Vijay Kumar Gaba

In a significant move for the banking industry, the central government has proposed to lift the embargo on grant of government business to private banks. Whereas, de facto the government has always favored public sector banks for grant of government business, the de jure embargo was imposed in 2012 post global financial crisis to protect the small savers and public entities from a potential collapse. Initially the embargo was imposed for a period of 3years; but it was extended further in 2015; through some private sector banks with public sector legacy (ICICI, Axis etc) were continued to be permitted to conduct some part of the government agency business. As per the latest announcement, the embargo is proposed to be lifted completely.

This announcement has come at a time when the government would be starting the process privatize couple of public sector banks (PSBs), and diluting its shareholding in other PSBs. In past couple of decades, many public sector undertakings have faced serious consequences due to dilution of government patronage to their business and/or introduction of private sector competition in their field of operations, e.g., Air India, BHEL, BEML, STC, MMTC etc. Obviously, lifting of this embargo will seriously impact the profitability of many smaller PSBs. Even larger PSBs will be impacted to some extent. The already subdued valuations of PSBs will naturally get further discounted. Banks like Jammu and Kashmir Bank, which substantially rely on government business, could face serious issues of sustainability.

The moot point therefore is whether liberalization in grant of government and public sector business must inevitably result in destruction of public sector wealth, or the liberalization could be better managed.

On a different note, RBI appears to be quite concerned about the financial markets and economic growth. RBI governor has been categorical in cautioning about crypto currencies. He has also raised the issue of divergence between performances of economic performance and stock market repeatedly. He has also raised concern over second round effect of fuel prices on economic growth.

Whereas, the financial markets and bond markets are fast pricing in an economy “overheating” scenario with sustainable rise in inflation, RBI has reiterated its commitment to continue with “accommodative” policy stance. In recent past, multiple bond auctions by RBI have devolved due to lack of demand at RBI cut off yields.

Obviously there is a divergence in RBI and market’s outlook about the price and yield scenarios. This implies either of the following two scenarios:

(i)    RBI is running behind the curve. If this is the case, the market shall be ready for a rate shock, whenever RBI does the catch up Act. Last time I remember this happened was during Subba Rao tenure, when multiple hikes were implemented in short span of time.

(ii)   RBI assessment of economic and earnings growth is closer to reality. In this case, also markets may be surprised negatively as it is pricing in a sharp recovery in earnings over FY22-23.

Historically, the disagreements\ between market consensus and RBI have not ended well for markets. I hope, this time it is different.

The latest earning season (3QFY21) has been one of the best in recent times. Companies across sectors reported encouraging revenue growth. The margins also improved on the back of lower input cost and wage rationalization. Accumulated demand (due to two quarters of lockdown) and festive season may have a significant role to play in the demand growth during 3QFY21. It is anticipated that as the economy continues to open up further as vaccination drive accelerates and mobility restrictions are eased further, the demand growth may sustain for few more quarters. The demand environment is also supported by the counter cyclical fiscal policy and continued accommodative stance of monetary policy.

The quarterly earnings surprised many analysts on both EBIDTA and PAT level; while on top line the surprises were lesser in number. For Nifty companies, on aggregate basis, EBIDTA margins and PAT margins were flat. However, after adjusting for exceptional losses in Bharti Airtel and Tata Motors, picture does not looks that disappointing.

In 3QFY21, double digit top line growth in metals, mining, cement, construction and manufacturing also augurs well for the macro growth. In fact, the cement industry reported third consecutive quarter of good results with EBITDA/mt for the whole industry coming in at Rs1,000+. It was due to continuation of strong pricing and lower operating costs as witnessed during the first two quarters of FY21. The industry witnessed volume growth of 5.6% YoY after 2 quarters of decline. This these trends support the view that Indian economy may recover to a normalized 5%+ growth trajectory in FY23. Of course it is not something to celebrate, but it does provide a whiff of relief that the fears of a deeper recession have been alleviated completely.

The markets however appear to be discounting an all clear blue sky scenario, which might be little over optimistic. Cost advantages available in 3QFY21 are dissipating fast with sharp rise in raw material & energy prices and normalizing wages. Considering that EBIDTA margins in 3QFY21 may already have reached close to their all-time high in case of many large companies like Hindustan Lever, the earnings growth expectations from the current level may some room for disappointment.

After a spate of highly optimistic commentary oover past three months, some voices of caution have started to emerge. Analysts at BofA see rising commodity prices and bond yields as key risk for Indian equities in near term. A recent note from BofA research read, “With the Nifty already at our year-end target of 15,000, continuation of a broad-based market rally appears unlikely.” The research notes that steel, cement, crude, coal, copper, aluminium, iron ore, palm oil and caustic soda are the key commodities relevant for the Nifty companies and prices of these commodities are up by up to 75% since June 2020.

Similarly, Nomura analyst sees ‘rising number of Covid cases, higher commodity prices, rising in trade and current account deficit and rising bond yields as key risks to Nifty rally in the near term.

At CLSA, while earnings estimates for for over 2/3^rd of coverage stocks have been raised after 3QFY21 earnings, recommendation downgrades by analysts are about 3x the number of recommendation upgrades; with valuation.

A note from ICICI Securities also notes that “Margins largely augmented by ‘cost control’ and product mix even as input prices continued to put pressure on gross margins in general. This phenomenon is continuing in Q4FY21 as evidenced by further rise in ‘manufacturing inflation’ component within WPI to 5% largely driven by metal prices.”. The note also cautions that rise in credit cost may surprise negatively for some financials.

A note from IIFL Securities notes that, “The steady margin improvement up to the previous quarter, driven by aggressive cost-cutting measures and benign input costs, has paused for now. Normalising activity and rising input costs are putting pressure on EBITDA margins.”

After the upgrades, the Nifty earnings is now expected to grow @20% CAGR over FY20-FY23 period, with FY22 EPS growth estimated to be over 33% yoy. Obviously, the current earnings estimates do not leave any room for disappointment. 4QFY21 and 1QFY22 earnings seasons must therefore be keenly watched. Any sign of disappointment on either revenue growth or EBIDTA margins may cause significant volatility in the market.

Crypto currency (e.g. Bitcoin) is proving to be the best asset class for the Covid-19 infected FY21. Most crypto currencies have yielded astronomical returns in a year that suffered the worst synchronized global recession since the great depression of 1930s. Against this, the traditional safe haven Gold, Swiss Franc (CHF), USD and US Treasuries have yielded insignificant return. USD Index (DXY) in fact has declined over 10% YTD FY21. Silver is the only traditional asset, besides equities, that has yielded strong return in past 11 months.

Regardless, the overwhelming consensus amongst global strategists appear to be favouring gold and silver as overweight in asset allocation of non-institutional investors. Most wealth managers and investment strategists are suggesting upto 15% allocation to gold (for example see here). Many globally popular and prominent traders, chartists and strategists have suggested a massive bull market in Silver in next couple of years (see here)

Meeting with a senior asset allocator last week was quite revealing in this context. The gentleman advocated 10% allocation to gold, besides 10% allocation to global equities (mostly US equities). He strongly advised to avoid crypto currencies; though he expects a rather lucrative trading opportunity in silver. On a little deeper probing, he offered the following rationale for his asset allocation strategy:

(a)   Given the status of quantitative easing (money printing) by major central banks, global hyperinflation is inevitable. It is only a matter of time when the prices of all real assets and commodities explode. In these circumstances gold will provide safety cushion to the portfolio.

(b)   Stagflationary situation in US could lead to sharp depreciation in USD value and chances of return to gold standard could enhance.

(c)    Gold-Silver ratio is breaking out on technical charts. From a 10yr high of 120, the ratio has already corrected to 60. Technically it is expected to test the 10yr low level of 30 in short term. This implies a sharp rise in silver prices.

(d)   Unwinding of monetary stimulus would also lead to unwinding of carry trade in USD and EUR. This may lead to reversal of flows away from emerging markets to developed markets. Therefore buying some developed market equity is desirable. It is also desirable from (i) diversification viewpoint and (ii) strategic viewpoint, i.e., to take stake in global businesses doing very well.

His arguments were quite convincing on first hearing. But on second thought these left me mor confused than ever. What I could not understand from his detailed presentation was:

(a)   If a hyperinflationary situation does materializes as popularly believed, won’t I have much serious problems to deal with. How 10% gold will solve these problems?

(b)   If USD and EUR get debased due to excessive money printing, INR will naturally appreciate against USD. Since gold is mostly priced in USD terms, won’t any appreciation in gold in USD terms will get neutralized by appreciation in INR vs USD.

(c)    What is the guarantee that gold does not suffer from the same malaise as USD? Is it totally improbable that the physical stock of gold has been leveraged many fold to issue paper gold?

(d)   Why can’t the targeted Gold-Silver ratio be achieved through fall in gold prices rather than rise in silver prices?

(e)    If USD and EUR do get debased, why would an alternative currency not emerge to maintain stability in global trade?

(f)    Since anticipated hyperinflation is mostly expected to be the outcome of a supply shock rather than a demand surge, a further dose of quantitative easing might be in order to encourage building of new capacities. If that is the case, then the whole premise of higher yields and hyperinflation might fail.

(g)    If USD and EUR debasement is a serious concern, then how does investing in global equities make sense?

(h)   A hyperinflationary condition may lead to material monetary tightening in India. Higher rates shall then warrant serious de-rating of equity valuations which are assuming prolonged period of lower rates and lower inflation. Even real estate may also suffer from poor demand due to higher rates in that case. We may need to worry more about INR debasement in that case rather than USD or EUR!

Many more such questions bothered me for couple of days, before I reminded me of the following basic learnings from the first chapter of my investment strategy book:

1.    India has 1.38bn people who need to eat & wear clothes, want decent healthcare, and aspire to have a decent shelter of their own. These needs and aspirations will continue to create many decent investment opportunity for me in India for next few decades at least.

2.    A tiny investor like me should never bother about diversifying the investment portfolio too much. A totally unproductive commodity like gold and mostly unknown animals like foreign equities are for large investors and traders with much stronger risk appetite. I should be happy with ordinary assets like high quality domestic equity (businesses which I can see and feel everyday); debt to my government and some large corporates; a house for myself; share in portfolio of good rental properties; and some liquid money in bank. Chasing few extra bps of returns is meaningless and fraught with risk which I can hardly afford. I cannot afford to risk even a single penny for earning few bragging rights.

3.    An information that has travelled seven seas to reach a commoner like me has no arbitrage value. If I know that USD hegemony is under threat; hyperinflation is on the anvil; silver is going to rise astronomically, then I must strongly believe that these happening will NOT shock the markets in any manner whatsoever.

For a large part of 20^th century Coal was a very important part of our lives. Railways, which were the largest medium of long distance inland travel, operated mostly on coal. An overwhelming proportion of electricity was generated using coal. The black gold was also a key ingredient for producing steel, cement, aluminium, copper, and a variety of chemicals. Things began to change slowly in second half of 20^th century and change accelerated in the last quarter of the century. Petroleum and Natural Gas started to gain share as major source of transportation fuel, electricity production, industrial feed stock and medium for cooking. From last decade of 20^th century, the share of renewable sources in India’s energy mix is also rising consistently. Nonetheless, coal remains the most important source of energy for Indian consumers and industry.

As per the latest data published by USEIA, “primary energy consumption in India has nearly tripled between 1990 and 2018, reaching an estimated 916 million tons of oil equivalent. Coal continued to supply most (45%) of India’s total energy consumption in 2018, followed by petroleum and other liquids (26%), and traditional biomass and waste (20%). Other renewable fuel sources make up a small portion of primary energy consumption, although the capacity potential is significant for several of these resources, such as solar, wind, and hydroelectricity.”

The agency further noted that “India was the third-largest consumer of crude oil and petroleum products after the United States and China in 2019. The gap between India’s oil demand and supply is widening. Demand for crude oil in 2019 reached 4.9 million b/d, compared to less than 1 million b/d of total domestic liquids production.”

Also “Diesel remains the most-consumed oil product in India, accounting for 39% of petroleum product consumption in 2019, and is used primarily for commercial transportation and, to a lesser degree, in the industrial and agricultural sectors.”

It is also important to note that out of the most 30 polluted cities in the world, about two third are in India. About 1.7million deaths (about one fifth of all deaths) are attributed to pollution every year (see here). It is also estimated that India loses about 1.4% of GDP every year due to pollution.

The India’s thrust for use of electricity as primary transportation fuel must be assimilated in this background. In my view, there are two primary objectives for increasing the share of electric mobility:

(a)        Achieving energy security, by reducing reliance of imported fossil fuels; and

(b)        Reducing carbon emission by vehicles.

As per a study by KPMG India, by 2030 India should expect EV penetration of 65-75% in 3W; 25-35% in 2W and 10-15% in personal 4W and 20-30% in commercial 4W and about 10-12 in overall busses.

In my view, like mobile telephony and digital payment, the pace of acceleration in adoption of EVs would surprise most of the analysts and administrators. The usage of EVs would only be limited by the lacunae in ecosystem rather than the willingness of users.

Innovative solutions for faster development of EV ecosystems are already being devised. Business models such as battery swapping would alleviate the need for millions of charging points, for example.

Three things must be taken care of in developing the EV ecosystem in the country:

(i)    Power generation through renewable sources must be accelerated materially. Charging EV batteries with thermal power will not serve the purpose of pollution control.

(ii)   India should try to become self-reliant in manufacturing of EVs, including all components. Otherwise, EV related import will replace fossil fuel import defeating the purpose of security.

(iii)  A strong framework for end disposal of used batteries and EVs must be established beforehand.

Insofar as investment ideas in listed space are concerned, I believe it will be a mixed bag for most existing OEMs and component manufacturers. Some will gain, some will lose and some might become redundant. The new crop of entrepreneurs which will focus exclusively on EVs will have plenty of gainers. I shall keep a watch for opportunity to invest early in some of these new ventures as and when they list; for I am too small to invest in an unlisted enterprise.

In Sri Ganganagar town of Rajasthan, the retail price of petrol has reached in three digits for the first time in Indian markets. This is culmination of a series of price hikes over past one year. Over 25% rise in domestic retail fuel price has happened when the average global crude prices have been much lower. Even on yoy basis, the brent crude prices are almost unchanged presently; and INR is stronger by over 5% as compared to USD.

The consistent rise in transportation fuel, when the consumers were deep in distress, economy was struggling and crude prices were falling sharply, has invited sharp criticism of the government. It is pertinent to note that all subsidies on transportation fuel were removed some years ago and presently none of the transportation fuel is subsidized. Therefore the rise in fuel prices cannot be attributed to rationalization of subsidies. Social media is also full of satirical memes about the consistently rising fuel prices.

In this context, it is also pertinent to note the following:

(i)    Retail fuel prices started rising sharply from May 2020, when the first of various Covid-19 stimulus packages was announced by the government.

(ii)   The rise in fuel prices has occurred when the consumption had declined.

(iii)  Most part of the rise in retail fuel prices could be attributed to additional duties and cess imposed by central and state governments.

India’s annual oil consumption is over 19 billion barrels approximately worth Rs9.5trn. A 10% hike in duties and cess on retail oil price would be Rs1trn, more than the amount provided for distribution under direct cash transfer (PM KISSAN) scheme to 12million rural poor.

A valid question to ask therefor would be “is the government using duties and cess on retail fuel prices for the purpose of wealth redistribution and socio-economic equity?”

In my view, it is a complex problem and needs much deeper study. On the face of it may appear a straight forward transfer of money from those who could afford (consumers of transportation fuel) to those who need it badly. However, if we consider the following propositions, the issue may not appear as simple.

(a)   Meeting a significant part of the rise in social sector expenditure and subsidies through higher duties and cess on transportation fuel has allowed the government to keep fiscal balance in check with lower than anticipated market borrowings, allowing RBI to keep the benchmark yields and borrowing cost for large borrowers at relatively lower level.

It would be interesting to examine, how much “large borrowers” have benefitted from lower interest rates and stronger INR, as compared to the loss on higher fuel cost.

(b)   For businesses higher fuel cost is mostly a pass through expense, meaning the incidence of higher fuel cost is passed on to the end consumer. Given that the propensity to consume is much higher at the bottom of the pyramid, implying that on relative basis the poor people may be hit more by the rise in consumer products due to higher fuel prices.

(c)    The cost of travel in public transport has not increased in tandem with the rise in transportation fuel. The rise in transportation fuel duties could also be a design to implicitly encourage people to use public transport.

One of the key features of the Union Budget for FY22, that needs to be noted by the investors, is the proposal to implement some important reforms in the power sector. The finance minister mentioned the following in her speech on this subject:

“61. The distribution companies across the country are monopolies, either government or private. There is a need to provide choice to consumers by promoting competition. A framework will be put in place to give consumers alternatives to choose from among more than one Distribution Company.

62. The viability of Distribution Companies is a serious concern. A revamped reforms-based result-linked power distribution sector scheme will be launched with an outlay of Rs3,05,984 crores over 5 years. The scheme will provide assistance to DISCOMS for Infrastructure creation including pre-paid smart metering and feeder separation, upgradation of systems, etc., tied to financial improvements.”

Budgetary outlay for the sector has also been enhanced by 22% from FY21RE. The increase is on account of higher allocation for:

(i)    Central power generation companies to add 2 to 2.5GW thermal capacity and some hydroelectric projects in HP and J&K;

(ii)   Integrated Power Development Scheme (IPDS), which aims to augment T&D infrastructure in urban areas;

(iii)  Smart Grids Scheme under 'National Smart Grid Mission' to set up an electrical grid with automation, communication, and IT systems to enhance T&D infrastructure, aiding loss reduction

(iv)   Setting up a separate central transmission utility (CTU) for unbundling of planning and execution arms of Power Grid Corporation of India Ltd.

As per Crisil commentary on Budget, the Rs3.06trn outlay for power sector for a period of five years, may fund discoms over and above the Rs 1.2trn provided under Atamnirbhar Bharat package in FY21. As per CRISIL’s analysis, the combined ~Rs 4.2trn totals up to about double their incremental debt requirement of ~Rs 2trn between fiscals 2020 and 2023, and is close to the full incremental debt requirement till FY25. Besides, Rural Electrification Corporation Ltd (REC) is also set to raise ~69% higher funds through IEBR in fiscal 2022 over revise estimates of fiscal 2021.

The Electricity (Amendment) Bill to be tabled in the current Parliament Session, shall further strengthen the reform push to improve the financial health of the sector. In particular implementation of smart metering to give effect to DBT of power subsidies shall be a key development to watch.

Option to move from public distribution companies to private distribution companies or from one private distribution company to the another may benefit the efficient private sector distributors in medium term.

Incidentally, last week global rating agency Moody’s upgraded India’s power sector outlook to “stable” from previously “negative”. The power demand in India recorded a new high in January surpassing all previous records.

The pace of vaccination across the globe is accelerating with each passing day. It is hopes that in next 6 months, we may have a reasonable number of people inoculated against Covid-19 infection; and the life may begin to normalize (even if it is new normal!) and become more predictable as compared to the life in 2020.

However, from investors’ perspective a rather strange thing seems to be happening. Many investors had bought shares of leading vaccine manufacturers in the hope of extraordinary gains. To their disappointment, many of them are suffering losses.

Pfizer Inc. (-8.1% in one year) and AstraZeneca (-4.75% in one year) are two examples; though Moderna Inc (up 740% in one year) has done well.

In Indian context, AstraZeneca (-20% YTD 2021); Pfizer (-13% YTD 2021) Dr Reddy’s Lab (-8% YTD 2020) have all performed poorly on stock exchanges. The other listed vaccine prospect Cadila Healthcare (-2% YTD 2021) is also doing poorly.

Obviously, it is a case of the excessive exuberance cooling off. The stock prices may revert in due course. But this has five important lessons for small investors to learn.

1.    The stock prices movement is usually akin to the movement of a pendulum. The far it moves on right (up) side, it usually covers the same distance on the left (down) side also.

2.    Buying something in exuberance, based on some popular news or widely prevalent expectation, is seldom a good idea. One usually ends up buying closer to the peak.

3.    A good stock bought at an elevated level may not eventually give you losses. In due course of time the stock will give decent gains.

But remember, a stock that has fallen 25% from your purchase price (100 to 75), would need to rise 33% (75 to 100) from low for you to breakeven. This journey (100-75-100) could be exhausting sometime and result in significant opportunity loss.

4.    More business may always not mean more profit and higher stock price.

Investors, who did invest in L&T based on the growth in its order book over past 5years, have not been rewarded much. The order book, revenue and profit of the company have almost doubled in past 6years; but the stock price is up less than 25%.

Same thing could be true with profit from the increased revenue from vaccination for these pharma giants.

5.    Environmental, Social and Corporate (ESG) consideration in investing is not only a fad. It is increasingly becoming a norm. A vaccine for pandemic that caused extreme social distress may not be acceptable as a medium to make extraordinary profit. The authorities (mostly socialist governments these days) accelerated approval process may essentially accompany limit on profiteering.

This is an important lesson that needs to be remembered before a hasty decision is taken on the news of some company winning a coal mine bid etc.

 A year ago, no one would have listed “container shortage” as one of the primary constraints in global trade. But the fact is that there is acute shortage of containers in global supply chains and it is severely constricting the global trade. This has also led to significant rise in logistics costs. In that sense, this condition in global supply chain may at least qualify to be a grey swan (if not black).

There are multiple reasons for shortages of containers in global supply chain. The prominent amongst them being the following:

(a)   Chinese economy has recovered faster than any other major economy in the world. The Chinese exports to the western countries have mostly normalized whereas western countries are not in a position to export the things back. This has led to the empty containers being stuck on major western ports.

(b)   Chinese exporters are paying huge premium for empty containers. Consequently, it has become profitable for shipping lines to transport empty containers to China against transporting goods between other ports.

(c)    Many producers used on-sea ships for warehousing surplus produce during the worldwide lockdown. Many containers and ships may still be stuck with such “no-where to go” cargo.

(d)   Turnaround time at many major ports has increased materially due to congestion.

(e)    Limited operational air freight capacity has also led to higher demand for shipping containers.

This shortage of container is hampering global trade and businesses in more than one ways. For example consider the following-

·         Many Indian companies have reported lower exports in 3QFY21 due to container shortages. The cost of shipping has increased materially due to premium pricing of containers. Perishable goods waiting to be shipped at ports are getting damaged.

·         Food prices across the globe have risen substantially despite overall good production. For example, despite bumper sugar production in India, the global sugar prices have risen materially as Indian producers are not able to ship the allotted quota of sugar exports. Canada and some African countries are stuck with stock of pulses.

·         Large e-commerce companies seem to be worse affected by container shortages, as they are not able to fulfil cross country orders timely. Global corporations like Ikea have termed the present situation as “global transport crisis” (see here).

·         Many automobile manufacturers and electronic product manufacturers have complained about severe shortage of components. The waiting time for delivery of many popular vehicles in India is now in excess of 4 months. Even the lead time for servicing of TVs and Washing Machines is running into weeks due to shortage of spares.

·         The working capital requirements for many exporters who are unable to ship their produce timely may increase materially impacting their margins for few quarters.

This unexpected phenomenon could also be one of the reasons for sharp rise in inflationary expectations across the globe leading to a massive reflation trade in bulk commodities like iron ore, steel, fertilizers, coal and coke etc.

The questions to be asked therefore are

·         Whether this “global transportation crisis” (GTC) will last long enough to derail the still nascent economic recovery?

·         If this GTC is resolved in next couple of months, would the “reflation” trade collapse unceremoniously, or this trade has more legs besides logistic constraints?

·         If GTC is not resolved in next few months, shall we see a precipitous rise in global cost of capital due to high inflation, and therefore a sharp correction in equity prices?

Of course it is sort of a perfect storm. Negotiating this is very critical for producers, traders, investors and central banks. Whether they would be able to do that will only be known in due course. For now, we can only quote Shakespeare, “There are many events in the womb of time which will be delivered. Traverse, go, provide thy money. We will have more of this tomorrow. Adieu.” (Othello, Act 1)

 From the queries I receive from friends and readers these days, one thing appears certain – these are most challenging times for small and HNI investors, especially those who decided to raise substantial cash in their portfolios last spring as the pandemic fear gripped the markets.

Many of these investors are not convinced about the sustainability of current stock prices and continue to expect a sharp correction is in the offing. Nonetheless, they find the daily rise in stock prices alluring and difficult to resist. In this intense struggle between their convictions, expectations, beliefs, fear of missing out (FOMO) on a secular rally (if their conviction is misplaced), and greed to make some quick money, some of them appear to have already surrendered to their fears (FOMO) and greed and invested in stocks which normally they would have avoided due to inferior quality of management, earnings and/or balance sheet.

I personally do not support –

(i)     A binary call on portfolio, i.e., mostly invested or mostly cash.

I like to stick to my pre-defined asset allocation, regardless of the market conditions. An opportunistic tactical allocation sometimes becomes necessary, but it does not exceed 10% of the standard allocation.

(ii)    Investing against conviction.

I find investing in ideas without conviction or with borrowed conviction totally avoidable. Empirically, I have found most investment endeavour that lacked conviction or were based on borrowed conviction, usually get wound up in an unpleasant manner.

(iii)   Allowing the sentiments of greed and fear to drive investment strategy.

Investment strategy of an investors should be driven by his individual circumstances – stability & security of income, health, savings, financial and social status (house, marriage, dependent children & parents) etc. Market movement driving the investment strategy is a certain prescription for disaster, in my view.

(iv)   Investing in poor quality for quick gains.

Just because the good quality stocks and bonds are have become expensive cannot be an argument for buying poor quality bonds or stocks. The events in stock and bond markets during 2017-2019 could be a good guide on how to conquer the temptation to make quick gains in stocks or earn few extra bps on bonds.

(v)    Bothering about relative return.

The rule is that if you are diabetic, the sweets in neighbour’s plate should not be your concern. The investment goals (returns) of an individual investor should be mostly pre-defined as per his investment strategy based on his risk profile. Benchmarking returns to some random index or other measure may be appropriate for professional investors (e.g., fund managers) whose remuneration depends on his performance. For individual investors it is meaningless. Remember, you have to pay your child’s college fee from the money you earn from investment. You cannot be happy losing only 2% when Nifty is down 12%.

So, my suggestion is that the investors suffering from fear or greed may urgently call their respective advisors and make an investment strategy for themselves, rather than floating uncontrollably between hope & desperation.

I would also recommend keeping investment strategy away from the realm of fiction. Being average is a great strength for an investor. Over 90% of Indian investors may be earning less than nominal GDP growth rate on their financial investment portfolio over a longer period. Chasing the returns usually seen in fictional success stories and few cases of extraordinary brilliance, could be dangerous to their financial health. Always remember you are riding an ordinary bicycle. You should not be competing with 1500tonne Lorries racing on expressways, for you might get crushed without anyone noticing.

 Delhi APMC’s Azadpur Mandi (wholesale market) is the largest fruit and vegetable market in Asia. Farmers and traders from across the country bring their produce to this market for selling. This Mandi is also one of the largest import and export hub for fruits and vegetables in India. A visit to this Mandi is always fascinating. From the lorry drivers travelling from all corners of India one can gather first-hand account of the socio-economic state of affairs in the country.

Azadpur Mandi is an ideal reflection of socialist and secular society. One finds very rich traders & commission agents and very poor laborers together struggling to pass through filthy and narrow by-lanes of the Mandi. Hindu, Muslims and Sikhs work, eat and live together here most amicably. The social and legal issues like child labor, drugs, labor exploitation, human rights violation, labor’s dignity etc. are mostly meaningless here; and no one seems to be bothered about these “mundane” issues here. Here one can get cheapest and tastiest street food in the city, which is enjoyed by the rich traders and poor workers equally.

Over last weekend, I met some large fruit and vegetable commission agents in the Mandi to assess the current business conditions and their assessment of the demand in next few months. The following is the summary of discussion.

·         For many of them, business is down 25-50% as compared to pre-Covid average. Moreover, full recovery is not expected even in next 3yrs.

·         The demand for fruits and vegetable from hotel industry is down significantly. Curbs on travel and gatherings have impacted the demand. Their feedback from hotel industry indicates that growth in corporate travel and attendance at social functions may not return in next couple of years at least.

It is pertinent to note that the ratio of per person fruits and vegetables used in food preparation in hotels is usually 2x of the quantity used at home.

·         Marriage attendance that used to be in excess of 1000 is structurally down to 200-300. In the view of most traders, the fat big Indian weddings may not return for few more years, if at all. People are now becoming very comfortable with small gatherings. Virtual participation of outstation guests through live telecast is becoming more of a norm.

·         As per few estimates, in pre Covid period over 2lac outstation students were living in Delhi to take coaching for various examinations. These students were mostly living in paying guest accommodations and guest houses. The number is now estimated to be down to less than 25000, as online coaching has become popular. The demand for fruits and vegetables for catering to these students (canteens and dhabas) may be structurally down.

·         Many corporate and other institutional canteens are still closed or working at lower capacity, as workers and students are preferring to carry home cooked food due to hygiene reasons.

·         A huge part of the credit extended by Mandi traders to the retail merchants and street hawkers in pre Covid period has turned bad with no hope of recovery.

·         Many traders expect the low attendance in wedding, work from home (WFH) and Learn from home (LFH) etc to reflect on demand for textile, footwear, food, jewelry, cosmetic, travel, and fuel demand etc.

Overall, the current mood is despondent and the future outlook is not so optimistic either.

By the way, if you are overwhelmed by the “Aarthiyas are crooks and main force behind the latest farmers’ agitation” narrative, it would be worthwhile to visit Mandi for couple of hours to balance your views.

Promoting tourism has been a key priority of the Indian government since former Prime Minister Rajeev Gandhi started the famous Bharat Utsav programs in various countries in mid 1980s. As per the headline numbers, India has seen some steady growth in number of tourist arrivals in past 20years. The share of India in international tourist arrivals increased over 3x from 0.37% in 2001 to 1.24% in 2018. The share of India in international tourist arrivals in Asia Pacific region has increased from 2.22% in 2001 to 5.05% in 2018.

India ranked 34th in Travel and Tourism Competitiveness Index, improving significantly from its rank of 65 in 2013. Tourism contributed 5% share to India’s total GDP in 2018-19.

From pure statistical purpose, we may seek some comfort from this data. However, if we consider the rich historical and cultural legacy, treasure of architectural marvels, and geographical diversity of our country, this data appears pathetic. It reflects on the poor tourism infrastructure, poor perception about security and safety of foreign tourists, and lack of control over unscrupulous elements who abundantly fleece foreign tourists. This is in spite of the notional Atithi Devo Bhav (Guest is God) campaign.

The data looks even poorer, when we consider that almost a fifth of the international tourists coming to India are from neighboring Bangladesh. These people usually visit India to meet family or for pilgrimage. Another 23% of tourist come from US and UK. Foreign tourists from the top 10 countries accounted for 67% of the total foreign tourist arrivals in India in 2019. Among the foreign tourists, 57.1% tourists visited for leisure, holiday and recreation, 14.7% for business purposes, and 12.7% was Indian diaspora.

The international tourist arrival growth has slowed down in past three years noticeably. As per the recently released Economic Survey for FY21, —

“9.18 The tourism sector in India had been performing well with Foreign Tourist Arrivals (FTAs) growing at 14 per cent to 10.04 million and Foreign Exchange Earnings (FEEs) at 19.1 per cent to US$ 27.31 billion in 2017. However, the sector underwent a slowdown in 2018 and 2019 before declining sharply in 2020. The Foreign Tourist Arrivals (FTAs) in 2019 stood at 10.93 million compared to 10.56 million in 2018. In terms of growth, the growth rate of FTAs declined from 14 per cent in 2017 to 5.2 per cent in 2018 and further to 3.5 per cent in 2019. Foreign Exchange Earnings (FEEs) from tourism stood at US$ 30.06 billion in 2019 as compared to US$ 28.59 billion in 2018. In terms of growth, the FEEs declined from 19.1 per cent in 2017 to 4.7 per cent in 2018, picking up slightly to 5.1 per cent in 2019.”

Personally I find these statistics as a massive opportunity. Given the tourism potential in India, the share of income from tourism sector in India’s GDP could be increased materially from the current less than 5%. This would however need some serious effort from all. We would need to inculcate the right values to our children from primary school level. Honesty, Truthfulness, Cleanliness, and Respect for Women are some of the quintessential traits required for attracting larger number of global tourists.

As an ardent traveler myself, I find the lack of proper sanitation and overwhelming crowd of intimidating touts as the most discouraging factor. Pertinent to note that in the diabetic capital of world there is no public toilet worth use on 300kms road from Haridwar to Gangotri.

 In past couple of years some state governments have announced reservation for local residents in private sector jobs. Some other states are also considering to implement similar provisions. Given that the word “reservation” itself is not liked by a large section of Indian population due to legacy reasons, this trend has evoked strong reactions from the businesses and job seekers from other state who fear losing out to the local population in these states.

Many issues like, Right to Equality, likely productivity loss due to lack of competent people, likely higher wage cost due to limited supply of qualified people within particular state, etc., have been raised by the concerned people. Concerns have been raised about flight of businesses to other states, further worsening the regional inequalities.

In my view, it is a very good idea, of implemented pragmatically. If the state governments work with the private entrepreneurs to develop the education, skill and training ecosystem in their respective states and provide fiscal incentives to businesses for giving preference to local people for their incremental job requirements, this stipulation could materially promote the regional equality and employability of youth. This shall also reduce the cost for businesses as they could move away from expensive concentrations like NCR, Bengaluru, Mumbai, Chennai, Hyderabad and hire good people at relatively lower cost. The investments being made in transportation infrastructure, Bullet Train, Economic Corridors, Dedicated Freight Corridors, Regional Airports etc. shall support efficient relocation of businesses to hinterlands.

 The finance minister seems to have reinvigorated the animal spirits of Indian entrepreneurs and financial market participants. The Union Budget for FY22, is perhaps the most celebrated budget after the “Dream Budget” presented by the then Finance Minister P. Chidambaram in 1996.

This is also perhaps the first time when markets have cheered higher fiscal deficit. This ought to be taken as a sign of rising assertive India, which is fully aware of its importance in global order and refuses to be bogged down by unreasoned views of global rating agencies.

The market also cheered the fact that after dithering for six years, this NDA finance minister has picked up the threads from Vajpayee led NDA.

The finance minister has spoken about “privatization” of a majority of CPSEs, instead of “disinvestment of minority stakes”, as was the case in NDA-1.

The massive thrust on infrastructure building to ward off the impact of economic sanctions imposed in the wake of 1998 nuclear tests and bursts of dotcom bubble etc. was the hallmark of Vajpayee government. His government gave up government monopolies on Coal, Ports, Airports, Mobile Telephony, Roads, Power, Oil & gas exploration etc.; and introduced schemes like SEZ to encourage domestic investments. The incumbent finance minister has also ignored the fiscal slippages due to pandemic induced lockdown and focused on investment in infrastructure building.

It is widely expected that this Budget could unleash third round of Economic Reforms (Reform 3.0), after 1991-1994 and 1999-2001. It is therefore pertinent to evaluate whether the incumbent government has learned lessons from the earlier rounds of reform and adequate precautions are being taken to ensure that collateral damage of reforms could be minimized. For example—

·         Opening of Indian economy to global competition in early 1990s, led to redundancy of numerous small and medium sized Indian producers. This led to a surge in bad loans in the financial system and eventually led to failure of gigantic institutions like UTI, ICICI, and IDBI etc. High interest rates, higher inflation and sharp depreciation in INR during 1991-1998 were also partly associated with the reforms.

·         Massive investment in infrastructure building during NDA-1 regime resulted in massive demand-supply match. The investment resulted in accelerated growth during 2003-2008 period, but led to bankruptcy of many infrastructure projects (power, roads, airports, telecom, Oil & Gas etc.) due to lack of demand and strained finances. Schemes like SEZ were implemented without adequate regulatory framework, and was eventually reduced to land grabbing exercise by unscrupulous entrepreneurs. A part of the present day stress in banking system could be attributed to the projects initiated in early 2000s.

·         Both rounds of reforms resulted in two very popular governments not getting re-elected.

We shall have to see that the government does not lose sight of the severe stress in unorganized sector and burgeoning household debt.

I also found the following points in budget that may need closer scrutiny of investors:

·         Most of the development programs announced and funds allocated are for a period of 5-6 years. This effectively means that the government is resorting to long term plans, as was the case in (now scrapped) Planning Commission era. The only difference is that NITI Aayog the body that replaced the Planning Commission, may not be holding wide and deep consultation with State Governments on various issues, even though the number of central schemes transferred to the States has increased materially.

·         It is now many years since FRBM targets have been violated. It may be time to scrap this law and work out a more practical legislative framework. It would be prudent to stringently control the Revenue Deficit rather than bother too much about fiscal deficit in this phase of growth. Borrowing for investment should not be considered a problem so long servicing is not an issue.

·         The government continues to place very high reliance on high rate Small Savings for financing the fiscal deficit; while the sourcing from very low cost external debt is minimal. The appropriateness of this strategy needs to be evaluated.

·         Allocation for Information Technology and Education in FY22BE is less than the FY21BE. Similarly, allocation for Health in FY22BE is less than FY21RE; and allocation for Scientific Departments in FY22BE is less than FY21BE.

This does not sound congruent with the core ideas of the budget.

·         Corporate Tax collection target for FY22BE is lower than the FY20 actual collections. This needs to be corroborated with projected 14.5% rise in nominal GDP.

·         It is proposed to pre fill IT returns with details of income from salary, interest, dividend and capital gains from listed securities.

The government must make sure that it remains a facility for the tax payers and does not become a source of harassment. For example consider this. IT department will take data of capital gain on listed stock from Stock Exchanges. This data will be based on gross trade prices. In case of frequent traders the charges (brokerage, STT, Stamp Duty etc.) may be more than the amount of gain itself. Obviously, tax payers will have to correct the pre filled amount in the returns. If department runs a variance check, a large number of returns may be pointed oout and this could potentially lead to harassment of tax payers.

 “Progress lies not in enhancing what is, but in advancing toward what will be.”

—Khalil Gibran (Lebanese Thinker Poet, 1883-1931)

Allaying all fears, the finance minister presented a brave budget. She took all Covid-19 blows on (fiscal) body and refused to yield to fiscal pressures. She prudently refused to indulge in allurements of raising resources through additional taxation. The Budget for FY22 is continuation of various measures announced during 2020 to support the economy. The recognition of the need of new economy (ecommerce workers, startups, e-learning, new education techniques etc.) and willingness to let go the control over even strategic CPSEs are signs of pragmatism. This is perhaps the only budget in independent India that does not propose to make any change in income tax rate structure.

It is now upon the administrative ministries, departments and state governments responsible for executing the proposals. Like Rishabh Pant, who went to Australia with a poor record of recent execution, the performance of these executing organs of the government in recent past has not been encouraging. It is to be hoped that the execution will improve materially in next 15 months and Indian economy shall emerge winner.

The stock market celebrated the budget ebulliently. This is despite the warnings by RBI Governor and CEA (Economic Survey) that stock market appear disconnected from the real economy.

Six core ideas of the budget

1.    Health and Wellbeing of citizens - Preventive healthcare, better sanitization and clean water

2.    Physical & Financial Capital, and Infrastructure – investment in building physical and financial infrastructure.

3.    Inclusive Development for Aspirational India – Recognition of the needs of new economy

4.    Reinvigorating Human Capital – Modern education policy

5.    Innovation and R&D – National Research Foundation to research ecosystem in country

6.    Minimum Government and Maximum Governance – Aggressive disinvestment; administrative reforms; easier and transparent tax administration

Key development proposals

·         Rs 64180cr to develop capacities of primary, secondary, and tertiary care Health Systems, strengthen existing national institutions, and create new institutions, to cater to detection and cure of new and emerging diseases.

·         Universal water supply in all Urban Local Bodies; and liquid waste management in 500 AMRUT cities. (Rs. 2,87,000cr in 5yrs)

·         The Urban Swachh Bharat Mission 2.0 (Rs. 1,41,678cr over 5years).

·         Voluntary vehicle scrapping policy Commercial vehicles 15yrs age and personal vehicles 20yrs age would need a fitness test.

·         Rs. 35000 allocated for Covid-19 vaccination. More to be allocated if needed.

·         Mega Investment Textiles Parks (MITRA) Scheme to be announced in addition to PLI.

·         A Development Financial Institution (DFI) with Rs20000cr initial capital to be set up. The institution to have Rs5trn loan book in 3yrs.

·         Proposal to set up National Monetization Pipeline. DFC to be monetized after commissioning in June 2022.

·         Award of 8500kms of road under Bharatmala project in FY22.

·         Private sector may be allowed to own and operate 20000 city busses under PPP mode.

·         Portability to be allowed between power distribution companies. Rs3.05trn for upgrade of power distribution infrastructure.

·         Proposal to launch a Hydrogen Energy Mission in 2021-22 for generating hydrogen from green power sources.

·         Private players to be allowed to manage and operate major Ports.

·         Proposal to consolidate the provisions of SEBI Act, 1992, Depositories Act, 1996, Securities Contracts (Regulation) Act, 1956 and Government Securities Act, 2007 into a rationalized single Securities Markets Code.

·         Proposal to introduce an investor charter as a right of all financial investors across all financial products.

·         FDI limit in insurance sector increased to 74% from present 49%.

·         Asset Reconstruction Company and Asset Management Company to be set up to consolidate and take over the existing stressed debt and then manage and dispose of the assets to Alternate Investment Funds and other potential investors for eventual value realization.

·         Rs. 20000 cr allocated for recapitalization of public sector banks.

·         The limit of Rs50lac outstanding for action under SARFASI Act reduced to Rs20lac for large NBFCs.

·         Proposal to launch data analytics, artificial intelligence, machine learning driven MCA21 Version 3.0 with modules for e-scrutiny, e-Adjudication, e-Consultation and Compliance Management.

·         Clear roadmap for privatization of CPSE. Proposal to take up the privatization of two Public Sector Banks and one General Insurance company and IPO of LIC in FY22. Rs1.75trn to be raised from disinvestment in FY22.

·         Social security benefits will extend to gig and platform workers. Minimum wages will apply to all categories of workers, and they will all be covered by the ESIC.

·         15,000 schools to be qualitatively strengthened to include all components of the National Education Policy.

·         Higher Education Commission to be set up for standard-setting, accreditation, regulation, and funding of higher education institution.

·         National Research Foundation to be set up to develop research ecosystem in the country. (Rs50000 over 5years)

Direct proposals

Personal taxation

·         No change in tax rates and slabs.

·         Assesses above 75yr of age having only pension and interest income need not file return, if TDS covers their full tax liability.

·         Dividend income to be considered for advance tax only when announced. For FPI, TDS on dividend to be at lower treaty rate.

·         ULIPs Premium over Rs2.5lac in a year to be treated at par with Mutual Fund Investment.

·         Interest on contribution to Provident Funds on contribution exceeding Rs2.5/year to be taxable. (Wef 1-04-2021)

·         The additional deduction of `1.5 lakh shall therefore be available for loans taken up till 31st March 2022, for the purchase of an affordable house.

·         IT Returns to come pre filled with salary, interest, dividend and capital gain of listed securities.

·         Person in whose case TDS/TCS of Rs50,000 or more has been made for the past two years and who has not filed return of income, the rate of TDS/TCS shall be at the double of the specified rate or 5%, whichever is higher.

·         Proposal to increase safe harbor limit from 10% to 20% for the specified primary sale of residential units.

Business taxation

·         Further affordable housing projects can avail a tax holiday for one more year – till 31st March, 2022. Tax exemption to be notified for Affordable Rental Housing Projects.

·         For assesses carrying 95% or more transactions digitally, Tax Audit would be needed only if turnover exceeds, Rs10cr.

·         Eligibility for claiming tax holiday for start-ups extended by one more year - till 31st March, 2022.

·         TDS of 0.1% required on purchase transaction exceeding ` 50 lakh in a year, provided the supplier’s turnover exceeds rs10cr.

·         TDS requirement on dividend paid to Trusts (REITs/InVits) in whose hand dividend is not taxable.

·         Provisions for Equalization Levy on ecommerce players rationalized.

Assessment Procedures

·         Time limit for reopening of assessment reduced to 3yrs from present 6yrs. Re-opening for serious tax evasion to be made more objective and system driven.

·         Dispute Resolution Committee to be set up for small assesses and Settlement Commission to be wound up. ITAT to also go faceless.

·         Time limit for completing assessment reduced to 9months from the end of relevant assessment year.

Budget at a glance