: Alas, that what the investors don’t understand and that’s what I am trying to explain to you. There are different asset classes like Bonds, Equities, Commodities, Gold, Derivatives, Art and Artifacts, Real-Estate, etc, available for an investor to invest in. Each one of them has a risk profile of their own.

I can see that I am losing you. Let me explain.

Risk has a negative connotation in our day to day life, but not entirely so in the case of Investments. The uncertainty or deviation from expected returns is known as risk in the case of investments. For example, if you invest in the shares of Reliance Industries Limited, with an expectation to earn 20 per cent return in one year, an actual return of — 30 per cent is a deviation from the expectation, just as a return of 30 per cent.

If you take the case of fixed deposit in a bank, you get as much as you expect. So it is riskless, unless the bank goes bankrupt. But in the case of Reliance, your returns would depend on the performance of the company, the dividends, the future projects etc. So the uncertainty is much more.

Srikanth: I get it. So if I do not have the risk taking ability, I should not put my money in risky assets. But if I do have the risk taking ability as well as the appetite for it, I can invest in risky assets, though I should be aware of the risks that I am taking.

Prof. Nicky: Ah… there you go… Perfect… I couldn’t have put it better!

Friday, April 13, 2012

Value investing and the margin of safety

Co-Author: Mallikarjun Gaddam

This article was originally published in the business section of on April 13th, 2012

During early 2009, a mutual friend, Nicky, who is an expert on Value Investing, asked us to invest in the shares of Patni Computer Systems Limited.

Each of us bought 100 shares on his insistence. The share price of Patni was around Rs 97 on the day we traded. Today, the price of Patni shares are Rs 490 each and each one of us has made a cool profit of over 400 per cent in about two years.

Of course, we are grateful to our friend. But we are also very intrigued by the concept of value investing. We went back to Nicky with loads of questions.

Nicky: Value Investing is basically putting your money in stocks which are trading at prices lower than they are worth.

The important thing to keep in mind is that, the market may take a long time to realise the worth of the stock and hence you might have to wait for a long time before you can sell the stocks and realise the profits. During this period, you must not panic even if the stock price falls, as that would be a temporary phase.

Nupur: But how do you know which stocks fall in this category?

Nicky: The key is the balance sheet. Start looking for smaller companies, small-to-mid-cap, that are trading at a discount to their intrinsic values. These stocks are generally.

Mallikarjun: But how do we know which stocks are trading at a discount to their intrinsic value?

Nicky: Let me take you through how I discovered that Patni was a 'value' investment. Patni had a market capitalisation of Rs 1,300 crore (Rs 13 billion) in February 2009, with almost zero debt. They had investments and cash worth Rs 1,177 crore (Rs 11.77 billion) and Rs 293 crore (Rs 2.93 billion) respectively. This alone translated to Rs 108 per share, 11 per cent more than its market price per share at that time.

Nupur: That is excellent from our investment perspective. But why was their stock price lower than Rs 108 then?

Nicky: That is because a lot of really good companies are often neglected and are out-of-favour with the investors due to their lack luster performance in a particular period. They are often a misunderstood group of companies.

Mallikarjun: So we must thank you for identifying Patni and believing in the company and its long-term potential.

Nicky: Actually Benjamin Graham would frown on me for asking you to make the investment at Rs 97.

We both looked at Nicky, perplexed by his last statement. We clearly thought that we bought at a great price!

Nicky: Graham, the father of value investing, believed in a rule of thumb. He called it the "margin of safety". He would buy companies which traded at a minimum of 33 per cent discount on their Net-net working capital.

Mallikarjun: Net-net Working Capital?

Nicky: Yes. Graham calculated Net-net Working Capital as the difference between the Current Assets of a Company and its total liabilities (long term plus short term). Then he would take 67 per cent of this value to calculate the stock price at which he would want to buy the stock.

Adopting this method, Graham would buy the shares of Patni at Rs 90 only, calculated as per the balance sheet of Patni on December 31, 2008.

Graham did this to avoid any risk of losing money. Intrinsic value is often very subjective, and depends on the assumptions of the person doing the calculation. In order to protect ourselves from the uncertainty of the true intrinsic value, the margin of safety should be large enough.

You must not feel that you took any unnecessary risk though. As in the case of Patni, the investments and cash made up for almost 65 per cent of the total assets. This means that the quality of assets that Patni had, was very high.

In contrast, there are other stocks which might meet the margin of safety requirements as per Graham, but their assets might constitute more of inventory and debtors. Inventory might become obsolete and debtors might become bad debts.

Thus the quality of assets and the industry also needs to be considered before deciding if the stock is a 'value stock' or not.

Nupur: Your explanation does not mention earnings anywhere. Does it mean that earnings are not a consideration in value investing?

Nicky: No way am I stating that earnings are not relevant to value investing. Earnings reflect the efficient use of assets deployed, represented by asset turnover, inventory turnover ratios.

The analyses of these are important to know if the company has the potential to perform in the long term. Earnings and balance sheet figures together go a long way in ensuring that as investors we do not lose.

Nupur and Mallikarjun chuckle together: Well, as the sage of Omaha says: "The first rule is not to lose. The second rule is not to forget the first rule"!

Thursday, April 12, 2012

Do cash holdings impact funds' performance?

Co-Author: Dhruva Raj Chatterji, Senior research analyst at Morningstar India

The article was first published in the Economic Times, April 12th, 2012

The debate whether cash calls of actively managed funds have worked in their favour or not has been on for a long time. We tried to delve deeper and check if equity funds in India observe better performance when holding higher cash during market downturns; or do they end up missing out on sudden upturns in the market.

In India, fund houses like Escorts, Reliance, Sahara and Taurus are known to take cash calls, with cash holdings in excess of 20% on many occasions. It should be noted here that the excess cash holdings played out mostly in the period of 2008-09, when the financial crisis was underway.

Post that period, cash calls by most funds have tempered down substantially-but then again, so has the adversity in stock markets.

On the other hand, fund houses like Fidelity, Franklin Templeton, HDFC and Tata have maintained lower cash holdings, in the range of 4-8%, over the past five-year period, across most of their funds.

Taking two categories of equity funds -large-cap and small- & mid-cap -we compared the highest cash holding funds with the lowest cash holding funds. In the case of large-cap funds, the numbers reveal that the top 20 high cash holding funds held about 9% more cash on average than the bottom 20 cash holding funds over the past five years, but have earned about 1.2% lower returns (annualised) than them over the same period.

The performance is particularly poor over the 3-year period, where their returns are about 7% lower than those funds with lesser cash holdings, within the large-cap category.

We find a similar pattern in the case of small- & mid-cap funds - although much starker. It seems that the top 10 funds with the highest cash holding within this category earned about 5.5% less (annualised) than the bottom 10 funds with lower cash holding over a five-year period. Over three- and one-year periods, they earned approximately 9% (annualised) and 6% lesser, respectively.

Cash also seems to have a varying impact, depending on the category of funds. Large-cap funds, by virtue of investing in more large and liquid stocks, are able to buy and sell the shares quickly, and hence the role of cash becomes less important.

On the other hand, in the case of small- or mid-cap funds, keeping excess cash might mean losing out on an upswing, as the lower liquidity of these shares would result in the prices zooming up due to any sudden demand. The vice-a-versa is also true.

That is, in the case of illiquid stocks, selling might not be easy when there is a redemption pressure or a downturn. This probably explains the higher historical average cash holdings of mid-cap funds when compared to their large-cap peers.

We observe that the key risk in taking cash calls lies in deploying it at the right time. Fund managers often miss out on a sudden upturn.

Clearly higher cash holdings have resulted in lower fund returns in the following months, especially when the markets have turned around very suddenly. Again, here the impact seems to be starker within the small/mid cap fund category, where there are instances when the funds with high cash holdings have underperformed those funds with lowest cash holdings, by more than 3% (on average) in the following month.

On a closing note, besides the cash holding, there are other important factors, too, which have a bearing on the performance-like the quality of the fund management team, the processes in place etc.

However, avoiding high cash calls and remaining more invested across market cycles do point towards a more disciplined approach in investing. Moreover, the approach helps to neutralise the risk of being caught on the wrong foot, especially in the event of a sudden upswing in the market.

As legendary fund manager Peter Lynch once said: "Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves."

Wednesday, April 11, 2012

Why the annual Budget is like a bikini

With Vivek Kaul
The article was originally published in on April 10th, 2012

Five things you did not hear the Finance Minister Pranab Mukherjee say in the budget speech.

"Statistics are like a bikini. What they reveal is suggestive, but what they conceal is vital," said Aaron Levenstein, an American professor of business management. And not Navjot Singh Sidhu as we Indians tend to believe. The annual budget of the government of India is also like a bikini. A lot it is revealed about it through the budget speech made by the Finance Minister, but the vital aspects lay hidden in the budget document. Here are five things you did not hear the finance minister Pranab Mukherjee say in the budget speech he made a few weeks back.

1. The government of India in the financial year 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012) spent 65% more than what it earned:
That the government spends more than it earns, we all know. This difference, known as the fiscal deficit, is expressed as percentage of the gross domestic product (GDP). For the financial year 2011-2012, the fiscal deficit of the government of India stood at 5.9 per cent of GDP. But this number somehow does not convey the grimness of the scenario that the government of India is in.

The expenditure for the year 2011-2012 has been estimated to be at Rs 1,318,720 crore (Rs 13,187.2 billion). In comparison the government's income for the year is at Rs 7,96,740 crore (Rs 7,967.4 billion). This works out to a difference or fiscal deficit of Rs 5,21,980 crore (Rs 5,219.8 billion). Hence in simple English the government spends 65.5 per cent more than what it earns.

When we compare the situation in this way we come to realize that the government is spending much more than what it earns. If you or me were to do that we would be in trouble pretty soon. The government as we shall see has a longer lifeline.

2. The fiscal deficit of the government of India has gone up by more than 300% in the last five years:
For the financial year 2007-2008 (i.e. the period between April 1,2007 and March 31, 2008) the fiscal deficit stood at Rs 1,26,912 crore (Rs 1269.12 billion), against Rs 5,21,980 crore (Rs 5,219.80 billion) for the financial year 2011-2012. Now what does that tell you? In a time frame of five years the fiscal deficit has shot up by nearly 312 per cent.

During the same period the income earned by the government has gone up by only 36 per cent to Rs 7,96,740 crore (Rs 7,967.4 billion).

When expenditure is expanding nearly 9 times as fast as your income, it can't be a good thing. No wonder, the finance minister gave that piece of information a miss.

3. The fiscal deficit target for the financial year 2012-2013 (i.e. the period between April 1, 2012 and March 31,2013) is likely to be missed:

When the finance Pranab Mukherjee gave his budget speech in February last year, he had set the fiscal deficit target for the financial year 2011-2012, at 4.6 per cent of GDP. He missed his target by a huge margin when the real number came in at 5.9 per cent of GDP. The major reason for this was the fact that Mukherjee had underestimated the level of subsidies that the government would have to bear.

He had estimated the subsidies at Rs 1,43,750 crore (Rs 1,437.5 billion) but they ended up costing the government 50.5 per cent more at Rs 2,16,297 crore (Rs 2,162.97 billion). The finance minister had underestimating the subsidy level of the three main categories of food, fertilizer as well as oil.

This has been the case in the past as well. In 2010-2011 (i.e. the period between April 1, 2010 and March 31, 2011) he had estimated the oil subsidies to be at Rs 3,108 crore (Rs 31.8 billion). They finally came in 20 times higher at Rs 62,301 crore (Rs 623.01 billion). Same was the case in the year 2009-2010 (i.e. the period between April 1, 2009 and March 31, 2010). The estimate was Rs 3,109 crore (Rs 31.09 billion). The real bill came in nearly eight times higher at Rs 25,257 crore (Rs 252.57 billion) (direct subsidies + oil bonds issued to the oil companies).

Similar underestimates have been made for the financial year 2012-2013, to project a fiscal deficit of 5.1 per cent of GDP. The total subsidies bill has been estimated to be at Rs 1,90,015 crore (Rs 1,900.15 billion) a good 12 per cent lower than the subsidy bill for the year 2011-2012.

The government has constantly underestimated the cost of subsidies and there is no reason to believe that it would not be the same for this year as well. Oil prices are unlikely to go down, and inflation is also not seen slowing down. Hence it is most likely that the government will miss its fiscal deficit target for this year as well. The only way to cut this bill is to cut the level of subsidies, and that is unlikely to happen. As a known stock bull said on TV the other day, even Saudi Arabia doesn't sell kerosene at the price at which we do. And that is why a lot of kerosene gets smuggled into neighbouring countries and is used to adulterate diesel and petrol.

4. The government is in a huge debt trap:
The fiscal deficit target for the financial year 2012-2013 has been set at Rs 5,13,590 crore (Rs 5,135.9 billion). The government raises this money from the financial system by issuing bonds which pay interest and mature at various points of time. Of this amount that the government will raise, it will spend Rs 3,19,759 crore (Rs 3,197.59 billion) to pay interest on the debt that it already has. Rs 1,24,302 crore (Rs 1,243.02 billion) will be spent to payback the debt that was raised in the previous years and matures during the course of the year 2012-2013.

Hence a total of Rs 4,44,061 crore (Rs 4,440.61 billion) or a whopping 86.5 per cent of the fiscal deficit will be spent in paying interest on and paying off previously issued debt. What this means is that new debt is being issued to pay off old debt and pay interest on it.

The situation is similar to that of an individual who takes new loans to pay off older loans or rotates credit card debt across his various credit cards. The government can keep doing this for a long period of time because in the worst possible scenario it can print money and repay the debts that have accumulated and in the process reduce the value of the domestic currency. This is what many governments in the developed world are doing right now. You and I can't do this and ultimately will fall prey to debt collectors or will end up behind bars!

5. Interest rates will continue to be high:
As explained above the government finances its fiscal deficit by issuing bonds on which it pays interest. Who buys these bonds? These bonds are primarily bought by banks which by law need to invest 24 per cent of their deposits in such bonds. At the same time the government is also competing with private companies and you and I for this money. The banks have the option of lending their deposits to companies and also give it out to individuals in the form of car loans, home loans, credit cards, personal loans etc. Hence the government has to offer a higher rate of interest on its bonds. Given this, the rate of interest charged by banks on all other forms of loans goes up because they are more risky than lending to the government. Hence if the government is offering a rate of interest of 8 per cent on its bonds, then the banks are likely to charge more on all other forms of loans that they make. So the next time the finance minister talks about the interest rates going down, be skeptical. The interest rates cannot go down as long as the fiscal deficit doesn't go down and that doesn't seem to be happening any time soon.

Vivek Kaul is a writer and can be reached at

Monday, April 9, 2012

Let your money grow

This article was first published in Postnoon on April 6th, 2012

Laxmiamma has been putting away the Rs500 that she saves every month, under her mattress. This has been going on since 2002. She likes the smell of money whenever she picks up the mattress. She likes to keep counting them. She likes their fading color; it indicates that she has been saving since really long and speaks volumes about her discipline!

Somewhere in her heart, Laxmiamma has the desire to buy back the gold bangle that she had to sell off when her husband took seriously ill some 25 years back and the family needed the money for his treatment. The bangles were a wedding gift from her grandmother and had 25 gms of gold. They were her pride. She felt like a queen when she wore them.

Alas, there is still a long way to go. She only has Rs61,500 (500*12*10yrs3months)under the mattress. Two years back when she had gone to the Jeweller, he told her that it would cost her Rs40,000. When she went with Rs40,000 to him, he said that the price of gold has gone up and it will cost 60,000. Three months back when she went with Rs60,000 to him, he said that now the bangle will cost Rs70,000. “If this is the way the price keeps going up, I’ll never be able to buy those bangles”, thought Laxmiamma with tears welling in her eyes.

This is the story of a lot of us. While prices keep going up, our income and savings do not go up in the same proportion. And this is where Prof. Nicky enters the scene.

Prof. Nicky does not promise to solve all your financial problems or make money grow on trees. Prof. Nicky gives simple tips on money and investment, which might help ease your situation.

Enter Laxmiamma and Prof. Nicky.

Prof. Nicky: Laxmiamma, why do you keep your money under the mattress? Does it grow there? And what if there is a thief in the house one day? Why do you take the risk of keeping it at home? Why don’t you invest it? In this way, the money is not only safe, it grows too! Yes, money can grow if invested well.

Laxmiamma: “You mean keep it in the bank?”

Prof. Nicky: That is the easiest way to invest. You could at least start by putting your money in the bank. Infact, you would have been able to buy your gold bangles by now if you had invested your money in a recurring deposit with a bank every month. By now you would have Rs84,682/- (using 6% p.a. interest and the Future Value of Annuity Formula) in your account instead of Rs61,500/- under the mattress.

With popping eyes, Laxmiamma asks, “Really?”

Prof. Nicky: Really. You might actually have earned even more, if you had invested in other assets like Equities, Mutual Funds, Bonds, and Derivatives. In the past ten years, the Equity indices have given over 400% returns in India. Of course with return comes risk, but one must balance the two and invest in asset classes where they are comfortable with the risk.

Laxmiamma: I understand that I should invest. And I am going to start by putting my money in the bank from now on, rather than under the mattress. But pray do tell me more about risk and return and these other asset classes that you have mentioned.

Prof. Nicky: I will tell you that in this column some other time. Till then, why don’t you think about risk and return in our day to day affairs?