EPFO – The new savior for Govt. divestments

“EPFO to invest 5% of its corpus in stock market” made headlines during this week. 

(Link: http://www.livemint.com/Politics/Zt14mjK3CJKcTDDR5PO5AL/EPFO-to-invest-5-of-its-corpus-in-stock-market.html).

Image Source: Financial Express

Why Now?

Around Rs.8,000 crores funds from Employee Provident Fund (EPF) will find way into Exchange Traded Funds (ETF) of Public Sector companies in which Govt. wants to divest. During the last fiscal year, Govt. could not meet its divestment target. So it had to find new players to help them  with their divestment plans. Finance ministry did not have to try hard to find the elephant in the room. Now EPFO will become another savior along with LIC, UTI getting into market when there are no sufficient takers for the Govt. stake in PSU’s when Govt. wants to sell.

Will it affect EPF subscribers significantly?

EPF is a pensioner’s fund. To keep its risks lower, it had never put money into equity market so far. Now, 5% of the corpus will hit stock market. EPF subscribers need not worry much, as 5% exposure to equity market does not alter risk profile significantly and moreover the PSU’s like ONGC (to which major chunk of money would go now) have given decent returns. LIC (which also has a larger cash pool like EPF) is one of the market makers and had made good money over the last decade in the stock market. Another positive factor is reducing Govt. ownership and increasing retail participation through EPF might make those PSU organizations more responsible in their operations and finances.

Times Ahead

But Govt. would not stop with 5% (this is just initial step) and will increase it to 10% or even higher levels in the coming years. That will bring liquidity to stock market but at the risk of employees contributing towards their retirement. Risk has its rewards too. If PSU become more efficient and offer better returns for their shareholders, EPF subscribers will also see their savings growing at a better rate. Else, this would become another form of tax on them.

RBI chief vs former SBI Chief

It is former chief of SBI vs Governor of RBI. Look at these two articles:

• Former SBI Chief Criticises Rajan for Not Cutting CRR (Link: http://profit.ndtv.com/news/economy/article-former-sbi-chief-criticises-rajan-for-not-cutting-crr-752874)

• Banks Not Lowering EMIs is 'Nonsense', Says Raghuram Rajan (http://profit.ndtv.com/news/economy/article-banks-not-lowering-emis-is-nonsense-says-raghuram-rajan-752845?utm_source=taboola)

Former SBI chief says CRR cut would have allowed banks to reduce interest rate but RBI Governor disagrees. Who is right? While I am no expert on this subject, here is my attempt to understand the situation objectively. Let us understand CRR first.

Purpose of CRR

Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits (currently set at 4%) of customers, which commercial banks have to hold as reserves either in cash or as deposits with the central bank. It is idle money which cannot be lent, so Banks do not earn any interest on it. But it comes at a cost as banks have the obligation to pay interest to depositors on the whole of deposits. Banks do not like this and have been asking RBI to scrap CRR or reduce it. It has come down from a high of 15% during 1990’s to 4% now. But RBI will not scrap CRR as it does serve an important purpose. RBI wants to ensure that Banks do not run out of money when depositors want to liquidate their deposits. CRR along with SLR (at 21.5%) acts as a cushion of safety. When NPA’s are rising which will take out the money from banking system, Banks can still meet their payment obligations to depositors using this buffer. That makes faith in banking system remain intact in troubled times but the absence of it can threaten smoother operations. That is the interest of RBI. But Banks want to maximize their profits.

Credit growth and NPA

Let us look at how banks have managed credit growth and NPA. 

The first chart shows overall trend in credit growth is down but it is important to note that it is SBI and nationalized banks experiencing slower growth while private sector banks are not experiencing such a severe slowdown.

Credit growth in % (Data Source: RBI site)

Similarly SBI and public sector banks have more non-performing assets than their private counterparts. The written off loans reduce the money in banking system. Now we know who managed their loans better.

An IMF report says the percentage of debt owed by loss-making firms reached 23 percent in 2013/14. (Link: http://www.niticentral.com/2015/03/16/imf-report-on-indian-corporates-wakeup-call-for-government-of-india-306869.html). 

Public sector banks have approx. 4% of net NPA (and around 6% gross NPA). If they had done proper due diligence before issuing loans and acted tough on recovering their loans, they would have fared better. But they don’t have all the control as they (public sector banks) all report to Finance ministry and obey the instructions from them. Then why criticize RBI for not cutting CRR? What else to do in idle time? RBI sits on idle money with a purpose. But banks would have made their money without bothering much about CRR.

Opinion: The New Silk Route to World Bank of China

Old route or a grand plan?

The New Silk Route is not just another road or route for trade with China. And the new Asian Infrastructure Investment Bank is not another cooperative global bank. They both are set to accomplish much more than business. Both are promoted by China to make it economic superpower and their currency a reserve currency, an alternate to Dollar and Euro. Here is how.

Interest free loans

The US dollar as a reserve currency, dominates international transactions now (even when US is not involved in transactions). For example, when India buys Gold from Switzerland or Gulf buys clothing from Asian countries, they are likely to carry out the transactions in dollars. Companies in both countries must possess dollars to carry out the trade, which leads to greater demand for the dollars. So the Central Banks around the world hold majority of their foreign exchange reserves in dollars. That is like interest free loan to US Govt. which gets capital at no cost to spend on the welfare of its own country. Who would not want interest free loan? China is on its way now.

Higher reserves for a weaker currency

For many years, China had pegged its currency to dollar. That helped China to mop up trillions of dollars reserves and print its currency to fund domestic growth. Once you have enough money, you do not wish to be a daily wage labor; instead you want money to work for you. As the wages in China went up, its advantages of low cost manufacturing hub started losing out, and China is planning to avoid dependency on exports for its economic growth by devaluing its currency. It has to find ways to slowly disengage itself from US and dollar reserves. But that will hurt growth and converting dollar into yuan may cause inflation.

Grand plan

What if those forex reserves are used to fund someone else, let us consider, you help neighboring countries to build roads to China and finance it? Nice, you found a way to lend your money and also upgrade your infrastructure at the borders. Those roads help boost bilateral trade, avoiding the use of dollar as China will insist it that way. That means China can reduce its dollar reserves and convert it into its own currency and lend it through Asian Infrastructure Investment Bank for building the silk route. As many partners begin to accept Yuan/RMB for trade, it becomes a reserve currency for Asia and some parts of Europe. China can go on printing which will end up as reserves in many countries replacing dollar at least partially. That lets China do what US does now, make others fund your growth.

Roadblocks

Everyone has a plan 'till they get punched in the mouth, so said Mike Tyson. Resisting China’s moves, the US and Japan have refused to join the Asian Infrastructure Investment Bank. That means Russia is in. India happily joined the Bank as it is set to get second biggest share there. One needs to see how China’s ambitions will take shape when its neighbors want to see the end of dollars dominance but are also wary of China’s arrogance and intriguing strategies.

Times ahead

‘The New Silk Route’ will not be built in a hurry and dollar’s dominance would continue for some more time. But most of the world’s growth is coming from Asian countries and they are free to choose the currency they want to use. The new Bank would come in handy to limit the use of dollars over a period of time. If and when that happens (I guess it is at least a decade away), dollar would not command the same value, wages in Asian countries would rise quickly from here, and the gap in GDP valuation (at current prices) would narrow between US, China and India.

The Temple Dancer by John Speed

This is one more book I thoroughly enjoyed. It is set in 17^th century of India. Two women protagonists take the Centre stage and crossover their paths toward their destinies. Dasanas is a Portuguese trader family based in Goa, are interested in reviving their trade relations with the Sultans of Bijapur. To make it happen they have something to offer in return to grand vizier of Bijapur, Maya a fine dancer. Portuguese has family bought Maya paying a hefty price and have to send her off to Bijapur. The caravan to carry her is joined by Lucinda, heiress to Dasanas family and Geraldo, a cousin of Lucinda who has arrived in India. The travel is led by settlement man Da Gama, and Pathan to ensure safety of the caravan. Slipper, a eunuch is also part of the caravan, but he is more than company to women in the journey. He is after something (jewelry and a robe cladded with precious stones) which is his but in possession of Maya.

 Journey begins from Goa via the Western Ghats. They are attacked by bandits, many of the guards get killed, Pathan saves Lucinda from the verge of getting killed from bandits and Maya is saved by Da Gama. Their relationships are strengthened after the incident. They take rest at Chitra’s house in Belgaum. Maya is attracted to Geraldo, and would like to forge a relationship with him but Geraldo has higher ambitions. When Da Gama reaches Bijapur he meets up with Victorio, representative of Dasanas family in Bijapur. Victorio finds that there is one more suitor for Maya, Whisper, head of eunuchs, willing to a pay seven lakh Huns for the nautch girl. Eunuchs are willing to pay a fortune for Maya since the stones she has in possession are worth more than the price they are paying her. That secret is known to only Maya and the Eunuchs. But Maya passes it to Da Gama for safe custody. Da Gama takes the stone to a jeweler shop and gets a look alike, fake stone made for him. He keeps the original stone with him and gives the fake to Maya.

Victorio plays cards with both Wali Khan, chief minister of Bijapur and Whisper offering Maya to both parties. And he has a plan to get married to Lucinda, who is the heiress to Portuguese clan. When the caravan begins journey out of Belgaum towards Bijapur, Victorio gets killed by Geraldo and Lucinda is accused for this. If Lucinda is punished to death, Geraldo would become sole survivor in the Portuguese family, and can become rich in less time and no efforts. He is supported by Slipper, the eunuch who has set eyes on the stones is possession of Maya and he does not want Maya to go Wali Khan at any cost. Both Geraldo and Slipper become a team and begins their journey to Sultana (wife of Bijapur Sultan, who is ruling until her young son Adil grows up to be a king). The travel path has routes through Gokak falls, a tiny passage, which can be passed by one man at a time. Making use of this opportunity, Pathan saves Lucinda again by kidnapping her. Later they both get married.

Rest of the caravan, Maya, Da Gama, Geroldo and Slipper reach the courts of Sultana. Both Wali Khan and Whisper claim ownership of Maya. Sultana decides Maya should belong to Wali Khan. Later in the day at the edge of the river, Slipper tries to snatch the stones from Maya. Since the bridge they were standing on collapses, Slipper falls into the river along with the precious stone. But it was a fake stone he took it away. Everyone who were aware of the stone, think it got lost in the river.

Da Gama returns the original stone to Maya. But Maya gets again sold to Mughals by Wali Khan. When she is set leave Bijapur, she hosts a dinner party to Geraldo. Before Geraldo departs, Maya shows off the stone in her possession for which many fought and lost their lives. Once she wanted to belong to Geraldo but was rejected. Geraldo with all his plots and evil schemes thought he had become rich but now he gets to know the fortune he let it go.

Subject, strategy and language are surprisingly superb for an author who has produced his first novel. John Speed, author, began studying history of India while in his school. While working on his novel, Tiger Claws, the characters of this novel haunted him, so ‘The Temple Dancer’ came first setting the stage for his next novel.

For anyone interested in historical fiction, this novel is surely an enjoyable read.

Michael Lewis: Flash Boys, The Money Culture and The Pacific Rift

If you are/were an online trader in equity markets or know about it, then you would appreciate reading ‘Flash Boys’ which decodes High Frequency Trading for the common investors and traders. Few big firms made use of High Frequency and algorithm based trading to take advantage of the information available on the order books of the stock markets and make favorable moves to pocket quick money. It looks unethical to bend the whole system to get to know the information few micro seconds earlier than the broader market and to have customized ordering systems for them to make this kind of trading work but that is how the Wall Street works.

There are few who made killing in the market by mastering the subject or by manipulating the system. And those people are the subjects of interest for Michael Lewis. ‘The Money Culture’ is a collection of essays which show the changing perceptions of investment bankers towards money and other stories from the Wall Street. The last few chapters of this book and the whole book of ‘The Pacific Rift’ are about the trading and investment relations between Japan and USA. Do you know why Japanese products are cheaper outside Japan than in their homeland? Why Japanese pay more than market value for properties in the US? And how is Japan able to manage trade surplus for so long? Why US based or any other foreign firms are not able to make into Japan’s domestic market in a big way? Are they not trying hard enough or is it the system in Japan makes it impenetrable? How a big earthquake in Tokyo can cause a severe damage in US financial markets while Japan comes out of it quickly? Author finds out answers for these through his research, travels and interviews with those high stake holders and the connecting links.

Michael Lewis was an investment banker employed with Solomon Brothers during 1980s but gave up that job to become a full time writer. Now he is a columnist for Bloomberg News and a contributing writer to Vanity Fair. He is one of my favorite authors and I intend to read all of his works. I have read six of his books and others too would be a matter of time.