Volume 2, Issue 3
September 3, 2011
Vinod gupta school of management, IIT KHARAGPUR Quantitative Easing—a double edged sword?
About Fin-o-Menal Fin-o-Menal is the Fortnightly Financial News Letter of VGSoM which is published by Finte`est, the Finance Club. Editors Mouli Ghatak Sagar Kapoor
Rates As On Sept 3, 2011
Editors’ Note Watch out for a completely revamped and refreshing look of Fin-o-menal from the next issue.
The present state of the U.S. economy can be personified as an ill patient, heading towards immobility, subjected to drugs, not known to be effective or safe. The drugs refer to the concept of Quantitative easing. The term has been in the global news as much as Anna Hazare has been doing the rounds in India. Let us examine this term closely.
result, the ratio of money in circulation to the goods and services would rise, the aftermath of which is a definite inflation. The Fed can counter this by selling off some of the huge inventory of bonds but by doing so, the interest rates would increase because just as increasing the demand for bonds lowers the interest rates, increasing the supply raises them. If inflation rises to uncontrollable levels, the Fed has to sell off the bonds which would drain out the money from the private economy at a rate that could result in a sharp recession, one that the world economy witnessed during the early 1980s.
To encourage public buying and discourage them to save, Central Banks’ resort to lowering of interest rates in a slow economy. But with interest rates in the developed nations hovering around the zero mark, there is no option available. The apex banks then resort to an unconven- The after effects of the first two rounds of QE tional method of "Quantitative Easing", which have raised the eyebrows of many economic exinvolves pumping electronically created money perts and policy makers, who question the feasibildirectly into the economy, ity of having a QE 3. by buying private bonds, Round 1 of QE was ansecurities and mortgages nounced during the refrom other banks and financession of 2008 to stabicial institutions. Thereby lize a struggling econothe QE helps in liquidating my post the housing the market which results in bubble and the Wall rise of asset prices, viz. Street crash. Consequentshare prices, real estate etc. ly in 2010, the FOMC This increases the national (Federal Open Market wealth and also the availaCommittee) announced a bility of cheap credit en$ 600 billion of second courages buyers. It also round of QE in order to helps in devaluing the curpromote a stronger pace QE — A Boon or a bane? rency, which influences the of the economic recovery exports’ of a country. The and to ensure that the increased demand ramps up production which levels of inflation is at levels with its mancreates employment and enhances the levels of date. Experts now argue that when QE 2 was economic activity. announced last year, the unemployment level was It is not all that rosy though. QE may seem to be 9.5%, now it is 9.1%. Neither is the dollar pera rational response to an economy in dire straits, forming too well (presently rated 6.8% lower than with nearly zero interest levels and high levels of what it was when QE 2 was announced!). Things unemployment, but the inflationary aspect of QE look gloomy with the economy growing at a yearmay easily go out of control. ly rate of 1% in the second quarter, a miniscule increase from a growth of 0.4% in the first quarter Let us imagine a situation where the central bank of the year. Factors such as high unemployment lends out the excess cash (it creates through QE) levels (9.1%) and close to zero interest rates from the Federal Reserve bank accounts which (0.1%) are responsible for the sluggish quarterly results in increased consumer spending. As a performance. In his address to the nation in
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Volume 2, Issue 3
Markets This Week Index
Opening Value (Aug 25)
Closing Value (Sept 2)
August 2010, the Federal Reserve chief, Ben Bernanke promised that the Fed would take all possible measures to boost America’s sluggish growth. Exactly a year later, Fed chief calls upon the politicians to take the initiative to do more. Strategically, given the fragility of the economy it is a timorous response. Regarding the mayhem in euro-zone, Bernanke said that he was confident that the policy makers and concerned people would appreciate the gravity of the situation at stake and act accordingly to resolve the issues. The discord between the situation and his response is quite obvious. He is helpless. The Fed could not have been in a "BETTER" lose-lose situation. There is overwhelming evi-
September 3, 2011
dence that QE 2 was a big failure, that gave rise to high inflationary levels that dented the middle class, but it remains to be seen whether the Fed launches a different set of tools or pulls out another rabbit a.k.a. QE 3 from its hat. The Fed needs to work in close co-ordination with team Obama and firstly look towards taming inflation before launching QE 3 or may be, implement a completely different set of tools to revive the global bourses. Well, “to QE or not to QE” remains a moot issue that needs to be addressed tactfully in the near future. (Contributed by : Balajee Rao, MBA 1st year)
(As on September 2, 2011)
The coolest JOB ever Commodities This Week Commodity
(As on September 3, 2011)
Sectors This Week Indices
(As on September 2, 2011)
“Lance Armstrong is to Tour De France as Steve Jobs is to Apple”, that is the stature of this phenomenon called Jobs. Although his stint as the CEO of Apple Inc has terminated, he is no way bidding adieu to the world of technology. In his letter of resignation to the board of directors he mentioned that he would be “watching and contributing” to Apple’s success as the chairman. Battling pancreatic cancer and a liver transplant in a span of seven years can take its toll, but it was not to be with Jobs. Being on a medical leave for a good part of the last two and a half years, Job’s passionate involvement ensured that Apple delivered products which changed the perspective of generations to come. The market value of Apple Inc. rose nearly four times, making it comparable to the GDP of some nations! Once ousted from Apple Inc. by the board of directors owing to a power struggle in 1984, few would have fathomed that Jobs would drive the organization to the pinnacle of acclaim (it was rated as the most admired company in the United States consecutively for the last three years). The social networking sites such as Twitter, Facebook were inundated with messages, paying tribute to the visionary. “What makes Steve Jobs particularly special is that it seems like he has personally handed you an iPhone or an iPad. So it feels like a gift from a family member”, says J. Krosnick, a psychologist from Stanford. “Apple won’t change; I will not mess with the formula that has worked so well for years”, assured Tim Cook, successor to Jobs. John Sculley, the other half of the “dynamic duo” at Apple stated that Jobs timed his resignation to perfection. “It would not have been good for Apple had he stepped down before the launch of the iPhone and the iPad”, observed Sculley. He assured that Jobs has left Apple in a perfect state for the coming cloud and mobility era. In a career spanning nearly 35 years, Jobs had to take some tough decisions in order to ensure
things went the way he wanted to, which invariably turned out to be the right choice. In the early 90s the industry giant looked fragile on account of mismanagement. However with the launch of the PowerBook Series, Apple garnered nearly 21% of the market share in less than half a year. It was in the year 1996, when Jobs returned to Apple as the Chief Executive Officer. He immediately decided to buy NeXt (USD 375 million), a company founded by Jobs when he was not a part of Apple. He also resorted to stern measures like shutting plants, laying off thousands of workers and selling of stock to arch rival Microsoft so as to receive a cash infusion of around USD 150 million. The organization underwent some sweeping changes during the next two years. It was in 1998 when the iMac was launched (a true blockbuster) resulting in 94% gains on net income, profits ballooned to USD 600 million and stock prices shot up 140% much to the delight of the investors. With a share price of USD 190 in May 2008 during the pre-recession period, the present share price of Apple Inc. “stands out” at USD 384. It is a testimony to the fact that Jobs understood the customers’ needs and never compromised on quality. Although the fact that Jobs is no longer with the company may sound like music to the ears of rivals like Samsung, but it is rest assured that Tim Cook has his task cut out to maintain the legacy of his predecessor. The Michelangelo of the digital industry revolutionized the music, mobile and the electronic industry and has set a benchmark that is to say difficult to maintain. A full day in Apple’s Cupertino headquarters during his last day as the CEO is nevertheless a sign of his commitment. As he fondly referred to Wayne Kretzky’s words “I skate to where the puck is going to be, not where it has been!” (Contributed by: Balajee Rao, MBA 1st year)
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Volume 2, Issue 3
Did You Know? Prior to a major homepage redesign back in 2007, Facebook’s front page used to feature a man’s face partly obscured behind a cloud of binary code. Dubbed the “Facebook guy,” the mystery man was not known. But now, David Kirkpatrick has revealed in his book The Facebook Effect that the image is a manipulated photo of Al Pacino created by a friend and classmate of Mark Zuckerberg.
International Markets this week
US Dow Jones
London LSE 5,292
Japan Nikkei 225 8,950
HongKong Hang Seng 20,212
(As on Sept 2, 2011)
September 3, 2011
and the BAD about Infra BONDS
Infrastructure Bonds and benefits A bond is a debt investment by the virtue of which an investor loans money to an entity (either corporate or government body). The amount is borrowed for a defined period of time at a fixed interest rate. One of the benefits of investing in Infrastructure Bonds (in India) is that it provides for tax savings (under Sec 80CC wherein it is stated that one can invest up to Rs.20,000 for additional tax deduction in excess of the current tax slab of Rs. 1,00,000). Inflation and Interest rate movements impact our investment decision in the infrastructure bonds. Who are issuing these Infrastructure Bonds? All Registered companies in the Financial Services and Non Banking Financial Corporation as classified by the Reserve Bank of India in the Infrastructure space. The expansion of capital markets and accompanying private capital flows provide new prospects of financing the infrastructure projects in emerging economies like India. The money raised is predominantly invested in Infrastructure projects. The Union Budget for (2010-11) introduced infrastructure bonds to help finance infrastructure projects which usually take three to ten years to complete. Resident Indian individuals and HUFs (Hindu Undivided Family) can invest in the bonds and get a deduction of maximum Rs.20,000 in computation of taxable income for the current financial year. Individuals investing in tax-free infrastructure bonds can achieve a tax-saving of Rs.2,000Rs.6,000 per annum depending upon the applica-
ble tax slab. The bonds have maturity period of 10 years with a five year lock-in period without a buy back option from the issuing company. The major problems: It is believed that the lock-in-period of five years is one of the major deterrents for a prospective investor in the infrastructure bonds. Despite the merits, the total investment in these bonds has not reached the requisite level. In order to lure investors towards infrastructure bonds, the bond issuer should diminish the lock-in-period. In addition, a minimum maturity of five years and a withholding tax of 20% on the interest received make these bonds unappealing. Also, due to high inflation, the central bank is forced to raise the short term rates making the yields on short term bonds more attractive than that of the bonds with longer maturity period. Moving Ahead: Not only the infrastructure bonds, but the entire bond market in India is plagued by lack of international participation owing to the problems incurred due to the regulators. Furthermore issues like high stamp duty, lack of speedy laws and unawareness are also equally responsible. The retail investors and FIIs need to be encouraged for active participation so that the investor base in this sector may expand. Currently the scenario in the Infrastructure Bond segment is in its embryonic stage both in terms of the market involvement and the framework required for effectual price discovery. (Contributed by Partha Pratim, MBA 1st year)
"Developments this summer have indicated that we are in a dangerous new phase. To stop the fragile recovery being derailed, we must act now." - IMF chief Christine Lagarde Toon of the week
Q u i c k Q u o t e : Money is not everything in life! There are Stocks, Bonds, Real estate, Gold and Silver — Anonymous
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Volume 2, Issue 3
September 3, 2011
The Hawk on the street : RBI and its stance on inflation The Reserve Bank of India (RBI) has vowed to continue with its anti inflationary stance with respect to the monetary policy, even if it comes at the cost of sacrificing growth. The message is clear. The apex bank of India is not going to back down from its July monetary policy review until the inflationary pressure subsides despite the negative global environment. In its annual report released last week, the apex bank expressed it unwillingness to accept the current high inflation levels as the “new normal” and reiterated that it will continue to tighten the monetary policy in a bid to protect the savings of the common man in the country. Inflation, as measured by wholesale prices, has moderated a bit to 9.22% in July compared with 9.44% in June consequent to the easing of the rise in food articles’ and petro-products’ prices. This, however, is far above RBI’s projection of 7% by March 2012. In the immediate future, the inflation is projected to hover at high levels (around 9%) and ease to 6.5% in March, 2012. Policymakers have detailed an incomplete pass-through of high global commodity prices, continuing food price pressures and rate of rise in manufacturing prices as the reasons for a near double-digit inflation. The report also underlined that the lack of support from the government, limits the RBI’s ability to fight inflation. It also warned that that government was likely to overshoot the budgeted fiscal deficit target of 4.6% for the current fiscal year.
Since March 2010, RBI has raised its key policy rates’ 11 times to contain inflation. The last such hike was in July when it had increased the Repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.25 per cent to 7.5 per cent. This had resulted in the Reverse Repo rate under the LAF to be automatically adjusted to 6.5 per cent and the Marginal Standing Facility (MSF) rate to 8.5 per cent. These steps were taken despite a majority of its members favoring a status quo due to global uncertainties in Europe and US. RBI is due to announce its mid quarter monetary policy review on 16th September and experts are of the opinion that “Central bank will go for another round of rate hike to arrest the supply led inflation , notwithstanding the adverse global scenario.” This increase in policy rate will force the banks to make money dearer to borrowers. In order to protect their own margins, banks will be forced to increase the lending rate. Also, if the global recovery weakens ahead then the movement of the global commodity prices will again have an adverse effect on domestic inflation. Against this backdrop, RBI’s decision to decelerate short run growth to curb the inflationary pressure doesn’t seem too aggressive.
(Contributed by Jayati Singh, MBA 2nd Year)
Is all that glitters only GOLD? It seems that the economic crisis has again arrived to haunt us as it did in the year 2008. The traditional safe avenues of investment have become increasingly unattractive to invest in; investment in Gold has come up as a safe haven for distraught traders in these troubled times. The S&P downgrade of U.S. debt surely did serve as a boost to the perceived value of gold within the eyes of capital markets. Furthermore, the ever increasing concern over the debt distress impacting Europe has rendered the euro a similarly distasteful option as a destination for risk-fleeing capital. It is of course worth mentioning that there has been a considerable alteration in the prevailing attitudes of the market towards gold and silver when compared to the financial crisis in 2008. Instead of fleeing gold, investors are visibly turning to it because no other asset shines as bright as it in the whole scheme of things. Defense against Disaster Some proponents of gold like it because they say it has an intrinsic value, i.e. they say that gold has value in and of itself. Hence, as the demand increases, the price of gold increases. Gold, like all precious metals, may be used as a hedge against any form of financial stress viz., inflation, deflation or currency devaluation. The currencies of a
lot many countries are under severe pressure because of massive government deficits and as more money is pumped into an economy, the less valuable the respective currency becomes. If the return on bonds, equities and real estate is not compensating for risk and inflation then the demand for gold and other alternative investments such as commodities increases. The Other Side Buyers are shifting to silver as gold prices are rising. It is getting pretty obvious that the traders are to bet big on silver as correction in the ‘yellow metal’ prices seem imminent. Gold holds no potential for any further return. Any correction in price would fetch losses, as the metal has already become unaffordable after setting a new high every alternate day since the past few months. Silver comparatively is under-bought. Hence, the bullion traders are now running towards silver as an investment option.
(Contributed by: Kunal Verma, MBA 1st Year)
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Mouli Ghatak Sagar Kapoor Editors’ Note Page 1 Watch out for a completely revamped and refreshing look of Fin-o-menal from the next issue. V...