Vijay Kumar Gaba

Some notes on the current state of the Indian economy.

Monsoon ‘abnormal’ so far

The monsoon season this year has been quite erratic so far. Statistically, during the period from 1^st June to 22^nd August the country has received 9% more than the normal rainfall. However, the temporal and spatial distribution of rainfall has been quite abnormal so far.

·         252 (36%) of the 703 districts in the country have witnessed ‘excess’ (20% to 59% above normal) to ‘large excess’ (60% or more above normal) of rains.

·         236 (34%) districts have received ‘normal’ (upto 19% above or below normal) rains.

·         215 (30%) districts have received ‘deficient’ (60% to 59% below normal) to ‘large deficient’ (more than 60% below normal) rains.

·         More importantly, the granaries of India – UP, Bihar, Jharkhand, West Bengal have been mostly deficient to large deficient. In UP, 66 out of 75 districts have been deficient to large deficient. In Bihar 35 out of 38 districts have received deficient to large deficient rainfall.

The agriculture activities have been affected in large part of the country due to erratic, large excess and deficient rainfall. However, the water storage levels in most reservoirs are now good and soil moisture is also better, which augurs well for the Rabi crop. Thus, despite a below par Kharif crop and poor summer vegetable crop; we may see decent overall agriculture growth in FY23. However, the rural demand in this festival season may be not buoyant. The rural credit may also face renewed stress in some pockets.

Infrastructure orders ‘strong’

NHAI reportedly awarded 6,306km of orders in FY22 – vs 4,788/3,211km in FY21/20, exceeding its target of 5000km. Other government departments and state governments are also accelerating the pace of infra order awarding, especially in roads, irrigation, metro, water and mining. It is expected that the order momentum may sustain in FY23 as well. Reportedly, more than Rs1trn of tenders have been issued in July 2022 alone. Roads, water, and railways continue to be the major contributors for the same.

Among sectors, roads, railways, water and irrigation, and power equipment (Solar EPC) saw strong inflows in April-July 2022. Growth in railways was driven by large wagon orders. Growth in power equipment was driven by solar EPC orders.

Considering the ‘above estimate’ performance of most infrastructure developers, it is evident that the execution may also be improving. It is reasonable to expect that the infrastructure activity may finally be taking off to an acceleration phase.

Inflation expectations ‘anchored’

Reported CPI for July 2022 was at 6.71%, at five month low level. Though, it remained above the RBI upper tolerance band of 6% for 7^th consecutive month. The core inflation-excluding food and fuel segments- came in at 6.04% in July compared to 6.22% in June. Thus a slowdown in inflation rate was primarily driven by food, transportation and communication.

The RBI Governor commented yesterday that “inflation is getting increasingly anchored; has moderated from the peak. Bond yields at the long end are reflecting the anchoring of inflation. Softening of crude and commodity prices is also supportive. Inflation has peaked and is expected to moderate.”

As per the brokerage firm JM Financials, “India’s inflation trajectory is trending downwards while core inflation should be range bound (5.9% - 6.4%) throughout the upcoming festive season before easing meaningfully. But the risk of percolation of high WPI inflation to retail inflation would keep CPI elevated, currently the wedge remains as high as 8.2% and even if July WPI print eases by 50bps, the wedge would still be 8%. Although global supply chains may show early signs of easing, geopolitical issues are far from over and any further escalation would negatively impact crude price and INR. We see Q2FY23 CPI inflation at 6.9% vs RBIs 7.1%, easing inflation would entail a policy action addressing more towards defending
INR than suppressing demand, hence Sep’22 MPC meet should see shallow rate hikes (30bps).”

Borrowing cost and deposit rates rising

As per rating firm CARE Ratings, “Credit offtake had shown an improving trend in the latter half of FY22, which has continued in the first four months of FY23. RBI has been working on reducing the liquidity surplus in the banking system which has been consistently reducing and is currently around the Rs 2 lakh crore mark from Rs 7 lakh crore at the beginning of 2022.”

Weighted average lending rate (WALR) for all banks has risen post RBI hiking the policy rates. Expectations of further policy rate hikes are also prompting certain banks to proactively raise rates. Deposits rates have also witnessed some hikes; though the rise in deposit rates, has been slower than the increase in lending rates.

The conventional wisdom guides that roads are meant for moving forward and trampolines are meant to get momentary high without going anywhere. Usually, the chances of reaching the planned destination are highest if the traveller takes a straight road. The chances are the least if they ride a trampoline. Walking on ropes may sometimes give you limited success.

Investors who jump up and down with every bit of news are only likely to lose their vital energy and time without moving an inch forward. Reacting instantaneously to every monthly or quarterly data, every policy proposal, corporate announcement, market rumor are some examples of circuitous roads or short cuts that usually lead us nowhere.

The developments in global financial markets in the past couple of years highlight that presently very few persons are interested in taking the straight road.

Taking the straight road means investing in businesses that are likely to do well (sustainable revenue growth and profitability); generating strong cash flows; maintaining sustainable gearing; timely adapting to the emerging technology and market trends; and most important consistently enhancing the shareholders’ value. These businesses need necessarily not be fashionable or be in the “hot sectors”.

In the Indian context, finding a straight road is rather easy for investors. Of course there are different viewpoints and strategies; having their own merits and inadequacies. It is possible that the outcome is different for various investors who adopt different strategies or take a different approach to invest in India.

For example, consider the case of investment in the infrastructure sector in India. Prima facie, it looks like a rather simple strategy. In an infrastructure deficient country like India, the case for investment in this sector should be rather simple and straightforward. But it has not been the case in the past 20 years.

Infrastructure has made money only for few

Infrastructure inadequacy of India has been one of the most common investment themes for the past few decades. However, more people may have destroyed their wealth by investing in infrastructure businesses or stocks of infrastructure companies than anything else. Especially in the past two decades, that have seen phenomenal development in infrastructure capacity building, the value destruction for investors in this sector has been equally remarkable.

There is no dearth of infrastructure builders who have become bankrupt with near total erosion of investors’ wealth who invested in their businesses. JPA Group, ADAG Group, Lanco, IL&FS, GVK, IVRCL, Gammon etc. are just a few examples. Their lenders, and the investors in their lenders, have been a colossal collateral damage too.

The fallacy in this case lies in the fact that while everyone focused on the “need” for infrastructure, few cared about the “demand”.

Indubitably, the “need” for infrastructure, both social and physical, in India is tremendous. However, despite significant growth effort in the past two decades, and manifold rise in government support for the society, especially poor and farmers who happen to constitute over two third of India’s population, the “demand” for infrastructure may not have grown at equal pace. The affordability and accessibility to basic amenities like roads, power, sanitation, education, health, transportation, housing etc., has improved a lot, but it still remains low.

As per a recent government admission almost one third of the population cannot afford to buy basic cereals at market price and therefore need to be subsidized. Only about one third of the adult population has access to some formal source of financing. Ever rising losses of state electricity boards and free electricity as one of the primary election promises, highlight incapacity or unwillingness of the people to pay for their power bills. The losses incurred by some of the most famous highway projects, e.g., Yamuna Expressway, highlights the low affordability to pay toll tax for using roads.

The optimism on the infrastructure sector in the decade of 2001-2010 might have been a consequence of overconfidence and indulgence of administration and corporates who sought to advance the demand for civic amenities to make abnormal profits. This was not only a classic case of capital misallocation, but also misgovernance by allowing a select few to take advantage of policy arbitrage. This has resulted in huge losses for investors, lenders, local bodies and eventually the central government also.

The investment in infrastructure companies’ stocks for a small investor is therefore a tight rope walk. They may achieve some success after a stressful balancing act to normalize the forces of greed and fear.

With over two third of the population struggling to meet two ends, all those statistics claiming “low per capita consumption or ownership” of metals, power, housing, personal vehicles, air travel etc. is nothing but a blind man holding the tail of the elephant. If we find per capita consumption of electricity of the population that has access to 24X7 electricity and can afford to pay full bill for this at the market rates, we may be in the top quartile of per capita electricity consumption.

The politics of “competitive majoritism” has also led to irrevocable government commitments towards profligate welfare spending. This has certainly provided some sustainable spending capability to the expansive bottom of the Indian population pyramid. This clearly indicates that the government finances are likely to remain under pressure for a protracted period. Therefore, in my view, capex and infrastructure themes may work sustainably in Indian markets only when necessary corrections are carried out. Till then it is the trampoline ride that will continue to give investors momentary highs, without taking them much distance.

The investors and traders, who jumped on this trampoline after listening to the enthusiastic budget speech in February 2022 promising trillions of rupees in infrastructure spending, would understand the best, what I am trying to suggest here.