The new prescription

Foreign generic companies set up base in India

The pricing pressures in the key US generics market are well-known, with resulting margin pressures on generic players.

Unfortunately, it's not only in the US that competition is increasing "" the domestic pharma industry has received another jolt with foreign generic players such as Ivax of the Us and Germany-based ratiopharm now setting up base in the country.

The country's low-cost structure, of course, is the primary motive for these foreign players to set up base here. These foreign players are now actively seeking to recruit Indian scientists and quality assurance personnel for both R&D and regulatory requirements.

This development is expected to result in domestic generic players, big and small, once again grappling with a further rise in their staff and R&D budgets, in a bid to remaining competitive.

For instance, Ranbaxy already had to deal with a 21.6 per cent increase in staff costs in CY04, while Dr Reddy's Laboratories' R&D costs were up 74 per cent in FY05.

A further hike in these overheads is expected to squeeze margins further, going forward.

However, for smaller generic players, the new operating environment is expected to result in a radically different operating strategy. Analysts point out that once foreign players lower their operating costs via Indian operations, it would force smaller Indian generic players to enter into sourcing agreements with foreign generic players.

That's because these smaller players would no longer be able to rely on lower costs to drive their growth in the overseas generics market.

Inevitably, the new operating environment is expected to give a fillip to the much awaited merger and amalgamation activity between generic players, both large and smaller sized.

Central banks go back to $

It's possible to interpret the US data for capital inflows for April as yet another signal of that country's inability to attract enough capital to cover its trade deficit, and therefore as another reflection of global instability.

But although net US securities purchased by foreigners fell to $53.6 billion in April, the lowest figure in twelve months, the dollar was unaffected, holding on to 9-month highs against the euro.

In fact, the key takeaway from the data was that official flows into the US, i.e. central bank buying, turned positive to the tune of $11.5 billion in April, after net sales of $14.4 billion in the previous month.

Clearly, the rally in the dollar has spurred dollar buying by central banks once again. The Japanese have turned buyers for the first time since last November, and China has once again started buying after selling marginally in March.

And with the Euro having committed political hara-kiri since April, the numbers look dated. Many more dollars must have flowed across the Pacific since April.

Nevertheless, there are quite a few dealers who believe that the huge US deficits would in the longer-term weaken the dollar. The strength of that opinion is seen from the number of investors flocking to gold, which is once again rising.

Normally gold prices move inversely to the dollar, but in recent weeks both the dollar and gold have rallied together.

That's because many investors bearish on the dollar have forsaken the Euro, whose political risks have risen sharply, for gold.

Split capital funds

Benchmark Asset Management Company, which first got exchange traded funds to India, have now launched the country's first split capital fund.

The fund launched by Benchmark is a three-year close-ended fund with a portfolio of debt and equity. Spilt capital funds have two classes of unit holders, with different risk-reward profiles.

Basically, Class B unitholders carry the equity risk on behalf of Class A unitholders, while Class A shareholders sacrifice return in favour of Class B shareholders.

While Class A shareholders are assured capital protection, their returns are pegged at just 40 per cent of the return generated by the equity portion of the fund's portfolio.

For instance, if the equity portion returns 100 per cent, the total return from the investment will be 40 per cent at the end of three years.

Class B shareholders get a fixed and a rather handsome 65 per cent return (or 18.15 per cent on an annualised basis) at the end of the three year period if the equity markets rise or even stay flat.

Returns fall only with a fall in the equity markets, and turn negative only when the fall in the markets is more than 40 per cent. In other words, the capital of even Class B unitholders is protected as long as the markets are trading at 60 per cent or more of the current value.

It seems highly unlikely that the markets could be lower three years from now - that would mean a Sensex level of around 4100 points. Also, to match the 65 per cent return Class B unitholders are assured if the markets stay flat or rise, Class B shareholders would have to hope for a rather dramatic 162.5 per cent rise in the markets. Anyone for a Sensex of 18000 in three years?

The risk-reward seems favourable for Class B shareholders, but the catch is that Benchmark would have only 25 Class B units for every 100 Class A units. Excess demand for Class B units would be returned and vice versa.

With contributions from Amriteshwar Mathur and Mobis Philipose