Selling Government Bonds

An article I wrote for "Wealth Insight" for June. Still remains relevant, though much more retrograde measure have since been announced

 

Trouble in the foreign currency markets

The big story in financial markets over the past few days has been the withdrawal of over $3bn by foreigners from the Indian bond markets. Government bond yields increased, the rupee weakened significantly against the dollar, and the stock markets went into a funk.

The government response ranged from the inane – “we are watching the situation” – is it a spectator sport? to the pathetic – “other emerging markets with high current account deficits have suffered similarly”. Mismanaging the economy is alright if others do it too.

Knee Jerk reactions

The Finance minister addressed the market holding out the possibility of raising inflation in the near term. While that is not what he mentioned, that is indeed the effect of the policies he promised. A key promise was to increase prices of gas in India with consequent price rises in user industries. Another was allowing Coal India to offer blended prices of coal to its purchasers – perhaps over ruling many a contract and allowing for a general increase in power tariffs across the country. As if this was not enough, he seemed to suggest that making it easier for foreigners to invest would solve the problems of foreign investors exiting their positions – much like a hotel manager with poor occupancy - driven by poor service - seeking to increase the size of the door to allow guests to come in.

Arbitrage vanishes – driving away the bond investor

A fundamental driver of financial markets is the assumption that arbitrage cannot exist for sustained periods of time. If investors can borrow at 0.5% per annum, and cover currency risk at, say, 5% per annum, they would invest in a market offering a yield of approx 7.5% – since this leads to a risk free return of 2%, thereby narrowing the arbitrage. This, more than any action of the government, was what drove investors to India in the recent past. A lot more would have come if the investment climate was less murkier.

A slight change in interest rates globally raised the cost of borrowing. Couple this with lower interest rates in India, and higher forward rate for currency cover - and the arbitrage vanishes. No amount of credit rating upgrades, or the ease of investing is going to change the fact that arbitrage is no more – and with that, the bond investor.

 Restore the arbitrage?

If India really wants the bond investor back, we need to restore the arbitrage – ie, raise real interest rates. This flies in the face of the demand of industry and stock markets. Commentators, including government functionaries who should know better, have been blaming the RBI for being almost cussed in its slow lowering for policy rates. It is almost as if lower policy rates would magically restore the economy to health. The reality, as almost always, is far from perception.

RBI has actually maintained a negative real interest rate (nominal rates – inflation) for most of the past 5 years. It has been ahead of the curve in cutting policy rates. This amounts to a huge stimulus to the economy. Along with this, The Reserve bank has, through use of liquidity enhancement methods, resorted to an unannounced “quantitative easing” program in India – where its balance sheet has increased 50% in less than 3 years since 2010. In addition, the government has run a constant deficit – leading to pump priming economic growth. Yet, common wisdom, especially in policy circles continues to blame the “high interest rate” as a reason for “demand destruction” and poor GDP growth.

The need for higher interest rates

India has been suffering from high inflation for over 4 years. Low real interest rates have caused low deposit growth of about 13%, and caused credit to deposit ratio to rise to 79% -the highest in the last 15 years. Savers seek to protect their money value by investing in shadow “foreign currency” in the form of gold. The rupee is under pressure. All this would suggest that real interest rates need to rise. However, try telling this to anyone in policy formulation or market analysts. The demand for the punch bowl to be returned to those drunk on negative real rates is unrelenting as it is vociferous.

Address the disease not the symptoms

The attempt of Indian policy makers seem directed more at the symptoms than improving the reality of doing business in India. If India is such a compelling growth story why is it that every major Indian group has invested and continues to invest significant amounts of cash overseas? The latest acquisition announcement of Apollo Tyres of a take-over of Coopers is a case in point.

The reality is unpleasant. Policy nightmares continue to prevent large projects from coming to stream – leading to restructured loans – and reducing the capability of Indian banks to lend further. The judicial system moves at glacial speed preventing rapid resolution of commercial disputes. The government arms move in opposite directions – with the taxman prompting retrospective amendments, while some other departments attempts to talk up investments. Coupled with a dithering and corrupt bureaucracy and polity, the India growth story seems to be a chimera. Keep your fingers crossed on what the next elections will throw up.     

Ben Bernanke’s taper and India’s economy: Wait for recovery gets longer

My latest column of the 24 Jun in the Economic Times

The last few weeks were eventful in all the wrong ways for India. Floods in the north led many to suffer. Financial markets suffered too — though from fears of withdrawal of financial "floods" — now christened "tapering".

Over $3.5 billion was withdrawn from the debt markets in India this month on the back of statements from the US Federal Open Market Committee (FOMC) indicating that the US Fed may start reducing its bond-buying programme later in the year. The Indian debt market had to be shut as yields increased beyond the trading bands. NTPC pulled out its bond issue over pricing issues. The rupee collapsed to nearly 60 to a dollar.

Is Fed shutting off the tap?
Ben Bernanke was at great pains to explain that the bond-buying programme was not being shut down. Liquidity infusion (printing money) would continue — only slower. That too was contingent on reduced unemployment (targeted at 7%) and higher inflation. While the Fed has sounded off the market based on its forecast of recovery, it has also indicated that its policies remain dependent on the data as time passes. It is likely that the timetable for the "taper" may well be extended.

Rupee unlikely to recover except in short term:Our economic mandarins have suggested that the rupee fall has less to do with India and more to do with emerging markets as a whole. That is, indeed, partially true. Other emerging markets too have suffered a withdrawal of funds, and have had their currencies weaken. 

However, India is in a worse position than other Bric countries. Foreign exchange reserves are barely sufficient to cover seven months of imports — the lowest it has been in the last 15 years. As a comparison, the other Bric members have 19-21 months of import cover. The latest trade deficit figures reveal a weakness in exports. A decade of mismanagement with unfettered inflation, uncontrolled and wasteful government expenditure, falling savings rate and inflated asset prices have made India a high cost economy.


Fundamentally, the rupee is headed towards 70 to a dollar. However, this is unlikely in the near term. A sharp fall in gold prices globally will reduce the pressure on the rupee even if the demand for gold remains unchanged. Unilever's purchase of HUL's equity will bring in around $4.5 billion in the next few days. Combined, in the immediate term, this should shore up the rupee somewhat.

Need a driver at the seat
Last week, the Cabinet committee on economic affairs (CCEA) took certain decisions — some were aimed at improving coal availability to power projects. Coal will now be imported —and the higher cost will be passed to consumers. In itself, the decision is better than no decision at all. At least, the power situation in the country can improve.

However, the irony is that India needs to import coal, when known reserves are enough to serve the needs of industry for several decades. Coal India's mines are about 10% as efficient as mines of similar characteristics in say, Australia. What is really needed is management of public resources in a manner that maximises public benefit, not rent-seeking. But that requires leadership — and that is another story. Equities may partially recover for now, but the storm is not over:Over the next couple of months, the early onset of monsoons, coupled with sale of grain from the government granaries, may lead to lower food inflation. The pressure on the rupee will ease, as gold imports slow, and the fear of immediate taper reduces.

Commodity prices are likely to remain subdued. In India, this should lead to selective recovery. Export sectors should gain from the foreign exchange windfall, though with a lag. Domestic commodity producers will benefit from the additional protection, while power generators may start up production — making some of the investments productive. Lenders to power generation companies may see some benefits.

However, these gains are unlikely to be long-lasting. In an earlier column in this paper, I had mentioned the dichotomy between the macro (liquidity driven, hence up) and the micro view (slowing earnings-high valuations, down). With the markets dancing to the tune of "taper", the macro upside has become limited. The dominant theme will, therefore, be micro.

Inflation at the consumer level will start hotting up in the third quarter of the fiscal year as increases in power and fuel cost work their way through the system. Government deficit will rise as revenues lag projections due to a slow economy. Political parties will spend on voters to try and buy their loyalties. Welfare spend will likely rise too. The cash economy is likely to again fuel inflation in the second half of the year.

If the taper is on schedule, the external sector will remain pressured, with consequent negative effects on the Indian stock markets. The wait for a sustained period of economic growth just got longer.

Japan-led free money is pumping up stocks but Indian market will remain shallow

My article for economic times carried in the edit page on last month. The article is reproduced below.

In the first week of April, the Bank of Japan (BoJ) announced a massive balance sheet expansion - by 1% of GDP per month. This sparked a sharp global rally in risk assets with most equity markets rising sharply, a rally that has continued in the current month. India too has witnessed a 10% odd rise in the headline index.

Interestingly, this coincides with a fall in commodity prices - reflecting both an increased supply comfort but, more, a subdued demand outlook . All this, as global economies struggle to grow. How far can this dichotomy - poor fundamentals and high stock prices - continue?

THE NEW HIGHS
Stock prices, it is said, are a reflection of future earning capacity of a company. Corporate results in the current quarter have been weak - something the market already expected . Consensus estimates of FY14 earnings assume a 16% growth over FY13 - almost twice what has been the likely growth for FY13 over FY12.

Importantly, over 60% of the growth is expected to come from financials , energy, autos and metals. This seems to be too optimistic. Consensus earnings continue to change over the year as fresh data gets factored in. It is likely that earnings downgrades will continue this year too - as they have over the past five years.

Assuming that actual growth achieved by Sensex companies in FY14 is closer to 10%, the market appears to be trading at 15.5 times current year's earnings. This does not seem particularly challenging given a falling interest rate scenario. Against a historic trading band of 12 times to 18 times, the market currently seems to be priced in the middle. Coupled with the wall of global liquidity, it is not surprising that the market seems to be reaching for new highs.
 
HOPES, NOT REALITY
The opposite argument is equally easy to make. At 10% growth, earnings are slower than trend. Consequently , valuations too should remain below trend. Earnings yield at 7% and growing slowly are not much more attractive compared to debt yields of 7.5%. Debt too will yield capital gains if interest rates were to continue their downward journey. Equity risk is not being paid for.

The problem compounds when we start looking for stocks to buy. The rally has been led by financial, pharmaceutical and consumer sectors. The consumer sector is showing signs of fatigue. Pharmaceutical stocks too are overstretched.

The financial sector is interestingly split down the middle. While state owned banks seem to compulsively lend to companies prone to stress, the private sector seems to have developed an uncanny ability to side-step future "problem clients" . The "buy private financiers" is now totally crowded - with all institutional investors hugely overweight on it. Valuations are seriously stretched - but who will say the bubble will not grow bigger before it bursts?

The rotation trade has begun. Infrastructure and capital goods stocks have witnessed a rally. Energy stocks are doing better on expectations of lower oil prices, some increase in price of power and improvement in coal availability. The truth, however, is that these trades are still based on hope rather than reality. There is no reason to assume the next few months will be better, with the local polity focused on elections rather than economy. CONFUSING, ALRIGHT

Base metal continues to suffer from over-supply and is likely to remain subdued. Telecom companies are witnessing some revival in growth, but are priced for that. Technology companies offer some contrast. While growth has slowed, and the global environment to outsourcing is becoming more hostile, valuations are now more reasonable, and a stronger economy in the US would revive the growth numbers. The rotation trade will therefore be more positive for IT now than it has in the recent past.

Are we, therefore, set for a period of benign rotation, with the market trending upwards? Unfortunately, this is not likely. Unless "beaten down" sectors demonstrate growth revival, rotation will soon stop. Also, domestic retail investors are still wary of the market - and institutional investors will invest only in "liquid" stocks.

This means the market will continue to remain narrow and we will eventually be left with two pools - one a high-priced , high-liquidity institutional market, the other a lowvalue , low -liquidity market of smaller stocks. SEBI's ill-advised recent move to introduce auctions in thinly traded scrips will further add to this separation. The primary market too is likely to remain busy - with a slew of issuance lined up. Surplus liquidity in the form of foreign inflows will likely meet an equally strong issuance pipeline.

In sum, while the macro trade seems to be up, the micro does not seem supportive. That seems confusing , but that's how it is. To quote Charlie Munger, vice-chairman of Berkshire Hathaway: "If you're not confused by what's happening now, you don't understand it."
 
The author is the CEO of a financial services company. Views are personal.

Gold – a tale of two priorities

My submission for the May edition of Wealth Insight

What a fall!

Over two day - 12^th and 15^th April 2013 - gold prices dropped an astonishing 18%. Volumes on the derivative exchanges were twice that on a “normal” day. The effect of the short-selling (selling without owning the gold – in the expectation of buying it back at a lower price) was to force traders having “long futures” (buy positions using leverage) positions to sell. Their stop loss orders would be triggered.

Was this just a trade based on technical analysis of price movements, or was there some “co-ordinated” trading. For this, we have to see what happened in the physical market (physical or cash market is where the underlying gold is traded). Despite the fall in “futures” prices, physical gold and silver prices are relatively firm. The price of “American eagles bullion coins” was at one point 26% higher than what “futures” prices indicated. Despite the price fall, in the days following the crash, the US Fed had to deliver over 2 tonnes of gold in the physical market as demand from US investors for the metal rocketed. In Asia, anecdotal evidence suggests that gold markets witnessed “sell-out” crowds at jewellers. Further, physical gold prices remained stubbornly higher than the “futures” market. The price fall seems largely restricted to the derivatives market.

Is there a shortage of metal building up?

Germany has nearly 3600 MT of gold reserves – highest among countries, next only to the USA. 1536MT of this reserve is in the custody of the US Fed Reserve of New York. Germany also has 374 tons stored with the French Central Bank and some at the Bank of England.

Germany recently requested the US Fed to return 300 MT of their gold. It also requested the French Central Bank to return its holding. The USA has informed Germany that return of the 300MT demanded will be executed over a period of 7 years. Incidentally, 300 MT of gold can be “couriered” in less than 10 airplane trips. The US Fed apparently owns 6700MT of gold – so why does returning 300 MT pose a problem?

Central banks like all other banks often hypothecate client deposits as collateral against other lending. Could it be that the US Fed has rehypothecated gold so much and among so many counterparties, that it is unable to demarcate the gold that belongs to Germany?

In the first week of April, ABN Amro bank changed its precious metal custodian rules and indicated to clients that they will no longer allow physical delivery. Accounts will now be “cash settled”. In other words, you cannot now get your metal – just the difference in price between your purchase and sale price. At the commodity exchange – Comex,  gold vaults have witnessed a withdrawal of 2 million ounces of physical gold – the largest in one quarter over the past decade. Physical gold seems to be in short supply.

  

 The gold conspiracy theory

Gold bulls have presented data indicating volatility in gold prices as a result of central bank action. Since gold is often viewed as an alternate currency, and confidence in “fiat currency” is being undermined by repeated money printing, a rise in gold price signals a lack of confidence in printed money. This can have disastrous consequences for financial markets if the trend catches on. Increased volatility in gold prices will erode its acceptability as an alternate to fiat money. A sharp fall will shake the confidence of investors.

Central bank action is difficult to prove or disprove as it is shrouded in secrecy, allowing speculation to gain traction. The circumstantial evidence forwarded starts with the question - who else could sell 400 tonnes of gold futures in a few hours – except central banks? Falling prices are not good for a seller unless the idea is to create market panic. This costs money, and only a money printing bank can afford this.

Central banks too have to operate through “agents” – the banks. The gold market action started just a day after a meeting called by the US Administration where the top 14 banks were present – to help coordinate bank trading action say the conspiracy theorists.

Another view point is that orchestrated sales were necessary since physical stock of gold and silver were insufficient to make good contracts that banks had signed to deliver gold to clients – and they needed to stop the requests. Without the coordination among all banks, a price crash of this magnitude would have been difficult since traders would have entered the market on both sides. By forcing out the buyers, the demand for physical delivery has been reduced significantly – allowing banks to prevent what could have been a catastrophic default – and would have lead to further erosion of credibility of paper currency.

The impact on India

India remains the largest “consumer” of gold. Economists have celebrated fall in gold prices arguing that this will lower current account deficit and reduce pressure on the currency. While this may be true, there is another point of view worth considering.

Unlike other consumption goods, gold is really in the nature of an investment. It can be seen as an attempt by Indian savers to invest overseas. A fall in its value reduces the “wealth effect” for investors. This is similar to the case of a foreign investor investing in India. When the Indian currency depreciates, the stock market is cheaper for the new investor, but an investor who is already invested sees a loss. Very conservative estimates of gold holdings of Indian investors would value it at $500bn. This is almost 25% of India’s GDP. A fall in the value of these savings will have a direct impact on the wealth effect. This could have a serious and negative impact on domestic consumption. At a time when growth of GDP is already weak, a further drop in consumption can hardly be treated as “good”.

Another point to note would be the effect on gold loans and their lenders. The gold loan industry had witnessed remarkable growth over the past 5 years. It is likely that a sharp fall in gold prices if sustained, will lead to significant NPA’s with attendant risks.

The pressure on the rupee will likely ease as oil prices weaken in the face of continued global economic weakness. All countries are now engaging in competitive devaluation of currency to enhance their exports. In such a scenario, the rupee may not face significant downward pressure – irrespective of gold prices. In trying to “cure” Indian investors’ desire for gold, India’s western educated economists would do well to understand the viewpoint of India’s unwashed masses. Often the unlettered are wiser.

Low brokerage alone will not bring investors

My interview in Business Line yesterday. Since this is based on a face-to-face interaction, I have been quoted in brief. I am reproducing the article with some additions to clarify what I mean:

The regulator has made a major disservice by making exchanges ‘for profit’ organisations. — Anand Tandon, CEO, JRG Securities 

The Government and capital market regulator SEBI’s effort to attract retail investment in equities has had little impact. Retail investors have incurred huge losses in the last few months. Even as broking firms are trying to woo retail investors with low brokerages, exclusive research reports and stock recommendations, the wild swing in the stock market has scared retail investors. The capital market is dominated by foreign institutional investors and domestic institutions, and needs a major overhaul to gain investors’ trust, says Anand Tandon, CEO, JRG Securities, in an interview with Business Line.  

Excerpts:

Why are retail investors shying away from market?

It is actually a simple problem, but also extremely complex. It is simple, because an investor will invest if there is a chance of making money. If eight out of 10 times he makes money, the possibility of losing twice is acceptable. On the other hand, if you loses eight times and make money just twice it is not acceptable, even if you hit a jackpot twice and cover up all the losses. Essentially, retail investors have not made money.

What has changed dramatically for small investors in the market?

Intense competition. In fact, the regulator has made a major disservice by making exchanges ‘for profit’ organisations. The original function of exchanges was to provide people access to capital. As opposed to that, today, as a ‘for profit’ organisation, exchanges provide liquidity pools. In the process, they create their own transaction charges. With new exchanges coming in, there is no proportionate increase in liquidity. The liquidity pool is getting divided. So, there is more and more illiquidity.

What is the impact on market intermediaries?

The competition among exchanges will have a trickle-down effect on market intermediaries. Some 20 years ago, one had to shell out Rs 4.5 crore to become a BSE member. Today, you do not even need Rs 45 lakh. An investment of Rs 4.5 crore would have become Rs 20 crore, even if it was invested in a safe product. But by bring in more exchanges, you have to pay Rs 10 lakh deposit, and become a trading member. Essentially, my investment of Rs 4.5 crore 20 years back, is equivalent to Rs 45 lakh today.The entry barriers are lower, resulting in poorer quality of new members

But competition is good for investors …

It is true to a certain extent. However, If there is such a plethora of intermediaries in the market, clients will be induced to trade more. Effectively, the market will become more short-term in nature. Providing a quality service will become a big challenge. If my competitor is willing to provide a trading account for free, I will need to match it. Of course, the compliance cost has gone to the roof.

We have to provide the infrastructure, dealing terminals, telecom backbone, and watch through every trade and keep records for eight years. The return I get is decided by the next door mom-and-shop competitor. I feel we have got into this vicious trap of over capacity. Consequently, brokerages have gone to the suboptimal level. There is no incentive for providing advisory services which will benefit investors.

What is the remedy?

In the interest of banks, the RBI can restrict banks from competing on certain services offered by them. Public insurance companies are not allowed to under cut. The Aviation Ministry, which has no business of regulating tariff, can express its concern to airlines about under cutting prices. Why does SEBI not monitor the fees charged by intermediaries, so that service quality is maintained?

Lower charges are beneficial for investors. Isn’t it?

No, not always. Take the case of the power sector. All the companies have bid the lowest price at which they can supply the power. Now, they are struggling to fulfil their commitment. Lowering brokerage charges alone will not bring retail investors back. There was a time when you could not charge more than 2.5 per cent.Now, even 2.5basis points is difficult to retain. Development of the market cannot be done in the absence of intermediaries.

Electronic currency can potentially take away the ability of central banks to control money

My column on Bitcoins that appeared in the "Poke me" section of economic times.

The unedited version (less dramatic) is below.

The future of money

Have you ever redeemed your credit card loyalty points to purchase a product of your choice? Or converted air-miles received as a frequent flyer to get some free tickets? If you have, you have already been exposed to virtual, electronic money. After all, a key purpose for money to exist is to function as a medium of exchange. These loyalty points serve the purpose of allowing you to exchange them for tangible goods and services.

When we carry out any of the above transactions, we do not see it as an alternative currency. The loyalty points can typically be exchanged for a limited set of goods, and are not universally acceptable. But what if they were? What if they worked as electronic money and were widely accepted?

Fiat money – a promise to pay backed by “confidence”

In a “Fiat Money” system – on which all contemporary economies are based, the notion of money - often represented by currency notes - is based on “confidence” that users have on the issuing authority. With no real assets backing the currency notes, issuers can issue as many notes as they want. However, economic growth cannot be assured by just printing money – it must come from higher production of goods and services. Consequently, if an issuer continues to “print” money, it will fall in value compared to other currencies or commodities.

One way to increase confidence is to back up fiat money by another commodity. Gold served as money for centuries, before it was replaced by “representative money” – where paper (representing the underlying commodity) could still be redeemed for gold. This changed in 1971 – when conversion was disallowed by the USA. Since then fiat money has been the basis of most transactions the world over.

Bitcoin – digital currency

All currency systems so far have required an issuing authority – with the ability to issue or destroy currency. In 2009, a yet unknown programmer using the pseudonym Satoshi Nakamoto published a proof of concept of a crypto-currency called “Bitcoin”. As the website (bitcoin.org) explains “building upon the notion that money is any object, or any sort of record, accepted as payment for goods and services and repayment of debts in a given country or socio-economic context, Bitcoin is designed around the idea of a new form of money that uses cryptography to control its creation and transactions, rather than relying on central authorities.”

Interested readers can study the specifics in detail at the website, but in summary, a user can create an online “wallet” and receive and pay bitcoins from it. All data (including transaction data) is stored in a distributed environment on the web. Since there is no issuing authority, the algorithm for generation of new bitcoins fixes the total number that will ever be in circulation.

Transaction ease is tremendous – there are no transaction charges (or very small ones), payments are easy to make and receive – like sending e-mails. In effect there are no political boundaries, no bank holidays and no one to censor who can receive or make payments and for what.

With reportedly only one breach which was sorted out, the system seems to offer sufficient security for people to have “confidence” in it. Bitcoins can be exchanged for regular currency at an automated price discovered basis transaction history. At present, the bitcoin website reports that daily transactions exceed $1mn per day distributed over 40,000 transactions. 

Why now?

So what makes bitcoins attractive in the current market context – and popular they clearly are (see graph of USD vs bitcoin over the past 1 year).

 

The key driver for popularity of bitcoins is risk that investors face in the current global economic environment, with central banks engaged in competitive devaluation of currency, and large financial institution risk remaining unmanageable.

Imagine if the depositors in Cyprus’ failed banks had, been holding their money in the form of bitcoins instead of holding their deposits in Euro. The Cyprus government, and European “troika” that forcibly took away almost 60% of the deposits would not have been able to get their hands on the money.

Investors have, over the past few years been using Gold and Silver as a portfolio insurance against currency devaluation and systemic risks of financial markets. However, like money, gold and other precious metals too are available to governments to usurp – and therefore, in a Cyprus like situation, are not adequate security. Bitcoins are however not accessible at a single location and, like the internet, cannot easily be controlled.

Bitcoins - the glitches

So long as bitcoins are used as a medium of transaction or as a store of value, it is highly likely that their popularity will grow. Questions arise on how governments would react – will bitcoin transactions be taxed for example?

Bitcoins offer total anonymity. One can have as many accounts as one wants. With smooth transition across borders without the use of banks, bitcoins have the ability to facilitate illegal transfer and transactions. The fact the governments’ are waking up to the emergence of online currencies is affirmed by a new law passed by the US government in mid March. It now requires that transactions more than $10,000 need to be reported.

Lastly, if its popularity rises, it will not take long for markets to start offering derivatives and structured products around it. With no regulatory framework, that would mean risk rise manifold. Despite these obvious road blocks, markets needs to look at this innovation carefully. The challenge that it throws to established order of central bank controlled currencies will, over time, lead to a re-examining of the very concept of money.

The Promise of Power

My latest article on nuclear power written for wealth insight

Nuclear power has been projected as the energy on which future growth will depend. But, it's neither feasible nor desirable...

Earlier this month, I had the opportunity to attend the book launch of "The Power of Promise" by MV Ramana. The book discusses Nuclear Energy in India and its outlook – a subject that needs greater public debate. In the context of an energy deficient India, nuclear power has often been projected as the panacea, the energy fount on which future growth of the economy will depend. The case for nuclear power is based on two major argument (a) it is cheap (b) it is non polluting and abundant.

Marshalling rare facts from a secretive nuclear establishment, Ramana argues that nuclear power as a major source of India's energy plan is neither feasible nor desirable.

Nuclear power: more expensive than coal
In 2003, an interdisciplinary study by researchers at MIT came to the conclusion "In deregulated markets, nuclear power is not now cost competitive with coal and natural gas". This study was updated in 2009. The conclusion remains: "the prospects for nuclear energy as an option are limited, the report finds, by four unresolved problems: high relative costs; perceived adverse safety, environmental, and health effects; potential security risks stemming from proliferation; and unresolved challenges in long-term management of nuclear wastes."

Ramana's conclusion is similar. He compares cost of power generated from coal to that generated from nuclear plant – using assumptions that are grossly in favour of the nuclear alternative. He assumes that coal fired generators last a decade less than nuclear reactors, have to pay more for fly-ash disposal (they don't). Simultaneously, the radioactive waste disposal in nuclear power plants is supposed to cost only 2 paise per unit (it will likely cost a lot more). Additionally, he assumes that coal travels 1,400 kms to reach the power plant (over 33 per cent of coal fired generators are either at the pit head or increasingly near ports where the coal can be imported). Despite all these assumptions, at any cost of capital over 4 per cent, coal based power generators are cheaper than the nuclear alternative on the basis of levelised tariffs.

Safety: a significant concern
None of the above factors in the cost that needs to be paid for security, and potential health issues. It is pertinent to note the response of various government departments with regard to preparedness in case of nuclear accidents. While reacting to the Parliamentary standing committee discussing the nuclear liability bill, the ministry of water resources remarked "The Secretary, water resources, was of the opinion that any nuclear incident may induce radioactive contaminations in surface, ground water bodies, and other water resources. However, he stated that the Ministry does not have any facility for testing water quality".

The Secretary, Ministry of Health and Family Welfare while deposing before the Committee mentioned that her Ministry is "nowhere (ready) to meet an eventuality that may arise out of nuclear and radiological emergencies." She further mentioned that while drafting the Bill the Department of Atomic Energy did not consult them. She added: "Since the response system to deal with any kind of emergency of such type, the hospitals are not well-equipped, it is natural that mortality and morbidity due to multiple burn, blasts, radiation injuries and psycho-social impact could be on very high scale and medical tackling of such a large emergency could have enough repercussions in the nearby areas of radioactive fall out."

Proponents of nuclear power maintain that the likelihood of a nuclear accident remains remote – not so. Incidents like the recent accident in Japan illustrate that the best systems are prone to failure and in a densely-populated country like India, can lead to disastrous consequences. As Ramana pointed out in his speech – if the manufacturers are really so confident of their equipment being safe, why are they insisting on shielding themselves from nuclear liability – clearly there remain a real and non-trivial risk of nuclear disaster.

Is the DAE plan feasible?
In 1964, Bhabha stated "There is little doubt that before the end of the century, atomic energy will be producing a substantial part of the power in India, and therefore practically all the addition to our power generation will come from it at that time". In 1972, Homi Sethna, chairman AEC, predicted that India would have 43GW of nuclear generating capacity by 2000. In reality, in 2000, India had 2.7GW.

In September 2009, the PM stated that India will have 470 GW of nuclear power capacity by 2050. To put this in perspective, out of the total generation of over 200GW in India, less than 5GW is currently nuclear. Can we really expect almost a 100 fold increase in nuclear power generation capacity over the next 40 years?

India's plan for rapid growth of nuclear power is contingent on using fast breeder reactors (FBR). FBR's generate plutonium and are supposed to provide fuel for the next reactor – a sort of chain reaction allowing unlimited amounts of fuel! However, Ramana's analysis reveals that when adjusted for the time taken for a reactor to generate enough fuel to power up the next, the theoretical rate at which reactors can be built, reduces by 60 per cent of what the DAE estimates. In other words, "a fast growth of breeder reactors is not even theoretically, let alone practically, achievable."

Rosier in the future
As with many government estimates, the future seems rosier than history would suggest. A recent example is the criticism that the government's economic mandarins are reserving for CSO's advance GDP growth estimate of 5 per cent for 2012-13. Responding to the CSO's decade low figures, the Deputy Chairman of the Planning Commission reacted "I think it (growth projection of 5 per cent in 2012-13) is very low. I have been told that CSO has taken data from April to November (2012-13) and they just projected it (advance estimates)". Hasseb Drabu's comment is worth noting - "The sources and methodology adopted by the CSO are laid out by the System of National Accounts 2008, the latest version of the international statistical standard for national accounts, adopted by the United Nations Statistical Commission (UNSC). ...In this context, it will be enlightening to know which system of national accounts in the world is not based on past data. Also, what other data can official national accounts possibly be based on?"

There cannot be a better time to warn of rosy projections based on views, not data, as we enter the Budget Session. As investors, we need to keep assumption firmly rooted to reality. And yes, India's quest for renewable energy needs to be strongly focussed on the solar option – where paradoxically, the government plans to impose an additional import duty!