Saturday, September 25, 2021

US Fed may not remain completely data driven

In its latest meeting the US Federal Reserve Open Market Committee (FOMC) reiterated its position stated in the last meeting. The Committee maintained status quo on the Fed rate (Repo Rate) and its asset (bond) buying program (US$120bn/month). The limit for single counterparty under reverse repo has been raised to US$160bn from the present US$80bn, allowing the banks to park more money with the Federal Reserve.

The Committee reiterated its stance of last meeting, stating that “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted”; implying that the FOMC decision on QE continues to be data driven, and the present reading of data guides a gradual unwinding of the monetary stimulus introduced to mitigate the impact of Covid-19 pandemic.

“While no decisions were made, participants generally viewed that so long as the recovery remains on track, a gradual tapering process that concludes around the middle of next year is likely to be appropriate”, the Fed Chairman said in a post meeting conference.

The Chairman also informed that the Committee feels that the Fed is closer to passing the test of “substantial further progress” on employment and inflation. Accordingly, more members now see the first rate hike happening in 2022. It is pertinent to note that in June, when FOMC members last released their economic projections, a slight majority of members had projected rate increase into 2023.

The markets have obviously read what it wanted to in the Fed statement. The bullish response to the Fed statement implies that market is giving more credence to the “slower growth” forecast than the “higher inflation” expectation. The market move post Fed statement implies that the confidence in “November Taper” is much lower given the slowing growth and uncertainties in Chinese markets. Even if the tapering begins in November, the pace may slower than anticipated. Also, the data for the “lift” (rate hike) may not adequate as of now and much more evidence may be required before a concrete lift decision could be taken.

Despite the headline inflation running much higher than the fed target of 2%, FOMC did not appear concerned about price situation. The Chairman repeatedly stressed in his interaction with the press that “he expects price pressures to subside as supply chain factors, goods shortages and unusually high levels of demand return to pre-pandemic levels’; thus reiterating his “transitory” stance on inflation.

Many analysts have related the Fed decision to postpone the question of Tapering to the November meeting, to the debt ceiling fracas in US. “The Fed never makes major changes to policy when there are major unresolved issues in Washington,” said Danielle DiMartino Booth, chief executive of Quill Intelligence. “Between the debt ceiling, budget resolution and potential for a government shutdown, there are plenty of political reasons for the Fed to not change policy.”

In my view, Fed would refrain from taking any decision till the (i) concerns over Covid-19 variants subside materially; (ii) political fracas in US ends amicably; (iii) dust created by Evergrande settles down and (iv) “transitory” nature of inflation is denied. November Taper, if at all happens, would be slow (may be US$10bn/month) and protracted. The rate hike decision is still in the realm of speculation.

A peep over the China Wall

Whether we like it or not, China is a key factor in India’s policy making function. The China factor materially influences our economic policies, foreign policy, and defense policy. This may be true to a material extent for US, Japan and Korea policy making functions also.

Inarguably, the Chinese economy has been one of the key driving forces for the global economy in past three decades. Chinese have labored hard for over five decades, since beginning of cultural revolution in 1966, to emerge as a potent global force. In past three decades they have subsidized the global economy by providing cheap labor and capital; and funded a large part of the US and EU fiscal deficits since early 2000s. The Chinese support was a key factor in keeping the global market afloat during the global financial crisis. It would not be entirely wrong to say that China also helped the developed economies in protecting “their environment” by letting them relocate most of their polluting industries to China.

In the process, China perhaps digressed a little too further from its core ideology of Marxism. The selective capitalism allowed many “depravities of the West” to permeate the Chinese system, e.g., rampant corruption, flagrant inequalities and conspicuous consumerism. “Growth at any cost”, has perhaps costed too much to the Chinese society and the system. There have been reports of growing dissent amongst citizens for a variety of reasons. The citizens exposed to the global economy and society naturally desired more freedom (especially of expression) tat was denied. The demographic control policies (one child, immigration to cities etc.) also created imbalances and dissent.

In past few years, the Chinese government has sought to change the course of its polices to address some of these issue. For example, -

First, China sought to move into higher orbit by asking to be treated at par with developed countries. They claimed global acceptability for their currency; bigger role in the multilateral institutions like World Bank; dominant role in global trade and commerce through “Belt and Road” and other Initiatives; bigger role in global geopolitics etc. Besides, China has also made substantial strategic investments in Asia, Africa, Latin America and European continents to garner wider support.

USA, that has been dominating the world since the collapse of USSR, obviously did not like the idea and an overt trade war ensued.

Second, China cracked down massively on its polluting industries by shutting huge capacities. This impacted the global supply chains and forced the global corporation to seek alternative supply sources. (India has been one of the major beneficiaries)

Third, to correct its growing demographic imbalances, China abolished its one child policy and allowed upto 3 children per family.

Fourth, Chinese authorities made a paradigm shift in policy towards businesses; and took punitive/restrictive actions against likes of Internet major Alibaba, food delivery leader Meituan, ride hailing app Didi, popular micro blogging app Weibo, and numerous private tuition entities to signal the change in the direction of of winds in China.

Fifth, it prescribed strict financial prudence norms for its real estate sector to ensure that there is no hard landing of the economy. Many prominent developers failed to meet these norms and were forced to take corrective action.

Sixth, and most important, the premier Xi Jinping, proposed a new economic policy framework (“New Development Concept”), comprising of three key concepts –

(i)    “Dual circulation economy,” which seeks to reduce China’s future dependency on export-driven growth, and instead have Chinese domestic consumer demand become the principal growth driver;

(ii)   “Common Prosperity,” which emphasizes income redistribution away from China’s billionaire class to low- and middle-income earners;

(iii)  New “industrial policy,” led by a revamped state-owned sector, giving top priority to new technology platforms as the drivers of the 21st century global economy, including semi-conductors, artificial intelligence, quantum computing, and new forms of advanced manufacturing.

The changes obviously would have far reaching impact on China, as well as the global economy. There are many popular view prevalent about the nature and extent of this impact. One popular view is that like Japan in 1980-1990, China will allow systematic undisruptive dismantling of the froth that has developed in its economy (soft landing). The other view is that 2020-2030 will be the decade of socio-economic revolution in China, as against the decade of cultural revolution (socio-political) during 1966-1976.

In my view, China is working on a new model in which the core ideology of Marxism (uncorrupted and equal society) shall become a guiding force; communist party will remain fully in control of markets; and China becomes a great global power. Arguably, it will involve significant geopolitical and trade conflict. Signs iof which are clearly visible to us in China Sea, Afghanistan, and Ladakh.

It remains to be seen how far Xi Jinping would be successful in implementing this new design. Nonetheless, the actions so far speak of the full commitment to the new policy framework. It is in this background that we need to assess the recent developments in China and global markets.

Evergrande – scarecrow or black swan?

One of the basic law of physics is that the higher an object is propelled into the atmosphere, the faster it returns to the earth; unless the propeller lends enough velocity to the object to help it transcend beyond the gravitational orbit of the Earth.

This principle of physics can be applied to the businesses also. A business that is propelled higher using the fuel of debt, risks crashing down to the ground zero, if the business model is not strong enough to take the business out of the debt spiral and place it in the orbit of sustainability. However, in cases where the fuel itself is contaminated (unsustainable debt); the fuel tank (management) is leaking, or the velocity is inadequate (unsustainable business model), the chances of business crash landing increase manifold.

In past one decade, we have seen many examples of this phenomenon in India. The businesses that grew remarkably in the decade of 2000s with the help of easily available credit, but had leaking tanks (unscrupulous management,) contaminated fuel (unsustainable debt) and/or inadequate velocity (poor business models) came crashing down in the decade of 2010s. JPA Group, Suzlon, ADAG, DHFL, Yes Bank, SREI, Bhushan Steel, are only few example. Globally, Lehman Brothers, which crash-landed in 2008, has become epitome of this phenomenon.

Chines real estate sector – symbol of malaise

The Chinese real estate development sector has been under scrutiny for more than a decade now. The sector has been at the core of phenomenal growth of Chinese economy in general and the financial sector in particular for past two decades. The real estate sector development apparently contributes more than one fourth of GDP of China and constituted over three fourth of the Chinese household wealth.

Nonetheless, numerous fables of ghost towns, unsustainable debt, window dressing of lenders’ books have been very popular in the past decade or so. Most bankers, investors and money managers have been worrying about this; though not many might have taken steps to reduce their exposure to Chinese enterprises materially. Perhaps, they were too confident that the Chinese authorities would not let any large business fail, lest it may deter the global investors from investing in Chinese businesses.

The things however have begun to change dramatically since past one year, with the Chinese authorities making a paradigm shift in its policy towards businesses. Though, the punitive/restrictive actions of Chinese authorities against likes of Internet major Alibaba, food delivery leader Meituan, ride hailing app Didi, popular micro blogging app Weibo, and numerous private tuition entities have been signaling the change in the direction of of winds in China, the scare of failure of real estate major Evergrande has drawn greater attention of the entire global markets towards the developments in China.

Evergrande in that sense has become the symbol of malaise prevalent in China, just like Lehman symbolized the malaise in US financial sector during the global financial sector.

For an Indian investors, it is pertinent to understand the Evergrande episode independent of the price action of the past week in the stock markets. Remember, panic is more likely to mislead than guide to a safe haven.

What is Evergrande?

Evergrande, a Guangzhou based real estate developer founded in 1996, is one of the largest real estate developer in China. As per the website of the group, it owns more than 1300 real estate projects (about 780 under construction) in close to 300 Chinese cities; has interest in many other businesses, including sports, media, electric mobility etc.

Evergrande, with over US$300bn in assets (close to 2% of Chinese GDP) is also one of the world’s highest indebted developers with more than US$300bn in dues to lenders and operating creditors. Out of this about US$129mn in interest was due for payment this week and US$850mn of principal repayments are due in next 3months.

Reportedly, the Chinese government has chalked out a bail out for Evergrande. In the arrangement, Evergrande may be virtually nationalized. This should provide some immediate relief to the markets, but it is not important in a larger context. This arrangement just kicks the can a little further to allow soft landing.

What’s the problem?

The rating agency Fitch recently downgraded a host of Chinese developers, including Evergrande; and warned about a “probable default” by the troubled developer. This warning has sent shock waves across the markets, as it was feared that a default by Evergrande may impact the entire real estate development and financial sectors in China directly; and commodities and consumer sectors indirectly.

It is estimated that a crash in real estate sector may hurt lot of homebuyers who have made substantial part payments, and thus impact their financial status materially. It is also estimated that material slowdown in real estate sector, may slow down overall Chinese economy materially, leading to substantially lowered demand for industrial commodities like steel and copper. This may have serious repercussions for global commodities markets; and also impact the consumption demand for things like iPhones in China.

The stocks and bonds of Evergrande and other major real estate developers like SIMIC crashed by 35% to 80%. While the Chinese homebuyers might lose money, if Evergrande projects are not completed in time or are abandoned completely; the global investors who had invested in stocks and bonds of Chinese developers have already lost substantial money. In that sense, the global investors are equally part of this problem.

In fact, the current problem may be more intense for the global investors who are over leveraged in the Chinese high yield bonds and have large unhedged exposure to Chinese real estate developers and their lenders, than for the Chinese enterprise and Chinese authorities themselves.

What caused the problem?

Prima facie, managing US$1bn of Evergrande’s payments due in near term, was never a material problem for Chinese government, which virtually owns the entire banking system and has huge surplus in reserves. After all, Indian government with almost one sixth GDP of China, and much smaller banking sector, could manage much larger problems (IL&FS and Yes Bank) with relative ease.

The problem in fact lies in the changing policy paradigm in China.

To implement far reaching reforms in the delinquent real estate sector, the Chinese government outlined three parameters to be followed by all the developers, viz., (i) The liabilities of any developer must not exceed 70% of its asset value (L/A < 70%); (ii) the net debt of developers must not exceed its net worth (net leverage < 100%); and (iii) all developers must have cash which is more than their short term debt (cash to ST debt > 1).

Apparently, the objective of stipulating these conditions was to preempt a systemic crisis that could potentially drag the entire financial system into a deep crisis. Last year a large number of entities failed the test.

The bigger problem was however identified in the business model followed by the developers like Evergrande. They apparently bid for land at very high prices. The local authorities were obviously very happy with these bids as it augmented their revenue substantially. The higher land prices were then passed on to the home buyers with inflated property prices.

This made bankers happy as they could lend more to homebuyers due to higher notional value of the collateral property; but resulted in substantially higher household debt and unaffordable home prices.

The household savings thus got diverted to inflated housing sector rather than the capital starved high technology sector which had to increasingly rely on the foreign capital. It also impacted the private consumption, frustrating the government efforts to make Chinese economy domestic consumption driven from the presently export driven.

To correct all these issues, Chinese authorities took a series of measures, including curbs on VC investment in real estate, and checking the corrupt practices in real estate sector.

Consequently, the real estate developers saddled with unsustainable debt and inflated assets are feeling the pressure. But it is important to note that it is not the real estate alone, but the entire high yielding Chinese debt that is feeling the pain. Also Evergrande may have become face of the problem, but it is certainly not the only one in problem. Many other like it, e.g., SIMIC, Fantasia, Suna, etc are also in trouble.






What are the implications?

A series of defaults in Chinese real estate sector could potentially have multidimensional implications. For example

(a)   It could lead to serious wealth erosion for the Chinese home buyers. To mitigate some of this impact, the Chinese authorities are resorting to transferring the assets of troubled real estate developers to the lenders, who shall get it completed and sell to the home buyers. A variant of this model is being tried in India also with assets of JP Associates, Amarpali, Supertech etc.

As stated earlier, beleaguered Evergrande Group has apparently negotiated a settlement with the lenders for a short tern respite. Besides, the Chinese authorities are ensuring adequate liquidity in the market to stem repeat of post Lehman market freeze and global contagion.

(b)   The bond and stock prices of troubled developers have already seen severe losses. The global investors holding these securities have already weathered the loss. However, it is hard to believe that after having experienced Lehman collapse, these investors had not hedged their risk.

(c)    The developments in Chinese real estate market could lead to material slowdown in the Chinese economy, and therefore the global economy, threatening the fragile recovery from the pandemic. The demand for commodities could collapse leading to sharp correction in prices.

It is pertinent to note that the signs of slowdown in global economy were already emerging  three months ago, with World Bank, ADB, IMF etc downgrading their growth estimates. China had anticipated slowdown in demand for commodity prices and accordingly started liquidating its strategic reserves of steel and copper. The commodity prices mostly peaked three months back. Most central bankers have recognized this trend, terming the commodity inflation as transitory; and refrained from acting on elevated price conditions.

Further, a slower Chinese demand may actually ease pressure on the global logistics and supply chain bottlenecks, thus providing a short term relief to the struggling industries worldwide.



Implications for Indian investors

The Indian investors must see the current developments in Chinese economy and markets as continuation of the trend that started with Trump-Xi trade war. This will only accelerate the move towards China+1 policy of global businesses; which is widely expected to of great benefit for Indian businesses.

In the near term we may see minor outflows from Indian markets, as the global investors with significant exposure to Chinese developers seek to rebalance their portfolios due to losses and redemption pressure. However, in mid to long term this could actually result in higher allocation (China+1) to India by investors also.

The Evergrande episode is expected to refrain the Central Bankers from rushing into monetary tightening; while PoBC continues to ease liquidity. This has obviously alleviated some of the near term concerns of the markets.

The most visible impact for Indian investors would however be the likely easing of inflationary pressures, providing some easing room for RBI.

It is less likely that the Chinese investors would seek to withdraw material investments from India, under the current circumstances, especially when the rules regarding fresh investment from China require much greater scrutiny.

However, beyond the immediate events, we need to keep a close watch on the developments of wider import occurring in China.

Evergrande – scarecrow or black swan?

In media, the Evergrande episode has been termed as sighting of the proverbial Black Swan, a rare event that may disturb the status quo materially.

Black Swan events are, by definition, completely unexpected events of large magnitude and consequences and usually mark a watershed in the history.

No surprises that the prospects of a default, and its perceived potential repercussions sent the global markets into tailspin earlier this week. Traders anticipating a repeat of Lehman moment in Evergrande default, rushed to close their positions. It was feared that failure of Evergrande will have a strong spiral impact on the global financial system and markets. It may result in collapse of China property development market, leading to sharp fall in property prices and erosion of collateral value for banks. The collateral damage will also be felt in metal markets, as China property developers have been a key drivers for the metal demand.

But it is pertinent to note that China real sector, its importance, challenges, problems and threats have all been analysed threadbare in past one decade. There is nothing that is not known to global investors and analysts. It is only the lure of high yield and confidence in Chinese authorities (they would not let it fail) that keeps the investors’ interest alive in this market. China and all its enterprise face close scrutiny of the global community, despite scant availability and low reliability of the information. To be honest very few investors and analysts would not expect the available information to be mostly manipulated. Everyone therefore is always on their guards in relation to anything connected with China. Therefore, Sighting a Black Swan in Chinese context itself is a Black Swan event.

I would therefore like to believe that Evergrande is a scarecrow that has been shown to the global investing community as a warning of the risk of investing in high yield bonds by over leveraging.

It is also a harbinger of the things that are likely to come over next few years. A decade of readjustments in China may require many adjustments in most corners of the world.

Monday, September 20, 2021

Does equity investing work for you?

Despite the risks inherent in equity share ownership, the traumatic shocks of 1992, 2000, 2008 and 2020, equity remains a popular investment option among both individual and institutional investors. In fact, after the global financial crisis of 2008-09, the riskier equity (startups and pre revenue) has become even more popular with the investors who have been chasing yields on one hand and had access to cheap money on the other hand.

After the market crash due to outbreak of pandemic, the inflows into global equity funds have surged exponentially. The net flows in 2021 YTD alone exceed the net flows during previous two decades (2001-2020).



Anecdotal evidence suggests that one of the main reasons behind this unshakable popularity is the possibility of scoring “big”. It is this chance of multiplying the money in short term, which has attracted hordes of investors to the stock market.

Nonetheless, there is no dearth of people who are scared of the word ‘equity investing’.  Some of them have lost their entire savings in stock market, and the others, considering it another form of gambling, did never invest in shares.

Where do you stand in this picture?

·         Is it true that the investment option, which has statistically given highest returns in all economic conditions, did never work for you?  If yes, did you try to examine the reasons for this?

·         Even if you made fabulous gains in the stock market, could you attribute these to careful planning, or was it a fluke?

·         Do you consider investing in stocks an art and a science, or just a ‘roll of dice’?

Saturday, September 18, 2021

Seven seas to cross for full recovery

 The latest macro data indicates that the Indian economy may be standing at an inflection point. It may have survived a major accident in the form of Covid19 pandemic; luckily scraping through with couple of broken bones and some bruises. The economy is recuperating well and is perhaps ready for discharge from the hospital. Of course, for next few quarters the economy may still need to use the crutches of government spending, before it could walk on its own.

The amount of bill for the recovery from pandemic would mostly be known in next six months. We would also know how the cost of pandemic would be shared between various stakeholders, i.e., government, citizens and businesses.

Post pandemic, the challenges before the government are multifold; and so are the opportunities. A successful resolution of these challenges could trigger a virtuous cycle of growth and catapult the economy to the higher orbit. A failure may not be an option, as it could cause a disaster of unfathomable proportion.

The popular words of Jigar Moradabadi may be used to describe the proposition before the Government of India ये इश्क़ नहीं आसाँ इतना ही समझ लीजे, इक आग का दरिया है और डूब के जाना है”.

1. Broken bones need to be strengthened

The foremost priority of the government should be to strengthen the broken bones (MSME Sector and Unorganized Labor). In fact, these two bones were weakening since demonetization in November 2016. Implementation of GST from July 2017 stressed these further. The pandemic was yet another major blow to these two segments.

Many MSMEs may have lost market share to the larger organized players. The changing consumer behavior in favor of digital platforms also seems to have impacted them. Broken supply chains and tighter credit norms also presented challenges before them.

According to a survey by community platform LocalCircles, “about 59 per cent of the startups and micro, small and medium enterprises (MSMEs) in India are expected to scale down, shut down or sell themselves this year due to the impact of the second wave of Covid-19 pandemic.”

Unorganized labor faced large scale displacement due to the pandemic. Many have since returned to their previous places of work; but the challenges remain. Not all of them have got work due to a variety of reasons. The urban unemployment level remains elevated despite economy opening up materially.

 


CMIE highlighted that the composition of this fall in employment in August reveals the challenges India faces in providing jobs. The loss was essentially in farm jobs. Non-farm jobs increased to absorb a very large proportion of the jobs shed in the farm sector to leave a net deficit of 1.9 million jobs. However, the non-farm jobs that expanded were mostly not the kind that could be considered good quality jobs.



2. Driver to accelerate growth need to be applied urgently

The drivers for the acceleration of the growth to swiftly recoup the deficit of two years need to be identified and applied. The government has shown intent to turn this crisis into an opportunity by pushing through some key reforms, especially in farm and manufacturing sectors. For example-

·         The government consolidated 44 labour laws into four codes under the Wage Code Bill, Industrial Relations Code 2020, Occupational Safety, Health & Working Conditions Code 2020 and Social Security Code 2020.

·         The three farm laws -- the Farmers' Produce Trade and Commerce (Promotion and Facilitation) Act, the Farmers (Empowerment and Protection) Agreement on Price Assurance and the Farm Services Act and the Essential Commodities (Amendment) Act – have been implemented to allow farmers to sell their farm produce at a price of their own choosing and even outside their respective states, thereby leading to better rural incomes.

·         The production-linked incentive (PLI) scheme rolled out for many sectors, covering a wide gamut of products and technologies, to encourage the domestic manufacturing sector, promote exports and make the country an integral part of the global supply chain.

·         FDI limits increased in key sectors like defense production, insurance, telecom etc.

·         Significant amendments made in Minerals and Mining laws to end monopoly of Coal India.

3. We need to go way beyond mere ‘V’ shape recovery

Merely achieving a full ‘V’ recovery to the pre pandemic level of economic activity will be inadequate, since pre pandemic the economy was slowing for many years and was completely unable to generate adequate jobs for the burgeoning youth population. The government will need to apply multiple accelerators for the sustainable growth to reach to the target of 8% plus.


4. …while preventing a regression to ‘K’ shape

Fourth, the pandemic has widened the divide in the society, as the recovery so far has been rather ‘K’ shaped. Income and wealth inequalities have widened. Disparities in access to digital infrastructure have amplified the divide in social sectors like healthcare and education. The gap between organized and unorganized sectors has enlarged materially. To maintain harmony and peace in the society, these gulfs would need to be managed.

As per a study done by the Azim Premji University scholars, “one year of Covid-19 pandemic has pushed 230 million people into poverty with a 15 per cent increase in poverty rate in rural India and a 20 per cent surge in urban India."

CMIE data showed that “the unemployment rate has gone up as high as 12 per cent in May 2021, 10 million jobs have been lost just on account of the second wave and 97 per cent of the households in the country have experienced declines in incomes”.

As per the study published by Azim Premji Foundation, almost 60% children cannot access online learning opportunities. Reasons for this varied from absence of a smartphone, multiple siblings sharing a smartphone, difficulty in using the Apps for online learning, etc. The issue of access is further exacerbated for children with disabilities. Among teachers of children with disabilities in their regular classes, more than 90% found them unable to participate in online classes.



Of course there is no credible precedent to show that these gulfs could be narrowed materially through state efforts alone. Nonetheless, by building strong bridges (Opportunities and Access) between the two sides which allow the underprivileged to freely and smoothly cross over to the other side, a positive momentum could definitely be created.

5. Need to prepare for short term disruptions that QE unwind might cause

The ultra-loose monetary policies were adopted by the central banks across the world to mitigate the damage caused by the pandemic. These would need to be reversed at some point in time.



There are signs that abundance of cheap money floating around combined with persistent logistic constraints and pent up demand is leading the prices to move beyond the tolerance limits of various economies. Most central bankers have promised the reversal of monetary stimulus to be orderly; but short term disruptions cannot be ruled out. The Indian government needs to create enough cushion for mitigating the adverse impact of these likely disruptions. These disruptions might particularly impact (imported) inflation, INR & bond yield due to abrupt outflows.





 6. Northern borders need to be guarded even more closely

While the world continues to recuperate from the pandemic the geopolitical standoff in Asia is worsening with Afghanistan becoming a symbolic battlefield between US and China (supported by Russia). The worries for India on Northern and North Eastern borders have risen materially with China & Pakistan supported Taliban taking control of Afghanistan, and complete exit of US forces from the region.

7. Erratic Monsoon may spoil the Diwali party

The erratic monsoon and continued supply chain issues mean that the prices of essential commodities (most notably Onion) could rise materially in the forthcoming festival season. As the process of elections in key states of UP & Punjab (and three others) will start around Diwali, keeping food prices under control would be a challenge for the government.



Augmenting supply may not be adequate

The direct measures that the government could take to support the economic recovery are broadly divided in two categories, i.e., (i) the measures to increase the production of goods and services or the supply side measures; and (ii) the measures to support the higher consumption for goods and services or the demand side measures.

The supply side measures usually include direct investment in building enabling infrastructure and augmenting production capacities; or providing incentives to the private sector for investing in capacity building. Some popular supply side measures include building and/or augmenting physical infrastructure and providing investment linked monetary and fiscal incentives, easing production and sales curbs on regulated commodities, relaxing restrictions on import of foreign goods and capital, augmenting money supply and easing credit norms for businesses, etc.

The demand side measures usually include providing monetary and fiscal concessions and incentives to consumers to stimulate demand and increase the utilization of existing capacities. Some popular demand side measures are interest subvention, direct cash benefits, rebate in taxes and levies, subsidizing the retail prices, and relaxing credit norms for consumers, etc.

It is felt that the government strategy to deal with the crisis so far has focused more on supply side measures. The measures to augment demand have been few and inadequate.

The supply side measures that included significant increase in the outlay for infrastructure building, PLI schemes for building capacities to substitute imports and promote exports, aggressive targets for achieving the committed emission norms, credit guarantees, accommodative monetary policy stance etc. These measures are beginning to show some results in terms increased construction activities and higher exports.

The demand side measures included direct cash distribution to farmers and laborers, encashment of LTC, interest subvention on affordable housing, some duty cuts, etc. These measures were materially offset by steep hike in fuel prices, food inflation, wage cuts, higher cost of education and lower rate on savings, etc. Consequently, the household debt has seen sharp rise, private consumption continues to slow down, and unemployment level stays elevated.

Government reluctant to spend

As per CMIE, “GDP data revealed that besides the second wave of Covid-19 deficient government spending constrained India’s economic recovery in the June 2021 quarter from the slump of fiscal 2020-21. Government final consumption expenditure (GFCF) fell year-on-year by 4.8 per cent in real terms during the quarter.



The government expenditure here includes public spending by both, the central and the state government. As per the data released by the Controller Auditor General (GAG), 20 state governments reported a 17.2 per cent increase their expenditure in the June 2021 quarter. But, the central government, on the other hand, kept its expenditure constant at the year-ago level. In real terms, this implies a 4.9 per cent fall in central government expenditure.”

 UBI could be one solution

As highlighted by the World Resource Institute, “About 90% of India’s workforce is informally employed, which includes gig economy workers. This population is extremely vulnerable to economic shocks and needs greater access to formal credit and social safety nets such as insurance and pension schemes.

Beyond employment guarantees, a universal basic income – broader than current schemes that are conditional upon occupation and land ownership – can help provide vital resources for subsistence, or for investing in education and health.”

Household debt needs to be contained

The latest NSSO survey on All India Debt & Investment, shows increase in average amount of debt among rural as well as urban households, with the average amount of debt increasing by 84% and by 42% respectively for rural and urban households for the six year period ended 2018. A large part of this rise could be due to success of financial inclusion efforts and formalization of credit access to households.


However, as per SBI research, “household debt in rural and urban areas might have doubled in 2021 from the 2018 levels”. SBI economist estimates that “rural household debt increased to 1.16 lakh and urban households debt to 33 lakh and this indicates that COVID impacted households significantly.”

Saturday, September 11, 2021

A random walk through the street

 

A random walk through the settlement statistic of NSE for past two decade and half decades provided some interesting insights into the market evolution over past two decades. It is interesting to note the things that have changed and the things that have not. Regardless, it is comforting to note that Indian markets are maturing well and the systemic risk appears to have subsided materially. The best part was to observe that our markets have become more democratic with deeper and wider participation.

(All data is sourced from www.nseindia.com)

Indian market maturing well

The latest bull market has shown that the Indian investors and traders are maturing very well. The tendency to recklessly over trade that was witnessed during dotcom bubble, and to some lesser extent during credit bubble of 2007-08, seems to have been reigned well now.

To give it some perspective, at the peak of the dotcom bubble, the average daily turnover of NSE was close to 0.8% of the total market capitalization in FY01. In FY08-FY09 it remained in the range of 0.3-0.4% of the total market cap. However, in the latest bull market, it peaked close to 0.3% in FY20-FY21.

In fact FY21 average daily turnover (ADT) as percentage of market cap has seen marginal decline over FY20, despite a 60% rise in the value of ADT.




Definitely, the changes in ownership pattern of Indian equity may have been at play in this. The institutional and promoter ownership is now much higher as compared to FY01. Nonetheless, there are clear signs of sensibility in day trading patterns, as depicted by the tremendous rise in the option volumes in past 10years. The traders now definitely prefer options more than the stocks, where they can better control their exposure in accordance with their risk tolerance.



A reliable evidence of the rationalization of speculative tendencies over past 20years is available in the form of lower interest in low value (penny) stocks.

In FY01, at peak of the dotcom bubble, in value terms only 8.4% of the traded value resulted into delivery of shares, while 91.6% value was intraday trading. Moreover, when we see the total number of shares traded resulting in delivery, it was 16.5%. This implies that traders were not only overtrading, they were trading more in low priced (penny) stocks.

The share of delivery in the value of trades increased to 27.6% in FY08, and this time the almost 25% of shares traded resulted in delivery; implying that the trading in penny stocks was much lower in FY08.

In FY21, the percentage of delivery has reduced materially to ~17% both in terms of value trade and number of shares traded; implying that traders continue to be cautious about penny stocks and focusing more on mid and large cap stocks for taking delivery.



Another evidence of market maturity comes from the share of smaller companies in the overall market activity.

In FY01, at the peak of dotcom bubble, numerous small, hitherto unknown and often unsustainable businesses were the top traded shares on the stock exchanges. In top 10 most active securities, 7 had market cap of 1% or less of the total market cap of NSE, with 4 having a market cap that was less than 0.1% of the total market cap.

In that year, on NSE the top 10 most active securities accounted for an insane 73% of the total traded value; whereas these securities accounted for just 13% of the total market cap. Himachal Futuristic (HFCL) with just 0.17% of the total market cap was the most active security accounting for over 15% of the total market turnover. Two other small cap companies Global Telesystem (0.11% of total market cap) and DSQ Software (0.05% of total market cap) accounted for 9% and 6.5% of total turnover respectively. To put this in perspective, the company with the largest market cap (Reliance Industries, 6.25% of total market cap) accounted for just 4% of the total turnover; and IT bellwether Infosys with 4.1% of total market cap, accounted for 8.1% of the total market turnover.

In FY08 also, 4 companies accounting for less than 1% of total market cap of NSE figured in the top 10 most active securities. The 6 top most active securities were Reliance group companies. But, the top 10 most active securities accounted for just 27% of the total turnover. Reliance Industries with 6.8% of total market cap contributed just 5% to the total turnover. IFCI was the only microcap stock in top 10 most active securities list.

Things improved significantly in FY20, when top 10 most active securities accounted for 20% of the market cap and 26% of the total turnover. Though this year also 4 companies with less than 1% of the total market cap figured in the list, the skew of share in total turnover was much smoother. Reliance Industries was again the top traded stock, but now accounting for just 3.6% of total turnover.



 

Systemic risks lower now

The stricter compliance norms, improved surveillance and disclosure practice and wisdom gained through hindsight have resulted in materially lower systemic risks in the markets.

Though the common man had started to participate in the stock markets from early 1990s as the economy was opened up, the development of Information Technology industry in late 1990s provided the real impetus. A large number of IT workers came from middle and lower middle strata of the society and had an opportunity to work in global companies. Young professionals from the smaller towns migrated to metropolis and foreign countries. ESOPs became popular and that laid foundation for a deeper and wider participation in the stock markets. The understanding about the financial investments however did not grew in tandem with the understanding of complex IT algorithms.

Besides, a large number of new entities, dealing in new economy businesses and services, came into existence. Many of these companies did not survive the test of solvency for long. Consequently, about one third of the companies listed on NSE in March 2000 had vanished by March 2004.

This was not repeated in 2008-09 and 2020 market crashes. The number of companies available for trading on NSE increased by 25% during the period from March 2007 to March 2010. During the period between March 2020 and March 2021 also the number of companies available for trading has increased by 1.5%.




Democratization of Indian markets

A key development in the stock market has been the democratization of the markets. Not long ago in the history of Indian stock market, the market participants were a small privileged group of people, mostly from established industrial families or senior corporate executives.

Common household investors had begun meaningful investment in listed equity in late 70’s at the time of forced dilution of foreign owned companies operating in India, under the provisions of a stricter Foreign Exchange Regulation Act (FERA). These companies now known as MNCs were then referred to as FERA companies in common market parlance.

Reliance in 80’s and PSU disinvestment and capital market reforms in early 90’s drew the 2nd lot of household investors. IT boom of late 90’s drew the 3rd and the largest set of new investors to the listed equity. However, the participants were mostly concentrated in the few larger cities of some industrialized states. The four top cities accounted for more than 80% of investment amount and investors.

Anecdotal evidence point to the fact that Covid19 enforced lockdown has drawn the latest set of investors to the equity markets. 2020 was the period when many businesses were either locked down or their workers were operating from home, whereas equity markets were functioning uninterrupted. This was one trading business that could be done from the comfort of homes and without any additional investment in infrastructure or facility building.

Since, traders and small business owner had no work to do; and bank deposit and bond returns were falling; many of them deployed their working capital in the equity trading. Many small and micro businesses which were declining since demonetization and GST implementation also shut down during this period, with their owner shifting their focus on financial investments.

Thanks to the significantly improved accessibility due to the financial inclusion efforts, technology and Fintech popularity, the participation in stock market is now much deeper and wider. People from across the country and wider spectrum of socio-economic background are participating in the equity investing.

One glimpse of this democratization process could be seen from the average trade size on the stock exchanges. In mid 1990s the average trade size on NSE was in excess of Rs1,00,000. This fell below Rs20,000 by FY12. In FY21 it has increased to above Rs 33,000, (higher than the past five year average of Rs26,000), but has again declined to around Rs29000 in past couple of months.

In a market with total market cap of Rs250trn, where the delivery percentage is just 17% of the total value and number of share traded on daily basis, an average trade size of Rs29000 is a stronger indication of democratization of market than the number of trading & depository accounts opened or mutual fund portfolios created.



Will the markets witness a major sectoral rotation from 2HFY22?

 If we consider the sector wise performance since April 2020, there exists huge disparity between various sectors. While Metals and IT have remained massive outperformers; the consumer (FMCG & media) and PSU Banks have been lagging far behind. Auto, Services, Pharma, and Infrastructure have performed mostly in line with the benchmark Nifty.

Pharma and Infrastructure performance is little surprising as both the sectors had major catalysts in Covid19 and massive government spending on infra building to stimulate the sagging economy.

But what is most surprising is the lack of investors’ interest in PSU banks. Notwithstanding, numerous research upgrades of SBI; government beginning the process of disinvestment in couple of PSBs; improved profitability shown by all the PSBs in FY21; and a market heavyweight buying material stake into Canara Bank; and many private sector lenders faring much worse than their Public sector peers - PSU Banks have failed to impress the traders and investors alike. We may attribute this underperformance to a number of factors, e.g., huge losses suffered by investors who invested in these banks in past 4-5years; material equity dilution to bridge the capital inadequacy gap; uncertainty about how the Covid19 related stress will reflect in bank books etc.

Impact of Covid19 pandemic on consumers’ income and consumption behaviour might have impacted the sentiment towards the consumption sector. The displacement of a large number of workers due to pandemic may also have been a factor impacting the consumption. Notwithstanding the huge stimulus to support the household consumption, the consumption growth has been lower than the estimates. Of course expensive valuation due to outperformance of stocks in previous years may also be one of the factors.

 

The question now is – “Do we have enough catalysts present to cause a major sectoral rotation in the markets?”

Will a weaker USD, sharp outperformance, and expensive valuations result in traders and investors moderating their preference for IT sector?

Will supply augmentation due to easing logistic constraint, and demand tapering due to inexorbitant commodity prices, result in softening of commodity prices and therefore traders rotating out of metal stocks?

Will the well managed fiscal conditions, reasonable valuations, improved earnings and growth visibility and an earnest beginning to implement the National Asset Monetization Plan, spur interest in infrastructure sector?

We would know the answers to these questions in due course; nonetheless it is not a bad idea to be alert and keep a close watch