Fingers Crossed


By Monish Chhabra ǀ 2nd November 2014

Last month, the US small-cap stocks were up by +7%, while oil was down by -10%.

Ms. Yellen must like that combination. She announced the end of quantitative easing (QE), which was run by the US Federal Reserve for the last 6 years.

QE is the buying of financial assets (mostly bonds, sometimes also equities) by the central bank, in order to increase the liquidity in the system, hoping ultimately to stimulate demand.

QE begins where the interest rates end - at zero. This central bank action is targeted at the 'quantity' of assets to be purchased (rather than the 'interest rate' to be achieved), and hence the name.

While the Fed thinks it has loaded the gun enough, BOJ (Bank of Japan) decided to buy more bullets. The latter announced an increase of its own QE, from 60-70 trillion yen a year to 80 trillion.

Are the Japanese learning this QE magic from the Americans?

Not at all. In fact, QE was invented in Japan.

March 2001 was the first time Japan did QE and it ran until March 2006. The central bank then scaled down its balance sheet and made the first rate hike in July 2006.

The key goal of the first Japanese QE was to achieve inflation. Inflation couldn't stay alive for even 2 years.

By Oct 2010, Japan was back at it, with a second round of QE. 4 years into it, many expansions have already been weaved in. The goal this time is 2% inflation. The jury is still out.

Does size matter? Indeed. Here again, Japan rules.

Central bank's balance sheet reflects the amount of QE undertaken. In the US, the central bank's assets are equivalent to 26% of the country's GDP. In Japan, it is 62%.

As far as QE is concerned, it is more Japanese than American.

So does QE help?

It's effects on the financial markets are noticeable. QE has been shown to bring long-term interest rates down, narrow the spreads, improve the liquidity available to banks, stabilize the financial system and lower the exchange rate.

However, these influences are largely financial-engineering. They can re-distribute the risk but not eradicate it. They can facilitate the growth, but not create it.

QE's effect on economic growth or inflation is far less proven. While the central banks can load the gun, the trigger is still pulled between the lenders and the borrowers – who both need the 'desire' and the 'ability' to do so.

Markets lead on hope. The economic value has to catch up. If not, the castles of hope crumble down. One castle builder in India learnt that recently.

On 14th October, DLF - the largest property developer in India - along with its top 6 executives, was barred from the capital markets for the next 3 years. The SEBI order prohibits them from buying, selling or dealing in securities, directly or indirectly. The company shares plunged by -34% on the news.

What did DLF do wrong? Apparently, plenty.

They are held guilty of 'active and deliberate suppression of … material information … so as to mislead and defraud the investors' at the time of its IPO in July 2007.

According to the ruling, DLF (short for, Delhi Land & Finance) didn't disclose the financial dealings, related-party transactions and litigations for three of its subsidiaries at the time of its IPO. Instead, the group transferred the ownership of the subsidiaries to the wives of its 3 senior officers, purportedly to make them look like non-related entities.

Furthermore, the company provided personal loans to these employees for them to pay for the purchase of the subsidiaries. Subsequently, the ownership was extended and spread across 10 wives of the senior DLF officers. When any of these employees left the company, his wife sold the shares to some other entity related to the company.

Through all these changes in ownership, there was no change in bank account signatories, registered addresses or auditors, for any of the subsidiaries.

A similar pattern was used by DLF to dissociate itself from 355 subsidiary companies, before its IPO. The regulator called all of these “sham transactions”.

What had made DLF famous? This very IPO that haunts it today.

DLF was the biggest IPO ever in India, when it listed 10% of the company for $2.3 billion in July 2007. At that time, the group was developing real estate projects totaling 100 million square feet in size – arguably the largest in the world.

The promoted K P Singh, with his family, controls 75% of the company. The IPO made him worth $20 billion.

In 6 months after the IPO, the stock price more than doubled and reached the all-time high in Jan 2008. The company's market cap reached $48 billion.

Mr. Singh personally achieved a net worth of $36 billion at the peak, making him one of the richest in the world.

What now? Trouble, and more trouble.

Since the peak 7 years ago, the DLF stock is down by -90%.

DLF is loaded with debt of $3.6 billion at an average cost of 12.5%. Its annual sales are $1.3 billion and the current market cap $3.9 billion. SEBI's order this month means the group cannot raise any new capital to reduce its debt burden.

Recently, a new government came to power in the state of Haryana, which is the centre of the rise of DLF. On 27th October, the new administration announced that it would probe all land scam cases, including the controversial deals with DLF. The company's shares plunged by -10% at this news.

Whether QE or IPO, the underlying value-creation is the key.

'Print it and they will borrow' is just as wishful as 'build it and they will buy'.

This write-up is for informational purpose only. It may contain inputs from other sources, but represents only the author’s views and opinions. It is not an offer or solicitation for any service or product. It should not be relied upon, used or construed as recommendation or advice. This report has been prepared in good faith. No representation is made as to the accuracy of the information it contains, nor any commitment to update it.