@Leisure - Vol-12 | srei
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@Leisure - Vol-12

Newsletter
 

The Greece Sovereign Default -
An ongoing problem

It was in October of 2009 that the Greek Finance Minister announced that his country’s deficit would rise to nearly 12.5% of the gross domestic product. The structural weaknesses of the economy had been exacerbated by the global recession that began in 2008. The problems of high structural deficits, and debt to GDP levels on public accounts, which had been unchecked for a decade, were finally bringing the economy down to its knees. Naturally this led to fears among investors that the government would not be able to meet its debt obligations. It was not long before the credit rating agencies began downgrading the country’s ratings. By the time the next year had started, the ten-year debt yield spread had gone past 300 points.

Under pressure to take quick action, the government announced a series of austerity measures that included cutting bonuses and overtime wages, and freezing government salaries. However, this was not enough to stem the tide, and further austerity measures were announced. But this did not impress the credit rating agencies or the investors, and the country’s ratings continued with their downward slide.

A problem of this magnitude will always have ramifications far beyond the country’s borders, and the aftershocks were felt not just in Europe, but in other parts of the world as well. In May of 2010, the Eurozone countries, the European Central Bank and the International Monetary Fund announced a bailout package worth billions. But the conditions stipulated in the bailout package faced severe resistance in Greece. They caused political turmoil, which meant that the country delayed the implementation of the conditions.

The problem is still ongoing, and the latest update on it is that the government collapsed in December of 2014, leading to the announcement of snap elections towards the end of January in 2015. The Athens Stock Exchange has suffered massive losses in 2014, and the anti-bailout party, Syriza seems to be the people’s favorite at the moment.

 
 

Effect of RBI repo rate cuts on NCDs

It is common knowledge that a Non-Convertible Debenture (NCD) is a debt instrument issued with a specified maturity and coupon rate. Normally, the coupon rate stays fixed for the entire duration of the NCD and is redeemed at the end of the tenure by the issuer, usually for the face value of the NCD.

NCDs are traded in the secondary market also which means buyers and sellers of these NCDs transact between themselves without any involvement of the issuer. The price at which these NCDs trade may not be the same as their face value. This is because of two reasons:

  1. The NCD price may include a certain amount of accrued interest since the last pay-out.
  2. The market interest rates may have changed subsequent to the issue of the NCD which would impact their value inversely.

Usually, bonds and debentures gain in value if the interest rates have declined after their issue. The opposite scenario is of bonds losing value if interest rates have increased. For example, consider an NCD issued 2 years ago with a face value of Rs.100, tenure of 10 years and a coupon rate of 8%. Now suppose the current interest rate is 7.5%. The bond may now be valued at a price that is slightly higher than its face value, may be at say Rs.101.

This is due to the fact that the cash flows that the NCD generates are now being discounted at a lower rate of 7.5% than at the original coupon rate of 8%.That is, the NCD is generating more cash than is expected at this point in time and under the prevailing financial conditions, and hence, fetches a better price. This gain in value is an additional return for the NCD holder apart from the regular coupon receipts.

In a nutshell, a scenario of declining interest rates is very favourable to bond and debenture holders as it creates another avenue of investment return in the form of capital gains.

 
 

Why 2015 may be the year for debt investors

15th January 2015 is a momentous day for businessmen, investors, borrowers, consumers, etc. of India. This is because it was on that day that the RBI cut its interest rates by a quarter percent. Well, that in itself may not be much of a reason to celebrate as the cut is very small in quantum. But the real significance emerges from the change in direction of the interest rate cycle in India. The cycle now appears to have finally entered the declining phase which usually lasts for a reasonable period of time unless disturbed by extraneous events. This reversal comes as a huge relief to Indians since the interest rates remained at uncomfortably elevated levels over the last few years.

Why interest rates are likely to decline in 2015.

  • Declining inflation: This was a major cause for interest rates to remain high. But since inflation is now on a downward glide, the prospects for more interest rate cuts appear bright.
  • Stable currency:Just when the interest rates appeared set to fall a couple of years ago, the precipitous fall in the INR forced RBI to raise rates. The Current Account Deficit (CAD) is well under control now and is even expected to morph into a surplus thanks mainly to the crash in crude prices. This bodes well for a soft interest rate regime.
  • Government’s commitment to fiscal prudence: The central government has repeatedly committed itself to keeping its financial house in order. This would mean that government borrowing would be stable and is a good sign for interest rates.

Debt investors make capital gains on their holdings in a declining interest rate scenario. With economic conditions appearing conducive for a sustained fall in interest rates this year, debt investors may look forward to an attractive investment experience in 2015.

 
 

Buddy Jokes

1. What does an "accountant" do? He solves a problem you didn’t know you had in a manner you don’t understand.

2. Size defines the seniority of a manager. Here’s how:
1. The thickness of the carpet in his office.
2. The wider his desk.
3. The size of his car.

3. Bankers never die...They simply lose interest.

4. A well-tested parenting tip from the corporate world: Treat your child the way you would treat your boss. Do: praise him for his achievements; Don’t: tell him how undeveloped his brain is; Avoid: his tantrums.

5. Client:Yesterday I have bought an energy saving bulb from your shop, returned home, but it does not work.
Shopkeeper: It should not, it saves energy.