Petroleum price issues need urgent attention

The world is awash with global liquidity, thanks to virtually every country experiencing good economic growth, combined with petro-dollars accumulated by Middle Eastern countries and Russia. This surfeit of liquidity is invested in a variety of asset classes but, after a point, quality of assets declines and so does the scrutiny. Last week’s problems surfaced because hedge funds from Bear Sterns and MacQuerie revealed losses, generated in part by their sub-prime portfolio concerning home loans in the United States.

Investment banks that now rule the world! They are the ones companies go to, initially, for an IPO and then for follow-on public offerings (FPO). Again, for mergers and acquisitions. And, when companies grow large enough through organic growth and mergers, then investment banks arrange demergers of leveraged buyouts! They have also created a variety of derivative products, one of which is the securitised loan, through which loans given by banks are packaged together and sold in small bits to retail investors. With investors hungry for better returns, funds take larger risks, investing in ‘sub-prime’ (i.e. the most risky lending with the least amount of scrutiny which, therefore, yields the highest return to compensate for the added risk) securitised assets. When property prices fall, borrowers in the sub-prime market are the first to default, which is what caused the problem that has hit Wall Street, which in turn influenced Indian markets.

The BSE Sensex, which had been shell-shocked by the steep fall last Friday, recovered a bit on Monday and Tuesday, before the second steep fall of 615 points on Wednesday, on global market weaknesses. It then steadied to end the week at 15,138, down 96 over the week. The Nifty ended the week down 43, at 4401.

The US market has fallen further after our markets closed on Friday, suggesting a further drop in the coming week. Oil prices are high, at $ 78 a barrel. The weakness in the US housing market would reflect in reduced consumption, which would impact economic growth. How would that affect the Indian market? The India story continues to remain good, so any fall in the next week or two should be taken as a buying opportunity for fundamentally good stocks in well managed businesses.

To attract more funds (India needs over $ 30 billion in infrastructure projects alone), we must get our act together in diverse sectors, which, sadly, we are not. The energy sector is one. The $78 price for oil is one indication that the world is running out of the light sweet crude which is easier to extract and refine, and we will now have to look deeper and to spend more, refining heavier crude.

Now a looming shortage of oil means that the Government ought to be looking for ways to curtail its consumption. The auto industry is one of the main users, yet, through quirky logic, the price of petrol and diesel has been subsidized! This not only encourages more consumption but has also driven to red the balance sheets of three navratna public sector companies -- IOC, BPCL and HPCL.

The RBI raised CRR by 50 basis points, to suck out some Rs 13,500 crores of liquidity. When it buys dollars to prevent the rupee from strengthening too much, which would hurt exports, the rupees pumped into the system create excess liquidity. The RBI also removed the limit on repo, to allow banks to park more funds with the RBI and earn some interest thereon.