Saturday, 3 September 2016

6 simple steps to get your Financial Plan and Financial life on Track

By Ramalingam K

Financial planning is a process of understanding your income and expenditures, and planning accordingly for your future – both short term and long term life goals.
Most often when you go shopping, you look at how much money you can spend and then accordingly prepare two lists. The first list includes stuff you NEED and MUST BUY. And the second list is all about the stuff you WANT to buy if you have ANY EXTRA CASH left.
Now, look back at the second list. You will notice that the little things here are the ones that are really going to make you happy from within. But most often, as expected, you just begin on the ‘Want’ list before you run out of cash.
Financial Planning will help you change this. It is all about looking at the larger picture.
It is important to set your goals on what you ‘need’ and what you ‘want’ and pay equal attention to both.
These 6 simple steps will help you get your Financial Plan on track:
1. Know your income:
Where is your money coming in from? Pay check, investments, small business, etc. Try to add-on as much as possible – without killing yourself about it.
2. Understand your expenses:
Where does your money go? Food, bills, mortgages, shopping, recreational spends, medical emergencies, education, etc. – and try to save.
3. Estimate what will remain:
Try to do this regularly and start thinking about what you can do with the remaining funds. This will also help cheat yourself into saving more, by not spending. Invest, don’t spend.
4. Invest wisely:
Don’t let money lie in dud investments. There are numerous investment options in the market. Invest keeping in mind your short term and long term life goals, your budget and what you want out of your investments.
5. Pay-off mortgages :
Paying off your loans on property, credit cards, etc. as fast as possible, will give you peace of mind sooner and allow you to start saving sooner. Another little known fact about loans is that you will also save up money paid out as interest by shortening the term of your mortgage.
6. Improvise, if needed:
Things change. Over time, good stocks may turn bad. Inflation rates may get to your fixed investments. Modify plans if necessary. Break bonds and reinvest if needed. Look at the long term returns and take action – change course. Don’t panic every time though; play smart.
Following a plan does not mean you will get everything you want immediately. But having a realistic financial plan – and sticking to it – will ensure that you achieve most of your life goals.
The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Director and Chief Financial Planner of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at ramalingam@holisticinvestment.in
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Monday, 29 August 2016

7 Misconceptions about Mutual Fund SIP

Systematic Investment Plan or Mutual Fund SIP is fast becoming a common term in the investment market. But a lot of people are still uncertain - some are cynical of the “new thing” in the market while most are just confused. With so many misconceptions on what Mutual Fund SIP is about, how and who can use it, it’s high time to clear out a few myths!
What is Mutual Fund SIP?
A Systematic Investment Plan (SIP) is not an investment; it is a method of investing in Mutual Fund SIP is not an investment scheme, just an investment strategy. Let us determine a few myths surrounding Mutual Fund SIP that can hold us off from attaining financial freedom.
i: SIP stands for SYSTEMATIC Investment Plan
This is one of the biggest mistakes that people do when considering systematic investment plans. People think that Mutual Fund SIP is for investing small sum of money. Mutual Fund SIP can be done for investing Rs 1000 per month, 1 lac per month and even for 1 crore per month.
Mutual Fund SIP is just a concept for a periodical, well-disciplined, long-term investment not limited to the amount of investment.
Irrespective of the amount invested, it is important to understand that the investment is into an underlying asset. And instead of timing the purchase, we are simply averaging the ‘per unit cost’ of the investment. The rupee cost averaging works alike for all. Regular investment through ups and downs, whether it is a small or big amount, using Mutual Fund SIP, results in better long term returns.
ii: Penalty if I stop my Mutual Fund SIP in between?
This is another prevalent myth about Mutual Fund SIP investment. Considering Mutual Fund SIPs in equity funds, if you have committed to an investment for a period of say 10 or 20 years, then you cannot change its tenure or the amount. And if you do, you will be penalized. This is not true.
You can continue, or stop, or adjourn the Mutual Fund SIP, as and when you wish to do so. This can be done by giving a written request duly signed, allowing about one month for the fund to adhere to this instruction. And,
or changing the amount, all you need to do is stop the existing Mutual Fund SIP to start with a new one.
iii: Lump sum or SIP?
There are two questions that need to be answered before we decide to make a choice between Lump sum and SIP.
Can you be sure of your lump sum investment today, to fetch guaranteed positive returns after 5 years?
By investing as a lump sum, there is a possibility that, you may enter the market at a very wrong time. Whereas by investing in SIP, you are restricting yourself to enter everything at a wrong time. Mutual Fund SIP reduces the risk by diversifying our investments on different timelines.
Timing the market is very risky due to its volatility – you can never be sure what the state of the market will be after 5 years. But by investing the same amount in installments regularly over 5years, you can use the market volatility to your advantage. You would be participating not only in the upswings of the market but also restricting the losses in a falling market. So, the robust returns in case of Mutual Fund SIP, are received despite the fact that the investments would be subject to volatility at different levels.
The second question is whether everyone has large, lump sum amounts to invest at one go? It is easier on your everyday budget to invest smaller amounts regularly.
iv: My returns are low – SIP isn’t working for me!
People tend to keep looking at their investments to see how much their returns are. If you invest in SIPs, looking at the absolute returns after short intervals is not going to make you feel good. SIPs are based on the Internal Rate of Return (IRR) of the investments.
Usually, in a short term SIP, the absolute returns seem lower than the IRR. This is because in an SIP, you invest at various points in time, not the whole of it at one go. Therefore, there is no one point-to-point annualized return. The returns will look good, if you consider the varying intervals of investment, after a long term.
v: Markets are high! SIP can wait
People ask – when should we start investing in SIP? The right answer is – Any time is a good time! If we could predict the markets, then the concept of SIP wouldn’t exist! It is not the time at which you invest that is important but the duration for which you invest regularly.
The volatility of the market is used to an advantage by investing in an SIP. The ups and downs of the market make sure that in the long term the price fluctuations don’t affect you because of the concept of averaging the cost of investment.
What you think NOW, as the market high will be a lowest point of investment, 5 YEARS LATER.
vi: Mutual Fund SIPs are ONLY for long term
Mutual Fund SIPs need not be continued for long term. Even Mutual Fund SIPs can be enrolled for a minimum of 6 months. However, the investments made in that 6 months need to stay for long term.
In other words, the “investing” time of Mutual Fund SIP can be short term. The “holding” time of an investment done through Mutual Fund SIP should for long term.
vii: No for Mutual Fund SIP as I have a variable surplus every month
This is again a misconception. I have a variable surplus every month. So SIP is not suitable for me. Because SIP accepts only a fixed investment every month.
The point I would like to highlight is, you can commit a lower sip every month and add whenever you have surplus. For e.g. your surplus/savings varies every month from Rs 5000 to Rs.7000 to Rs.10000. In this case commit an SIP for Rs.5000 and make additional investment of Rs.2000 in the months you have surplus of Rs 7000. Similarly do an additional investment of Rs.5000 when you have a surplus of Rs.10000.
You can make SIP and additional lump sum investments under the same folio.
SIP: Smart Investment Plan
It is important to take well-informed decisions about your hard-earned money. Thus, it is necessary that we are free of any myths and misconceptions. Whether the amount is small or big, by investing the same regularly and giving it adequate time, you will reap the benefits of SIPs in the long term. Getting away with trivial myths, can also help us believe SIPs to be SMART Investment Plans !!! Also, to be a successful long term investor, having a well drafted financial plan will be of immense help.

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Director and Chief Financial Planner of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached atramalingam@holisticinvestment.in

Friday, 24 June 2016

#Brexit Special by CommerceCafe


World stocks headed for one of the biggest slumps on record, and billions of dollars were wiped off the value of European companies.


1 David Cameron to step down by October.

2 Stock markets fall, with banks leading way.

3 Sensex plummets 604.51 points to end at 26,397.71; Nifty nosedives 181.85 points to 8,088.60.

Britain has voted to leave the European Union, forcing the resignation of Prime Minister David Cameron and dealing the biggest blow to the European project of greater unity since World War Two.

Global financial markets plunged on Friday as results from a referendum showed a near 52-48 percent split for leaving a bloc it joined more than 40 years ago.

Sensex fell 604.51 points to end at 26,397.71; Nifty nosedived 181.85 points to 8,088.60. 

The pound fell as much as 10 percent against the dollar to levels last seen in 1985, on fears the decision could hit investment in the world's fifth-largest economy, threaten London's role as a global financial capital and usher in months of political uncertainty.

World stocks headed for one of the biggest slumps on record, and billions of dollars were wiped off the value of European companies. Britain's big banks took a $130 billion battering, with Lloyds and Barclays falling as much as 30 percent. 

An emotional Cameron, who led the "Remain" campaign to defeat, losing the gamble he took when he called the referendum three years ago, said he would leave office by October.

"The British people have made the very clear decision to take a different path and as such I think the country requires fresh leadership to take it in this direction," he said in a televised address outside his Downing Street office.

"I do not think it would be right for me to be the captain that steers our country to its next destination."

Quitting the EU could cost Britain access to the EU's trade barrier-free single market and mean it must seek new trade accords with countries around the world. The United Kingdom itself could break apart, with politicians in Scotland - where nearly two-thirds of voters wanted to stay in the EU - calling for a new vote on independence.

The EU for its part will be economically and politically damaged, facing the departure not only of its most free-market proponent but also a member with a U.N. Security Council veto, a powerful army and nuclear capability. In one go, the bloc will lose around a sixth of its economic output.

The result emboldened eurosceptics in other member states with populist leaders in France and the Netherlands demanding their own referendums to leave.

The vote will initiate at least two years of divorce proceedings with the EU, the first exit by any member state. Cameron - who has been premier for six years and called the referendum in a bid to head off pressure from domestic eurosceptics, including within his own party - said it would be up to his successor to formally start the exit process.

His Conservative Party rival Boris Johnson, the former London mayor who became the most recognisable face of the "leave" camp, is now widely tipped to seek his job. Johnson made no comment as he left his home to jeers from a crowd in the mainly pro-EU capital.


There was euphoria among Britain's eurosceptic forces, claiming a victory over the political establishment, big business and foreign leaders including U.S. President Barack Obama who had urged Britain to stay in.

"Dare to dream that the dawn is breaking on an independent United Kingdom," said Nigel Farage, leader of the eurosceptic UK Independence Party, describing the EU as "doomed" and "dying".

"This will be a victory for real people, a victory for ordinary people, a victory for decent people ... Let June 23 go down in our history as our independence day."

European politicians reacted with dismay.

"The news from Britain is really sobering. It looks like a sad day for Europe and Britain," said German foreign minister Frank-Walter Steinmeier.

"Please tell me I'm still sleeping and this is all just a bad nightmare!" former Finnish Prime Minister Alexander Stubb tweeted.

The shock hits a European bloc already reeling from a euro zone debt crisis, unprecedented mass migration and confrontation with Russia over Ukraine. Anti-immigrant and anti-EU political parties have been surging across the continent, placing unprecedented pressure on the centre-left and centre-right establishment that has governed Europe for generations.

French National Front leader Marine Le Pen called for a similar referendum in France, changed her Twitter profile to a Union Jack and declared "Victory for freedom!"

Dutch far right leader Geert Wilders, also demanding a referendum, said "We want be in charge of our own country, our own money, our own borders, and our own immigration policy."

U.S. presidential candidate Donald Trump, whose rise has been fuelled by disenchantment with the political establishment in the United States that has parallels with populism in Europe, declared that Britons "took back control of their country". He was in Scotland opening a golf club.

Britain has always been ambivalent about its relations with the rest of post-war Europe. A firm supporter of free trade, tearing down internal economic barriers and expanding the EU to take in ex-communist eastern states, it opted out of joining the euro single currency or the Schengen border-free zone.

Cameron's ruling Conservatives in particular have harboured an anti-EU wing for generations, and it was partly to silence such figures that he called the referendum in 2013.

World leaders including Obama, Chinese President Xi Jinping, German Chancellor Angela Merkel, NATO and Commonwealth governments had all urged a "Remain" vote, saying Britain would be stronger and more influential in the EU than outside.

The four-month campaign was among the divisive ever waged in Britain, with accusations of lying and scare-mongering on both sides and rows on immigration which critics said at times unleashed overt racism.

It also revealed deeper splits in British society, with the pro-Brexit side drawing support from millions of voters who felt left behind by globalisation and believed they saw no benefits from Britain's ethnic diversity and free-market economy.

At the darkest moment, a pro-EU member of parliament was stabbed and shot to death in the street by an attacker who later told a court his name was "Death to traitors, freedom for Britain".

Older voters backed Brexit; the young mainly wanted to stay in. London and Scotland supported the EU, but wide swathes of middle England, which have not shared in the capital's prosperity, voted to leave.

Concerns over uncontrolled immigration, loss of sovereignty and remote rule from Brussels appear to have trumped almost unanimous warnings of the economic perils of going it alone.


The United Kingdom itself now faces a threat to its survival; Scottish First Minister Nicola Sturgeon said Thursday's vote "makes clear that the people of Scotland see their future as part of the European Union."

Her predecessor, Alex Salmond, said Scotland was now likely to push for a second independence referendum. It voted against seceding in 2014. Northern Ireland's largest Irish nationalist party, Sinn Fein, said the result intensified the case for a vote on whether to quit the United Kingdom.

The global financial turmoil was the worst shock since the 2008 economic crisis, and comes at a time when interest rates around the world are already at or near zero, leaving policymakers without the usual tools to respond.

The body blow to global confidence could prevent the Federal Reserve from raising interest rates as planned this year, and might even provoke a new round of emergency policy easing from all major central banks, despite their limited options.

The Bank of England said it would take all necessary steps to secure monetary and financial stability. Japanese Finance Minister Taro Aso promising to "respond as needed" in the currency market.

EU affairs ministers and ambassadors from member states gather in Luxembourg by 10 a.m. (0800 GMT) for previously-scheduled talks that will provide the first chance for many to react.

Left unclear is the relationship Britain can negotiate with the EU once it leaves.

To retain access to the single market, vital for its giant financial services sector, London may have to adopt all EU regulation without having a say in its shaping, contribute to Brussels coffers, and continue to allow free movement as Norway and Switzerland do - all things the Leave campaign vowed to end.

EU officials have said UK-based banks and financial firms would lose automatic "passport" access to sell services across Europe if Britain ceased to apply the EU principles of free movement of goods, capital, services and people.

Aside from trade, huge questions now face the millions of British expatriates who live freely elsewhere in the bloc and enjoy equal access to health and other benefits, as well as millions of EU citizens who live and work in Britain.

Sunday, 19 June 2016

10 Tips for the Successful Long-Term Investor


Courtesy : Investopedia 

While it may be true that in the stock market there is no rule without an exception, there are some principles that are tough to dispute. Let's review 10 general principles to help investors get a better grasp of how to approach the market from a long-term view. Every point embodies some fundamental concept every investor should know.

1. Sell the Losers and Let the Winners Ride!

Time and time again, investors take profits by selling their appreciated investments, but they hold onto stocks that have declined in the hope of a rebound. If an investor doesn't know when it's time to let go of hopeless stocks, he or she can, in the worst-case scenario, see the stock sink to the point where it is almost worthless. Of course, the idea of holding onto high-quality investments while selling the poor ones is great in theory, but hard to put into practice. The following information might help:
  • Riding a Winner - Peter Lynch was famous for talking about "tenbaggers", or investments that increased tenfold in value. The theory is that much of his overall success was due to a small number of stocks in his portfolio that returned big. If you have a personal policy to sell after a stock has increased by a certain multiple - say three, for instance - you may never fully ride out a winner. No one in the history of investing with a "sell-after-I-have-tripled-my-money" mentality has ever had a tenbagger. Don't underestimate a stock that is performing well by sticking to some rigid personal rule - if you don't have a good understanding of the potential of your investments, your personal rules may end up being arbitrary and too limiting. 
  • Selling a Loser - There is no guarantee that a stock will bounce back after a protracted decline. While it's important not to underestimate good stocks, it's equally important to be realistic about investments that are performing badly. Recognizing your losers is hard because it's also an acknowledgment of your mistake. But it's important to be honest when you realize that a stock is not performing as well as you expected it to. Don't be afraid to swallow your pride and move on before your losses become even greater.
In both cases, the point is to judge companies on their merits according to your research. In each situation, you still have to decide whether a price justifies future potential. Just remember not to let your fears limit your returns or inflate your losses

2. Don't Chase a "Hot Tip."

Whether the tip comes from your brother, your cousin, your neighbor or even your broker, you shouldn't accept it as law. When you make an investment, it's important you know the reasons for doing so; do your own research and analysis of any company before you even consider investing your hard-earned money. Relying on a tidbit of information from someone else is not only an attempt at taking the easy way out, it's also a type of gambling. Sure, with some luck, tips sometimes pan out. But they will never make you an informed investor, which is what you need to be to be successful in the long run. 

3. Don't Sweat the Small Stuff.

As a long-term investor, you shouldn't panic when your investments experience short-term movements. When tracking the activities of your investments, you should look at the big picture. Remember to be confident in the quality of your investments rather than nervous about the inevitable volatility of the short term. Also, don't overemphasize the few cents difference you might save from using a limit versus market order.
Granted, active traders will use these day-to-day and even minute-to-minute fluctuations as a way to make gains. But the gains of a long-term investor come from a completely different market movement - the one that occurs over many years - so keep your focus on developing your overall investment philosophy by educating yourself.

4. Don't Overemphasize the P/E Ratio.

Investors often place too much importance on the price-earnings ratio (P/E ratio). Because it is one key tool among many, using only this ratio to make buy or sell decisions is dangerous and ill-advised. The P/E ratio must be interpreted within a context, and it should be used in conjunction with other analytical processes. So, a low P/E ratio doesn't necessarily mean a security is undervalued, nor does a high P/E ratio necessarily mean a company is overvalued. 

5. Resist the Lure of Penny Stocks.

A common misconception is that there is less to lose in buying a low-priced stock. But whether you buy a $5 stock that plunges to $0 or a $75 stock that does the same, either way you've lost 100% of your initial investment. A lousy $5 company has just as much downside risk as a lousy $75 company. In fact, a penny stock is probably riskier than a company with a higher share price, which would have more regulations placed on it.

6. Pick a Strategy and Stick With It.

Different people use different methods to pick stocks and fulfill investing goals. There are many ways to be successful and no one strategy is inherently better than any other. However, once you find your style, stick with it. An investor who flounders between different stock-picking strategies will probably experience the worst, rather than the best, of each. Constantly switching strategies effectively makes you a market timer, and this is definitely territory most investors should avoid. Take Warren Buffett's actions during the dotcom boom of the late '90s as an example. Buffett's value-oriented strategy had worked for him for decades, and - despite criticism from the media - it prevented him from getting sucked into tech startups that had no earnings and eventually crashed.

7. Focus on the Future.

The tough part about investing is that we are trying to make informed decisions based on things that have yet to happen. It's important to keep in mind that even though we use past data as an indication of things to come, it's what happens in the future that matters most.
A quote from Peter Lynch's book "One Up on Wall Street" (1990) about his experience with Subaru demonstrates this: "If I'd bothered to ask myself, 'How can this stock go any higher?' I would have never bought Subaru after it already went up twentyfold. But I checked the fundamentals, realized that Subaru was still cheap, bought the stock, and made sevenfold after that." The point is to base a decision on future potential rather than on what has already happened in the past. 

8. Adopt a Long-Term Perspective.

Large short-term profits can often entice those who are new to the market. But adopting a long-term horizon and dismissing the "get in, get out and make a killing" mentality is a must for any investor. This doesn't mean that it's impossible to make money by actively trading in the short term. But, as we already mentioned, investing and trading are very different ways of making gains from the market. Trading involves very different risks that buy-and-hold investors don't experience. As such, active trading requires certain specialized skills.
Neither investing style is necessarily better than the other - both have their pros and cons. But active trading can be wrong for someone without the appropriate time, financial resources, education and desire. 

9. Be Open-Minded.

Many great companies are household names, but many good investments are not household names. Thousands of smaller companies have the potential to turn into the large blue chips of tomorrow. In fact, historically, small-caps have had greater returns than large-caps; over the decades from 1926-2001, small-cap stocks in the U.S. returned an average of 12.27% while the Standard & Poor's 500 Index (S&P 500) returned 10.53%.
This is not to suggest that you should devote your entire portfolio to small-cap stocks. Rather, understand that there are many great companies beyond those in the Index, and that by neglecting all these lesser-known companies, you could also be neglecting some of the biggest gains. 

10. Be Concerned About Taxes, but Don't Worry.

Putting taxes above all else is a dangerous strategy, as it can often cause investors to make poor, misguided decisions. Yes, tax implications are important, but they are a secondary concern. The primary goals in investing are to grow and secure your money. You should always attempt to minimize the amount of tax you pay and maximize your after-tax return, but the situations are rare where you'll want to put tax considerations above all else when making an investment decision .

The Bottom Line

There are exceptions to every rule, but we hope that these solid tips for long-term investors and the common-sense principles we've discussed benefit you overall and provide some insight into how you should think about investing.

This is What RBI's Chief Raghuram Rajan Wrote to his Staff


Message to RBI staff from Dr. Raghuram Rajan.
Dear Colleagues,
I took office in September 2013 as the 23rd Governor of the Reserve Bank of India. At that time, the currency was plunging daily, inflation was high, and growth was weak. India was then deemed one of the “Fragile Five”. In my opening statement as Governor, I laid out an agenda for action that I had discussed with you, including a new monetary framework that focused on bringing inflation down, raising of Foreign Currency Non-Resident (B) deposits to bolster our foreign exchange reserves, transparent licensing of new universal and niche banks by committees of unimpeachable integrity, creating new institutions such as the Bharat Bill Payment System and the Trade Receivables Exchange, expanding payments to all via mobile phones, and developing a large loan data base to better map and resolve the extent of system-wide distress. By implementing these measures, I said we would “build a bridge to the future, over the stormy waves produced by global financial markets”.
Today, I feel proud that we at the Reserve Bank have delivered on all these proposals. A new inflation-focused framework is in place that has helped halve inflation and allowed savers to earn positive real interest rates on deposits after a long time. We have also been able to cut interest rates by 150 basis points after raising them initially. This has reduced the nominal interest rate the government has to pay even while lengthening maturities it can issue – the government has been able to issue a 40 year bond for the first time. Finally, the currency stabilized after our actions, and our foreign exchange reserves are at a record high, even after we have fully provided for the outflow of foreign currency deposits we secured in 2013. Today, we are the fastest growing large economy in the world, having long exited the ranks of the Fragile Five.
We have done far more than was laid out in that initial statement, including helping the government reform the process of appointing Public Sector Bank management through the creation of the Bank Board Bureau (based on the recommendation of the RBI-appointed Nayak Committee), creating a whole set of new structures to allow banks to recover payments from failing projects, and forcing timely bank recognition of their unacknowledged bad debts and provisioning under the Asset Quality Review (AQR). We have worked on an enabling framework for National Payments Corporation of India to roll out the Universal Payment Interface, which will soon revolutionize mobile to mobile payments in the country. Internally, the RBI has gone through a restructuring and streamlining, designed and driven by our own senior staff. We are strengthening the specialization and skills of our employees so that they are second to none in the world. In everything we have done, we have been guided by the eminent public citizens on our Board such as Padma Vibhushan Dr. Anil Kakodkar, former Chairman of the Atomic Energy Commission and Padma Bhushan and Magsaysay award winner Ela Bhatt of the Self Employed Women’s Association. The integrity and capability of our people, and the transparency of our actions, is unparalleled, and I am proud to be a part of such a fine organization.
I am an academic and I have always made it clear that my ultimate home is in the realm of ideas. The approaching end of my three year term, and of my leave at the University of Chicago, was therefore a good time to reflect on how much we had accomplished. While all of what we laid out on that first day is done, two subsequent developments are yet to be completed. Inflation is in the target zone, but the monetary policy committee that will set policy has yet to be formed. Moreover, the bank clean up initiated under the Asset Quality Review, having already brought more credibility to bank balance sheets, is still ongoing. International developments also pose some risks in the short term.
While I was open to seeing these developments through, on due reflection, and after consultation with the government, I want to share with you that I will be returning to academia when my term as Governor ends on September 4, 2016. I will, of course, always be available to serve my country when needed.
Colleagues, we have worked with the government over the last three years to create a platform of macroeconomic and institutional stability. I am sure the work we have done will enable us to ride out imminent sources of market volatility like the threat of Brexit. We have made adequate preparations for the repayment of Foreign Currency Non-Resident (B) deposits and their outflow, managed properly, should largely be a non-event. Morale at the Bank is high because of your accomplishments. I am sure the reforms the government is undertaking, together with what will be done by you and other regulators, will build on this platform and reflect in greater job growth and prosperity for our people in the years to come. I am confident my successor will take us to new heights with your help. I will still be working with you for the next couple of months, but let me thank all of you in the RBI family in advance for your dedicated work and unflinching support. It has been a fantastic journey together!
With gratitude
Yours sincerely
Raghuram G. Rajan

Thursday, 16 June 2016

Why crude oil prices have started rising again

The collapse of global crude oil prices in 2014 was easily one of the biggest energy stories on the planet. By early 2016, oil had slid to $33 per barrel, a level not seen since 2003. Gasoline was dirt cheap, SUVs were coming back in style, Venezuela was imploding, and the US fracking boom started fizzling. It was a really big deal.

Over the last month, however, prices have started to creep back up again, rising to $50 per barrel this week. We're still nowhere near the levels seen before the recent crash, but it’s a noticeable uptick, with potentially important ripple effects around the world. So what’s going on? And will this rally actually last?
Because oil is so easily shipped and traded around the world, prices (mostly) depend on just two things: global supply and global demand. The best place to get a handle on these two factors is the International Energy Agency’s monthly Oil Market Report. The graph below, from the latest edition, tells the tale:
Oil production and consumption noted in millions of barrels per day. (IEA Oil Market Report)
As you can see, between 2014 and 2016 the world was pumping out far more oil than anyone needed, causing prices to crash. Oil production (the green line) was surging, driven in large part by the US fracking boom, Iraq’s postwar recovery, and Saudi Arabia’s decision to keep its own output high.
Meanwhile, oil consumption (the yellow line) was slowing, held back by economic weakness in China and Europe. All that surplus oil was being stored in inventories (in blue) for later.
But as of mid-2016, production and consumption have started coming back into balance, which is putting upward pressure on oil prices. The IEA lists three important factors here:
1) A few key sources of oil have been cut off due to disruptions. The massive wildfires in Fort McMurray, Alberta, have taken more than 700,000 barrels per day of Canadian oil sands production offline. In Nigeria, militants have stepped up their attacks on oil and gas infrastructure. Violence in Libya continues to hinder oil exports there. And Venezuela’s political situation has deteriorated so drastically, the IEA says, that it may soon muck up oil operations.
The US Energy Information Administration notes that "unplanned global oil supply disruptions" are at their highest level since at least 2011. This has even overwhelmed the fact that Iran has lately added 700,000 barrels per day to world markets after the US and EU sanctions lifted sanctions. The net effect is to push prices up:
(Energy Information Administration)
Note that some of these disruptions are temporary (particularly the fire-related outages in Canada), but others could prove longer-lasting.
2) Global oil demand is growing faster than expected. In part because oil is so cheap, countries are using more of it. The IEA now expects global oil demand to grow by an extra 1.3 million barrels per day in 2016. Partly that’s due to fast-growing developing countries like India. But, surprisingly, US oil demand is expected to surge this year by about 255,000 barrels per day. Americans have been taking advantage of cheap gasoline to drive more miles this year than ever before.
3) Low prices are starting to cramp the US shale boom. What makes crude oil markets so tricky is that prices depend on production — but production also depends on prices.
Back in the early 2010s, when global crude prices were hovering around $100 per barrel, US energy companies decided it would be profitable to go after costly and hard-to-extract sources of crude, using fracking to get at the oil locked away in the shale formations of Texas and North Dakota. The resulting "shale boom" basically doubled US crude oil production and helped precipitate the global price crash.
But now those low prices are forcing US drillers to cut back, laying off thousands of workers and idling their drilling rigs. US field production of oil has finally started falling in 2016, as the chart below shows. And, overall, the IEA expects US shale production to drop by 500,000 barrels per day this year:
 (Energy Information Administration)
Monthly totals shown.
US shale drillers have been trying to fend off this day of reckoning by slashing their costs and making their operations more efficient. But at a certain point, economic reality bites down. The shale wells that they’ve already drilled are rapidly becoming depleted (there’s only so much oil a given well can produce), and it will no longer be profitable to drill new wells. (It costs more to extract shale oil than it does for, say, Saudi Arabia or Kuwait or Iraq to pump oil, which is why US production falls first.)
Now here’s where things get really tricky: As US shale producers cut back, global oil production will fall and oil prices will start rising. But at a certain point, if prices rise high enough, those shale drillers will fire up their rigs again and resume drilling. It’s a complicated game of ping-pong.
No one knows for sure how high prices have to rise to convince US shale companies to start drilling again. Is it $50 per barrel? $60 per barrel? Some companies may feel burned by last year’s short-lived price rally and are wary about jumping back in to drill only to then lose money when prices consequently fall. Others may decide to open up the thousands wells that they’ve already drilled but haven’t yet tapped. And if companies dostart increasing production, how far do prices fall again? Where is the equilibrium?
So if you want to figure out where oil prices will go next, you have to take this all into account. Some of the factors pushing up oil prices right now, such as Canada’s wildfires, are only fleeting. Others, like violence in Libya and the deterioration of Venezuela, seem more likely to stick around for a while. And then there’s the ever-tricky question of how the US oil industry responds to prices. Plus the fact that the world still has some 3 billion barrels of oil tucked away in storage. No wonder oil prices are always so tough to predict.

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