The Wise Investor March 2010 Sundaram BNP Paribas Asset Management

Sundaram BNP ParibasAsset Management

Sundaram BNP Paribas Asset Management:Investment Manager for Sundaram BNP Paribas Mutual Fund / Portfolio Management Services: Sundaram BNP Paribas Portfolio Managers

Bear in mind ‘unrest’

Tax hikes, spending cuts and actions tocurb the influence of unions would havebeen easier and carried conviction, if thebanking big wigs had been dealt with in anobjective manner. In the U.S, thegovernment and central bank are seen tobeen on the side of Wall Street and evenObama, with a message of `Change’ &`Yes,We Can’, has made no difference to this perception.This is true of quite a few other countries,including the U.K, as well. This lack of credibility and the divergence in approach to the big banks and to the man on thestreet is not going to help efforts to curbburgeoning government deficit and debt.That an eminent scientist such as StephenHawking has threatened to say goodbye to Cambridge after 50 years to protest the U.K government’s move to cutspending on science tells the tale. Storiesabound of cuts in hospitals, army anduniversities (even though student feescontinued to be hiked).Even as we seem to have a veneer of seeming stability in the financial systemand fleeting signs of a recovery (aided by massive stimulus and comparison’s withlow base after the tumble in Q3 & Q42008 and Q1 2009), we have a completeloop of tough choices.The sustainability of this recovery is also very dependent on

Vol 3 - Issue 12

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March 2010

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Rs.3.50

This means government borrowingswill rise even further and rates willhave to go up eventually; the rate-hikes story does not appear to be anoutcome for this year or the next,barring token increases. This story,when it eventually pans out, will haveimplications for markets.Now if we add unrest and theprospect of rising rates eventually torising debt burden, the present needfor more stimulus as governmentsare unwilling to let reality set in and the problems faced by savers due tolow rates, you get a heady cocktail.Compared to this quagmire, thegovernment of India appears better placed, as of now, to deal with theproblem of fiscal deficit andgovernment borrowings.It does not suffer the presentdeveloped-world problems such aslost-credibility,lack of growth,financialinstitutions in weak shape, bailoutwrath and overburdened consumers, to name a few.It has to, however, start dealing with the issue of government deficit.Combined fiscal deficit in the statesand centre is in double-digit territory.First measures have been taken in thebudget, but there is a long way to go.The three-year road map bristleswith optimistic assumptions, but atleast a beginning has been made.State finances are an even tougher story in the Indian context.We need to get the fiscal house in the centre and states in order beforeunrest becomes a possible risk inIndia, too. For now, unrest is a story to track in developed-worldcountries.

T.P.Raman

Managing Director SundaramBNP ParibasAsset Management

stimulus and central bank support.Governments face rising debt, yet need to spend big time to sustain the presentrecovery (and it is much). Even if governments want to cushion againstdeflation and decide to spend further onstimulus,they can do it for at best another year or two.That, too, would be a stretchof present perilous state of governmentfinances, and only mean more pain later. Just take a look at Japan for a reality-based feedback with experience of 20-years plus, and counting. Japan today is the worst placed on the governmentdebt front in the developed world after years of wrong choices to fight deflation.People have continued to suffer deflation;savings as a percentage of GDP haveplummeted; low rates force moredrawdown of capital by savers to takecare of living expenses;and yet there is noway out.This state now beckons in other parts of the developed world, too, whichhave already suffered one lost decade.Tax hikes & spending cuts appear to be the only way out and public reactionscould be of an unpredictable nature.Ironically if unrest becomes a big issue,political pressures will force governments to go slow on these measures andpostpone the day of reckoning.The past month may well mark thebeginning of a turning phase, as publicanger and popular resentment with thepolicy orientation of governments,especially in the developed world, starts to get expressed in an increasingly visiblemanner.The focal point for such trends isnow Greece with the likes of Spain,Portugal, Italy and U.K, not too far behind.The genesis is in the high and still-risinglevels of government debt – a risk that isnow integral to the U.S, too. As stimulusspending and bailouts galore take away trillions, the burden was, is and will likely be on taxpayers.Unemployment looming large means taxhikes and spending cuts are not going tobe received well. Governments face amassive dilemma in trying to balancefactors that are almost impossible to juggle around, but those that will have tobe dealt with at some stage.That time for Greece appears to havecome, though it may still be able topostpone real pain, for a bit more, with abailout from the European Union. Thesigns of unrest emerging as a key variableare,however,clear.This has implications for the likely direction of policy making and the choices are not appealing.Government debt (triggered by fiscaldeficits) is a problem now, in both thedeveloped world and several emergingeconomies, including India. Across theworld, governments have resorted to jugglery over the years to mask reality:butit is easy to put what is on the record andoff the record together to get a picture of the true state of affairs.The picture is not pretty by even thefanciest stretch of imagination. What isdifferent in the developed world today-with a few exceptions such as Japan,SouthKorea and Canada-is that the trillionsspent or put up as cushion to save the bigbanks and an almost complete return toold ways by them in 2009 has leftgovernments with little credibility.

Sundaram BNP ParibasAsset ManagementTheWise Investor

March 2010

2

The Ring of Fire

World 44608 49722 31901 60880 100.0 100.0 100.0 100.0 -10.3 55.9 -47.6 -26.7United States 13555 13748 10455 17660 30.4 27.7 32.8 29.0 -1.4 31.5 -40.8 -23.2Canada 1638 1609 992 1749 3.7 3.2 3.1 2.9 1.8 62.2 -43.3 -6.3Brazil 1229 1326 565 1273 2.8 2.7 1.8 2.1 -7.3 134.7 -55.6 — Mexico 370 363 247 398 0.8 0.7 0.8 0.7 2.1 46.8 -37.9 -7.0Chile 236 229 130 208 0.5 0.5 0.4 0.3 3.1 76.0 -37.5 13.5United Kingdom 2796 2975 1981 4051 6.3 6.0 6.2 6.7 -6.0 50.2 -51.1 -31.0France 1719 1900 1480 2736 3.9 3.8 4.6 4.5 -9.5 28.4 -45.9 -37.2Germany 1238 1371 1075 2208 2.8 2.8 3.4 3.6 -9.7 27.5 -51.3 -43.9Switzerland 1046 1076 848 1217 2.3 2.2 2.7 2.0 -2.7 26.8 -30.3 -14.1 Japan 3553 3488 3268 4545 8.0 7.0 10.2 7.5 1.9 6.7 -28.1 -21.8Honk Kong 2195 2268 1312 2655 4.9 4.6 4.1 4.4 -3.2 72.9 -50.6 -17.3India 1260 1294 640 1813 2.8 2.6 2.0 3.0 -2.7 102.3 -64.7 -30.5Australia 1180 1253 652 1415 2.6 2.5 2.0 2.3 -5.8 92.1 -53.9 -16.6China + Others 12593 16823 8256 18952 28.2 33.8 25.9 31.1 -25.1 103.8 -56.4 -33.6

Data Source: Bloomberg;The last available figures for each year have been taken;Analysis: Sundaram BNP Paribas Asset Management End December 2007 figures have been reckoned as the peak as different countries reached the point on different dates.The approximate distance from peak has not been indicated for Brazil, which peaked only in mid 2008.

Region/CountryMarket Cap ( $ Billion) Share inWorld Marke Cap (%) Returns (%)Distancefrom Peak (%)End Feb20102009 2008 2007 End Feb 2009 2008 20072010TYD2009 2008

Market Cap of Global Markets -A comparison in 2007 (close to peak),2008 (close to bottom),2009 (recovery) & the present

Current AnnualDeficit

P u b l i c S e c t o r D e f i c i t ( % G D P )

Public Sector Debt (%GDP)

10.07.55.02.50-2.5-5.0-7.5-10.0-12.5-15.00 25 50 75 100 125 150 175

OutstandingStock of DebtItalyJapanGreeceUKUSAIrelandSpainFranceCanadaNetharlandsGermanySwedenNorwayFinlandDenmarkAustralia

Global Market SnapshotChart of the Month

Source: Reuters EcoWin, SEBX-asset Research

This chart that caught our eye waspublished in PIMCO Investment Outlook for February 2010.

Reading the chart:

The burden of debt isstarting to bite the advanced economies.This Ring of Fire provides a terrific snapshotof the risks that lurk. It shows how Greeceis most likely a precursor of what is in storefor a few other developed markets.The vertical axis shows fisical deficit (publicsector deficit as a percentage of GDP).Bear in mind that the horizontal axis only showsgovernment debt or public sector debt as apercentage of each country’s GDP.Powerful as the chart is, the real picture willbe when you add private sector debt, too.Private sector debt burdens are becomingpublic sector debt in this financial andeconomic crisis via bail-outs,takeover by thegovernment and purchase of dubious assetsby central banks across most of thedeveloped world.On a complete debt (private + public) basis,you can safely assume that every country will move much further to the right in theRing of Fire. Visualise how much morepowerful and potent such a picture wouldlook.The implications will obviously not bepositive. – Editor ofThe Wise Investor

Sundaram BNP ParibasAsset ManagementTheWise Investor

March 2010

3

IndiaView Equity

The recent budget marks a new beginning by the Government to reduceits borrowings and reduce income taxes, and allow consumption to grow the economy,rather than the stimulus it had earlier offer during the peak of the financial crisis in the second half of 2008.Like rest of the world,India had three rounds of stimulus packages to ensure that the growth momentum is not stalled. Indeed the costs have been high,and we have come to a break point. The consolidated fiscal deficit for FY2010 is close to 10%, and needs to be reined in.The budget is no longer so munificent.• It has sought increase indirect taxes and reduces subsidies on petroleumproducts and fertilizers.• Import duty on oil has been imposed as also excise duties on all goodshiked.• All subsidies are to be paid out as cash rather than bonds, which werein a sense an off balance sheet item.From a mere Rs 50,000 crore deficit in 1991,the current deficit is now eight times that level at close to Rs 4,00,000 crore.This has in no small measure contributed to the inflationary regime presentin the country.This alarming situation, along side the recent events in Greece, as well as arating downgrade looming large,has prompted the Government to swallow the bitter pill and take measures to curtail the fiscal deficit and has been firmabout it. Will they follow the course remains to be seen,as Governments are usually loathed to swallow debt reduction programs on a long term basis? A fewof the assumptions have been ambitious such as revenues from 3G auctionsand the disinvestment program.Should the government succeed in its effort to reduce its borrowing, itpaves the way for a more sustainable growth environment in the country.The total tax collections at the centre and state level are now close to 20%of GDP, and hence there is a limited room to maneuver on the taxcollection front.There is a case for tax levels to come down as India has among the higher tax levels with no social security program to protect the tax payer in theevent of sickness, or unemployment.The bond markets have been nervous, and have not reacted to the budgetas yet. This appears to indicate that the markets are not biting as yet, and itwill take some more convincing, before it does so. Equity markets havebeen a little more optimistic, as there was a correction in global equity markets prior to that.The budget has now made it clear that the government’s role in buildingassets is diminishing and the incremental asset build up will now have tocome from the private sector.India in the global context:There are more pressing issues facing the globalfinancial markets these days. It starts with Greece and its large debt andfiscal deficit. Most experts are of the belief that the IMF will have to rescueGreece and administer strong medicine of reducing expenses and increasing taxes.A few countries in Europe continue to increase the retirement age in thehope that they can delay generous pension payments. With many countrieshaving a high level of debt, the debt pay down will be difficult with intendedand unintended consequences. What may those be? We think that taxes will increase in many countries, as also many subsidiescut either directly or indirectly resulting in lower savings and hence lower spending in many of these countries. This issue appears to be a global oneas almost all countries raked up debt to insulate their economies from theglobal slowdown. The unwind of this excess will be slow and painful.It is in this context that we find the firmness in commodity prices surprising.Apart from China and India consuming more,almost all other countries areconsuming less. There is also fresh capacity coming up across almost allcommodities such as iron ore,oil and coal. Much of this was planned during the boom years in 2007 and 2008, and are now getting ready.Similarly, in oil, we find that there is enough to go around and yet oil pricesare firming up. Some of this may be attributable to commodity exportingnations being financially well off and not in a distress to sell unlike in the past.And the other reason could be investments by banks and hedge funds intocommodities.Some of this could go away, should the so-called“Volcker Rule” go through. When some of these proposals were discussed, there was a distinctnervousness in commodity markets.

Budgets and beyond

Satish Ramanathan

Head-Equity Sundaram BNP Paribas Asset Management