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by Ajit Dayal

Last weekend the world was on the edge. The world is hanging on - even though if only by a thread.
But India seems to have fallen off the cliff.
Let’s hope there are some branches to reach out to and help us break our fall - or that the floor may not be too far away.

 

Graph 1: The BSE 30 Index heads into the pit

 

The morning of Monday, October 13 began with the Finance Minister telling a pre-market open press conference that India will be affected by global events, but will still do well. The fundamentals of the economy are strong. (Yes, I agree with that view.)

The Finance Minister said, however, that there are people in certain sections of the media who are writing things without checking their facts. India is a free country, and we are free to write what we wish but we must not cause any panic. (And, yes, I agree with that view, too.) The market rallied by 781 points (+7.4%) by the end of that day.

But the freedom to spurt gave way to the freedom to fall. By the end of the week, the BSE 30 Index had declined by -5.3% and had closed below the 10,000 level - its lowest closing level since June 20th, 2006.

So this is what we do with the freedom we have granted ourselves: We regress backward in time. Or take comfort by "crying wolf".

The opera looks for a phantom

ICICI Bank - the poster boy for the new era of Indian banking - has been a miserable performer on the Indian stock market.

 

Graph 2: ICICI pays the price for growth

 

Over the years, ICICI Bank has grown aggressively and gained market share. During this time, the more savvy corporate treasurers who work in Indian companies have privately joked about a bank that is willing to borrow at the highest interest rate in wholesale markets and lend out at the lowest rates in the retail markets. Banks are not meant to be in the market share business - they are meant to be in the "profit" business, after assessing the risks of lending.

For years, HDFC lost market share in its main home loan business and many grumbled at this sleepy financial company. HDFC looks smart now, doesn’t it? In the long run, sticking to a focus on risk control and correctly pricing risk is what makes a finance company rock solid.

But rather than admit their mistakes of focusing on growth and market share, the management of ICICI Bank is busy tracing sms messages from mobile phones in remote parts of India. These mobile phones were reportedly part of some bearish cartel that was knocking down the ICICI stock. But I wonder: Did anyone ask if there were any mobile phones used to create the bull cartel when the share price of ICICI Bank was galloping in the previous years?

No, we have the freedom to enjoy the rewards when times are good and look for scapegoats when times are bad. There may - or may not - have been a cartel hammering the share price last week. But couldn’t there have been a cartel pushing the share price on the way up in the previous years? I guess when every employee of ICICI Bank felt wealthy with all their stock options, there was little reason to file a complaint with the police.

ICICI Bank is solvent and sound - I don’t doubt that. They will not go under. But, in a tougher economic lending environment, they may not make as much money as people thought they would.


The opera is over - now they are looking for the phantom. ICICI probably followed a script that gets applauded in a risk-taking world and gets punished in a risk-averse world. There is nothing wrong with that - we just need to recognize it for what it is. When a movie is known to be a comedy, you will not opt to see it on the night you wish to see a serious movie.

One person’s freedom....is another’s shackle

And while the ICICI drama was playing itself out, there were other dramas erupting all over India. All acting out a freedom of expression. All asserting their rights: 

The UP Chief Minister refused to let the Congress Party chief inaugurate a factory. Jet Airways announced they were laying off staff - and then withdrew their decision. The DMK may withdraw support for the UPA because the Indian government supports a regime in Sri Lanka that is against the ethnic Tamils.

Freedom is a wonderful weapon, but as the Finance Minister pointed out ,it needs to be balanced with the responsibility of checking the facts, and against the consequences of any action taken.

The mutual fund industry enjoyed their freedom, too. And forgot about their responsibilities - so we had a bail-out in India.

Like the left complains, we love to ape the west, particularly America. The problem in the mutual fund industry, from what I could gather, was that the mutual fund houses saw a huge inflow of debt money in the past 2 years. Companies were flush with cash - either from the profits they had made or the money they had raised from IPO’s and placement of shares with foreign investors. Since interest rates were low, they kept all this excess money in "liquid" funds.

So the mutual funds happily collected all the money they got. And they got some Rs. 400,000 crore of this debt money from companies.

The companies were happy because they were getting a decent rate of interest plus they could withdraw the money when they needed it to start paying for their capital expenditure plans. Well, the mutual fund industry forgot to clarify one teeny-weenie detail: That while they had collected Rs. 400,000 crore from the hundreds of companies, and invested it in supposedly "liquid" assets; the average daily trading volume of the debt papers owned by the mutual funds was Rs. 4,000 crore a day. Just 1% of the total money they had collected.

I can picture the CEO of the mutual fund company having a conversation with his marketing head:

- "Mr. Marketing, please tell your investors that we cannot take any more of their money. The liquid funds are getting illiquid."

- "Sure, Mr. CEO, I will do that. But, if the other CEOs of the other mutual funds continue to take money, then you will lose market share. Not good for your bonus and your future salary."

That must have been a pretty short conversation.

As short as the conversation was when someone in ICICI Bank may have asked their seniors, "we are getting all these awards for being such a great bank but do any of these business magazines who give us the awards actually understand the risks we are taking?" It must have been a quick one for sure. ICICI Bank continued to win awards.

The mutual funds continued to get more and more flows into the liquid funds. And then the cycle turned. The companies no longer had access to any sort of IPO market - so their fund raising has slowed down. The economy is slowing - this means that their existing businesses are not generating as much cash as before. The banks are not that willing to lend money as they were one year ago. And the banks are charging higher rates of interest. And they now need money for their capex plans.

So they head to the mutual fund to withdraw their "liquid" money. Only to find that the liquid funds have invested their money in assets that do not trade that much every day. If every investor in every liquid fund would want their money back it would take 100 days to get the money back.
Not very liquid. More like a pretty solid chain and shackle.

So the mutual funds have a "window" - the RBI has rightly given them access to funding to tide over these unusual times. Problem solved. Just like in the case of Bear Stearns or Lehman. One group of people earned good salaries and bonuses for their lack of responsibility and exercise of their freedom. Another group gets to pay the bill.

Capitalism at its best.

But it isn’t capitalism, is it? It is a heads-I-win and tails-I-keep-what-I-have structure. A bit like freedom. We have the right to do what we please but don’t have to bear the cost of our actions. Factories will be stopped from being built. Jobs will not be created because someone else is creating them. But companies cannot lay off people. Even if they need to.

It is hardly a coincidence that in a week that the Dow Jones gained +5%, the BSE 30 Index lost -6% (in US Dollars). The Dow is still on the edge. India has tipped over.

The heat and dust of Indian politics is upon us. It was inevitable. The state elections are next month. And then the general elections sometime before May, 2009. Local passions will take over from global cues. The Dow may recover - India may stall. Big Brother will have a whole new meaning - and won’t be as attractive as Shilpa Shetty.

Source: ICICI Bank: Indian Capitalism At Its Worst