Vijay Kumar Gaba: October 2018

Wednesday, October 31, 2018

Following the custom

Wishing all the readers a very Enlightening, Blissful and Joyous Diwali. May the Mother Supreme destroy all the darkness and sorrow.

Some food for thought

"I hate mankind, for I think myself one of the best of them, and I know how bad I am."

—James Boswell (Scottish Lawyer, 1740-1795)

Word for the day

Shambles (n)

A scene or a state of great disorder or confusion.

A place of mass slaughter or bloodshed

First random thought this morning

As per some media reports, India has attained the distinction of being number one in world in respect of kids under the age of five dying of toxic air. As per WHO data about 60,000 toddlers in India died due to toxic air in 2016. Surprisingly, no government has claimed the credit for making this distinction.

In recent past we have seen people from all walks of life vociferously shouting about Sabrimala, Ayodhya, fire crackers, dahi handi, Durga pujo, 377, 498, Triple Talaq, etc. These are indubitably important issues. But in no sense these are more important saving the future of the country.

Thousands of young kids are losing their life prematurely. Millions other are forced to live a handicap life, with poor vision, infected lungs, and host of respiratory and cardiovascular complications. Even Baba Ramdev is not objecting to business being generated for MNC cosmetic companies due to premature graying of hairs of millions of children!

No politician is stalling parliament over this issue. No one is seeking a debate in the parliament. No one is forcing the Prime Minister to make a statement on this issue. No candle light marches. No protests at Jantar Mantar. Nothing.

Most unfortunately, citizens are taking every order of courts aimed to curbing pollution as an attack on religion. What would you call this situation? I could not find an appropriate word. May Shashi Throor could help!

Chart of the day

Following the custom

It's Diwali time again. This is also the time when the stock market celebrities take out their finest ethnic drapes and appear on various shows hosted by business channels and share their annual outlook about the Indian economy and markets. Invariably, almost all of them speak in one language - the language of hope and optimism. A variety of investment ideas are also shared with the viewers, primarily for one year investment horizon.

Besides, most of the domestic brokerages publish a special Diwali Picks report, which presents a set of attractive investment ideas with one year investment horizon. Insofar, it is customary and done in the festive spirit, it is a welcome practice; more so this year when the mood is somber.

Honoring the custom, I would also like to note the following points, that could be positive for Indian markets in next one year or so:

(1) Emerging market valuations have almost reached the trough. The valuations of Indian stocks have also corrected meaningfully from the peak. A good number of quality midcap stocks are now trading at their trough valuation. Some more correction in next few months would make Indian equities more attractive than their global peer.

(2) In next 7months most of the political concerns would be alleviated one way or the other, lifting many dark clouds hanging over the outlook for Indian economy.

(3) There are early signs of pick up in investment cycle in India. We may get confirmation of trend in next 2-3 quarters. If confirmed, this investment cycle may last for 4-5years, providing many good investment and trading opportunities.

(4) The trade related tension between US and China, may open up many significant opportunities for Indian businesses, as most of the advanced countries with massive manufacturing basis in China may look to diversify their supply source.

(5) Stable rates and currency, may lure long only investors back to Indian markets, as the unwinding of USD carry trade subsides, with Fed indicating a pause towards end of 2019.

(6) As the late rains have created adequate moisture in land, we may see a good Rabi crop this time. Hopefully, a good monsoon would add to farmers' joy and rural demand will come back robustly next festival season.

(7) IBC process would get stabilized by next Diwali. We may see many large cases getting settled relieving the banking system. Large corporate banks shall be able to raise adequate growth capital and get going with their business, easing liquidity pressure and easing credit conditions in the market.

(8) Global growth may bottom out around 3% - 3.2% with healthy inflation, unleashing a goldilocks period for emerging equities.

(9) US yields and USD may peak out by summer of 2019, halting the flow of USD back to US assets, bringing emerging assets, including Indian assets, back in favor.

(10) With investment cycle and farm sector growth picking up, we may see the domestic growth estimates for FY21 topping 8% mark.

To many, these points may sound too optimistic this morning. Well, these might actually be so. I shall leave this debate to sometime after Diwali.

From today, I am taking my Diwali break. My next post will be on Monday, the 12th November.

Tuesday, October 30, 2018

Check for signs of Investment cycle turning up

Some food for thought

"Not everyone grows to be old, but everyone has been younger than he is now."

—Evelyn Waugh (British Author, 1903-1966)

Word for the day

Diablerie (n)

The domain or realm of devils.

First random thought this morning

It is often seen that cricketers highlight the evening dew as an external factor in determining the outcome of a day-night cricket match. Why?

Isn't dew a key factor that is known to all the stakeholders well in advance? Shouldn't the game strategy take care of it? Why is it cited as an external factor that helped in changing the outcome of the match?

The same thing applies to the politics also.

Aam Aadmi Party (AAP) knew very well, before preparing its manifesto for Delhi elections, the power, accountability and limitations of the Delhi administration, as per the constitutional provisions. Nowhere in the manifesto of AAP it's mentioned that their promises are contingent upon Delhi Administration getting more power or Delhi getting the status of full state. Then why AAP is taking refuge under this excuse for its failure to fulfill the promises made in the manifesto?

Similarly, BJP came to power fully knowing the state of economy, treasury and politics. In fact one of its primary election plank was poor state of economy (10year of policy paralysis), and treasury (stimulus post GFC, MNREGA, food security, pay commission, OROP etc.) BJP was also fully aware about its political limitation (lack of adequate numbers in Rajya Sabha, etc.) BJP did also adequately highlight the poor state of infrastructure, employment, corruption, inequality, institutional inadequacies etc. allegedly due to 70yr misrule of Congress.

Fully cognizant of all these facts, BJP made promises in its election manifesto. Nowhere did it mention that all these promises are subject to Congress cooperation in Rajya Sabha, or correction in the circumstances that are prevailing due to Congress misrule. The promises were made unconditionally for a 5yr term. It has to answer accordingly. The platitudes like "we have done more in 4.5yr than what Congress did in 70yrs" are not acceptable.

It is high time that the Election Manifesto of parties is made a statutory document, and all parties are accountable for what they promise. A delivery percentage of less than 50% should lead to ban on contesting elections for one term.

Chart of the day

Check for signs of Investment cycle turning up

A recent study conducted by RBI staff (India's Investment Cycle: An Empirical Investigations by Raj, Sahoo & Shankar) highlighted some encouraging signs for Indian economy. The study highlighted that the Indian investment cycle that was struggling for some years, has shown some signs of turning the corner. Though, it is yet to be seen whether this turnaround is sustainable or not. However, if the current trend sustains, we may be at the cusp of bull market that may sustain for 5year.

It is therefore important to assimilate the findings of this study and keep a close watch on the variety of factors to find if the turnaround in investment cycle in India is sustainable. The investment strategy shall according be modified suitably.

The following are some of the key findings of the said study that an investor may want to note:

1 The real investment rate in India generally trended upwards to peak at 36.7 per cent in 2007-08, before declining to 30.3 per cent by 2015- 16 due to a variety of factors such as the adverse impact of the global financial crisis, the twin balance sheet problem – high leverage by the corporate sector and high nonperforming assets (NPAs) of the banking sector, and subdued domestic capital market conditions.

The slowdown in the investment rate was one of the major factors, which pulled down India’s growth rate from a high of 9.3 per cent in 2007-08 to a low of 6.7 per cent in 2017-18.

Though the investment rate has picked up since 2016-17, there is uncertainty about the sustainability of the recent upturn in investment activity and its role in stepping up India’s growth rate – both in the near- and the medium-term.

2. One percentage point fall in investment rate dents growth by 0.4-0.7 percentage points. Investment rate is also highly correlated with the non-agriculture GDP growth rate, particularly in recent years.

3. Interest rate is one of the major factors in investment decisions, as user cost of capital, plays an important role in capital formation. The negative relationship between real interest rate3 and investment rate in India is also evident after the 1990s when interest rates were deregulated.

4. Apart from the cost of capital, availability of financial resources/funds is another important factor that is expected to drive investment, especially because India has a bank-dominated financial system. Non-food credit growth of commercial banks is closely related with the investment rate.

5. The private sector is the biggest contributor to gross capital formation and it has played a crucial role in driving India’s investment activity. However, the fiscal deficit in India appears to have crowded out private investment as is evident from the negative relationship between the GFD and the investment rate.

6. Global growth is also observed to have an important bearing on India’s investment activity through exports. For instance, the GFC during the second half of the 2000s impacted the Indian economy through trade and finance channels. The global GDP growth turned negative in 2008 and 2009. Sluggish global economic activity dampened India’s export demand and led to a slowdown in investment activity.

Signs of Investment cycle turning up

7. In the post-liberalisation period, four major downturns in the investment cycle have been witnessed. The first phase of severe downturn was in the first half of the 1990s, when the Indian economy was hit hard by the balance of payments crisis, leading to import compression and a deceleration in domestic economic activity. The next phase of downturn in the investment cycle occurred in the early 2000s due to an adverse impact of the bursting of the information technology bubble. The third phase of downturn during 2008-10 reflected knock on impact on the Indian economy through the trade, finance and confidence channels, resulting from the global financial crisis and seizure of the international capital market.

The last phase of downturn in the investment cycle occurred from 2011-12 to 2015-16, reflecting a combination of global and domestic factors. During this phase, world GDP growth fell from 4.3 per cent in 2011 to 3.2 per cent in 2016; average domestic inflation was around eight per cent; real interest rate was high at around five per cent; the combined GFD of the Centre and states was on an average of 7.1 per cent; and the average current account deficit was 2.6 per cent. Bank credit growth collapsed as domestic commercial banks became risk averse due to large gross NPAs and the corporate sector focused on deleveraging rather than fresh investments.

8. The investment rate began to turn around from 2016-17. This is also reflected in several other high frequency indicators such as industrial production which has picked up since the H2:2017-18. Capital goods production, in particular, has increased sharply, reflecting strengthening of capital formation.

9. Bank credit growth (y-o-y) of scheduled commercial banks (SCBs), which decelerated from 21.3 per cent in March 2011 to 4.5 per cent in February 2017, has also shown a gradual pick-up from Q3:2017-18. The recent improvement in credit growth is also becoming increasingly broad-based. Credit flows to industry, which contracted during October 2016 to October 2017, has turned positive since November 2017.

10. Resource mobilisation through initial public offerings (IPOs), which has been picking up since 2015-16, rose sharply in 2017-18.

11. Capacity utilisation in the manufacturing sector, which plays a significant role in promoting fresh investment activity, has also picked up since H2:2017-18 and has reached the long-term average level in Q4:2017-18.