Vijay Kumar Gaba

As I mentioned yesterday (see here), the current conditions are very different from the conditions in the 1980s when the US Federal Reserve under the chairmanship of Paul Volcker, managed to kill inflation with a deeper recession, but without pushing the world into an economic depression. But this does not imply that we have nothing to learn from history.

May 2021 Bulletin of the Reserve Bank of India, carries some useful insights about the performance of NBFCs during the pandemic. Being a critical source of consumer and MSME finance, performance of NBFCs is usually a broad indicator of the consumption demand, and consumer and business sentiments.

The key highlights of the NBFCs performance, especially during 2H2020, are noted as follows:

·         Pandemic has hit NBFCs hard. “The impact of the pandemic can be seen on both asset quality and liquidity, although the latter was addressed to a considerable extent through timely policy measures.”

·         An unfavourable mix of COVID-19, sell-offs in financial markets and the abrupt winding-up of specific schemes by a mutual fund contributed to NBFCs facing record spike in yields on their debt in Q1: 2020-21. The sharp market differentiation continued between the highly rated and other NBFCs, notwithstanding the surplus liquidity and aggressive policy rate cuts.

·         Retail participation in the NBFC debenture issuances, notwithstanding their small share in overall subscription, witnessed an upswing since June 2020, whereas Mutual funds reduced their exposure to NBFC CPs between March and September 2020 However, Q3:2020-21 witnessed a renewed interest of mutual funds in NBFC CPs. Banks’ subscription of CPs has also increased at a steady pace after Q1:2020-21.

·         The number of deposit-taking NBFCs (NBFCs-D) has gradually diminished and currently stands at 64, of which six have been prohibited by the RBI from accepting further deposits.

·         The consolidated balance sheet of NBFCs registered a Y-o-Y growth of 13.0 per cent and 11.6 per cent in Q2 and Q3:2020-21, respectively. “This double-digit growth in an adverse macroeconomic environment points to the resilience of NBFCs, which were able to cushion the impact of the pandemic on their balance sheets through quick adoption of technology, policy support and reasonably strong fundamentals.”

·         NBFCs continued to preserve cash to ensure adequate liquidity in view of the prevailing uncertainty due to the pandemic.

·         Due to risk aversion and market pessimism post-IL&FS, the share of market borrowings (debentures and CPs) in the total borrowing had fallen and correspondingly the share of bank borrowings had risen. NBFCs also moved towards longer term borrowings in tune with the tenure of their assets to manage their asset-liability mismatch.

·         In Q2 and Q3:2020-21 market conditions had eased, as indicated by the pick-up in market borrowings, particularly in debenture issuances. In the same period, bank borrowings grew at a robust pace, although slight deceleration was exhibited in Q3:2020-21.

·         In the aftermath of the IL&FS event, the NBFC sector attempted to realign its asset-liability mismatches by moving away from short-term borrowings to long-term borrowings. Accordingly, term loans growth remained high at 22.6 per cent and 18.3 per cent in Q2 and Q3:2020-21 (Y-o-Y), respectively.

Term loans constituted over four-fifth of NBFC bank borrowings at end-December 2020, followed by working capital loans and cash credit. While term loans continued to grow at a robust pace, they exhibited a deceleration in Q2 and Q3:2020-21, compared to Q2 and Q3: 2019-20 reflecting tepid demand for on lending of funds. An uptick in working capital loans was witnessed in Q3: 2020-21.

·         Over 70 per cent of the NBFC borrowings are now payable after 12 months and their share has remained stable, indicative of the growing market discipline among NBFCs. Similarly, over 70 per cent of NBFC advances are also now long term (that is, receivable after more than one year).

·         The industrial sector remained the largest recipient of credit from NBFCs-ND-SI even as its share moderated between Q3:2019-20 and Q3:2020-21. Retail sector, followed by services, are the other major beneficiaries and their share grew during the period under consideration.

·         Industrial sector, particularly micro and small and large industries, seemed the worst hit by the pandemic as they posted decline in credit growth. Imposition of lockdown, abrupt stoppage of economic activities and disruption in supply chains to contain the spread of the virus could have affected these sectors the most.

·         Passenger vehicles sales increased by 13.6 per cent in December 2020. It is mirrored in the disbursal of vehicle loans by NBFCs, as these loans grew by 10.7 per cent in Q3:2020-21. Loans against gold also grew robustly as it filled in the cash requirements and possible working capital requirements of small firms.

·         The profitability of the NBFCs improved in Q2:2020-21 compared to the corresponding quarter of the previous year on account of steeper fall in expenditure than in income. Given the persistence of infections, the full effects of the lockdown and suspension of business on the asset quality of NBFCs will be evident gradually.

In the recent Global Competitiveness Report, the World Economic Forum examined how different countries are traversing on the road to recovery from the health and economic shock of Covid-19 pandemic, which “impacted the livelihoods of millions of households, disrupted business activities, and exposed the fault lines in today’s social protection and healthcare systems”. On the positive side, the shock is believed to have accelerated “Fourth Industrial Revolution on trade, skills, digitization, competition and employment”.

There is large section of observers who reject World Economic Forum in general and its research in particular, as mostly elitist and prejudiced against developing economies. I do not have any strong objection to the views of this section of people. However, I do occasionally study the work done under the aegis of WEF and find it useful for identifying the problem areas and directions for further study. I read the Global Competitiveness Report 2020 also with this perspective. The following are some of the points that I find mostly incontrovertible and useful in making a reasonable assessment of the present situation.

·         Before pandemic high levels of debt in selected economies as well as widening inequalities was a major area of concern. The emergency and stimulus measures have pushed already high public debt to unprecedented levels, while tax bases have continued eroding or shifting. Now, the priority should be on preparing support measures for highly indebted low-income countries and plan for future public debt deleveraging. In the longer run (transformation phase) countries should focus on shifting to more progressive taxation, rethinking how corporations, wealth and labour are taxed.

·         The COVID-19 crisis has accelerated digitalization in advanced economies and made catching up more difficult for countries or regions that were lagging even before the crisis. In the revival phase, countries should upgrade utilities and other infrastructure as well as closing the digital divide within and across countries for both firms and households.

·         Skills mismatches, talent shortages and increasing misalignment between incentives and rewards for workers had been a major problem for advancing productivity, prosperity and inclusion for many decades. The focus should now turn to new labour market opportunities, scaling up reskilling and upskilling programmes and rethinking active labour market policies. The leaders should work to update education curricula and expand investment in the skills needed for jobs in “markets of tomorrow”.

·         The pandemic has highlighted how healthcare systems’ capacity has lagged behind increasing populations in the developing world and ageing populations in the developed world. Now, the health system capacity needs to be expanded to manage the dual burden of current pandemic and future healthcare needs. Especially, there should be an effort to expand eldercare, childcare and healthcare infrastructure and innovation.

·         Over the past decade, while financial systems have become sounder compared to the pre-financial crisis situation, they continued to display some fragility, including increased corporate debt risks and liquidity mismatches. The countries now prioritize reinforcing financial markets stability, while starting to introduce financial incentives for companies to engage in sustainable and inclusive investments.

·         Pre-crisis, there was increasing market concentration, with large productivity and profitability gaps between the top companies in each sector and all others; and the fallout from the pandemic and associated recession is likely to exacerbate these trends. In the revival phase, therefore, the effort should be to strike a balance between continuing measures to support firms and prevent excessive industry consolidation with sufficient flexibility to avoid keeping “zombie firms” in the system.

·         Post global financial crisis, a trend was seen emerging against globalization. In revival strategies, countries should lay the foundations for better balancing the international movement of goods and people with local prosperity and strategic local resilience in supply chains.

It is emphasized that “The global economic outlook for 2021 is highly dependent both on the evolution of the pandemic and on the effectiveness of the recovery strategies of governments”. It is critical to assimilate that the governments across the globe have deployed US$12trn to support households and businesses with emergency income and cash flows. This support shall begin to expire as the process of “unlocking” progresses. The recent economic recovery with the support of these support measures may not be a guidepost for the future economic trends. “Instead, the road towards economic recovery will be long, asymmetric and asynchronous across different economies”.

Where does India stand on the road to recovery?

1.    Amongst G-20 countries, India is a dismal and distant last in terms of percentage change in the skills of graduates during 2016-2020. Suadi Arab, China and South Korea share the podium positions in this area.

2.    India with 9.5% NPA level (2018 data) has the lowest score of soundness of banks amongst selected countries and ranks at the bottom (only better than South Africa) in terms of finance access to SME.

3.    India is placed close to the bottom in terms of share of global patent applications.

4.    Global business leaders see no significant improvement in the globalization of India’s value chain in future.

5.    India ranks much below the global average on workforce upgrade (law and social protection), investment in of skills and upgrading education curricula, digital access, rethink on competition and antitrust framework, creating markets of tomorrow, investment in R&D and innovation, diversity & inclusion,

6.    India is placed in the 9^th declie (bottom 20%) in terms of readiness for economic transformation post pandemic.

In view this gives a fair idea of areas where we are lacking and need to work hard. As an investor, this also allows me to upgrade my matrix of key factors that I focus on for identifying major risks and opportunities.

UK has allowed the administration of vaccine for SARS-CoV-2 virus (commonly known as Covid-19) developed by Pfizer. Russia and Chinese authorities have also confirmed approval of separate vaccines. In India also couple of developers has expressed confidence that an effective vaccine will soon be available for Indian population.

This is certainly a matter of relief for the distressed mankind living in fear since outbreak of the pandemic. However, for the investors in stock markets wider availability of vaccine could be a matter of slight concern.

So far the investors in equity have had a decent run in 2020, regardless of the severe correction in the early days of the pandemic. In my view, a large part of the price gains in equity stocks could be attributed to the accommodative monetary policy adopted by the central bankers world over.

In past 9 months, a significant part of the cheap and abundant money may have actually flown to the financial assets (mostly equities) as (i) the requirement of money in real businesses have been less; and (ii) the interest rates have persisted at lower levels making it un-remunerative for investors to keep money in short term debt or deposits.

The rising certainty about vaccine availability and subsequent normalization of the accommodative monetary policies may rock the stock market party in 2021. It may be pertinent to recall the impact of taper tantrums on stock markets in 2013, when Fed started to wind up the QE used for supporting and stimulating the economy in the aftermath of global financial crisis in 2008-09.

In a 2017 study, Anusha Chari and others (National Bureau of Economic Research, Cambridge, see here), examined the impact of monetary policy surprises extracted around FOMC meetings on capital flows from the United States to a range of emerging markets. The study revealed “substantial heterogeneity in the monetary policy shock implications for flows versus asset prices, across asset classes, and during across the various policy periods.”, as per the study—

“The most robust finding is that the evolution in overall emerging market debt and equity positions between various policy sub-periods 14 Not reported but available from the authors. 33 appear to be largely driven by U.S. monetary policy induced valuation changes. In nearly every specification, the effect of monetary policy shocks on asset values is larger than that for physical capital flows.

Further, there is an order-of-magnitude difference between the effects of monetary policy on all types of emerging-market portfolio flows between pre-crisis conventional monetary policy period, the QE period and the subsequent tapering period. We detect some significant effects of monetary policy on flows and valuations during the period of unconventional monetary policy (QE). However, the effects are not consistent over all dependent variables. In contrast, during the period following the first mentioning of policy tapering, we uncover a consistent and large effect of monetary policy shocks on nearly all variables of interest.”

Normalization of global trade to pre pandemic levels may essentially obliterate the supply chain bottlenecks and ease commodity inflation. Remember, the pandemic has not caused any physical destruction, as is usually the case with a larger war. Therefore, normalization would not require any major reconstruction or rebuilding endeavor. The damage is mostly to the personal finances and small businesses. This will keep hurting the demand growth for few years and keep the need for additional capacity building low. The new capacities would all be built in healthcare and digital space, not much in the physical space.

In Indian context, in past six months, the yield curve has steepened the most in past two decades at least.

As per media reports, many private companies are able to raise 3month money at 3-3.3%, a rate lower than the policy reverse repo rate as well the corresponding bank fixed deposit rate. Obviously this is an anomalous situation and may not sustain for long.

There is little doubt in my mind that any further steepening of the curve could fuel Nifty to the realm of 15000 in no time. But I have serious doubts whether in a fast normalizing economy, as claimed by various government officials, economists and other experts, the short yields may continue to soften, or even sustain at the current level, especially when the inflation is seen bottoming at or above the RBI target rate.

Any sign of “withdrawal” might shock the brave traders, who are assuming unabated flow of cheap money. Beware!

 I have always believed that “equity investment” is a serious business but mostly done in a casual manner. In past three decades I have observed that most investors take equity investment decisions based on factors that are not related to the underlying business of the company they are investing in. While this may be more true for the small household investors (Retail) and High Networth Individuals (HNI); the professional fund managers (Institutions) and large traders are also seen taking decisions based purely on factors like politics, geopolitics, and monthly or weekly data (trade, jobs, production), etc. No wonder the “breaking news” on TV channels causes more volatility in stock prices than the management guidance about the business of the company.

I have seen many Retail and HNI investors spending less effort and time in taking equity investment decisions than they would normally spend on buying a shirt. And worst, they spend much less effort and time in taking a decision to dispose an investment than they would do for disposing an old shirt.

From the interviews and comments of some reputable professional fund managers it appears that they usually assign significantly higher weightage to the macro factors, especially political promise of policy reforms etc., than required, especially when the empirical evidence is materially against placing reliance on such political promises.

I am raising this issue this morning, because I believe that even in normal times, investors face numerous uncertainties and challenges. The consequences of these uncertainties vary vastly and are difficult to assess. Investors have to consistently struggle to assess the impact of fast changing technologies, markets, processes and methods on their investment portfolios. The consistently changing macro environment, e.g., interest rates, inflation, liquidity, demand etc., needs to be incorporated in assessing the sustainable valuations of their portfolio. The information asymmetry, regulatory changes, product innovation and debasement of governance standards at business entity level, are some of the regular challenges that an investor has to face. The challenges rise multifold in the uncertain times, like the present one.

The outbreak of pandemic has created enormous uncertainty in almost all spheres of life; especially businesses. A large number of businesses are struggling for survival. Multifaceted challenges have subjected a host of businesses (and some industries) with extreme uncertainties having material and severe consequences. Unlike the previous crises (dotcom bubble of 1999-2000 and global financial crisis of 2008-09), which mostly impacted one set of businesses, this crisis is more pervasive.

The impact of crisis led disruption is exacerbated by the fact that prior to the crisis the global economy was witnessing massive technology transition. Artificial Intelligence and clean fuel technologies were changing the landscape for many businesses. To make the matter more complex, the widespread trade war (involving USA, China, Japan, EU, and UK) was redefining the global trade and terms of trade. As per some reports, the IMF’s GDP contraction forecast for 2020 is more than double the estimated contraction that took place in 2009, the worst year of the global financial crisis.

The equity investors in India have made sub-optimal returns in past five years. Many investors are indicating that the past five year returns for them are in low single digits, with some reporting even negative return for past three years. In these circumstances, it is critical that investors make a holistic review of their investment process. Especially, those investors who have made material changes in their portfolio in view of the 2014 & 2019 India general elections and 2016 & 2020 US general elections, need to immediately sit with their respective advisers, if any, and make necessary amends.

 With each passing day, the realization is growing that it will “years” not months or quarters before the normalcy returns to the global economy. Regardless of the statistics on global trade, national income and corporate earnings, the impact of pandemic on humanity, especially poverty, inequality, and suppression is overwhelmingly devastating. The pandemic has indubitably undone the decades of efforts in poverty alleviation and public health in numerous developing and underdeveloped countries.

As per a recent Bloomberg report based on a study conducted by the World Bank and Philippine’s local agencies, “almost half of shuttered businesses were unsure when they could reopen”. As per the report, “in emerging parts of Southeast Asia, where a wave of job losses and weak social safety nets mean millions are at risk of losing their rung on the social mobility ladder. The region is likely to come in second behind the Indian subcontinent in charting the number of new poor in Asia this year.” This points to a long, drawn-out recovery. Southeast Asia’s GDP is estimated to be to be 2% below the pre-Covid baseline even in 2022.

As per last year’s projections, South Asia was expected to add more than 50million people with $300bn in disposable income to middle class strata. This attracted many global corporations to invest huge amounts in building capacities in this region. With the poverty levels rising and prospects of growth acceleration fading, the viability of these capacities is now questionable.

As per the Bloomberg report, “As many as 347.4 million people in Asia-Pacific could fall below the $5.5 a day poverty line because of the pandemic, according to the United Nations University World Institute for Development Economics Research.  That’s about two-thirds of its worst-case global estimate, and underscores the World Bank’s forecast of the first net increase in worldwide poverty in more than two decades.”

As per HSBC research, The magnitude of the economic free fall in Southeast Asia’s five biggest economies was severe in the second quarter. Indonesia shrank 5.3% year-on-year, Malaysia 17.1%, Philippines 16.5%, Singapore 13.3% and Thailand 12.2%, data compiled by Bloomberg show. Vietnam, which was among the few trade-war winners, will see its three-decade economic ascent grind to a near halt this year. Contractions could persist through early next year.” That’s signalling a prolonged financial squeeze for Southeast Asians.