Tuesday, January 30, 2018

Prelude to Union Budget - 1

"The only way not to think about money is to have a great deal of it."
—Edith Wharton (American, 1862-1937)
Word for the day
Ad absurdum (adv)
To the point of absurdity
Malice towards none
Silence was never so glittery as it is today.
#Manishankar Iyer # PChidambram #GVLNarsimharao
First random thought this morning
China is still far from being recognized as a developed economy. Nonetheless it has started behaving like one. Ignoring short term concerns, it is acting ruthlessly to check pollution and spiraling debt. It is keeping its currency stable, and continues to open its markets. It is assertive on geo political issues and shown great ambitions in terms of CPEC and OBOR.
We certainly have many lessons to learn from Chinese, keeping all our prejudices aside.


Prelude to Union Budget - 1

I spent the weekend reading reports published by various market participants highlighting what they expect from the Union Budget for FY19 to be presented day after tomorrow.
In all I read 23 reports. I found all the report unusually similar in their content, expectations and forecast. The jargon used was insipidly the same. "Rural Income", "2019 General Election", "Housing for All", "Power for All", "Roads" and "Fiscal Tightrope" were the most common terms used in all these reports.
There is stark divergence in views relating to the likelihood of changes in tax provisions relating to Long Term Capital Gains and Inheritance (Estate Duty), the two issues that are being most discussed and feared about by the market participants and financial media. The dominant view is that the finance minister will maintain status quo on these issues to keep the markets in good stead. The minority view is that while the exemption for LTCG may stay, the minimum holding period may be increased to bring parity between equities and other assets. However, none believes that LTCG exemption will be withdrawn completely.
All the report relied heavily on the government statements, promises and various documents and lacked in any originality.
This confirms my view that Union Budget is no longer a critical event in the economic calendar of the country, as none of the analysts/economists seem to have put any material effort in preparing these reports.
In short, the consensus view on budget could be summarized as follows:
(a)   The government may maintain fiscal deficit target at 3.2%, and project higher tax revenue growth (both GST and Income/Corporate Tax) and even larger disinvestment target.
(b)   The focus of the budget will be rural voters. Expect higher allocation for rural housing, rural electricity, raising farm income (productivity - micro irrigation, farms inputs; pricing, and profitability).
(c)    Roads and Railways will continue to dominate the infra spending.
(d)   Export sector may be given additional incentives to improve worsening trade account situation and create additional employment.
(e)    The elections to many large states scheduled to be held later this year, and the next general elections due in May 2019 shall have significant bearing on the budget.
(f)    No major change in tax rate is likely. Most changes in tax laws would be administrative in nature aimed at improving compliance and ease of doing business.
Tomorrow I shall share my perspective for the FY19 Union Budget, for whatever worth it is.
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Wednesday, January 24, 2018

Nazrana, sweets and blankets

Next post on Monday, 29 January 2018.
Greetings for the 68th Republic Day of India
"If a fellow really likes potatoes, he must be a pretty decent sort of fellow."
—A. A. Milne (Indian, 1863-1902)
Word for the day
Instauration (n)
Renewal; restoration; renovation; repair
Malice towards none
Do you seriously think that committing suicide by jumping into fire is a good idea?
First random thought this morning
Stuck in a traffic jam yesterday in Delhi, I did my favorite thing again, i.e., bothering people with uncomfortable questions. Like every year, this time also, I checked with people about what they feel about Republic Day.
But unlike past 10-12yrs, this year the reactions of people were quite different. People were well prepared for this question. Their responses were extremely guarded. No one wanted to be on the wrong side of the FRINGES. Almost everyone answered with nationalistic fervor. Everyone implied that it is just not a long weekend for them.
You speak to yourself, and decide how many of them might be lying, and why this suppression of true feelings could be an ominous trend.


Nazrana, sweets and blankets

In the corridors of power, since independence the spring season belongs to the Finance Minister. This is the time when the Union Finance Ministry prepares and presents the union budget for the next following financial year.
Till 2016, the budgets were presented closer to the festival of Holi, which is sort of closing ceremony for the spring celebrations. But since last year, the presentation of budget has been advanced to be closer to the festival of Vasant Panchami, which marks the beginning of the spring festivities.
This is the time when everyone knocks at the doors of the Finance Minister with his/her wish list.
Industry and businesses want tax concessions, better infrastructure, easier (read lenient) compliance. Farmers wants more subsidies, no tax and better infrastructure. Workers want tax concessions, more allowances, better civic amenities (health, education, water, sanitation, roads, electricity etc.). Homemakers want lower food and energy inflation. Defence personnel wants higher salary and allowances and better weapons and equipment. Scientists want better research facilities. Exporters want more incentives, weaker INR and better logistic infrastructure. Importers want lower tariffs, faster and easier custom clearances, stronger INR and better logistics. So on and so forth. No one wants to pay higher taxes and adhere to stricter compliance.
The fact however is that the finance minister of 2018 is significantly less powerful and resourceful than the finance ministers of yesteryears. He virtually has very little discretion in mobilization and allocation of resources.
Most of the indirect taxes, forming about 50% of total tax revenue are out of union finance ministry's purview and are now in jurisdiction of GST Council or State Governments (in case of petroleum products, alcohol and real estate etc.)
Post acceptance of the recommendations of 14th Finance Commission in 2015, the formula for allocation of tax revenue between the central government and states has changed materially in favor of the State Governments. Consequently, implementation of most welfare schemes is now responsibility of the State government.
Insofar as the Corporation tax is concerned, the finance minister himself laid down the road map committing to reduction of tax rate to 25%, and withdrawal of a number of exemptions. Not much deviation is expected there.
Thus the Finance Minister has very little to do insofar as granting the wishes of various sections of the Society are concerned.
He is no more or less than the erstwhile feudal princes, who lost their states and privy purse. The people, as a habit show them respect. In lieu, they distribute sweets and blankets on special occasions.
Expect no more from him on next Thursday....more on this next week
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Friday, January 19, 2018

Begin from the beginning

"As different streams having different sources all mingle their waters in the sea, so different tendencies, various though they appear, crooked or straight, all lead to God."
—Swami Vivekanand (Indian, 1863-1902))
Word for the day
Moira (n)
A person's fate or destiny.
The personification of fate.
Malice towards none
What about decentralizing film certification!
Let each state issue a separate certificate to all movies. So that a producer can boycott one or more states if it wishes to.
First random thought this morning
Media reports suggest that the finance ministry may be mulling 100% FDI in private banks and 49% FDI in PSBs. If implemented, this could result in complete undoing of Bank Nationalization. Large, private banks like HDFC Bank (34%), ICICI (35%), IndusInd (58%), Axis (49%), Yes (46%), Kotak (41%) etc. already have substantial foreign holding. These bank can easily see their foreign holdings going up materially, thus effectively making them foreign banks.
The foreign holding in PSBs, e.g., SBI (12%), PNB (12%), BoB (14%) is relatively small. If the private banks get substantial foreign capital, most smaller PSBs will get further marginalized and rendered irrelevant in the broader picture. The few (4 or 5) that are left will be more private than government.


Begin from the beginning

Stock market blatantly refused to acknowledge the study on the status of education in India (The annual status of education report 2017). This report highlights the pathetic state of primary and secondary education in areas where most of the future workers are dwelling.
Investors appear least concerned about the fact that not in a distant future, Indian companies may not find enough skilled workers locally and may have to depend on foreign workers for even routine clerical jobs.
A nation which should ideally be the largest provider of skill workers to the world might become a net importer of skill workers.
As per the report, though Standard VIII enrolment has doubled in past one decade, only two third of class VIII students stay in school for more than 3years. Implying that the dropout rate of students exiting the RTE framework (14yr of age) is very high.
Furthermore, the report suggests that lack of employment opportunities and availability of good incentives is making a large number of students staying in colleges, pursuing post graduate courses etc. But only a fraction of these PG students may be employable. Many students take such subjects in colleges that do not make them job worthy, because the institution accessible to them offers only such subjects.
The report finds that "Even accounting for work and enrollment in a vocational course, one third of youth who are not currently enrolled in the formal education system are not doing anything. Those who are working are probably doing so in low productivity jobs given their age and education profiles. This does not bode well for the future of these youth."
While a number of ultra nationalists are busy proclaiming fancy facts regarding how India is origin of most modern scientific and mathematical concept and innovations, the fact on the ground is that amongst the children in age group of 14-18yrs:
  • About 25% still cannot read basic text fluently in their own language.
  • More than half struggle with division (3 digit by 1 digit) problems. Only 43% are able to do such problems correctly.
  • Amongst the youth in this age group who have completed eight years of schooling, a significant proportion still lack foundational skills like reading and arithmetic.
  • 24% of surveyed youth could not count money correctly.
  • 21% could not name the State they live in.
  • 14% could not recognize the map of India.
  • 36% could not name the capital of India.
The experts sitting in Yojna Bhawan, need to set the priorities right.
But more than the government, the people of this great nation need to understand that giving or taking a fraudulent education degree (BEd, BT, NTT etc.) is a bigger crime than murder.
By killing one person or robbing a house, a criminal perhaps ruins one family.
People adulterating food may expose a few thousand consumers to health hazard.
A clerk at Motor Vehicle Department does not understand that by giving driving license to an untrained driver for Rs1000, he is potentially endangering the life of all his family members who use roads and are exposed to the such rouge drivers' litany .
But the people allowing incompetent people to become teachers for few thousand rupees, do not understand that they are exposing the entire nation to a grave danger.
These incompetent teachers cause huge stress in the society, as the students inappropriately passed by them (mostly to hide their incompetence and in many instance for money) fail to get any job. Many of these grow as frustrated and cynical citizens. Some of them become criminals too. The more resourceful find a way to get into government jobs (through quota or bribe), adding to the inefficiency and corruption in the administration.
The growing instances of petty crimes like chain rapes, snatching, and even murders involving juveniles, clearly highlight the inadequacies of our teachers.
Anyone who is investing in India for long term needs to be worried about this trend. If this trend is allowed to persist for another decade, this country may not even remain worth living, leave alone investing.
And all those who trolled Mrs. Amir Khan for saying so a couple of years back, might her find words prophetic!
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Thursday, January 18, 2018

Better late than never

"The will is not free - it is a phenomenon bound by cause and effect - but there is something behind the will which is free."
—Swami Vivekanand (Indian, 1863-1902))
Word for the day
Decathect (v)
To withdraw one's feelings of attachment from (a person, idea, or object), as in anticipation of a future loss, e.g., He decathected from her in order to cope with her impending death.
Malice towards none
Surprisingly, people are expecting so much from union budget!!
First random thought this morning
The latest trend in the country seems to be alleging threat to life from BJP and RSS.
If one were to take statements of Hardik Patel, Jignesh Mevani, Praveen Togadia, et. al. at face value, the prime minister and the BJP president may come out to be the most notorious mafia dons who are committed to eliminate all voices of opposition.
The worst part is that media is leaving no stone unturned in sensationalizing their wild and prima facie baseless allegations!


Better late than never

One of the major changes which have taken place in past decade or so is wider acceptance of the role of the foreign capital, enterprise and technology in India's growth endeavor.
Despite recognizing the acute shortage of capital, for many decades post independence our political establishment had remained ambivalent to the role foreign capital should play in India's economic development.
The Congress Party that governed the country for most part of the post independence period allowed its confused foreign policy to override its economic policy. Despite committing to non-alignment movement (NAM), it favored communist Eastern Europe, over fast advancing, technologically & financially rich western countries. It failed to recognize that Western Imperialism, which it was opposing and dreading, had died with the Second War, and USSR which it was favoring in the name socialism, was the only imperial empire left in the world.
We mostly kept technology leaders like USA, Japan, Germany and France out of our markets, in the name of pseudo socialism. The consequence was over dependence on poor and materially less productive Eastern European technology, capital constraints and least favorable treatment at most of the multilateral global forum.
Though, the economy started opening up in early 1990s, the ambivalence on the role of foreign capital, technology and enterprise persisted as the so called socialist forces sought to displace the dominance of the Congress Party. BJP that was emerging as an alternative force was also deeply confused. Though the communist USSR had disintegrated, China emerged as the fulcrum of global left politics. BJP favored the anti China USA and anti Islam Israel for economic and strategic cooperation. But the core of BJP, i.e., RSS remained averse to any kind of foreign role in Indian markets.
Moreover, in 1998 Atal Bihari Vajpayee led NDA government tested nuclear weapon and attracted economic sanctions from the developed world, seriously hampering the still evolving process of market liberalization that started in early 1990s.
UPA-1 government led by Dr. Manmohan Singh was supported by a host of socialist and communist parties and hence could do a little on this front.
It was UPA-2 government in 2009 which shed all the ambivalence and took a definitive positive stance on the role of foreign capital, technology and enterprise. Significant progress was made by this government in enhancing India's economic relationships with countries like Japan, USA, Germany and France.
The incumbent NDA government has very admirably taken forward the initiative of UPA-2 and significantly deepened and broadened the scope of engagement. The best part is socialists and RSS are not seen complaining much either....to continue tomorrow
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Wednesday, January 17, 2018

Decolonialization of economic model

"The whole secret of existence is to have no fear."
—Swami Vivekanand (Indian, 1863-1902))
Word for the day
Nonviolence (n)
The policy, practice, or technique of refraining from the use of violence, especially when reacting to or protesting against oppression, injustice, discrimination, or the like.
Malice towards none
Sophistry is a form of violence, perhaps the worst kind.
All those who avow by Gandhi, must avoid sophistry and chicanery of all sorts.
First random thought this morning
"A democracy can neither forbid propaganda nor allow it. It cannot forbid propaganda without undermining freedom of speech and expression. But it cannot allow propaganda without destroying any hope of cultivating an enlightened citizenry whose political and economic decisions are based on evidence rather than misinformation, on facts rather than partisan descriptions, on reasoned analysis rather than emotional appeals. The first paradox of propaganda is that democracy cannot afford not to tolerate propaganda's open or concealed contempt for every democratic ideal." (Ellul (1965) as quoted by Dennis A. Rohatyn in Philosophy History Sophistry (1997).

Decolonialization of economic model
In past decade of so a number of institutional changes have taken place in Indian economy. Many of these changes are important as these provide a platform for higher economic growth in decades to come. Some of the most important institutional changes, in my view are as follows:
Historically, various regions of India have witnessed an undesirable skew in the growth trajectory. The coastal India has seen most of the industrial development, mostly due to logistic infrastructure constraints that made industrial development in hinterland economically unviable.
Besides coastal towns, the important cantonments of Mughals rulers and British empire have seen higher development of trade and commerce due to better infrastructure and significant government business.
The skew in industrial development got permeated to the social constitution of these regions also. The commercially developed regions have mostly seen better development in areas like higher education, financial inclusion, water, sanitation and healthcare.
Due to better education facilities, these areas naturally got most of the engineering and scientific talent and thus got lead in developing as important center of modern technology and ITeS services.
For obvious reasons these are the centers that attracted most of the foreign business interest also.
These industrially developed areas accounted for most of the tax collections, and therefore development resource allocation. The skew therefore kept worsening over the years. Even the historically superior agriculture states like UP and Punjab lost to Gujarat, Tamil Nadu, Maharashtra and Andhra etc. in terms of growth in agriculture GDP.
In past three decades an effort has been made to institute a shift in the industrial base to industrially underdeveloped areas through a variety of fiscal incentives. These efforts have yielded results to an extent. But since most of these incentives were driven by political expediency without much economic rationale, the results have not been up to the desired mark.
The states and areas that produced maximum raw material and labor were exploited by industrially developed states, as the colonial economic model of British continued even in independent India.
The changes in policy relating to exploitation of minerals, formula for allocation to revenue to states, GST, land acquisition laws etc., seek to diminish the skew by empowering the resource owning states. Some of the faster growth in erstwhile backward states in recent past could be attributed to these changes. Given that maximum youth population is located in these states only, we shall see the economic changes translating into qualitative social changes also in due course.....to continue tomorrow
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Tuesday, January 16, 2018

Cook your own meal

"Arise! Awake! and stop not until the goal is reached."
—Swami Vivekanand (Indian, 1863-1902))
Word for the day
Vatic (adj)
Of, relating to, or characteristic of a prophet
Malice towards none
What did change post Nirbhaya?

First random thought this morning
Some "sensational" media research suggested that in past two decades, some very "sensitive" cases have been assigned to "Junior" judges in the Supreme Court. The report was trying to highlight that something is amiss at the apex judicial forum in the country.
The report implies that someone who has experience of 25-30yrs of judicial experience before being appointed a judge of SC, will still be junior judge, if he is 5yr younger to the Chief Justice. A judge who has served as Chief Justice of a High Court, and delivered judgments of far reaching consequences, will still be junior and incompetent to hear appeals of similar matters.


Cook your own meal

Have you ever been to vegetable market after 9:30PM? The market at 9:30PM is very different from the market at 5:30PM.
At 5:30PM, the market is less crowded. The produce being sold is good and fresh. The customer has larger variety to choose from. The customer is also at a liberty to choose the best from the available stock. The vendors are patient and polite, and willing to negotiate the prices.
As the day progresses, the crowd increases. The best of the stuff is already sold. Prices begin to come down slowly. The vendors now become little impatient and less polite and mostly in "take it or leave it" mode.
By 9:30PM, most of the stuff is already sold, and poor quality residue is left. The vendors are in a hurry to wind up the shops and go back home. The prices are slashed. There is big discount on buying large quantities. Vendors are aggressive and very persuasive.
Customers now are mostly bargain hunters, usually the small & mid-sized restaurant, caterers and food stall owners. They buy the residue at bargain price, cook it using enticing spices and oils, and serve it to the people who prefer to eat out instead of cooking themselves, charging much higher prices.
The cycle is repeated every day, without fail, without much change. Everyone complains, but no one tries to break the cycle. Implying, all participants are mostly satisfied.
A very similar cycle is repeated in the stock markets.
In early cycle, good companies are under-owned and available at reasonable prices. Market is less volatile. No one is in a hurry. Smart investors go out shopping and accumulate all the good stuff.
Mid cycle, with all top class stuff already cornered by smart investors, traders and investors compete with each other to buy the average stuff at non-negotiable prices. Tempers and volatility run high.
End cycle, the smartest operators go for bargain hunting. Strike deals with the vendors (mostly promoters and large owners) to buy the sub-standard stuff at bargain prices. Build a mouth watering spicy story around it. Package it in attractive color and sell it to the late comers and lethargic at fancy prices.
The cycle is repeated every day, without fail, without much change. Everyone complains, but no one tries to break the cycle. Implying, all participants are mostly satisfied.
If my message box is reflecting the market trend near correctly, we are in the end cycle phase of the current market cycle. I daily get very persuasively written research reports and messages projecting great returns from stocks which no one would have touched early cycle or mid cycle.
The stories are so persuasive and the packaging so attractive that I am tempted to feel "it's different this time." But in my heart I know for sure, it is not!
If you are tempted to say that I am saying this crap for almost 5months now, I agree unashamedly with no regrets whatsoever.
Have a look at top 50 price gainers at BSE in past one year. Earnings of most of these companies is not congruent with the rise in market price. In some cases it has been even lower. The stories are truly enticing and even inspiring in some cases.
Out of 8516 BSE listed companies for which data is available, 5095 reported negative EBIDTA in last results. Another 1348 enjoy enterprise value (EV) which is more than 15x. More than 600 companies had EV between 10 and 15. In early cycle more companies trade at better PE ratios.
Make your own assessment of what I am trying to say
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Friday, January 12, 2018

Gurdas Mann singing Dil Da Mamla again

"You cannot be a hero without being a coward."
—George Bernard Shaw (Irish, 1856-1950)
Word for the day
Denouement (n)
The outcome or resolution of a doubtful series of occurrences.
The final resolution of the intricacies of a plot, as of a drama or novel.
Malice towards none
In the spirit of pluralism, the administration shall tell schools to hold a 10minute meditation session every day, in which all students should be encouraged to silently pray the way they like it, instead of current practice of chanting specific prayers.
First random thought this morning
The outrage of the Congress leaders over cabinet decision to allow 100% FDI in single brand retail is inexplicable. If Congress Party truly believes that this decision is in the interest of the Nation, they should rather welcome it.
The fact that BJP, which opposed the move in 2012, has finally chosen to follow the path taken by Congress should encourage the Congress leaders. What is there to complain in it! After all their leader Rahul Gandhi has famously proclaimed that Congress is not a party but a "thought" (सोच) or ideology. If BJP chooses to conform to at least some part of Congress ideology, it should be a subject of celebration for Congress.


Gurdas Mann singing Dil Da Mamla again

People in their 40s and 50s would remember the kind of anticipation and excitement the New Year Eve entertainment program of Doordarshan (DD) used to ignite amongst middle class households.
While the elite (there were only a few back then) partied the whole night and poor shivered, the middle classes would usher the new year sitting in front of their B&W TV sets, listening to Gurdas Mann and watching some sundry comedians trying hard to make people laugh.
The advent of satellite television and rise in middle class aspirations, which took them out of home to party on roads and in clubs, completely diminished the charm of DD. For entertainment, DD now is the recourse of only those who can't afford a cable connection or Jio sim!
Somewhat similar is the situation with the Union budget now.
In earlier days, the rich would eagerly wait for the budget for incentives to make investments and loopholes to evade taxes. The middle classes would wait for some tax concessions. The poor would anticipate more subsidies and welfare schemes.
That situation prevails, no longer.
Tax incentives and deductions have been largely rationalized. Tax rates are mostly predictable. Indirect taxes are out of budget and totally in the realm of GST council. Most welfare schemes have been transferred to states. The union budget is now a boring accounting exercise.
The financial media though tries its best to make it a marketable event, to rake up their TRP. They would rake up all sorts of stories, mostly baseless, to keep the audience interested.
Tax on long term capital gain (LTCG) arising from sale of publicly traded equities is one such stories (like Gurdas Mann's performance) that is served almost every year. If my message box is a benchmark, at least half the market participants are discussing and worrying about it, once again.
Since, a large number of readers have sought to know what do I anticipate from budget, especially regarding LTCG taxation, I may reiterate that I have stated many times before:
In my view, The finance minister is like CFO of a business corporation. His job is to keep account of the receipts and expenditure of the government; manage resources necessary for executing the plans approved by the Cabinet; ensure optimum utilization of available resources; and keep adequate provision for meeting contingencies.
He is accountable to all the stakeholders, insofar as the transparency of accounts is concerned. His discretions are however limited to choosing the sources of revenue needed for executing the plans of the government.
Zero tax on long term capital gains on listed equities has always been a bone of contention. In past, every year, mere hint of withdrawal of this exemption has made markets jittery. But to develop a vibrant debt market an encouraging start ups, brining parity in taxation of debt instruments, unlisted equity and listed equity might become necessary.
In my view, the exemption to the listed equities from LTCG is an anomaly that would need to be corrected at some point in time, sooner than later.
Evaluating holistically, the activity of buying and selling equity shares in secondary market per se does not provide any risk capital to the underlying businesses.
It in effect just changes the beneficial owner of the business. Prima facie it sounds illogical why should someone who is actually transferring his risk, be rewarded with lower (or no) taxes?
It is extremely difficult to support the argument that holding a listed stock for more than one year in any way helps the economy or the markets.
The logic of holding a security for longer term, if at all, enhances the chances of higher returns for the investor. Why should the investor be given tax breaks for enhancing his return prospects?
One could appreciate the "development of capital market" argument in case of investing in IPOs, PE funds, or venture funds etc., as in such cases the businesses get the much needed risk capital. But the secondary market transactions do not pass this muster.
The incentive for longer term holding period has, in my view, failed miserably in improving market liquidity or minimizing market volatility.
It is common knowledge in market place that the LTCG exemption for tax has been abundantly misused for money laundering purposes.
In fact in past couple of years, the regulator and taxation authorities have also initiated action in many cases for misuse of LTCG taxation provision for money laundering.
In fact, to the contrary, the day traders, jobbers and market makers who provide the much needed liquidity to our shallow markets, and hence motivate risk taking, deserve serious tax incentives.
Abolition of Securities Transaction Tax (STT) may actually lead to material rise in daily volumes and deeper markets, thereby materially lowering the transaction cost and market volatility.
In absence of a functional retail debt market, companies depend heavily on "fixed deposits" from household investors for meeting their working capital requirements. These deposits are fully unsecured and entail high risk for investors, in lieu of marginally higher interest rates as compared to bank lending rates.
Providers of unsecured debt take much higher risk and therefore deserve more tax incentives....More on budget views next week
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Thursday, January 11, 2018

Will Murphy's law fail again?

"Science never solves a problem without creating ten more."
—George Bernard Shaw (Irish, 1856-1950)
Word for the day
Suspiration (n)
A long, deep sigh
Malice towards none
If Lalu Yadav, who needs people to serve him in jail, is socialist, who is feudal in India?
First random thought this morning
“The world’s largest taxi firm, Uber, owns no cars. The world’s most popular media company, Facebook, creates no content. The world’s most valuable retailer, Alibaba, carries no stock. And the world’s largest accommodation provider, Airbnb, owns no property.” (Tom Goodwin)
The world is changing like never before, and some of us are busy debating who first discovered the Law of Gravity and banning movies. Someone needs to rise and tell the Rajasthan government "Ok, Brahamgupta-II, discovered the Law of Gravity some 500yrs before the apple fell on Isaac Newton's head. Get the history books and science almanacs rewritten. Charge Newton with crime of plagiarism. Celebrate the legend of Padmavati and kill your daughters in wombs so that they never need to perform Johar. Make sure no child dares think blasphemy like Brahamgupta, Newton or Galileo."

Will Murphy's law fail again?

In recent past there have been many instances when the Murphy's Law failed completely. There were so many things that could have gone wrong. But none actually did.
The moot point that now confronts me is should I take this defiance as an exception or a trend.
For example, with developed world largely standing at full employment level and historic low wage growth, would wages rise sharply or not?
It is pertinent to note here that it is for the first time in a decade that the world is forecast to grow faster in unison. This widespread growth is most likely to unite the central bankers, also for the first time since the global financial crisis (GFC), in their monetary policy stance. GFC saw all central bankers easing the policy in unison. This time we may see them tightening in unison. A glimpse of what this could mean for the global market was provided a couple of days ago when BoJ dropped a feeble hint of the shift in policy stance (see here)
The cost of capital ought to jump higher as growth aims to rise higher and liquidity gets constricted.
It is important to note here that the global leverage has risen materially in past 4-5years. But this leverage has not gone into building additional capacities. On the contrary, we have seen low growth forcing many capacities to shut down or curtailed.


2018 Global growth forecast; Source: Oxford Economics




With two major components of cost (wages and interest) rising, and supply of key commodities still constrained, the rise in inflation is inevitable.
The argument could be whether the spike will happen in 2018 or it may wait for some more time.
The following comments of Ex RBI governor Dr. Raghuram Rajan, who famously foresaw the 2008 GFC coming a couple of years ahead, made in a recent interview to Bloomberg are noteworthy in this context:
"Whenever there is asset price inflation you have to ask yourself, why is it there? And clearly there are some supports for it. Growth is strong for the first time across the world. You’re seeing Europe come back very strongly in the last few quarters and Japan is going the normal way it goes – a country with a labour force declining at one percent a year, for it to grow at one and a half percent every year is great. The U.S. is doing reasonably well. With all the engines firing, on the real side there is some optimism. The concerns have to do with two factors, one is the monetary side and second is the financial side. On the monetary side, when do we see inflation? If in fact you have strong growth, and economies at levels of unemployment not been seen for long, when do we see more wage inflation, when do we see that translate more into goods inflation, that’s the question on the monetary side.
When that happens, you will find interest rates picking up more strongly and that will have an effect on asset prices. The other factor is the financial side. How much debt have we built up in these go-go years. On the retail side, the government side, the corporate side? Covenant-lite loans are at an all time high at this point of time. The question is at that point when interest rates start picking up, when liquidity seems a little less available than it is now, do we see a substantial reaction on the financial side?"
"I think as you remove monetary accommodation, you signal also that the financial side needs to adapt and you give it time to adapt which is Important. So the buildup of leverage that you see, both the Implicit leverage in positions as well as the explicit leverage in debt, I think that will start tapering off if in fact there is a signal that accommodation will be taken off."
There is a strong view that the respective governments may not like the monetary policies to be tighten as it may not be congruent to their political ambitions. The fear is that more and more government may move to compromise the autonomy of central bankers to suit their political ends. I do not feel strongly about this possibility. But if this fear does materializes, this may have disastrous outcome. The hyperinflationary expectations of 2009-10 shall be definitely met in 2019-20, in this scenario.
There is another argument that there are no structural conditions prevailing for the inflationary pressure to sustain for long. Therefore any episode of high inflation shall be brief and passing.
I mostly agree with this assessment. The ageing demography, rising economic inequalities, move towards complete dematerialization of transactions, automation of processes, digitalization of retail trade, energy efficiency and focus on renewable, a good proportion of capacities lying idle or underutilized, etc. are some of the factors that shall keep the inflation low structurally for a long time, perhaps till a major war breaks out and destroys a good part of the present day economic infrastructure.
I therefore believe that any panic reaction due to rise in cost of capital and core inflation, shall still be an opportunity to buy risk assets.
To conclude, I would like to quote the following note of caution sounded by UBS's Larry Hathway:
"The maximum damage from inflation comes if it is unexpected or if it is unpredictable. Unexpected inflation causes damage, because the investor who holds bonds yielding 1% for a decade is going to feel cheated if inflation turns out to be 1000%. Of course, no one would voluntarily buy 1% yielding bonds if 1000% inflation was expected. Thaler’s Law comes into operation here; people dislike losing money more than they like making money. As a result episodes of unexpected inflation will lead to a significant adverse reaction on the part of consumers."




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