Vijay Kumar Gaba

 Expectation is a strange animal. More you beat it, the stronger it rises. Consistent underachievement is perhaps the only way to kill it.

The weather in the market has changed rather dramatically over the past two weeks. As we changed the calendars about four weeks ago, it was a partially clouded sky, but no one was forecasting a hailstorm, the markets are witnessing for the past 6 trading sessions. Seven odd percent fall in the benchmark Nifty is certainly not indicative of the damage that has been caused to equity investment portfolios, as the theater has been mostly outside the Nifty.

The sharp correction in equity prices is nothing unusual. In fact it has been a regular feature of the markets ever since the advent of public trading of corporate. However, in modern times this volatility assumes a wider socio-economic significance because the markets have become increasingly democratic. The access to the market is no longer confined to an elite section of the society. Investors in listed equities now come from all walks of life – young college students to old pensioners and top metros to the poorest districts of the country.

No surprise, the policy makers afford significant importance to the “markets” and markets also expect undivided attention from the policy makers like a possessive child. The markets begin to throw tantrums if they get any hint of likely coercive or disciplinary action from the policymakers.

Moreover, social media has not only made markets more sensitive to the flow of information; it has also made markets more susceptible to manipulation by vested interests. The market participants are often inundated with incoherent data from across the globe, invoking “fast finger first” type reactions from traders. Robotic traders, which account for a significant part of the market activities these days, often follow the herd and accelerate the prevailing trend.

As per the popular commentary, the market fall in the present instance is precipitated by the following “factors” and/or “fears”:

(a)   The US Federal Reserve (The Fed) is expected to end its bond buying program that was started in 2019, and begin hiking the policy rates from March onwards. It is expected that these Fed policy actions may result in higher bond yields and tighter liquidity leading to unwinding of USD carry trade. This shall lead to outflow of foreign funds from emerging markets that have benefitted from the deluge of liquidity created by central bankers of developed countries.

In this context, it is relevant to note that:

(i)    This move of the Fed is most anticipated since the past many months. The markets are known to act in much advance of these anticipated events and rarely wait till the last minute.

(ii)   The foreign investors have been net sellers in the Indian secondary markets for most of the current financial year. In fact, in the past 13months they have already sold Rs1.1trn worth of equities.

(iii)  The empirical evidence indicates that the Fed rate hike cycles usually lead to higher equity prices.

(iv)   Indian bond yields have already risen sharply over the past six months. Even if the Fed raises 50-75bps over 2022, the yield differential will still be attractive for the foreign investors.

(v)    In 2021, the last action of 17 central banks was a hike in rate, and none reduced. In spite of this, markets made all-time highs across the world.

(b)   There could be a Lehman like collapse or a dotcom like bust in the market.

The global central bankers have learned their lessons well from the global financial crisis. From the Greek sovereign crisis to Evergrande default, there is sufficient evidence to support their ability to mitigate the contagion impact of any major failure.

Insofar as the valuation bubble is concerned, we have already seen 50-70% correction in numerous inflated assets/stocks in the past three months, while global indices were recording new highs every day. The ability of markets to handle sectoral busts is certainly much better than the dotcom era of 2000.

(c)    Hyperinflation is upon us and financial assets will lose their value.

The global experts are still struggling to define whether the current episode of inflation is supply driven or demand pulled. The helicopter money that led to sudden spurt in demand has been largely exhausted. It is paradoxical to assume that no more helicopter money would lead to price erosion in the equity market but continue to fuel inflation in goods markets. The growth has already moderated world over and logistic constraints are not structural enough to last for years. Technology that has been the biggest deflationary force in the world continues to advance.

The traditional inflation hedges like gold have shown no sign of heating in demand. The German and Swiss benchmark yields are still negative and Japanese bonds are witnessing no bear attacks. The Chinese central bank has lowered rates.

(d)   There could be a full-fledged war between Russia and NATO allies.

Neither the conflict at Yatseniuk’s Wall (Russia and Ukraine border) is new; nor is the conflict in Middle East Asia new. The bogeyman of WDM (Weapons of Mass Destruction) in Iraq killed almost every chance of significant united NATO action two decades ago. Russia invaded and annexed Crimean peninsula from Ukraine in 2014. The US and Russian relations have shown no apparent signs of deterioration post that. The German Navy Commander recently revealed the German thoughts on potential Russia-Ukraine conflict.

(e)    The pandemic effects are unknown. The rising inequalities and poverty will plunge the world into chaos.

There is sufficient empirical evidence available to show that the rising inequalities have benefitted the larger companies and therefore stock markets. The world has been a chaotic place for at least the past 2 million years. In fact the past two decades perhaps have been the most peaceful period in the post Christ era.

(f)    The finance minister may impose new taxes in the budget to manage the resources for populist agenda of the government.

The Union Budget actually ceased to be an important event many years ago. Indirect taxes are mostly no longer part of the budget now. Direct taxes are mostly rationalized and have little scope for tinkering. Fiscal data is announced every month and it is easy to estimate the deficit and borrowing figures on a regular basis. Usually there are no negative surprises on this account in the budget.

This time particularly, the finance minister is in no position to cut tax rates and it can hardly afford to hike taxes. There could be some minor tinkering here and there, but nothing major should be expected. The fiscal deficit figure will account for Rs 1trn from LIC IPO, which is not certain. Obviously, assessing the accounting part of the budget may be difficult.

Obviously, the market behavior is not in congruence with the narrative. If the investors were truly fearful about the factors they are talking about, then they must have moved towards the shelter (defensive and deleveraged) from the cyclical. Whereas, in 2022 so far, IT, Pharma, FMCG have been the worst performing sectors and cyclical energy and financials which mostly face the brunt of tightening money cycle have performed the best.

In my view, the markets are fearful because (a) they are feeling guilty about the excessive greed shown towards internet and renewable energy; and (b) a large majority of investors lacking in conviction would have followed the pied pipers rather than making an informed decision about their investments, are falling in the ditch.

 The latest edition of the World Economic Forum’s global risk report (The Global Risk Report 2022) offers some valuable and interesting insights into the current global risk perceptions and areas of concern. The key message is that “A divergent economic recovery from the crisis created by the pandemic risks deepening global divisions at a time when societies and the international community urgently need to collaborate to check COVID-19, heal its scars and address compounding global risks.”

The clear and present global challenges include “Supply chain disruptions, inflation, debt, labour market gaps, protectionism and educational disparities are moving the world economy into choppy waters that both rapidly and slowly recovering countries alike will need to navigate to restore social cohesion, boost employment and thrive. These difficulties are impeding the visibility of emerging challenges, which include climate transition disorder, increased cyber vulnerabilities, greater barriers to international mobility, and crowding and competition in space”. To meet these challenges, the world needs trust and cooperation within and between countries, lest the world shall continue to drift apart.

Risk Perception of global managers

Results of the Global Risks Perception Survey, that underpins the report, highlight the following key sentiment indicators:

·         Most respondents see social risks in the form of “social cohesion erosion”, “livelihood crises” and “mental health deterioration” continue to worsen.

·         Frighteningly, “only 16% of respondents feel positive and optimistic about the outlook for the world, and just 11% believe the global recovery will accelerate. Most respondents instead expect the next three years to be characterized by either consistent volatility and multiple surprises or fractured trajectories that will separate relative winners and losers.”

·         The societal and environmental risks are seen as the most concerning for the next five years.

·         However, over a wider horizon of next 10 years, health of the planet dominates concerns;  with “climate action failure”, “extreme weather”, and “biodiversity loss” ranking as the top three most severe risks. “Debt crises” and “geoeconomic confrontations” are seen as among the most severe risks over next 10 years.

·         Technological risks—such as “digital inequality” and “cybersecurity failure”—are seen as the other critical short- and medium-term threats to the world.

·         About the present risk mitigation methods and techniques, the global risk managers believe that “the current state of risk mitigation efforts fall short of the challenge in areas like “Artificial intelligence”, “space exploitation”, “cross-border cyber-attacks and misinformation” and “migration and refugees”. The present risk mitigation efforts are seen as effective in facing the established risks such as “trade facilitation”, “international crime” and “weapons of mass destruction”.

Climate Action Failure – top most long term risk

The failure in addressing the climate concerns is perceived as “the number one long-term threat to the world and the risk with potentially the most severe impacts over the next decade. It is highlighted that the “Climate change is already manifesting rapidly in the form of droughts, fires, floods, resource scarcity and species loss, among other impacts. In 2020, multiple cities around the world experienced extreme temperatures not seen for years—such as a record high of 42.7°C in Madrid and a 72-year low of -19°C in Dallas, and regions like the Arctic Circle have averaged summer temperatures 10°C higher than in prior years.

It is evident that “Governments, businesses and societies are facing increasing pressure to thwart the worst consequences. Yet a disorderly climate transition characterized by divergent trajectories worldwide and across sectors will further drive apart countries and bifurcate societies, creating barriers to cooperation.”

Cyberthreats emerging as prominent risk

As per the Report, “in 2020, malware and ransomware attacks increased by 358% and 435% respectively—and are outpacing societies’ ability to effectively prevent or respond to them. Lower barriers to entry for Cyberthreats actors, more aggressive attack methods, a dearth of cybersecurity professionals and patchwork governance mechanisms are all aggravating the risk.”

It is anticipated that “attacks on large and strategic systems will carry cascading physical consequences across societies, while prevention will inevitably entail higher costs. Intangible risks—such as disinformation, fraud and lack of digital safety—will also impact public trust in digital systems. Greater cyberthreats will also hamper cooperation between states if governments continue to follow unilateral paths to control risks. As attacks become more severe and broadly impactful, already-sharp tensions between governments impacted by cybercrime and governments complicit in their commission will rise as cybersecurity becomes another wedge for divergence—rather than cooperation—among nation-states.”

“Involuntary migration” poses a potent risk

Economic hardships, climate change and political instability in many countries is forcing a lot of people to migrate to safer places involuntarily. At the same time, effects of pandemic and other factors are resulting in increased economic protectionism and restrictive labor markets, creating higher barriers to entry for migrants. “These higher barriers to migration, and their spill-over effect on remittances—a critical lifeline for some developing countries—risk precluding a potential pathway to restoring livelihoods, maintaining political stability and closing income and labour gaps.”

In the most extreme cases, humanitarian crises will worsen since vulnerable groups have no choice but to embark on more dangerous journeys.

It is noteworthy that “the United States faced over 11 million unfilled jobs in general and the European Union had a deficit of 400,000 drivers just in the trucking industry.”

Space could be new war zone

The report mentions that ‘New commercial satellite market entrants are disrupting incumbents’ traditional influence over the global space commons in delivering satellite services, notably internet-related communications. A greater number and range of actors operating in space could generate frictions if space exploration and exploitation are not responsibly managed. With limited and outdated global governance in place to regulate space alongside diverging national-level policies, risks are intensifying.”

“One consequence of accelerated space activity is a higher risk of collisions that could lead to a proliferation of space debris and impact the orbits that host infrastructure for key systems on Earth, damage valuable space equipment or spark international tensions.”

 ·         In a recently published paper International Renewable Energy Agency (IRENA) said that hydrogen could disrupt global trade and bilateral energy relations, reshaping the positioning of states with new hydrogen exporters and users emerging. IRENA sees hydrogen changing the geography of energy trade and regionalising energy relations, hinting at the emergence of new centres of geopolitical influence built on the production and use of hydrogen, as traditional oil and gas trade declines. IRENA estimates hydrogen to cover up to 12 per cent of global energy use by 2050.

“Hydrogen could prove to be a missing link to a climate-safe energy future”, Francesco La Camera, Director-General of IRENA said. “Hydrogen is clearly riding on the renewable energy revolution with green hydrogen emerging as a game changer for achieving climate neutrality without compromising industrial growth and social development. But hydrogen is not a new oil. And the transition is not a fuel replacement but a shift to a new system with political, technical, environmental, and economic disruptions.” (See here)

·         On 15 August 2021, Prime Minister announced the launch of National Hydrogen Mission (NHM) with an objective to cut down carbon emissions and increase the use of renewable sources of energy. NHM aims to leverage the country’s landmass and low solar and wind tariffs to produce low-cost green hydrogen and ammonia for export to Japan, South Korea and Europe. It also aims to exploit immense possibilities for India to collaborate with the Gulf Cooperation Council (GCC) countries that have also invested significantly in developing hydrogen as a future source of energy.

·         A couple of months ago, Adani Group announced a mega plan to invest US$70bn in developing renewable sources of energy. The group chairman Gautam Adani, reportedly said, "By 2030, we expect to be the world's largest renewable energy company without any caveat - and we have committed USD 70 billion over the next decade to make this happen. There is no other company that has yet made so large a bet on developing its sustainability infrastructure”. He also claimed that “we are strongly positioned to produce the world’s least expensive hydrogen, which is expected to be an energy source plus feedstock for various industries that we intend to play in”. Reportedly, the Adnai Group is already the world’s largest solar power developer. (see here)

·         Last month, the largest infrastructure developer in India, Larsen and Toubro (L&T) announced that it is partnering with ReNew Power to develop and operate green hydrogen projects across India. The company expects green hydrogen demand in India for applications such as refineries, fertilisers and city gas grids to grow up to 2 million tonne per annum by 2030 in line with the nation’s green hydrogen mission. This would call for investments upward of $60 billion. (see here)

·         Earlier this month, Reliance Industry announced that it plans to invest ₹60,000 crore, to build an integrated solar photovoltaic module factory, an advanced energy storage giga factory and an electrolyser giga factory to manufacture modular electrolyzers used for captive production of green hydrogen for domestic use as well as for global sale.

·         China has been investing massively in hydrogen capacities over past five years, as it aims to achieve peak carbon by 2030 and zero net carbon by 2060. China automative industry has advanced enough to establish a hydrogen energy value chain  strengthening production of core components and materials for fuel cells, and scaling production to lower costs.

Several cities across China have released ambitious hydrogen energy blueprints recently.. Under the Accelerating the Development and Commercialization of Fuel Cell Vehicles in China program, seven Chinese cities have reportedly invested US$365 million over the past five years, far exceeding the initial budget of US$61.73 million. Sinopec has started building the world’s largest green hydrogen plant in the far Western region of Xinjiang. As per recent reports, Shanghai expects to have 10,000 hydrogen-powered cars on its roads in 2023, and the value of the city’s hydrogen car industry is expected to hit 100 billion yuan by 2023. Chinese experts believe, “It is impossible to use lithium-powered cells for heavy trucks above 49 tonne, so hydrogen fuel cells are the best alternative, and logistics-intensive ports across China are especially suitable for establishing diesel-to-hydrogen demonstration areas”.

From the above cited instances it is clear that Hydrogen is emerging as a preferred source of clean energy world over, in addition to the other renewable sources of energy like Solar and Wind. Green hydrogen, the hydrogen produced through the electrolysis process, is apparently a more viable and preferred fuel for larger motor vehicles and air transport as compared to the lithium battery cells powered through solar or thermal energy.

As per IRENA, “The technical potential for hydrogen production significantly exceeds estimated global demand. Countries most able to generate cheap renewable electricity will be best placed to produce competitive green hydrogen. While countries such as Chile, Morocco, and Namibia are net energy importers today, they are set to emerge as green hydrogen exporters.” It is expected that by 2030 green hydrogen would cost-compete with fossil-fuel hydrogen globally.

Growth of the hydrogen economy will translate into exponential growth in key equipment, component and chemical suppliers. This will also result in some moderation in present estimates for battery cell powered vehicles.

Investors may therefore beware of investing in a technology or practice that is transient in nature. I would though continue to prefer “sustainable growth” as a whole, as an investment theme rather than focusing on one or two enablers like clean energy.

In 10 years, geopolitical and global trade reorganization would be a much bigger investment theme than solar power plants and lithium batteries, in my view.

 Struggle with nature has been an integral part of the evolution of homo sapiens. The Man has not only braved the inclement natural conditions for a million year, but also emerged victorious under most circumstances. They have crossed oceans; scaled mountain peaks; tamed raging rivers; built oases in deserts; braved extreme cold at the poles and extreme heat at the equator; and still survived and continue to evolve.

Cockroaches are an insect group that is believed to have originated 300-350 million years ago. They have shown extreme tolerance for a variety of climate – from arctic cold to tropical heat, and thrived.

The common saying is that only the human race and cockroaches may manage to survive an Armageddon due to their adaptability and strong survival instincts.

Many young investors may not have heard the term “peak oil”. This term was popular till the global financial crisis in the later part of the first decade of this century. The term was essentially used to denote that crude oil supply will soon peak out to catastrophic consequences for the global economy; which relies heavily on fossil fuels for their energy requirement. The term has however become redundant in the past one decade. Most producers have cut the production of fossil fuels in the past few years, as most economies have started to move away from fossil fuels towards cleaner sources of energy. The factors like demographic changes in developed countries and technological advancements may also have contributed to lower fuel consumption.

I clearly remember discussing this with a group of investors in mid-2008. This was the time when top global brokerages were aggressively selling the theme of hyperinflation. Brent crude was trading at US$130/bbl and Arjun N. Murthi, an analyst at Goldman Sachs, had just created a sensation by forecasting the crude oil prices to top US$200/bbl in the not so distant future. Fortunately, most of the assumptions made by Mr. Murti did not materialize and a few months later, in December 2008, the research team at Goldman Sachs cut their 2009 crude price target to US$45/bbl. (Actually, oil prices peaked in July 2008 at US$148 and fell to US$37/bbl by end of 2008).

In mid-2008 when oil prices had crossed US$125/bbl for the first time, the Indian economy was struggling with the mounting oil subsidies, impact of global financial crisis and rise in bad loans at banks. The group of investors I was interacting with was unanimous in their view that oil will be the nemesis of the Indian economy in particular and global economy in general. “Peak Oil” was the Bogeyman scaring them. I narrated this small bit of history of Man and Cockroaches to the group. My point was, if we are not worried about the pile of Nuclear weapons with hostile neighbours like Pakistan and China, why should we be worried about “Peak Oil”. The human race which has never accepted defeat from nature, how would it lose to dirty fuel! My view was that the world will find an alternative much sooner than what most people might be expecting presently.

No surprises that less than 15 years later, no one even hears the term “peak oil” any more. Non-fossil sources are already beginning to dominate the energy landscape of many developed economies. Many large emerging economies are targeting to become carbon neutral in the next 25-30 years.

I considered narrating this instance at this point in time to draw attention towards the euphoria building in Electric Vehicle space. The prices of Lithium, carbon, rare earths used in Lithium batteries, stock prices of EV makers/potential makers and their ancillaries/potential ancillaries have seen sharp rise in the last one year.

I fail to understand how transition to electric mobility will increase the sale of cars. For how many customers, the only criteria for buying a car is the fuel cost; because this is the only potential increment to the customer base.

Assume lower fuel cost adds 20% to the existing customer base. A car manufacturer which sells 10000 conventional fuel cars a year, other things remaining the same, it may potentially sell 12000 cars 10years later if we transition completely to electric mobility. As of now it is not clear, but if we assume 20% higher manufacturing margins for electric cars, this would mean 40% higher profit after 10 years. ROCE may not rise as much due to incremental capex required for the complete transition.

This sounds like a great proposition for the OEM as well as ancillaries. But what if technology changes in 10 years? Hydrogen cells become more viable and popular and battery cell fuelled vehicles meet the fate of Nano. Multiple experts have already mentioned that Lithium based batteries may not work for truckswith over 50tonne capacity.

I would consider that transition to electric vehicle manufacturing is a survival endeavour for most of the OEMs, rather than a more profitable diversification. It is the same as your local Kirana store owner putting up a computer in his shop for accounting and billing. Insofar as gains are concerned, this would be a transformative transition, the gains of which will accrue to the entire economy, not only the auto sector. For example, saving on fuel cost may boost spending on health and entertainment.

Some more thoughts on the new disruptor ‘ Green Hydrogen” tomorrow.

 If we consider the returns given by various global equity indices in the past one year period, the MSCI Czech Republic Index tops the chart with 45% return. MSCI Turkey with ~34% return and MSCI Argentina with ~31% return share the podium with Czechs. In the past five years—

·         The Czech economy has grown at less than 5% CAGR; inflation has averaged ~3%; interest rates have risen from near zero in 2017 to 3.75% presently. Youth unemployment rate has ranged between 5% to 12%.

·         The Turkish economy has also grown at less than 5% CAGR; inflation has ranged between 10% (2016-17) to 36% (present); interest rates are ~16%; and unemployment rate is above 11%. Turkey has witnessed violence, political instability, and Lira collapse.

·         The Argentina economy has hardly grown in the past five years. The inflation rate has ranged between 15% to 60% (presently 50%). Interest rates have ranged between 25% to 85% (presently 40%). Financial and political stability of Argentina has been under severe stress. The Peso collapsed.

(In comparison, MSCI India Index has been the fifth best index with ~29% return. Indian economy has grown above 5% CAGR; inflation has averaged below 6% and interest rates are around 4%.)

Prima facie, this selective set of indicators would imply that the stock market performance is mostly alienated from the economic, social and economic realities, at least in the short period of one to two years.

Someone can argue that the outperformance of Turkish and Argentinian equities must be seen in the light of past underperformance and hopes of recovery in near future.

To that my answer would be – (a) MSCI Turkey Index has been amongst the top 10 performing global indices in past 3years; and (b) if hope is one of the primary criteria for investing in equities, regardless of the prevailing hopeless condition, then perhaps the whole discipline of equity research and analysis may be redundant. Investors should buy assets that have suffered from hopelessness in the recent past. This strategy has worked very well, for example, in the case of Greek, Italian, Portuguese and Spanish equities & debt post global financial crisis.

This implies that the key to make money in financial markets lies in “hopelessness” and not in “hope”. Perhaps that is what drives investors to buy stocks of hopeless companies like DHFL, JP Infratech, BILT, Sintex etc. However, the investors bothering about non-events like union budget and state elections and reacting in the hope of a “lottery” outcome and markets staging a pre-budget rally complicates the narrative.

Regardless, I do not prefer to hinge my investment strategy on hope alone. I would like to explore if there is some method in equity outperformance in the present period of socio-economic distress; and whether the asset prices in general are actually reflecting the ground realities.

I would in particularly like to test the following hypotheses:

(a)   Are the rising inequalities world over resulting in larger businesses growing faster at the expense of smaller and unorganized businesses?

If this is true, in Indian context it may mean 1000 odd listed companies gaining market share at the expense of lacs of micro and small enterprises. So greater the stress in MSME, better it may be for the larger listed entities and therefore for stock markets.

(b)   Are citizens losing faith in state controlled assets like currencies and public debt?

This may reflect in less preference for cash and treasuries and rising preference for unregulated assets like private equity, cryptocurrencies, NFTs, private realty, corporate debt etc.

(c)    Is equity becoming the most preferred inflation hedge with household investors?

Does this explain the underperformance of Gold, a traditional inflation hedge?

(d)   The past decade has seen two phenomena – (a) a sustained rally in equity prices and (b) remarkable rise in the role of technology in business.

Does this mean the new average jobs now require high skills, leaving very low paying jobs for average skilled or poorly skilled workers, pushing the youth in 20s and thirties who have seen only a bull market in equities towards “lucrative” business of equity trading that is commonly assumed to require low skills?

I would love to hear the views of readers on these propositions. I shall be sharing the result of my exploration in due course.

As per the latest reported data (7 January 2022), RBI was holding a total of US$632.7bn in non INR assets. This includes US$569.3bn foreign currencies, US$39bn gold, US$19.1bn SDRs and US$5.2 reserve position in the IMF.

Considering our emotional attachment to gold, I would like to categorize it as emergency reserve only. So effectively, RBI has US$569.3bn worth of foreign currency to meet the regular demand.

Considering an expected trade deficit of US$200-220bn for FY23, we appear adequately covered for monetary tightening by global central bankers and consequent unwind of USD carry trade potentially leading to FPI outflows.

Assuming, that the global central bank monetary tightening is able to reign the runaway inflation, and India inflation remains at midpoint of RBI target range, we may end up with 2-2.5% INR depreciation for the year, implying end FY23 exchange rate (INR/USD) of 75 to 75.5; of course, not a matter of much concern.

Some recent news headlines have drawn attention to the impending redemption of US$256bn foreign debt in 2022 (see here). This is ~44% of the total last reported US$596bn external debt (September 2021). Some reports have presented the situation as challenging, given the tightening monetary conditions overseas.

Some analysts have drawn attention to the fact that the pace of forex reserve accretion has slowed down in 2021. RBI added US$124bn to its kitty in 2020, while 2021 addition was only US$48bn. Material outflows on account of net negative FPI flows resulting in larger than presently anticipated current account deficit could potentially result in a mini crisis; though not to the tune of what we saw in 2013.

In this context the following points are noteworthy:

(a)   Private commercial borrowings (ECBs) are largest component of this debt with ~37% share; followed by NRI deposits ~25% and short term trade credit (~17%).

(b)   Only about 52% of India’s external debt is denominated in USD. Over ~33 is actually INR denominated debt. Rest is ~6% (JPY); ~3.5% EUR) and ~4.5% (SDR).

(c)    Non-Financial companies owe ~41% of India’s foreign debt. This includes top private and public sector corporations. Deposit taking lenders owe ~28%; government ~19% and other financial corporations owe ~8%. About 5% is intercompany lending.

(d)   Of the total debt due for repayment in 2022, about 40% is owed by deposit taking lenders (Banks and NBFCs). Most of this is long term debt maturing in 2022. Obviously, these borrowers would have made adequate arrangements to repay/renew this debt. About 50% is owed by other corporations and mostly comprises of short term trade credit that mostly keeps on renewing automatically.  (See details here)

I would also like to draw attention towards the following recent headlines:

Ø  RIL raises US$4bn in 10 to 40yr debt at coupon rate ranging between 2.8% to 3.8%. The offering was oversubscribed 3 times. Out of this US$1.2bn will be used to repay the debt becoming due for repayment in 2022. (see here)

Ø  Including RIL, a total of US$6bn debt has been raised in first two weeks of January alone. Corporations like SBI, JSW Infra, Shriram Transport Finance, India Clean Energy etc. have been able to reduce their borrowing cost by 30-35bps in these renewals. (see here)

Ø  The global arm of UPL Limited has raised US$700m to repay its older debt at 35bps lower cost. The proceeds of the loans will be used to repay part of the debt it had raised to fund the $4.2-billion acquisition of Arysta Life Sciences in 2019. The company has redeemed US$410m debt recently and plans to repay more in 4QFY22. (see here)

Obviously, raising money overseas may not be a challenge for corporate India. Reduction or complete elimination of QE money may not be a significant credit or currency event for Indian economy in 2022. Insofar as the lower addition to new forex reserve by RBI in 2021 is concerned, it may be due to change in RBI stance toward liquidity (buying USD from market involves increasing INR liquidity). Net FPI outflows were not much as secondary market selling was mostly offset by primary market buying.

The real potential challenge for Indian Economy and INR could come from the following:

1.    The Central Bankers fail in reining the inflation despite monetary tightening, as the inflation presently is mostly a supply driven phenomenon. India’s crude cost import cost crossing US$100/bn could put a serious pressure on current account.

2.    Persistent erratic weathers across the globe could further deteriorate the food supply situation leading to further rise in global food prices.

3.    A major geopolitical even could cause temporary supply restriction further worsening the present logjam at major ports hampering exports and exacerbating supply challenges.

4.    Outbound FDI outpacing the incoming FDI, as more Indian businesses look to establish local presence in foreign jurisdiction to counter hyper nationalism or continued mobility restrictions.

In the first few trading sessions of the calendar year 2022, the benchmark Nifty has gained close to 5%. This rather sharp up move has surprised many market participants, considering that macro conditions have deteriorated in the past two weeks. The inflation has increased. The global energy prices have risen sharply. The US Fed commentary has become particularly hawkish. The NSO has moderated the GDP growth estimates, forecasting it to be lower than the recent RBI estimates. The RBI has announced OMOs aimed at draining more liquidity from the market. The Corona cases have grown exponentially in the past two weeks, leading to stricter mobility restrictions. The latest IIP data has pointed to deceleration in economic growth momentum. Politically also, the ruling BJP may have lost some popularity points in the five states going to election from next month.

This less expected strong performance of the markets has evoked mixed reactions from the market participants.

One section of the market participants has grown extra cautious, fearing that this strong start to the year may fizzle out soon as the economic realities begin to hit harder and investors caught at higher levels may have to bear greater pain.  

The other section finds the strong start to the year a good omen for the rest of the year. The experts in this section believe that strong domestic flows will continue to drive the markets in 2022. They feel that the global markets shall adjust to the new monetary policy in the next couple of months and USD may begin to flow towards emerging markets like India.

Yet another section believes that the Indian markets may spend most of the year 2022 consolidating their position, moving in a broader range. It is felt that presently we may be at the midpoint of the range and hence the market offers a balanced risk reward equation at this point in time.

Personally, I am not a fan of market level forecasting and like to work on individual business where I would like to invest my money. Trading in equity markets is a highly specialized skill that requires strong technical skills, understanding of short term business cycles, high risk appetite, and good liquidity position. Incidentally, I possess none of these prerequisites to the successful trading enterprise.

Regardless, to satisfy my curiosity I did some star gazing, and noticed the following trends that may interest the short term market traders.

1.    In the past 10 years (2012 to 2021) Nifty has given a positive return in 9 years. Only in 2015 Nifty yielded a negative return of -4.1%. The annual positive return has ranged between 3% (2016) to 28.6% (2017).

2.    In 7 out of the past ten years, the sum of the returns in the best 3 months was higher than the annual Nifty returns. This implies that in these 7 years, the sum of returns in the rest 9 months was negative.

3.    January has appeared 4 times in the best three months of the year. Two of these years (2012 and 2017) were amongst the best 3 years of the decade. However, the other two years (2015 and 2018) were amongst the worst 3 years of the decade.

4     February and August have appeared only once in the best 3 months of the year (2021). This was one of the best 4 years of the decade.

5.    Whenever January has appeared in the list of best 3 months of the year, February and March were not in that list.

6.    July has appeared 4 times in the list of 3 best months. On three of these four occasions (2015, 2016, 2018), Nifty peaked in July and August and the annual returns were lowest in the decade, ranging between -4.1% to 3%.

If the current rally sustains for the month of January and the past is any guide to the future, then there are 75% chances that the year 2022 may yield a low single digit return and the months of February and March may not be great months in terms of stock returns.

Do you believe in this data jugglery? Well I do not. The basic idea of sharing this statistics is to show that it means literally nothing.

 Chart for the day

Thought for the day

“The only thing that interferes with my learning is my education.”

—Albert Einstein (German Physicist, 1879-1955)

Word for the day

Corvine (adj)

Pertaining to or resembling a crow.

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The Publisher of this note do not offer any portfolio management, brokerage, money management, equity research or investment advisory services of any kind. Please take advise of a qualified and registered investment advisor before taking any investment decision.

Material from these reports may be copied freely, without any need for permission from the Publishers. This is however subject to copyright consideration of the contents of third parties.

Please refer to the attached PDF for full report important disclosures.

 

 

 Wishing all readers on the auspicious occasion of Lohri, Makar Sankranti, Maghi, Poush Sankranti, Pongal, Surya Uttarayan, Bhogi, Tusu, Bihu, Pedda Panduga and much more. 

May this auspicious transition of Sun God may empower the universe with divine energy and light and protect humanity from all demonic forces.

Happy Earning Season

Technically the quarterly result season starts from first day of every calendar quarter. However, the formal festivities begin with the IT Services major announcing their quarterly performance 10-13 days later. This season, perhaps for the first time in history, the top three IT service players chose to kick start the festivities together on 12^th January. Obviously it was an auspicious start to what is popularly anticipated to be an extremely fruitful earnings season.

Near consensus on corporate performance

There is near consensus on corporate performance during 3QFY22 in particular and FY22 as a whole in general. Post 2QFY22 a majority of brokerages have upgraded their earnings estimates for Nifty for FY22 and FY23.

Sector wise also, there is near unanimity on (a) continuing strong earnings momentum in IT Services and chemical sectors; (b) compression of spreads and decline in profitability for metal companies; (c) strong growth in BFSI segment with further improvement in asset quality and NIMs; (d) sequential improvement in auto numbers even though overall performance may be weak; (e) lackluster performance of pharma and consumer staples and (f) sequential improvement in consumer discretionary.

The following excerpts from brokerage commentary on quarterly performance are noteworthy:

Nifty PAT to grow 20% yoy (Kotak Institutional Equities)

We expect net profits of the Nifty-50 Index to increase 20% yoy and 3% qoq; and estimate EPS of the Nifty-50 Index at Rs726 for FY2022 and Rs844 for FY2023.

Sector wise - (1) banks (steady sequential decline in slippages, lower provisions, better performance of large banks), (2) metals and mining (higher realizations and volumes on a yoy basis, but weaker sequentially), (3) oil, gas and consumable fuels (higher qoq and yoy realizations for upstream companies, improved marketing and refining margins for downstream companies sequentially) and (4) retailing (strong volume growth led by increase in footfall and operating leverage-led margin expansion).

Expect decline in the net income of (1) automobiles (production issues, RM headwinds) and (2) construction materials (weak demand environment, higher fuel and power costs) sectors.

Earnings strong but breadth weak (MOFSL)

After two strong quarters of earnings growth, we expect MOFSL Universe to register another healthy quarter of 22% YoY growth in 3QFY22 on a high base of 33% YoY growth in 3QFY21. While the aggregate growth is impressive, it is narrow and driven by just four sectors – Metals, BFSI, O&G and IT. Two-thirds of the incremental growth is steered by Metals and Oil & Gas (O&G) sectors, with the Financials sector driving the remainder. However, the breadth of earnings remains weak with 42% of companies likely to post YoY decline in earnings while 38% are expected to post>15% earnings growth. The key 3QFY22 drivers are: a) Metals – likely to post 60% YoY profit growth and contribute 35%/35% to incremental MOFSL/Nifty earnings growth for 3Q, respectively; b) O&G – high Brent crude prices and demand led to higher GRM’s and volumes for OMCs; c) BFSI – higher loan growth due to improved economic activity and lower slippages leading to asset quality improvement and d) IT – strong demand backed by multi-year growth tailwinds on Cloud migration to drive topline growth. The key inhibitor is Autos – likely to drag down the earnings aggregate as it is impacted by semiconductor shortages for PVs amid demand concerns for 2W and tractors.

Nifty FY22E EPS has seen an upgrade of 2% to INR743 (v/s INR730), while Nifty FY23E EPS has remained almost unchanged at INR872 (v/s INR873). We introduce FY24E earnings and estimate Nifty FY24 EPS to be at INR993.

IT Services – growth to defy seasonality and remain strong (MOFSL)

The strong demand environment is expected to continue in 3QFY22, with Tier II players again outgrowing Tier I companies within our coverage universe.

Despite adverse seasonality, Tier I companies should deliver revenue growth in the 3.2-4.8% QoQ CC range, while Tier II players will have a wider band of 3.6- 7.1% (excluding PSYS, which will benefit from inorganic growth).

We expect a strong initial outlook for FY23E, with companies maintaining their view of multi-year growth tailwinds on the back of Cloud migration. Guidance for 4QFY22 is also expected to be positive on the back of continuing deal wins.

We see margins for most companies (excluding company-specific factors) to be in a narrow range as supply pressures (attrition and hiring) are offset by operating leverage. Among Tier I players, EBIT margin will be in a tight (-20bp to +40bp QoQ) range, although they will see a steep decline v/s 3QFY21 profitability.

Critical quarter for BFSI sector (Axis Securities)

The Banking sector will continue to deliver growth driven by a growth in the retail segment. Moreover, asset quality is expected to remain under control and challenges should further moderate on a QoQ basis. NIMs are likely to remain stable and might even see marginal improvement on a sequential basis. Moving forward, key focus areas will be growth prospects and fueling the corporate segment which is currently seeing some sluggishness. We will watch the top four banks very closely for growth guidance. The smaller banks are expected to continue focusing on maintaining asset quality in light of significant deterioration seen during the last one year. NBFCs will also be closely watched for asset quality. At this juncture, we

believe Q3FY22 will be similar to Q2FY22 for NBFCs and funding costs will remain manageable. Overall, earnings prospects should improve for the BFSI sector during the quarter and management commentary on growth would be a key monitorable.

Cement – demand recovery and softening costs (Emkay Equity Research)

Industry EBITDA/ton declined 11% YoY in Q3CY21 and remained under pressure in Q4CY21 due to input cost inflation and soft demand. However, cost inflation should ease off from early CY22E with a softening in input prices (down 15-40% from recent peaks). After a ~50% increase in the past two years, industry EBITDA/ton is expected to remain flat in CY21 but is likely to increase by 4-5% in CY22E.

Expect demand to likely grow by 8-9% YoY in CY22E (vs. 6-7% long-term historical average), driven by higher infra spending, pick-up in the housing segment and revival in urban real estate activity. The South and West regions should see 8-9% growth on a low base, while the North regions may clock 6-7% growth. While demand has been impacted in the past few months by heavy rainfall, construction bans in North, sand mining issues in East and limited labor availability, it should pick up in the coming months with the onset of a busy construction season and easing inflation in construction costs.

Maintain our positive view on the sector based on robust earnings compounding and a structural RoIC reset, with medium-term demand growth visibility and calibrated supply additions.

Speciality Chemicals – strong underlying trend

Estimate our chemical coverage universe revenue to grow at 42% YoY (7% QoQ) during Q3FY22 on sharp rise in prices due to input cost inflation. However, gross profit is also expected to grow 29% YoY which indicates strong underlying trend.

Steel – Margins to normalize (Prabhudas Liladhar)

Expect EBITDA of steel companies under our coverage universe to fall sharply by 19% QoQ due to lower volumes and contraction in margins. Sales volume is expected to contract by 6.5% QoQ due to subdued domestic demand. Steel realisations would increase by 2.5% QoQ/Rs1,500/t, falling short of expected rise of 10% QoQ/Rs4,500/t in costs on account of higher coking coal cost. Owing to higher costs partially offset by increase in realisations, EBITDA margins would fall by 14% QoQ/Rs3,130 to Rs19,880.

Chinese steel demand is estimated to fall by 4.7% YoY in CY21e at ~955mnt due to weakness in housing and auto sector, compounded with little support from Govt’s spending.

Margins came off sharply QoQ in Q3FY22e due to 2x increase in coking coal cost and soft realisations coupled with weak demand in both domestic and exports market. Factoring US$50 drop in steel prices offset by US$15/t lower coking coal prices, we expect EBITDA/t to stabilise at normalised level of Rs15,000/20,000 for non-integrated/integrated producers in Q4FY22e. Even after the fall, normalized margins are 33% higher over the historical average.

Capital Goods – Mixed bag (IIFL Securities)

While short-cycle industrials continue to lead with healthy growth, the pace of rebound in the long-cycle portfolio has remained soft in 3QFY22, partially marred by headwinds in construction activities and by inflation. Recovery in government ordering has been muted, resulting in bunch-up for 4QFY22, with likelihood of slippages; yet, overall inflows have increased QoQ. Investment sentiment across private & infra projects remains positive and will not be deterred by Covid 3.0.

Inflationary headwinds and resultant delay in order finalisation from the govt. sector persisted in 3QFY22 too, adding risks of order slippages to 1HFY23. Ordering in Defence, Metro, O&G pipelines and the water segment was better, while remaining muted in rail, road and T&D. Private-sector ordering in both, short-cycle as well as projects in B&F, FGDs, WHR, data centres and manufacturing sectors, continued to show an uptick.

Real Estate – affordability remains high, demand robust (HDFC Securities)

3QFY22 seems to be promising for the Tier 1 developers. Despite an inauspicious period, holiday season toward Dec-21 second half and emergence of Omicron, 3QFY22 presales remained healthy. Whilst Jan-22 second half was expected to be launch heavy, we believe that Omicron driven COVID-19 wave three will push back the launches towards end of Q4FY22.

Our recent channel checks with leading real estate channel partners suggest that demand momentum remains strong and Tier 1 developers continue to gain market share. Affordability driven demand, rising income levels and near low mortgage rates are some of the factors contributing to the sales. Whilst globally interest rates are expected to harden, a 25-50bps increase may not result in demand destruction. Developers remain accommodative on pricing as most of them are holding historical land bank besides commodities prices are off highs. Whilst we expect property prices to re-rate it may be on the back of more sustained economic recovery and positive sentiments on consumption.

We expect the aggregate revenue/EBITDA/PAT for the coverage universe to grow sequentially by 2/2/5%. The impact of commodities’ prices will smoothen over the project completion period as companies will take the hit once projects complete. Overall, taking price hikes may derail recovery and developers may not go ahead with the same.

Auto – Weak due to demand and raw material headwinds (Nirmal Bang Equities)

We expect 3QFY22 earnings of Auto & Auto Ancillary companies in our coverage universe to be relatively subdued due to sustained input cost headwinds and muted demand (weak festivals, supply chain constraints and moderating rural growth). We anticipate gross margin contraction of 10-40bps on a QoQ basis due to continued RM cost pressures. However, with major commodities showing signs of stabilizing/moderating prices at current levels, we note that further impact on gross margins could be limited. EBITDA margins should witness softer trends on YoY basis, but will be partially supported on a QoQ basis by positive operating leverage, price hikes and tight cost controls across most companies. We surmise that current issues of supply chain constraints and rising covid cases are dynamic, but we see them leading to subdued demand and weak profitability in 4QFY22 too. For 2Ws, narration on demand revival and electrification transition efforts would be a key monitorable while a sustained demand recovery in 4QFY22 is critical for CVs.

Chart for the day

 

Thought for the day

“Common sense is the collection of prejudices acquired by age eighteen.”

—Albert Einstein (German Physicist, 1879-1955)

Word for the day

Skookum (adj)

Large; powerful; impressive.

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The Publisher of this note do not offer any portfolio management, brokerage, money management, equity research or investment advisory services of any kind. Please take advise of a qualified and registered investment advisor before taking any investment decision.

Material from these reports may be copied freely, without any need for permission from the Publishers. This is however subject to copyright consideration of the contents of third parties.

Please refer to the attached PDF for full report important disclosures.