Do it yourself: Maharashtra

Wednesday, November 27, 2024

Hold on to your horses, for now

The benchmark Nifty50 has rallied over 3% in the past three trading sessions. This rise in Nifty50 has come after a fall of ~11% in the preceding eight weeks. Most market participants have attributed this rally to the assembly election results of Maharashtra. The incumbent alliance (Mahayuti) has registered a sweeping victory, with BJP winning ~90% of the seats it contested.

The popular narrative is that the overwhelming victory in the Maharashtra election would strengthen the Prime Minister led union government and reinvigorate the development agenda, especially the infrastructure capex. I find this narrative counterintuitive and mostly speculative. There is absolutely no substantive evidence to support these assumptions. To the contrary, there are some indications of slowdown in infra capex in FY26, as fiscal consolidation gets higher priority. In this context, I take note of the following:

· Mahayuti alliance was running a stable majority government in the state of Maharashtra for the past three years. Many key infrastructure projects like coastal road, metro rail, Sewri-Panvel link bridge (Atal Setu) etc. have been completed in these three years. Nifty50 made an all time high of 26216 in September 2024, when the opinion polls were indicating a loss or thin majority for the incumbent government. These election results change absolutely nothing (except perhaps the Chief Minister).

· In the 1HFY25, the government capex has contracted 15.4% yoy, against a target of 17% increase. There are indications that the overall FY25 capex may fall short of the FY25 budget target of Rs11 trilion. It is estimated that the government may not provide a material hike in capex budget for FY26, as in a volatile global environment, it may prioritize fiscal consolidation over capex. (see here)

· Reportedly, a lot of government contractors are facing delays in payments from the state and central government. This is adversely affecting their working capital cycle operating cash flows. Elections are cited as one of the primary reasons for these delays, however anecdotal evidence indicates that there may be a trend in delayed payments. Favoring infrastructure builders facing delayed payments (affecting execution) and slowing order flows might not be a great investment strategy, in my view. (also see here)

· The primary reason for the ~11% correction in Nifty50 was the declining earnings growth trajectory. Maharashtra election result, or any other datapoint that emerged in the past one week, do not change anything about the earnings prospects of the Indian companies. There are indications that RBI may continue in pause mode; pollution related restriction may impact demand in NCR region; consumption recovery may be back-ended in FY26; and new tax code may not offer any material relief to the individual taxpayers. It would therefore be prudent to wait for another 3-4 months before jumping into the markets.

Trivia: International gold prices have corrected ~3% in the past one month. Some recent reports (see here) suggest that “Israel nearing a ceasefire with Hezbollah, coupled with Trump's nomination of Scott Bessent as the U.S. Treasury Secretary soured the precious metal's safe-haven appeal. If you are also one of the investors who allocated 10% to gold in view of the rising geopolitical threat or Trump related uncertainties, you need to seriously review your investment strategy. Protecting 10% portfolio from war or eccentricities, while keeping 90% fully exposed to it, may not be a great strategy, after all.

Wednesday, December 4, 2019

Derisking political risk

The first thing what the incumbent Chief Minister of Andhra Pradesh did after assuming charge of office was to order cancellation of many projects awarded by the preceding government (see here). The Andhra Pradesh Government also decided to reopen power purchase agreements (PPAs) inked under the previous TDP government, that could potentially bring 5.2GW solar and wind energy projects with an estimated debt exposure of over INR21,000cr under stress (see here). The state moved ahead with this proposal despite strong request from central government (see here) and order of the High Court (see here).

Subsequently, the World Bank decided to "drop" funding of “Amaravati Sustainable Infrastructure and Institutional Development Project”, seriously affecting the future of the project which has already swallowed Rs 45,000 crore worth of public money with less than twenty per cent of the work completed. (See here) Following the World Bank, the Asian Infrastructure Investment Bank (AIIB) also decided to withdraw from funding the project. The multi lateral agencies took the decision to withdraw funding after the Central Government withdrew its request for funding of this project. Last month, the state government finally decided to abandon the project leading to severe financial loses to many contractors and the state exchequer.

If a number of small and medium contractors are to be believed, the Chief Minister Office has also ordered a hold on payments due to them for various projects under execution, and some even fully executed, pending investigation of any irregularity in awarding of contracts by the preceding government.

The incumbent Chief Minister of Karnataka had also expressed his intention to review the decisions taken by the preceding government, jeopardizing financial interests of numerous contractors and vendors.

Reportedly, the new government in Maharashtra is also treading on the same path. They have already ordered suspension of the Metro rail shed project for which most of the ground work has already been done. Apparently, Chief Minister Uddhav Thackeray has told media that he has ordered a review of all on-going development projects in the state, including the Mumbai-Ahmedabad bullet train. Interestingly, in this case the party of the incumbent Chief Minister was also part of the outgoing government.

This practice of cancelling or suspending ongoing projects and harassing the contractors & vendors is certainly not a good sign for the economy. On one hand, this shall dissuade many small and medium sized vendors from participating in the government business; while on the other hand it shall cause totally avoidable delay in execution of projects, in many cases impacting the viability of the project itself.

I think there is an urgent need to rework the standard government contracts to provide for protection to the contractors and suppliers against any such review, suspension, cancellation etc. unless the charges of corruption in award of the contract are conclusively proved in a court of law.

In my view, a better solution for de-risking the projects from political risk would be to create a middle layer that cushions all the third party contractors and vendors from political changes. All the state governments and the central government may be required to form a specialized project executing company. Once the government finalizes the project after obtaining all the approvals etc, the government should award the project to this company through an irrevocable contract and transfer necessary funds to it in the form of cash and marketable government securities. This company in turn should sub-contract it to the third parties. The intermediary company should be responsible for making timely payments to the contractors and suppliers, and ensuring timely execution of the projects.