January 2012 – Page 2

What does India import from Switzerland?

One of the more interesting things I learned while writing about India’s major trade partners was that Switzerland (not China) was the country that India ran it’s largest trade deficit with.

While you’d expect India to import a lot more than it exports to oil producing countries – I was a bit surprised to see that even Switzerland fell into that category.

I looked up further data on what India specifically imported from Switzerland and here are the numbers. The headings of the commodity name are rather long and I’ve retained the same thing that I found on official Department of Commerce website.

Commodity	In Millions USD
NATURAL OR CULTURED PEARLS,PRECIOUS OR SEMIPRECIOUS STONES,PRE.METALS,CLAD WITH PRE.METAL AND ARTCLS THEREOF;IMIT.JEWLRY;COIN.	$22,815.23
NUCLEAR REACTORS, BOILERS, MACHINERY AND MECHANICAL APPLIANCES; PARTS THEREOF.	$565.12
PHARMACEUTICAL PRODUCTS	$410.48
ELECTRICAL MACHINERY AND EQUIPMENT AND PARTS THEREOF; SOUND RECORDERS AND REPRODUCERS, TELEVISION IMAGE AND SOUND RECORDERS AND REPRODUCERS,AND PARTS.	$172.46
OPTICAL, PHOTOGRAPHIC CINEMATOGRAPHIC MEASURING, CHECKING PRECISION, MEDICAL OR SURGICAL INST. AND APPARATUS PARTS AND ACCESSORIES THEREOF;	$170.91
Others	$667.64
Total	$24,802.00

I think the first category consists mainly of gold and here’s a pie chart that I think really drives home the point.

AsÂ you can see the bulk of the imports are gold and pearls and I think gold must be the primary constituent in this category. Further, I think that the gold people buy for investment like gold ETFs and gold bars and coins sold by banks constitute a large part of these imports.

I say that because this category grew by 75% the last year and people suddenly didn’t start buying that much extra jewelery. This category also happens to be the main reason for growth in imports from Switzerland which grew by 68% overall in the last year. This will probably not grow as much this year so the deficit situation may change, but it’s really amazing how one commodity can drive so much growth in just one year.

It will be interesting to see where else does India import its gold from but that needs to be the topic of another post.

Reliance Industries Share Buyback: What should you look for?

Like a lot of other things – I came to know about the Reliance Industries (RIL) proposed share buyback program from a comment here.

The details will be out on the 20th but this is a good time to take stock of what a share buyback program entails and what are the things you should look out for.

The first thing is to find out is what type of share buyback offer this will be. As I wrote earlier – there can be two types of share buyback programs – one where the company buys the shares through the stock exchange and the second where they send out a form to their shareholders and ask them to tender their shares for the buyback.

If RIL decides to carry out the buyback program from the stock market then they would indicate a maximum price that they are willing to pay to buy the shares, and carry out purchases from the stock market periodically as long as the share price is below the maximum price they have decided. So, they could say that the company will buy shares as long as the price is below Rs. 1,000. This means that the company is allowed to exercise the buyback as long as the shares are under Rs. 1,000. They could buy it at Rs. 780 or Rs. 900 or any other price as long as it’s below Rs. 1,000.

They will also indicate a maximum amount that they can spend on the buyback but they are not obliged to reach that amount using the buyback. So, they may say that they will spend Rs. 1,000 crores on the buyback but that doesn’t mean they have to necessarily spend the Rs. 1,000 crore on the buyback – they can stop after spending Rs. 500 crore or just Rs. 10 crores.

If Reliance Industries decides to carry out the buyback by asking their shareholders to tender their shares – then they will set up a price at which the shareholders can tender their shares and the company will most probably buy a portion of the shares from the shareholders at this price.

So, in this case the company could say that they will exercise the buyback at Rs. 830 and send you a tender form to see if you’re interested or not. You fill up the form and tell them that you are interested to sell the 100 shares you have but so does everyone else. The company is not looking to completely delist, just buyback a part of its share capital so it will partially accept your tender offer – say buyback 50 of your 100 shares. How many shares they buyback depends on the response to their offer. People who have invested in IPOs can equate this to IPO allotments where you could apply for shares worth Rs. 1 lakh but get only shares worth Rs. 6,000 due to the huge response.

The takeaway from this post should be that you can’t just buy some Reliance shares from the stock market and turn around and sell it to Reliance Industries for a quick buck.

There are many nuances to how a share buyback works and you should familiarize yourself with them so you can ask the rights questions and evaluate the buyback offer yourself. Â As more details emerge, I will update this post or write a new one with the methodology they are using as well as the numbers.

You can read these two posts I wrote earlier if you’re interested to know more about buybacks in general.

Buying shares on announcements

From time to time I get emails about an announcement of a buyback, merger or a policy change with a question if it’s a good idea to invest in that particular stock or sector.

In general, I avoid taking decisions like this and I have a few simple reasons for that.

1. The event is already priced in: If you find out about something from a mainstream news media source which millions of people have access to then they will already act on that information and jack up the price.

I think infrastructure stocks and mutual funds from a few years ago are a good example of this. Everyone was convinced about the infrastructure story, and they were constantly mentioned in the media. How could people not buy into it? But if you look at their track record – they’ve done as badly if not worse than other sectors.

If you’re doing what everyone else is doing – where is the edge in that?

2. I may not fully understand the offer or policy change: This happens a lot in buyback offers where it’s easy to miss a detail like the buyback will only be a limited percentage of the shares outstanding so not everyone’s offer will be exercised or that the promoters will buy the shares from the exchange and not from shareholders, or in some cases they simply announce that they will carry out a buyback but later on change their mind!

If you don’t fully understand these things then it’s better to stay away from such offers. Do you really back yourself to play a game whose rules you don’t fully understand?

3. This strategy seems penny wise and pound foolish to me: Normally, you can’t expect a lot of gain from these kind of things – maybe 5% or so and to make that count you have to put in a large sum of money in the investment. Listing gains on stocks and bonds is a good example of this. The trouble with this kind of strategy is that while you do make money from time to time – one bad loss can wipe out all the gains you’ve made in the last year. This doesn’t appeal to me at all – it consumes a lot of time and effort but the risk – reward ratio is often skewed against you. While this kind of punting may be rewarding for brokers and traders who are glued to the market and have some sort of an edge as far as information is concerned – I don’t see how a regular retail investor can consistently make money doing these things.

These are some simple things that have guided my decision making over the years, and I don’t see it changing anytime in the near future. I know this is boring, but I’m happy seeking excitement in other areas of my life and leaving investments boring.

This post is slightly adapted from a comment in The Suggest a Topic page.

Define and explain sovereign debt

Sovereign debt is the debt owed by the government of a country, and it is usually denominated in the national currency (domestic debt), and international currencies (external debt) like the USD, Euro, Yen, Pound Sterling or even the local currency.

The government needs to borrow money when its spending is more than its revenues (known as fiscal deficit) and for people who have read this blog long enough – you would probably remember India’s fiscal deficit target in the budget posts that I did last year, and how it clearly showed why the government needs to borrow money.

When the government borrows – it can borrow in its own currency or in a foreign currency. Since a country usually becomes vulnerable due to external sovereign debt and not domestic debt let’s focus on external debt in this post.

A government that needs to pay for foreign goods and one that doesn’t have enough foreign currency will have to borrow in a foreign currency.

This is a good time to easily understand this concept because of the context of Iranian sanctions and the oil we import from them. Very briefly, the background on this is that India imports a lot of oil from Iran, and Iran demands that India pays for it in US Dollars.

India uses a Turkish bank to facilitate this transaction and due to the recent sanctions by the US and EU – the Turkish bank is likely to refuse being the intermediary, and force India to look for another channel.

If Iran accepted Rupee payments for its oil then there will be no problem because India could settle with them directly, but since they don’t (at least yet, and not likely to accept in full in future either) – India will have to find a way to settle this transaction in dollars.

This is a good example to see why you need foreign exchange in the first place, which is a concept I’ve seen some people struggle with occasionally.

Now, the debt that a country owes others is usually referred to as external debt, and the external debt number is often published in the newspapers etc.

One important thing that is not highlighted when you read about India’s external debt is that it is not Indian government’s external debt – but rather the total of Indian government’s external debt and India’s private sector’s external debt.

In fact, the sovereign debt or Indian government’s share of external debt is as low as 25% of the total external debt, and is long term and concessional in nature. So, the total sovereign external debt is just about 25% of the total external debt that is reported.

This is markedly different from a country like Greece which has a lot of its debt going to mature soon and owes it to private borrowers.

India’s sovereign external debt is concessional, long term and borrowed from developmental agencies instead of private borrowers so you will never hear phrases like ‘bond vigilantes’ that you hear these days with reference to Greece’s debt.

Turning to domestic debt – that’s a lot easier to manage than external debt because a government can print its own currency, and pay back the debt or inflate away the debt. This doesn’t mean that it’s good to have domestic debt or that there are no harmful effects of domestic debt. They are certainly there – if the government borrows too much money then their future revenues are earmarked to pay interest on that debt, and money that could be used for building roads get diverted towards repaying interest. Since taxes form a major way of earning revenues for a government – they will have to raise taxes or broaden the tax base to meet the growing expense, and if the economy stops growing or the growth slows down then the government will see that a large part of its tax collection are simply used to pay the interest on its loans.

Finally, Dr. Paul Krugman had a good column on US government’s debt a few days ago and it gives you a good perspective on the difference between an individual’s debt and the government’s debt.

This post was from the Suggest a Topic page.

India’s Major Trading Partners in 3 Charts

After looking at what constitutes India’s major exports, and India’s major imports – let’s now look at India’s major trading partners.

The three charts we will look at in this post are the top 15 countries that India exports to, the top 15 countries that import from India and the trade balance that India has with its top 15 trading partners. This data is for 2010 – 11 and taken from the Commerce Ministry website.

Let’s start with exports, and here are the top 15 countries that India exports to along with their percentage share in total exports for 2010 – 11.

One of the more interesting things in this chart is that if you were to combine China and Hong Kong they will take second place displacing USA. The thing that you don’t see in this chart is the growth rates, and while the US growth rate was 30.78%, UAE was 43.3% – that of China was 68.8%. In a few years time – these two combined could easily become India’s biggest export market.

Now, let’s take a look at the top 15 countries that India imports from.

China’s presence at the top probably doesn’t surprise anyone, and that a lot of oil producing countries are littered in the list is also expected.

To me, the most interesting one there was Iran. With the recent embargoes by US and EU, and no clarity on how India will pay Iran for their oil – expect to read about this a lot more in the coming days.

Now, let’s take a look at the total trade balance data. A positive number shows that India exports more than it imports to the country (trade surplus), and a negative number shows that India imports more than it exports (trade deficit).

The big thing in this chart is that India runs the biggest deficit with Switzerland and not with China! I don’t know what these imports constitute and if it’s because of an inordinate amount of gold imports from Switzerland. I will have a future post on that.

Other than that – the one thing that occurred to me was that China seems to have a lot of exports to all the oil producing countries and they seem to have strategically developed export markets in countries that they know they will have to import from because of oil, and that seems to be something unique to them; certainly not something that you see with India.

Europe downgrades, Japanese robot farms and Indian troubles

Yesterday I wrote about how things were getting quite in Europe, and today S&P downgraded a bunch of European countries!

The big name there is France, which is Europe’s second largest economy, but no longer a AAA country. They have downgraded 9 countries and affirmed the ratings of 7.

In Asia, the Japanese are using the Tsunami disaster to try out new things and one of the more incredible ideas is a 600 acre farm that will be wholly run by robots!

It was only a matter of time when this happened – Samsung, LG and Lenovo are launching TVs that can recognize hand gestures, faces and voice like Kinect – so very soon we will have TVs with no remotes!

Spiegel Online has a great piece on the Iran oil sanctions with aÂ great history on how oil sanctions have played out in the past, and this was a very insightful piece that I read this week.

Seth Godin talks about the first thing you do when you wake up and I must admit that I waste time in all of the ways he mentions.

At 7.7 millimeters – this is the smallest frog in the world – smaller than a tiny coin and the size of a house fly!

Finally, Rajeev Malik in Beyondbrics on saving India from its politicians.

Enjoy your weekend!

Update: There was an error in the post where I said S&P has downgraded 16 countries in all. They have downgraded 9 countries and affirmed the rating of 7.

Thoughts on India and the global economy

Kish had suggested this topic in the Suggest a Topic section, and I had it in drafts for a long time because I wasn’t quite sure how to approach this topic, and after a few re-writes I’ve decided to just pen down some thoughts I’ve had in the last few months.

When I think about the global economy – I think mainly of the US, China and Europe and India’s position with respect to these countries. That’s not because Saudi Arabia or UAE is less important but just because there doesn’t seem to be any big changes taking place there right now.

Let’s start with the US – in the last couple of months or so the data coming from the US has been largely positive and that’s different from how things were in the past few years before that. This is great news for the US, and the rest of the world because a lot of countries run trade surpluses with the US and depend on them for their own growth. More and more it looks like Warren Buffett’s prediction of a recession being very, very unlikely will come true. That is a positive for everyone.

Moving on to China – I think the question in the last few months has largely been how well China can manage it’s slowdown. No one seems to believe that property prices will start rising steadily again, or that major infrastructure spending will continue, but the main concern has been whether the Chinese financial system be able to withstand the slowdown and real estate losses and whether the authorities will be able to manage it such that there is no chaos.

I think their massive reserves will help them manage the losses and not let that spill over to the real economy too much. China is India’s third largest export market, and the largest import partner so any troubles in that country will be felt in India too but somehow from an Indian perspective – China doesn’t seem to be on the radar of many people. I don’t know why that is.

While Europe has not been getting as much coverage as it was in November or even December, none of the things there have fundamentally changed. The issue has been pushed down to deal with later, and that later usually arrives sooner than most people expect.

As far as Greece in particular is concerned – it is a very small export market for India and has shrunk by about 40% in the last year without anyone noticing it. The problem however is that the issues with Greece could spill over to the bigger economies and drag the whole of Europe with them. That has already happened, and it looks like it will continue to happen, and be a drag on global growth. The sooner the issue gets resolved – the better it is – but based on what has happened – I think this will continue to drag on for some more time.

While these issues have lingered for some time – I think the domestic problems in India are far bigger than the global headwinds of the last year, and that to my mind is a much much bigger threat to India’s growth than anything going on in the global economy. For a long time, we’ve just assumed that the economy will continue to grow at 8 or 9% but we’re finding out that it’s not the case. You can’t take this growth for granted and expect it without having sound policies and infrastructure in place.

Those steps have to be taken for India’s steady growth and at least the silver lining there is that those are within India’s control and the first wave of liberalization has shown that they yield positive results when taken and that should be the focus for everyone going forward as well.

Ideas on Tax Saving Schemes for First Time Tax Payers

I’ve seen a lot of comments in the last month or so that are from people who will be paying taxes for the first time this year.

There’s a fair bit of confusion on what to do and what option to choose, so I’m writing this post with some ideas with how someone who is going to pay taxes for the first time could approach tax saving schemes.

First of all – you will have to pay tax if you earn above the taxable limit – there’s just no way around it, so stop wasting your energy in trying to devise a method which gets you to avoid this.

There are some ways in which you can reduce how much tax you’re liable for and that’s where investments come in.

There is a section in the Income Tax Act which lists down certain expenses and investments that will enable a person to reduce their taxable income and as a result of that pay less tax.

This section is called Section 80C and the graphic on this page tells you what instruments you can invest in, what is their lock in period and what returns you can expect.

If you have some education loans or housing loans then you can use that to save tax, but if you don’t have that then you can invest in either mutual funds, fixed deposits, post office schemes or insurance products to save tax.

Since this is the first time you’re doing this and it’s rather late in the day to understand the nuances of these schemes properly there are two things you can keep in mind to help you make a quick decision.

First is that ELSS mutual funds have the lowest lock in period of just 3 years among these schemes and also happen to be the only equity product in this list. This means they are mutual funds that invest in shares and there is absolutely no guarantee with them.

Your investment could halve after 3 years, or it could double – it depends on the market, and there are absolutely no guarantees.

The second thing to keep in mind is that if you’re not comfortable taking this risk then you can opt for a fixed income product where the returns are defined at the beginning of the term and you can expect the principal plus interest to be paid out to you regularly. Among these options – a tax saving bank fixed deposit is probably the easiest for you to set up and the yields are as high (if not higher) than the other options.

The limit under 80C is Rs.1 lakh and if you exhaust this limit then you can invest an additional Rs. 20,000 in tax saving infrastructure bonds and reduce some more of your taxable salary.

Finally, if you are under the 10% tax slab and expect some big expenses in the near future then it may not even make sense to block your money in these products. Just pay the tax and keep your money in the bank to meet the expenses.

Keep these things in mind while deciding where to invest to save tax, and leave a comment if you have any questions.

Pay off house loan or invest?

Sandriano made a comment the other day with a question as to whether it’s better to invest in the NHAI bonds at 8.2% or pay off housing loan at 9%.

My response was that it’s probably better to pay off the housing loan if all your EMIs consist of mainly interest right now, but if that was not the case then we’ll have to look at it in more detail. He is in a stage where bulk of the EMI still consists of interest, and here’s how his loan looks like right now.

Thanks always for your inputs; always helpful in making informed decisions.
I think I got my answer. Nevertheless, here are the details. Bulk of the EMI goes towards interest.
Loan Amount: 28 Lakhs (LIC Hsg Fin)
Tenure: 20 yrs
Commencement: Dec 09
Interest: Locked for 8.9% for 3 yrs (until Nov 12) and market rate thereupon
Current Interest: 8.9%
EMIs paid till date (in months): 24

We will need to use the EMI calculator to see what the payment terms for this loan currently is and how will different payment terms affect this.

This calculator shows that the monthly installment is Rs. 25,000 – and during the term of this loan you pay Rs. 32 lakhs in interest in addition to the original 28 lakhs repayment. So, the whole repayment totals Rs. 60 lakhs over the period of 20 years.

This obviously sounds like a lot at first blush but consider the fact that Rs. 28 lakhs invested at 8.9% for 20 years compounded once a year yield Rs. 1.54 crores!

Now, Sandriano has already paid 24 installments so he has 18 years left, and theÂ NHAI bond had a 8.3% / 15 year option so let me just assume that you will be able to get 8.3% for three more years so we can have a straight comparison.

I downloaded this excel calculator for easy reference and found that on these terms – you would have paid about Rs. 6 lakhs in EMIs for the first two years, but the principal component of that would only be Rs. 1,11,084 and your outstanding principal is still Rs. 26,88,916 (out of the original Rs. 28 lakhs).

So, in a manner of speaking – it’s as if you’re going to take a loan for 18 years at 8.9% today for Rs. 26,88,916 and you suddenly get a windfall of Rs. 1 lakh and you want to see whether it makes more sense to pay off 1 lakh from the principal of this housing loan or would it make more sense to invest this in a tax free bond at 8.3% for 18 years.

If you pay off 1 lakh from the housing loan then your new principal is Rs. 25,88,916 and your new EMI is Rs. 24,082. So, your total cash outflow for 18 years is Â Rs.52,01,712 (24,082 x 12 x 18)

If you hadn’t paid off this house loan then your total cash outflow would have been Rs. 54,02,808 (25013 x 12 x 18). So, by paying off Rs. 1 lakh from the house loan, you save yourself Rs. 201,096 in lower EMIs over the course of this loan.

Now, in this case – you invested Rs. 1 lakh in the tax free bonds which earned you an interest of Rs. 1,49,400 (1,00,000 x 8.3% x 18 years) and you got the 1 lakh principal back at the end of the 18 years – so the total money you made in this investment was Rs. 2,49,400, which is Rs. 48,304 more than what you would have saved had you paid off your loan in the beginning of the time period.

So, based on this simple calculation I would say I was wrong earlier as you do get a higher cash-flow Â if you invest in the tax free issue instead of paying off the loan.

The one thing I would like to add is that in this comparison is that in case of investing the money – you get a very large chunk – Rs. 1 lakh at the end of 18 years, and even if you assume an inflation rate of 6% for 18 years – that one lakh will only be worth approximately Rs. 35,000.

In contrast – the EMI savings are constant throughout the time period and by virtue of not being lumpy their value might be more in terms of present value despite the absolute number being low.

I know that you can add many more variables to this calculation like tax saved, present value of future cash flows, reinvestment of interest etc. but based on my earlier post in which I compared the tax free bonds to a SBI fixed deposit – I feel that adding so many variables right at the beginning overwhelms many people without having any commensurate benefit.

Finally, given this situation what would you do and what are the other factors that you consider while deciding whether you should pay off debt or make an investment?

IDFC 80CCF Infra Bonds Tranche 2 Details

IDFC has come up with the second tranche of their infrastructure bonds, and I was a bit surprised to see that they are offering a lower interest rate from the other infrastructure bond issues that are open right now, and even their own earlier tranche 1 interest rates.

The issue is going to open on January 11 2012 and ends on February 25 2012. The issue is secured and rated ICRA AAA and Fitch AAA from ICRA and Fitch respectively.

Here are the other details about the issue.

Options	Series 1	Series 2
Face Value	Rs. 5000	Rs. 5000
Interest Payment	Annual	Cumulative
Tenor	10 years	10 years
Interest Rate	8.70%	8.70% compounded annually
Buyback	5 years	5 years
Maturity Amount	Rs. 5,000	Rs. 11,515

As you see, the interest rate is lower than some of the other issues that are open right now, and given the fact that most of these issues offer the same level of safety and listing benefits etc. – I don’t see a reason to opt for this one against the others that are available right now.

The only new question about infrastructure bonds that I’ve come across since the last time I wrote about them is if either IDBI or LIC is going to come out with an issue in the future.

I’ve not read anything that says they are and I don’t think banks can even issue these bonds, so I wouldn’t wait for these issues.

Another thing to keep in mind is that a few people mistook infrastructure mutual funds as 80CCF bonds and bought them last year. It’s a rare mistake but one that could occur so just something to keep in mind.