Afroz Ali Merchant
Director/Chief Executive Officer
Merchant Investments Pvt. Ltd
Governor of State Bank will announce Monetary Policy tomorrow. We believe that discount rate will be reduced by 50 basis points from 9.5% to 9%.
The inflation (consumer price index – cpi) numbers for the past few months (4 % in Dec 2014 and 4.3% in January 2015) and improvement in foreign exchange reserves and the substantial reduction in oil prices by almost 60% during this fiscal year will perhaps prompt State Bank to ease monetary policy.
IMPACT ON CAPITAL MARKET
While, the capital market has perhaps accounted for 100 basis points cut. However, we believe it is economically not healthy for any country to reduce discount rate by 100 basis points in one ago. India for example always changes monetary policy by 25 basis points. Last week when Governor Rajan of Reserve Bank of India reduced discount rate by 25 basis points, the Bombay Stock Exchange – the Senses Index went up by 600 points. This reduction was after a gap of 20 months and the first since Governor Rajan took oath as Governor. The leveraged stocks will be the biggest beneficiaries of cut. For example, companies like Engro Corp and Engro Fertilizer, D G Khan Cement, etc.
IMPACT ON OIL SECTOR
Perhaps, the biggest beneficiaries will be oil sector companies having circular debt. First, as the furnace price has also reduced by 60%, the circular debt can perhaps end over a period of time as oil prices are not expected to increase again to US$ 110 because of shale oil. The over supply in oil is because of shale oil and the drastic increase by oil producing to countries to go for extra drilling because of high prices.
MASSIVE RALLY IN OIL MARKETING COMPANIES
We believe that the biggest beneficiary of oil reduction will be Oil Marketing Companies as apart from one-time inventory loss, they will benefit huge as their margins were Rs 2.35 paisa per liter when oil price was Rs 110 per liter. Now, when the price is at Rs 78 per liter, their margin is same. Hence, from Feb 01, when the prices further reduce, they will benefit commission of almost 5 percent instead of about 2.5%. PSO’s sale during the last year 1,400 billion Rs. The Oil Marketing Companies sale will increase by almost 50% due to lower prices of oil plus closure of CNG stations in Punjab. It seems that the price which is Rs 78 per liter for pertrol versus Rs 71 per kg for CNG will become almost equal when the prices are reduced from Feb 01. Hence, there will not be any advantage for filling CNG even if they are open. Hence, again the Oil Marketing Companies will benefit.
ROOT CAUSE FOR CIRCULAR DEBT
The root cause for circular debt has been the increasing cost of furnace oil. Unfortunately almost 70% of our electricity is generated by furnace oil which is the most expensive fuel to generate electricity. India produces 120,000 MW of electricity of which 80,000 i.e two third is produced by coal. PSO imports furnace oil and sells it WAPDA, Hubco, KAPCO, etc. The power producers sells electricity it to PEPCO. The difference in the cost of production and the selling price has been increasing the circular debt because of high cost of furnace oil. Since, furnace oil has also reduced by almost 60%, there is a higher probability that the circular debt wil eventually be over over a period of time. The biggest sufferer of circular debt has been PSO being the Government organization who has to buy furnace oil and sell to power companies on credit. Power Companies are not able to pay PSO on time as they do not receive the proceeds from their customer – the Government on time.
PRINCE WALID BIN TALAL OF SAUDI ARABIA
One of the richest man in the world and the most successful Middle Eastern investor in a recent interview to Yahoo has said that 100$ per barrel oil was artificial and we will never see oil at 100$ again. Oil was allowed to trade in futures in 1980 and therefore the volatility also increased due to heavy trading in futures.
OIL PRICE – US$ 150 PER BARREL IN JULY 2008 AND US$ 30 DECEMBER 2008
Folks will remember that the prices of oil which reached 150 $ per barrel in July 2008 when the sub-prime mortgage crisis erupted in USA to US 30 per barrel and then reaching again to US$ 110 barrel in June before sliding started as is now traded around $S$ 45-48 per barrel. However, we should also remember that shale oil is a recent phenomenan and did not exist during 2008 crisis. Hence, oil returning to US $ 110 is a distant reality which may not happen in the next two to three years.
OIL IMPORTING COUNTRIES
The oil importing countries will be benefiting a lot because of dramatic reduction in oil prices. Our country’s imports of about 40 Billion US$ consist of 15 Billion US$ for import of oil. Hence, there would be massive savings about 7.5 billion US$ even if oil prices remain at 55 $ per barrel from the high of 110 $ per barrel. Currently, it is hovering between 45 and 48 $ per barrel.
We also believe that State Bank will further reduce discount rate by 50 basis points in March 2015 and another 50 basis points in May 2015 ultimately reducing it to 8 % in this fiscal year. Hence, it will become the lowest in 13 years when the discount rate was 7.5% in 2002.
The six monthly inflation numbers are at about 6% and with further reduction in oil prices from February 01, 2015 as indicated by Government, inflation numbers will reduce further. It is perceived that State Bank are IMF are okay if net interest rate is atleast 2 % with manageable foreign exchange reserves and current account deficit. The net interest rate currently is 3.5% (discount rate of 9.5 % minus 6 months inflation of 6%). Hence, there is greater probability of discount rate cut by 150 basis points over Jan, Mar and May policy. The Trade Deficit will be reduced substantially because of 60% reduction in oil prices and the Current Account will become surplus because of rapid remittances from overseas workers and reduced trade deficit. However, the remittances which have been increasing for several months may start decreasing as the oil exporting countries will have to curtail development spending because of low oil prices. They have already faced a burden of reduction of 300 billion dollars in oil income during the last few months when the crisis started primarily to reduce supplies from shale oil producers.