OneMint

What is Balance of Payments (BoP)?

Manshu — Sat, 26 May 2012 23:07:00 +0000

Balance of Payments (BoP) is an account of the international transactions of a country, and shows how the country is faring in trade, attracting capital from abroad, and the effect of that on its foreign exchange reserves.

The budget website has a BoP document and that contains the components of the BoP and understanding the components is a very good way to understand what BoP is.

When talking about the BoP – you will usually hear reference to the current account and the capital account and along with the change in forex reserves these form the most important parts of the reserves. They have mentioned errors and omissions as the fourth part, and I’ve included it for accuracy but if you think about it, that’s not really a head on its own.

Before we go any further, let’s look at this chart that has the hierarchy of these components and then look at each component one by one.

What is Balance of Payments

Current Account

The current account shows you the trade position of the country. It shows you the merchandise imports and exports, and then the invisibles part of it is also trade but it’s that part of trade where there is no physical good exported or imported.

In India’s case, the transfers and grants part of the invisibles is quite big relative to other countries because of the large Indian diaspora.

As far as I know India has always run a current account deficit which means that it has always imported more than it has exported. This is something I’ve touched upon several times earlier and if you want to read more about this you can read the posts on what India imports and exports.

The rest of this is fairly self explanatory so I’ll move to the capital account now.

Capital Account

Where current account shows you trade, capital account can be thought of as the investments part of the international transactions.

This is further broken out into equity and debt investment and the FII money and FDI money is part of the equity investments while the external commercial borrowings, money deposited in banks by NRIs and trade credits are debt investments.

Till recent years, India’s current account deficit was being financed by a capital account surplus which meant that foreigners were buying more assets in India or lending more capital to India than India was doing to the rest of the world, and as a result the foreign exchanges reserves were steadily growing. However, the trend has reversed lately, and even the capital flows have been negative.

Change in forex reserves

The difference between the current account and the capital account is reflected in the change in the forex reserves.

For example, in 2010 – 11 – India’s current account deficit was $45.9 billion but the capital account surplus was $62.0 billion and this resulted in increase in foreign exchange reserves of $13.1 billion. This doesn’t exactly total up due to the effect of errors and omissions.

Conclusion

India’s forex reserves had dwindled to lows of $5.1 billion in 1991 and as a result India had to borrow from the IMF by pledging its entire stock of gold. The IMF simply didn’t lend money against the gold, but India had to physically move all its gold to IMF locations and people talk about Air India planes full of India’s gold.

Though that happened more than two decades ago, it is always fresh in memory for most people and that’s why as soon as the foreign reserves start going down you start reading articles that talk about a BoP crisis or a repeat of 1991.

At over $290 billion, India’s position is far better than it was in 1991 but if you look at the example of any of our neighboring Asian tigers, or even the western countries when they were growing, all of them have grown by relying on exports and running trade surpluses, and that’s what India’s goal should also be.

This post is from the Suggest a Topic page.

You don’t need to buy a children’s plan to invest for your children

Manshu — Thu, 24 May 2012 23:56:36 +0000

I feel that investing is a lot more about emotions than it is about numbers, and it becomes even more emotionally charged when you think about investing for your children.

I regularly get emails about investing for children and there are two common things about all such emails.

The first one is the use of the word “best”. I’ve never seen someone write in to ask about a “good investment” for their children. It has to be the best investment, how can it be anything else?

The second thing I notice about these emails is that they generally refer to a children’s plan or a product that has the word “children” in it.

I think there is a general perception that plans or products that have the word “children” in them are significantly different from other plans, and only these plans should be used when you’re thinking about making investments for your children.

I don’t think there is that much difference though, and I’m fairly certain that if I made a table with the features of 5 plans and didn’t disclose which ones were children plans and which ones were other ones – it would be quite hard even for financial advisers to tell one from the other.

At their core, all plans or products invest in a few asset classes, give some insurance cover and have a certain time frame for maturity.

Instead of being swayed by the adjective of the plan you need to look at the components of the plan.

It’s a great idea to invest for your children and an even better one to start early, but you don’t really need to rely on any children’s plan for that. You can make that plan yourself with a little common sense and the right research.

Everyone knows what the big expenses are going to be – schooling, higher education, perhaps studies abroad and wedding, and if you start planning early and allocate money specifically for a purpose and invest in an asset accordingly you can build a good base for it.

For example, a Rs. 1,011 SIP yields Rs. 10 lakhs in 20 years if the money grows at 12%. You can put this relatively small amount away every month in a balanced fund with the idea that this will be used for higher education, and since you’re not going to need it for a very long time period you can ignore the volatility of the market and keep accumulating the funds. Similarly you can start with goals and work backwards to find a product that suits your need for any other goal that comes to mind.

Plan first, and then buy the product that suits that plan, let the dog wag the tail, don’t let the tail wag the dog.

The Rs. 7.50 Petrol Price Hike and India’s Vicious Cycle

Manshu — Thu, 24 May 2012 00:59:33 +0000

The big news today is the massive Rs. 7.50 petrol price hike and with this, petrol prices have crossed Rs. 73.00 per liter in all the metros with Bangalore being the worst at over Rs. 81.00.

Theoretically, oil market companies have hiked the prices and not the government since petrol prices are “deregulated” but no one even pretends this is true.

In a press release issued today, IOC says that the industry has lost Rs. 4,651 crores since the last price change in December because domestic conditions (read state elections) didn’t allow any price hikes after that.

Currently, the under – recovery on petrol is Rs. 6.28 / liter which is down from Rs. 7.17 / liter in the May 12 fortnight, and 8.04/liter in April 12 2nd fortnight.

The press release also says that the current hike is not enough and there needs to be another hike of Rs. 1.50 for the rest of the year to make up for the losses that have already taken place.

The under recovery on diesel, kerosene and LPG is expected to be Rs. 1,86,000 crores in this year, and the last time the price on these was increased in July 2o11. The under recovery on diesel is Rs. 13.64 per litre and the diesel subsidy was Rs. 81,192 crores last year.

It’s hard to see why diesel prices weren’t increased first, and perhaps that’s only because they will be increased in the days to come.

There will also be a lot of political drama in the next few days where other parties will ask the government to roll back prices and will try to extract as much mileage from this unpopular decision as possible, but it is highly unlikely that anyone will touch upon the subject of how the heck do you pay for all this?

Goa’s CM recently brought out the state budget and reduced petrol prices there but he did increase taxes on a host of things to pay for it, and that’s the reality that everyone needs to acknowledge.

Unfortunately, today we’re having discussions about issues in isolation where we talk about the INR depreciating, or fiscal deficit increasing, inflation increasing or petrol price hikes but not talking enough about the inter linkages between these things. Petrol price doesn’t exist in isolation and nor does the Rupee exchange rate, these things need to be looked at holistically.

For example, the government will badly miss the deficit target for last year and one of the reasons for that is they couldn’t raise enough money through PSU disinvestments last year.

They rushed through ONGC FPO and when that had a luke warm response, LIC picked up a stake in it on which it is sitting at a loss right now.

Then recently Moody’s downgraded LIC because they said the credit worthiness of LIC is highly correlated with the government’s credit strength and this downgrade reflects badly on both of these entities.

The downgrade affects how much money flows in India by way of FII investments and that’s bound to worsen by this which in turns affects the Rupee exchange rate and contributes to its depreciation.

This in turn makes oil pricier and the hole in oil marketing companies’ pockets become larger who then have to pass over the price to the customer which causes inflation and so on and so forth.

It’s as if India’s economy has fallen into a vicious cycle and the feedback loop worsens the whole situation.

The silver lining, if there is any at all, is that the feedback loop works the other way round too, and India has been through much worse in the past and been able to get through it.

The government (this or the next) can still turn things around and focus on real issues instead of wasting time looking at issues in isolation and trying to “fix” one problem that only ends up making another worse.

Factors to keep in mind while deciding whether to invest in a company fixed deposit or not

Manshu — Wed, 23 May 2012 00:10:37 +0000

Last week I wrote about the two big ideas that you should keep in mind while investing in corporate bonds, and this week I’m going to build on that post and write about some factors that will help you build a negative list of companies that you should avoid buying fixed deposits in.

My assumption here is that you want a lot of safety for your bonds, and a part of your portfolio is already invested in equities which exposes you to risk of capital loss, and that’s why you want to play it really safe when investing in bonds or NCDs of a corporate.

Avoid loss making companies

You will see that the difference between the interest rate of a NCD of a well established large, profitable company and a smaller loss making company is hardly 2 or 3 percentage points, and normally for most retail investors who aren’t going to invest a lot in any NCD – this difference will not translate to much in absolute terms. Keeping in mind the small gain and increased risk, I think it doesn’t make much sense to invest in NCDs of companies that are loss making and not very stable.

Avoid companies where promoters have pledged stock

NSE has data on companies where the promoters have pledged stock to raise money and to me this is usually a big red flag because raising money by pledging stock has got to be one of the very last options for any promoter as it can potentially lead to them losing control on their company especially in the ever volatile Indian markets.

Avoid companies where the auditors have mentioned irregularity

The annual report has a section for the auditor’s report where they give comments. Most of the time you won’t find anything of interest here but in some circumstances, the auditors will give comments mentioning some irregularity which is a red flag because who knows what else is going on?

Avoid over-leveraged companies

This is a relative term because a company like Muthoot has to borrow a lot in order to carry out its business while a company that’s not as capital intensive will not need to borrow so much money in the first place. You can look at the debt equity ratios of similar companies to figure out whether the company is over leveraged or not and usually articles about NCD issues touch upon this point and help get a sense of where the company stands with respect to its peers in the debt it has already taken.

Avoid companies with low credit ratings

Every company is required by law to get a rating for its credit issue when it offers new debt. You can read the rating report as well as what it signifies and stay away from companies that aren’t ranked stable or safe for their debt.

Outside of this, there are plenty of articles online that give you a good idea on what’s going on with a company and you should search and browse through a lot of them before deciding to put your money anywhere.

I think it is better to be conservative and stick to the very best issuers as far as NCDs are concerned because usually the few extra percentage points you get by way of interest won’t make up if even one in ten of your NCDs go bust in your investing life-time.

What is the difference between basic and diluted EPS?

Manshu — Mon, 21 May 2012 23:46:34 +0000

The P/E multiple or the Price / Earning ratio is probably cited more than any other when it comes to financial numbers.

The EPS (Earnings Per Share) is one of two inputs of the P/E ratio and companies have to report two types of EPS numbers – Basic EPS and Diluted EPS.

Basic EPS is calculated by taking the total net profit and dividing it by the total number of ordinary shares that are outstanding for the company.

If the total number of shares were increased then the profit per shareholder would reduce and that’s primarily what happens in the case of diluted EPS.

Diluted EPS is calculated by assuming that everyone who has an instrument that can be converted into an equity share converts it into an equity share and so the total number of outstanding shares of the company increase, thereby reducing the EPS.

Stock options are one example of these kind of instruments, preferred stock is another, and in the case of many Indian companies – FCCBs (Foreign Currency Convertible Bonds) feature prominently among instruments that can dilute the earnings. Subject to certain terms, all these instruments can be converted to ordinary shares by the instrument holders and if they did that then the profit available to each shareholder will be reduced and earnings will be diluted.

Now just because an instrument can be converted into a share doesn’t mean that it will be converted and that will be true in a lot of cases where the dilution occurs due to preferred stock or FCCBs.

The other aspect of this is that when you convert such instruments to ordinary shares the company is relieved of the obligations that arise due to them. So, if FCCBs were converted to shares then the company no longer needs to pay any interest on them and if the preference shares were to be converted to ordinary shares then they won’t have to pay dividends on that any longer, so that will actually increase the profit available to shareholders and that’s why the net profit that’s used to calculated the Basic EPS and Diluted EPS is different.

Although not exactly diluted EPS, one thing that comes to mind while talking about this subject is when companies do an IPO – they often sell promoter stock and issue new shares as well.

The EPS and PE ratios that are normally reported in the papers and present in the prospectus are the ones that are calculated before the new shares are issued. But that is a bit inaccurate because as soon as the IPO hits the market, the new shares will be issued and the earnings will be diluted to that extent. I have an extensive post on that with the specific example of Power Grid FPO and that will make a good further subject and also give some context on how the dilution actually works with some concrete numbers.

As always, questions and comments welcome!

This post is from the Suggest a Topic page.

Rupee slide is a symptom, not a problem

Manshu — Sun, 20 May 2012 20:14:04 +0000

As the Rupee hits new all time lows against the Dollar, it is natural to look for ways to arrest this slide and look for solutions to this problem.

The problem however is the not the Rupee slide itself – the fall in the Rupee is the symptom of underlying problems and you have to look at those problems to find solutions.

You can take short term measures to stop the fall but if they are not backed by long term efforts to correct the underlying problems, nothing will change and we will have to deal with the same situation 8 or 12 months down the line.

RBI allowing banks to set their own interest rates on NRE deposits and making these NRE deposits tax free is a good example of a short term measure. That would have surely helped bring in foreign exchange at the time, but since January, the Rupee has already lost 9% against the Dollar so whatever gains an NRI will make on the interest have already been nullified by the loss in the value of Rupee, and any similar measure is not going to be as attractive a second time.

While such short term measures are essential at the time of volatile downturns, past experience has shown that they aren’t enough to reverse the trend over a longer duration.

The exchange rate depends on the demand and supply of INR and foreign currencies, and that relationship is shown in the current account and capital account of the country.

Simply put, the current account is the account that shows the imports and exports of goods and services and the capital account is the account that shows the money invested by foreigners in India, and money invested by Indians outside the country.

As far as I know, India has never had a trade surplus, which means it has never exported more than it imported and the deficit that occurs as a result of this has been met by investments by foreigners in the form of FDI and FII inflows in India. But recently, even those have slowed down putting pressure on the currency.

A simple fish – bone diagram will help explain this better.

Rupee Slide

Current Account Deficit

The current account deficit as measured by the difference between exports and imports of goods and services has never looked in worse shape. The trade deficit last fiscal was $184.9bn, and this is as high as 9.9% of GDP.

On the import side, higher oil prices, and gold imports are causing a lot more outflow than previous years and as I wrote in January, these two alone contributed to 43% of Indian imports.

Exports have been slowing down too and in fact March of 2012 actually saw a drop in exports from a comparable period a year ago, something that hadn’t happened for more than two years.

Capital Account Deficit

On the capital account, FDI has been in the news for all the wrong reasons. Even historically, India has attracted lower FDI when compared with other emerging countries and the lack of reforms and the inability to make any progress on issues like FDI in multi-brand retail means that India has been below its potential in attracting FDI from the world.

FII investments have dried up due to the global flight to safety because of the resurfacing Euro concerns, but even before that, after the GAAR announcement in the budget, the FII volume had reduced quite a bit in the Indian market.

Investments also depend on the general economic environment and that hasn’t been good in the past few years leading to an environment which doesn’t inspire confidence in investors (both global and domestic) to put money in the market.

If you look at these factors, some of them are within India’s control and some aren’t – India can’t do anything to influence oil prices, or do anything about the Euro problems but it can certainly take steps to simplify labor laws, get clearances fast, build infrastructure to get foreign investments and other such things. These things need to be done anyway to help improve the standard of living of the people in the country, the volatile Rupee fall just gives a sense of urgency to carry them out.

Facebook, Grexit and Investing Wisdom

Manshu — Sat, 19 May 2012 00:37:59 +0000

The big news today is that Facebook barely traded above its listing price and had it not been for the bankers behind the issue, the stock would have surely ended the day in discount. This probably doesn’t bode well for the future but then with the market you never know.

There were a number of articles about Facebook’s valuation the whole week and most people expressed skepticism about the valuation, however none of them come even remotely close to the excellent valuation done by professor Aswath Damadoran.

All this excitement took all the attention away from the other big thing that’s on everyone’s mind these days – Grexit.

Hemant has a good article on what you need to think about when you start your own business.

Deepak Shenoy laments the recent moves to curb freedom as evidenced in a court order to ban Vimeo and the new set of IT Rules announced by Kapil Sibal this week.

Harvard Business Review on building your personal user interface.

Finally, the best thing I’ve read in a long time – pearls of wisdom from Paul Kedrosky on Facebook in particular, and investing in general.

Two big things to keep in mind while investing in company fixed deposits

Manshu — Wed, 16 May 2012 23:24:50 +0000

Rakesh had a comment on what parameters should be checked before investing in a company’s fixed deposit, and when investing in fixed income there are two big things that you should keep in mind, and I’m going to talk about them first before getting down to specific parameters in a subsequent post.

Investing too much money in just one instrument brings risk without reward

Unlike equity, there is no disproportionate reward for concentrating all your fixed income investments in one instrument.

What this means is that if you had Rs. 1 lakh today, and you invested all of that in a stock with the hopes that the stock triples in a year you could go broke but you could also get rich because there is no limit to how high a stock can go.

But the same thing doesn’t apply to fixed deposits. If a smaller, riskier company is offering you 13% per year, and a bigger more stable company is offering you 10%, when you put all your money at 13%, your upside is just that 3% extra and your potential downside is simply too much because if the company goes bust then you stand to lose not only the extra interest but the principal as well.

I first came across this idea in 2009 when GM defaulted and a lot of its bondholders who had invested their life savings in GM bonds were left holding worthless paper.

I think this is a very important thing to keep in mind while investing in any fixed income instrument whether a company fixed deposit or otherwise.

You don’t know what you don’t know

Manappuram is one company that recently came out with NCDs and their stock along with Muthoot’s stock (which also issued NCDs) recently tumbled when news broke out that RBI was putting some restrictions on gold loans.

This news itself doesn’t threaten the NCDs issued by these companies but it’s impossible for a retail investor to know about these kind of things before they happen and take precautionary measure. There are simply far too many things that you don’t know and only when the event occurs you realize that such a risk even existed.

This is just one example, but this can happen to any company, and just last week news broke out that TV-18′s losses widened which is another company that issued NCDs recently. While that was not as out of the blue as the RBI announcement, I think a lot of retail investors would have been surprised by it.

The two things I wrote about above are nothing new and I’ve written about them earlier as well in different contexts but if you think about them specifically with respect to investing in company fixed deposits, the big lesson to me is that you should always be humble about what you don’t know and appreciate that there is a big risk lurking somewhere and the best way to deal with that risk is to play it safe and spread your money around so that if something does go wrong it doesn’t wipe you off completely for what will be a few extra percentage points of interest.

In a following post I will write about the specific parameters that can help you build a negative list of NCDs that you shouldn’t invest in.

How can the government carry out disinvestment through ETFs?

Manshu — Wed, 16 May 2012 00:10:57 +0000

I read an interesting article about the possibility of the government taking the ETF route to carry out disinvestment, and that can be a novel way to carry out disinvestment because the government did pathetically last year as far as disinvestment is concerned and things haven’t improved much since that time so it won’t be surprising if they aren’t able to do much with disinvestment this year as well.

A bit of creative thinking will help in these times and an ETF to disinvest stocks could prove very helpful in meeting the disinvestment target. This idea is based on Tracker Fund of Hong Kong fund and they have already shown that the model works.

The way this will work is that the government will take a bunch of its listed stocks, and create a basket of shares which they will then sell to other ETF sponsors like Goldman Sachs.

They need to take companies that are already listed like Coal India because if those companies are to be part of an ETF then people need to see what the value of one unit of that ETF will be and that’s only possible if you have some frame of reference which in this case will be a listed stock.

The sponsor will then take those shares and create smaller units with them which can be bought and sold by Authorized Participants, and those APs will in turn buy and sell those shares to the general public.

People will then be able to trade the ETFs in the market and instead of buying a single stock, they can get an ETF with a bunch of PSUs.

The utility of the ETF will depend on the constituents and how low cost it can be and I’m skeptical that this will really be useful to an investor in the sense that it helps them fill a gap in their portfolio that they otherwise would have had.

Having said that, I’m fairly certain that this will do better than individual PSU stock sales because of the marketing muscle of the fund company that will combine with the buzz that’s always created when a PSU is disinvested and the novelty of this method. That alone should be enough to give enough legs to this scheme to succeed and that will be good for our cash strapped government.

Part 4: How should beginners approach investing in the stock market?

Manshu — Mon, 14 May 2012 22:41:48 +0000

In part 1 of this series I wrote about the evolution of an investor to either a trader or a long term investor, and said that I favor long term investing to short term trading.

Then in the second part I wrote about the implicit assumption that a long term investor makes which is over a very long period of time the market will move upwards, and then also spoke about the nature of a share or stock. That nature I said was that a stock is a representation of the earnings of a company, and looking at it that way helps you stomach the volatility that exists in the market and deal with the daily ups and downs.

In the third part I wrote about regular investing, calibrating those investments and three big ideas that drive that type of investment. First one was my expectation that markets will edge higher over a time period of 3 – 5 years, second one was that markets don’t move in a linear fashion and a lot of the gains that have come in the past have come from small time periods that have surprised a lot of people so you don’t want to get out of markets completely, and finally I said that while timing is not be possible, you can vary how much money you put in the market and take advantage of falls.

I ended that post saying that I’ll deal with what are some of the instruments that you can use to execute this strategy, and that’s what I’m going to write about in this post.

ELSS Tax Saving Mutual Fund

If you want to invest in equities then ELSS funds are a great way to get started. They are one of the best options in the 80C limit since they have the lowest lock in period, and by investing the equity portion of your portfolio in ELSS, you ensure that you get some tax benefit right away which can be pretty significant if you are in the 30% bracket and the advent of some great tax free listed bonds also means that even if you don’t invest in bonds with 80C tax benefits you can still get good yields so you can keep 80C for equities.

Here is a list of good ELSS tax saving mutual funds that I updated late last year and this gives some good options that you can select one or two from.

I think ELSS funds should be on top of your list if you’re looking to get started with investing in shares.

Balanced Mutual Funds

Balanced funds may appear an odd selection when you first think about them because most of them invest about 35% of their assets in debt products, but past performance has shown that balanced funds have given returns comparable to good diversified equity funds, and that stems from the fact that the debt portion of it protects you from the sharp downturns that Indian investors have had to face many times during the last two decades, and there’s hardly any reason why that would stop from happening in the future.

Here is a list of some good balanced funds that you can choose from.

Good Diversified Funds

Hemant has a great article on some of the best diversified funds with some great comments that can be used to select a couple of diversified mutual funds to add to the balanced funds in the list above.

Nifty Index Funds

Internationally, index funds have done a lot better than active funds, I believe this is not true for India, and I’ve highlighted the reasons in this post (also read instructive disagreeing comments from Nitin).

Having said that, I feel if you are going to construct an equity portfolio, at least a small part of that should be a low cost index fund based on a large cap index like the Nifty or Sensex. I say that because costs eat into returns and index funds are lower cost (thought not as low as American funds) when compared with active funds, and have also performed decently in the past and give you the peace of mind that the fund manager won’t be screwing around with your money. The reason to stick to the big indices is that the Indian market is not very deep and volatility becomes quite high when you start moving towards the smaller caps.

These are some options from which you can consider choosing from, and as to the question of how much money you should invest – I think a little less than you are comfortable with is a good way to start.

I say that because it is hard for people to come to terms with how violently and quickly the market can fall, and how difficult it is to not panic and sell when you own funds that have gone down 15% or 20% in a month or two. Getting into the market with lower amounts will ensure that you’re able to deal with this volatility and get a grasp on how you feel about the market and feel more confident going in with bigger sums later on.

If you’re starting off then it is likely that you are in your twenties and still have a good 30 – 40 years of investing ahead of you, don’t rush to put all in and then later find out that you weren’t ready to risk that much money. More than losing the money, it will turn you away from the market completely and that means you lose out on what is potentially a great opportunity to steadily grow your money in years to come.

This is the last post of this series, and I must admit this was a lot harder than I thought it will be and took a lot longer than I thought it would take, so if you found it useful please do forward the links to your friends, and as always, all comments are welcome!