Vijay Kumar Gaba: April 2020

Thursday, April 30, 2020

Shift in India's energy subsidies

A recent study by the Canada based International Institute of Sustainable Development has highlighted some interesting trend in the energy subsidies in India. The report titled "Mapping India’s Energy Subsidies 2020" examines how the Government of India (GoI) has used subsidies to support different types of energy.

As per the findings of the report, the following five key changes mark the shift in India's energy subsidies in recent years.

1. Oil and gas subsidies up by over 65%. This rise—from INR 40,762 crore (USD 6.1 billion) in FY17 to INR 67,679 crore (USD 10.07 billion) in FY19— is largely driven by higher oil prices and growing use of subsidized liquefied petroleum gas (LPG).

2. Renewable energy (RE) subsidies down by 35%. RE subsidies fell from a high of INR 15,313 crore (USD 2.3 billion) to only INR 9,930 (USD 1.5 billion) in FY 2019. This reflects falling RE costs but also a slowdown driven by policy decisions such as the solar safeguard duty and price caps in auctions. Several new, large policies have been confirmed since FY 2019, so subsidies may rise again in FY20.

3. Consumption subsidies rising. Success in expanding energy access has also increased the cost of consumption subsidies. State-level under-priced electricity is the most costly individual subsidy policy in India, estimated at INR 63,778 crore (USD 9.5 billion). Evidence suggests it is not well targeted.

4. Coal subsidies remain largely unchanged, and the net costs of coal are much larger than the revenues. Total revenues from coal taxes and charges and is greater than the total costs from coal-related subsidies, air pollution and greenhouse gas (GHG) emissions. Even with conservative assumptions, the outcome is a large net cost from coal. Coal subsidies are estimated at INR 15,456 (USD 2.3 billion) in FY19 and are expected to increase significantly from FY20, given non-compliance with deadlines to install air pollution control technology.

5. Support for electric vehicles (EVs) has skyrocketed. EV subsidies have grown over 11 times since FY 2017. This reflects the fact that India has only very recently stepped up its support levels for EV. Growth is expected to continue.

The report concludes that the "Recent increases in fossil fuel subsidies and decreases in renewable energy subsidies have not yet altered larger trends—since FY 2014, India has shifted significant public resources toward a clean energy transition. In FY 2014, the first year from which we track data, fossil fuel subsidies have fallen by more than half, largely driven by falling world oil prices and policy reforms to diesel and kerosene pricing, while subsidies for RE and EVs have increased over three and a half times, largely due to policy efforts to meet capacity targets. EV subsidies, in particular, have increased over 440 times from a very low baseline in FY 2014."

The report further highlights that "More remains to be done: subsidies for fossil fuels are still over seven times larger than subsidies for alternative energy. In FY 2019, subsidies for oil, gas and coal amounted to INR 83,134 crore (USD 12.4 billion), compared to INR 11,604 crore (USD 1.7 billion) for renewables and electric mobility."

In light of the current COVID-19 led crisis, the report cautions that while focusing on health and economic recovery must be the top priority, the government must not lose sight over clean energy transition that should reflect in coping strategies and support measures.

Next week, I shall discuss few more relevant details from the report.

Wednesday, April 29, 2020

COVID-19 is once in a century event, accept it

As per some media report, the government of India is considering a proposal to revive the struggling MSME sector. It is reported that the government is considering building a contingency fund of Rs400bn that will be used to provide guarantee to Rs3trn of fresh loans to MSME sector. Earlier, the RBI had proposed a moratorium of 3 months on the repayment of principal and interest on the terms loans. Presently, banks have an outstanding credit of Rs15trn to MSME sector. Now it is indicated that each MSME will be extended additional credit equivalent to 20% of the outstanding credit for 6 months period to kick start their locked down businesses. This additional credit facility shall be fully guaranteed by the central government.

"If" "implemented" "simply", without too many conditions and restrictions, it would be a meaningful measure to mitigate the collateral damage caused by coronavirus COVID-19.

I would like to share the following thoughts with readers in this context:

(a) The present crisis is once in a century kind of event. In fact this shall qualify to be the most impactful global event since the WWII. The government must handle this event likewise. Considering and implementing some incremental solutions for mitigating the impact of this event will not help in any manner.

The government therefore must not pay any heed to the fiscal hawks cautioning it about fiscal slippages. The government must constitute a special fund, by issuing 30-50yr maturity bonds in the global markets (given the near zero interest rates) and utilize that money for reconstruction and growth of the economy. This fund could be excluded from the regular annual budget. Repayment could be funded by Rs1/ltr cess on transportation fuel for next 30years.

(b) One of the primary obstacles in revival of the Indian economy is poor risk appetite of bankers. For a variety of reasons, bankers are not willing to assume any further risk. The government needs to provide an effective backstop to banks to encourage them for assuming risk. This will only put the wheels of the economy in motion.

(c) RBI needs to become proactive. It would need to lead the way to the economic recovery. The mandate of RBI needs to be changed from a regulator of Banks to the agent of growth with stability. During the crisis period, ensuring market stability through direct action must be a core principle of RBI policy framework.

For example, in the current circumstances, instead of expecting banks to bail or mutual funds and NBFCs might not be an effective strategy. Instead, RBI should have done a direct action by buying securities from mutual funds and NBFCs with appropriate haircuts and other commercial terms.

(d) The steps taken by the government must be wholehearted and well thought off. Bureaucracy must be given three clear instructions:

(i) The buck stops at the PMO.

(ii) The approach of the implementing agencies must be "how it can be implemented" rather than "how to avoid implementation". The agencies must be given adequate flexibility for taking on the spot decisions about relaxing the set rules.

The argument that it will be misused is invalid. If the government does not trust its own officers' integrity, either the officer or the government itself must go.

(iii) Failure to achieve the defined outcome shall attract stringent possible punishment.

Tuesday, April 28, 2020

Caveat emptor

The benchmark Nifty has gained more than 22% during the one month of lock down. The broader market indicator Nifty500 has also gained by similar margin. This counterintuitive trend may be perplexing many market observer. I am however not surprised by this sharp rally of past this month. In fact I believe that this rally may even extend little further in May.

In my view, this is a classical bear market rally in which the stocks are distributed to a large number of non institutional participants, popularly referred to as retail investors. A significant distribution takes place in the poor quality stocks, which are usually difficult to sell if the markets are falling.

As you would observe from the following table, on 14 out of 21 trading session between 23 March and 24 April, the institutional investors and insiders have been net sellers. They have sold a net amount of Rs12676cr of equity on NSE itself. The domestic institutional buy of Rs8420cr is roughly equal to the amount of monthly SIP flows (of retail investors).

During this period, the market breadth has been positive on 16 out of 21 days, and significantly positive on 10 days; implying that relatively smaller shares have participated more in the rally. If we consider the sharp up move in the volatility and higher than average volume (price & qty) it becomes clear that a smart distribution pattern is developing, that may continue further since the net amount of stock offloaded so far is less than US$2bn.

The smaller investors must make a note of this trend and be careful in their investment approach.

Friday, April 24, 2020

Cheaper is not always better

The elementary principle of economics is that the price of a thing that has any economic value is determined by the forces of demand and supply. Often in the short term a state of inequilibrium may exist leading to higher volatility in prices. However, the equilibrium is usually restored by operation of a variety of factors.

There is no denial that economics is youngest amongst the scientific discipline and pure scientists hesitate in admitting it as a discipline of science. Nonetheless it is evolving fast and becoming popular. Not getting into this academic debate, what I have understood is that in popular economics theory is that:

(a) Price of currency is usually a function of demand and supply of that currency at any given point in time. Higher supply should normally lead to lower exchange value and vice versa. The demand of the currency is determined by the relative real rate of return (interest) and structure of economic activity (e.g., current account balance and inflation) in the parent jurisdiction.

(b) Price for a particular commodity is determined by the demand and supply conditions of that commodity at any given point in time. The demand of commodities fluctuates as per the level of economic activity in the consuming jurisdiction, export demand and outlook for the foreseeable future. The supply of commodities may fluctuate due to a variety of reason - local to the producing jurisdiction as well global. Cost of production, weather conditions, civil and geopolitical disruptions, inventory levels & cost of carrying inventory, etc are some of the key factors that may influence the supply of commodities in the short term.

(c) Interest rates are usually function of demand and supply of the money in the monetary system. Demand for money is again impacted by the level of economic activity and outlook in foreseeable future; whereas supply of money is mostly a function of risk perception and relative returns.

The traits of human behavior like "greed", "fear", "complacence", "renunciation", and "aspirations" are usually accounted for as the balancing factors for demand and supply and not considered as determinates of price as such. This in my view is the cause of most problems facing global economy in the present times. Consequently, the business of forecasting and trading in currencies, money and commodities has become extremely difficult and fraught with risk. The huge volatility and irrationality in crude oil market in past 6 months is just an example of this.

In past three months I have seen hundreds of reports forecasting prices of commodities, currencies, and interest rates. Most of these forecasts appear mere extrapolation of the current price trend and hence do not inspire any confidence.

In Indian context, exchange value of INR, 10yr benchmark yield and crude oil prices evoke much interest. Interestingly most economic growth forecasts appear predicated on these, whereas logically it should be the other way round.

INR depreciation is beyond economics

In the summer of 2007, I had just moved to the financial capital Mumbai from the political capital Delhi. The mood was as buoyant as it could be. Everyday plane loads of foreign investors and NRIs would alight at Mumbai airport with bagful of Dollars. They would spend two hours in sweltering heat to reach the then CBD Nariman point (Worli Sea link was not there and BKC was still underdeveloped), and virtually stand in queue to get a deal where they can burn those greenbacks.

Mumbai properties were selling like hot cakes. Every day one used to hear some mega property deal. NRIs from middle east, Europe and US were buying properties without even bothering to have a look at them.

Bank were hiring jokers for USD 100 to 500k salary for doing nothing. I was of course one of these jokers!

That was the time, when sub-prime crisis has just started to grab headlines. Indian economic cycle started turning down in spring of 2007, with inflation raising its head. RBI had already started tightening. Bubble was already blown and waiting for the pin that would burst it.

INR appreciated more than 10% vs. USD in first six months of 2007.

Then INR depreciated over 75% during period from January 2008 to August 2013. This was the time when Fed was printing USD at an unprecedented rate. There was no shortage of EUR, GBP and JPY either.

The point I am making is that in the present times when most globally relevant central bankers are using unconventional policy measures with impunity to stabilize their respective economies, the value of currency is seldom a function of demand and supply alone.

Regardless of the economic theory, it is the faith of people in a particular currency that is primary determinate of its relative exchange value.

2005-2007 was the time when the Indians had developed good faith in their currency. Local people were happy retaining their wealth in INR assets, despite liberal remittance regulations and NRIs were eager to convert a part of their USD holding in INR assets. The situation changed 2010 onwards. There is no sign of reversal yet. Despite huge popularity of Narendra Modi amongst overseas Indians, we have not seen any material change in remittance pattern in past six years. Despite tighter regulations, local people appear keen to diversify their INR assets. Most of the USD inflows have come from "professional investors" who invest others' money to earn their salaries and bonuses. These flows are bound to chase the flavor of the day, not necessarily the best investment. Whereas the outflows are mostly personal, or by corporates with material promoters' stakes.

In my view, no amount of FII/FDI money can strengthen INR if Indians do not have faith in their own currency. Yield and inflation have become secondary considerations.

...so are interest rates

Yesterday, RBI auctioned 91 days and 182 days treasuries bills at far below the policy repo rate and lower than the recently reduced reverse repo rate. Even at ~3.6%, it accepted only one fifth of the bids received. SBI has reduced the rates on whole sale fixed deposits to 2.5%.

Obviously, the supply of money at this point in time is overwhelming higher than the demand. Like crude, banks have no place to park their deposits.

However, interpreting these lower rates as supportive for growth would be a huge mistake; just as it was with lower crude prices (see here). In fact in the present circumstances, low interest rates are likely to do more harm to the economy than help it. In next 12months, there is going to be hardly nay growth in investment demand irrespective of the interest rates. However, lower interest rates may damage the consumption demand as it may lead to lower interest and rental income for consumers, negative real return for savers, worsening income inequality.

Remember, lower interest rates because demand for money is less is as bad a thing as in case of anything else.