Hi Friends Sharing with this group an article from Ajit Dayal contributed by SB in another yahoo group of his. I too am a member of Equitymaster and do regularly read articles posted by Ajit Dayal. PS: This article is forwarded just for enlightening our group members - once again no puns intended. Regards Floyd
--- On Mon, 30/11/09, Team Equitymaster <newsletters@ equitymaster. com> wrote:
From: Team Equitymaster <newsletters@ equitymaster. com>
Subject: The Honest Truth - Shaken by the sheikhs
To: "Reader" <sureshbhagtani@ yahoo.com>
Date: Monday, 30 November, 2009, 11:48
The rabbit is a restless and nervous animal.
And investors, like frightened rabbits, went scurrying to safer haven on news that Nakheel, a real estate development company owned by the government of Dubai, would seek a 6-month moratorium on the payment of their interest and debt. Monies due in December 2009 by Nakheel would now be paid after May 2010.
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As the Thanksgiving weekend broke in USA, investors rushed back into the US Dollar and government bonds issued by "safe" countries like USA and Germany. The MSCI Emerging Market Index of stocks declined by -5%. It had gained about +65% so far this year.
Long praised for its spectacular growth, Dubai has proven itself to be just another wonder of the era of free money - without a game plan on what to do the day the era of free money would end.
The "growth-by-debt" junkies
In many ways, Dubai is like a Citibank - built on the illusion that being "large" is the solution to every possible risk.
Just as Citibank saw every global citizen as a potential customer, Dubai saw every grain of sand as the foundation of a new real estate development project.
Just as Citibank added customers and businesses to get a larger share of your wallet, Dubai was busy building the largest buildings, the largest man-made islands, and the largest indoor ski-slopes.
"Build and they shall come" is the policy that the Chinese followed in the late 1990's. Eventually the Chinese got hit by the write-offs in their state controlled enterprises (like the PSU companies in India).
And don't forget the dusty business plans of private banks like ICICI Bank and most of the real estate firms in India.
Many of the private sector banks wanted to "acquire customers" so that they could increase market share and have a "large" loan book.
Maybe these Indian companies have learnt their lessons and will be more careful in the future.
Maybe.
Those managements that built their businesses on excessive debt and weak risk assessment were under severe strain after the bankruptcy of Lehman Brothers in September 2008. Dubai is a minor - but necessary reminder - on how a failure in one corner of the geographical world can shut down global credit markets.
And hurt companies that rely on sucking money from any corner of the world to fund their growth.
But Dubai is by no means the only place being built on dreams.
The real estate firms in India saw every square foot of agricultural land as a way to use their political connections to sell you 0.6 square feet of property at exorbitant prices - and charge you on a per square foot basis. The real estate robber barons lived off their unabashed use of debt and the art of pricing on a super built-up area.
The US consumer must also have been a role model for Dubai's ambitious debt-fuelled plans. Every item in a store was a "must-own" on the shopping lists of US consumers. And the same Citibanks of the world were willing to lend the US consumers money for their insatiable demand. The financial geniuses at Lehman, Goldman, and Merrill only did what any good financial engineering firms would do - found ways to trade that debt and make fees on it. The rating agencies - blinded once again by glamour and the fees they get from the issuers of debt - were once again behind the curve.
Why is it shocking?
Any visitor to Dubai knew that the end was near.
Dubai knew it was in trouble Source: Bloomberg
There were the newspaper articles on how people were leaving their debt-financed cards and unpaid credit cards at the airports and flying away to safety.
I guess the fine for not repaying debt must be pretty severe in Dubai.
Businessmen in Dubai knew that business was slow.
The fact that the government of Dubai was in trouble was not new.
It was as public as could be without really being written about in the press. (click here to read.)
But the surprise may have been in the fact that Abu Dhabi, the energy and cash rich Emirate "allowed" Dubai to make its statement on debt restructuring.
Or, worse, is it possible that Abu Dhabi was not even aware that its neighbour was about to seek a debt rehabilitation package?
Over the past few years, Abu Dhabi has seen its glamorous neighbour build monuments to the gods. With no energy reserves to speak of, Dubai was keen on establishing itself as the financial capital and trading capital of the Middle East and Africa. It was also presenting itself as the gateway to Pakistan and India.
Not a bad objective.
But, because it was funded by debt, the business plan was susceptible to cracks in global financial markets and to the changing sands of lending policies of nervous rabbits.
And, like the US consumers buying 5,000 square feet atrocious Mac Mansions for a family of three people, Dubai's grand sizing was probably a bit idiotic.
As author Jim Krane noted on CNN, the tall buildings meant that every time someone on the top floor flushed the toilet, the water pumps had to send water half a mile up to refill the tanks for the next flush. A few tall buildings and a Palm complex, Krane noted, could use as much electricity as an entire city.
Not very efficient for a country short of energy.
Should we sell Indian stocks?
Dubai is geographically closer to India than Lehman Brothers was.
And we have more business links to Dubai than to Lehman.
Millions of Indians work and live in the Middle East and send their money back home. Indian banks lend money to some of these India-connected businesses. And Non-Resident Indians deposit their money in NRO and NRE accounts.
Yes, Dubai is more real and closer to us than Lehman was.
And will have more of an impact on the Indian economy.
But the negative fallout will be minimal.
Here is an extract from a comprehensive report in Economic Times: "Over 5 lakh Indians have returned from Dubai since September 2008, of which two lakh are Malayalees. Almost 60% of these people are technical or non-technical skills professionals. 'Over 50 lakh Indians work in the Middle East of which 20 lakh are from Kerala. We do not expect large number of returnees now,' K V Mohankumar, CEO of Kerala NRI group, Non Resident Keralites' Affairs (Norka)."
Kerala has an estimated 20% of the total Middle-East exposure in terms of remittances. So there could be some localised problems in that state.
And there will be company specific problems: banks with loans to the sheikhdoms and companies with projects in the Middle East will declare their potential exposures in the next few days.
But the Dubai debt issue pales when compared to the Lehman bankruptcy.
Lehman shocked global markets - the Dubai bankruptcy will re-price risk for companies in emerging markets. That is the big difference in the financial aspect of things. Lehman's bankruptcy made all the rabbits around the world run for cover - they refused to lend money to anyone. The Dubai bankruptcy will make the rabbits search for patches of grass where they can eat their carrots in peace. India will be one such patch of grass where they will continue to chew away.
So, don't sell Indian stocks because of what happens in Dubai.
And gold?
Gold will have a 2-way pull.
The flight to safety will move people towards gold.
But the flight to safety will also move people towards the US Dollar and weaken other currencies like the Indian Rupee.
So, while the price of gold in dollars may decline its value in Indian Rupee may stay the same (see Table 1 below). A Rs. 20,000 per 10 gram price of gold can be achieved in a combination of ways. A permutation of the USD price of gold and the INR/USD fx rate.
Table I: Gold price a function of the Indian Rupee / USD fx rate | GOLD PRICE IN US DOLLARS PER TROY OUNCE | | | 1,000 | 1,050 | 1,100 | 1,150 | 1,200 | 1,250 | 1,300 | 1,350 | 1,500 | | INR | GOLD PRICE IN INR PER 10 GRAMS (Fine Gold content in 10 grams equals | 0.3199 | troy ounces of (0.995 purity) | | 43.00 | 14,130 | 14,826 | 15,522 | 16,218 | 16,914 | 17,610 | 18,306 | 19,002 | 21,090 | | 44.00 | 14,453 | 15,166 | 15,878 | 16,590 | 17,302 | 18,014 | 18,727 | 19,439 | 21,576 | | 45.00 | 14,777 | 15,505 | 16,234 | 16,962 | 17,691 | 18,419 | 19,148 | 19,876 | 22,061 | | 45.50 | 14,939 | 15,675 | 16,412 | 17,148 | 17,885 | 18,622 | 19,358 | 20,095 | 22,304 | | 46.00 | 15,101 | 15,845 | 16,590 | 17,335 | 18,079 | 18,824 | 19,568 | 20,313 | 22,547 | | 46.50 | 15,263 | 16,015 | 16,768 | 17,521 | 18,273 | 19,026 | 19,779 | 20,532 | 22,790 | | 47.00 | 15,425 | 16,185 | 16,946 | 17,707 | 18,468 | 19,229 | 19,989 | 20,750 | 23,033 | | 47.50 | 15,586 | 16,355 | 17,124 | 17,893 | 18,662 | 19,431 | 20,200 | 20,969 | 23,275 | | 48.00 | 15,748 | 16,525 | 17,302 | 18,079 | 18,856 | 19,633 | 20,410 | 21,187 | 23,518 | | 48.50 | 15,910 | 16,695 | 17,480 | 18,265 | 19,050 | 19,836 | 20,621 | 21,406 | 23,761 | | 49.00 | 16,072 | 16,865 | 17,658 | 18,452 | 19,245 | 20,038 | 20,831 | 21,624 | 24,004 | | 49.50 | 16,234 | 17,035 | 17,836 | 18,638 | 19,439 | 20,240 | 21,042 | 21,843 | 24,247 | | 50.00 | 16,396 | 17,205 | 18,014 | 18,824 | 19,633 | 20,443 | 21,252 | 22,061 | 24,489 | | 50.50 | 16,558 | 17,375 | 18,193 | 19,010 | 19,827 | 20,645 | 21,462 | 22,280 | 24,732 | | 51.00 | 16,719 | 17,545 | 18,371 | 19,196 | 20,022 | 20,847 | 21,673 | 22,498 | 24,975 | * Gold prices in INR are inclusive of all the duties and taxes applicable in Mumbai (The above given table is only for information purposes.)
Source: Quantum Gold ETF research by Quantum AMC
Well, the sheikhs have caused quite a stir.
Dubai's government-controll ed Nakheel went out to build the famous Palm Islands. Abu Dhabi - whether it likes it or not - will have to help build a Calm Island.
Moral: a mirage, built on debt, is still a mirage.
And a bunch of nervous rabbits looking for carrots in a mirage is a recipe for disaster.
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