Why is the Land Titling Bill is not in headlines?

The Union Cabinet of the UPA government headed by Dr. Manmohan Singh had approved the draft of “The Land Titling Bill, 2010”. This was supposed to be a model law to be adopted by all states and union territories. The objective of the proposed legislation was, inter alia, to provide for a uniform law across the country “for the establishment, administration and management of a system of conclusive property titles with title guarantee and indemnification against losses due to inaccuracies in property titles, through registration of immovable properties”.

The Bill was prepared by the Rural Development Ministry’s ‘Department of Land Resources’  to bring uniformity across the country and replace the existing deeds system fraught with excessive litigation due to inaccuracies in property records.

It is a well-known fact that the present system for keeping records of property titles and transactions has numerous inadequacies. There are multiple, usually unconnected, agencies involved in the process. The multiplicity of agencies, their inherent inefficiency and varying processes of updation of property records, often lead to inaccuracies in the ultimate records, causing avoidable disputes and litigation.

The Bill was primarily based on the Australian System of 1858 (commonly known as ‘Torren System”), which has been adopted by multiple countries subsequently. Under the Torren System, the government is the keeper of all land and title records, and a land title certificate issued by the designated authority represents proof of full, indefeasible, and valid ownership.

Under the present system of ownership through deeds, all property titles are “presumed titles”. These titles are claimed by people through diverse legally recognizable instruments, which could be inaccurate, fraudulent, incomplete, or inconclusive, giving rise to disputes and litigation.

The Bill however was never presented for approval before the Parliament as most states did not respond favorably.

In November 2019, “the Committee to draft Model Act and rules for states and model regulation for union territories on conclusive land titling”, set up by the NITI Aayog submitted its report. Subsequently, in October 2020, the NITI Aayog circulated the draft of a model Act and rules on conclusive land titling to be adopted by all states and union territories. The proposed bill is apparently based on Maharashtra’s draft land titling Act. The Maharashtra draft is based on the recommendation of the task force that was set up in 2017 under chairmanship of noted agriculture economist T Haque, comprising experts from across the country.

Like 2010, most of the states have “failed” to respond to the draft legislation. However, unlike the case with the 2010 draft Bill, the central government this time has warned the states to reply promptly, otherwise their silence will be treated as affirmation. Obviously, the states do not like this approach of the central government much, and a constitutional crisis may be brewing underneath.

Surprisingly, this issue is mostly missing from the popular narrative. Inarguably, when implemented, this would be one of the most important reforms in post-independence India.

…more on this tomorrow

So far so good

 The latest result season (3QFY22) has ended on a mixed note. While aggregate numbers look on expected lines, the internals however show a different picture. There is significant divergence in performance of various sectors. In fact, the number of companies that did not meet market expectations is higher than the number of companies beating the expectations. Raw material inflation hurt most of the manufacturing sectors. Lack of pricing power in view of poor demand thus resulted in margin compression for most of the manufacturing sector. Financial sector was the brightest spot with credit demand accelerating, and asset quality, recoveries & profit margins improving. IT Services and Real Estate were other sectors that witnessed better performance on better demand environment. Metals and mining had another great quarter as prices remained elevated, with non-ferrous performing better than the ferrous metals. Oil & Gas sector performance however was below expectation. Though the headline Nifty EPS did not see any noticeable change post results, in broader markets earnings downgrades outnumbered the upgrades.

The most notable features of 3QFY22 results were (i) continued deleveraging of corporate balance sheets; (ii) material decline in rural demand and (iii) significant disappointment by small cap stocks.

Some of the key highlights of 3QFY22 results could be noted as follows:

Nifty EPS

Nifty EPS for FY22E has been reduced by ~1% to INR735 (earlier: INR743) largely due to a big downgrade in TTMT earnings. FY23E EPS has been broadly unchanged at INR874 (earlier: INR872) as downgrades in Autos, Metals and Consumer sectors were offset by upgrades in O&G and BFSI sectors. (MOFSL)

NIFTY EEPS has seen only minor tweaks in the current quarter with 15.6% EPS CAGR over FY22-24 with FY22/23/24 EPS of Rs691, 807.5 and 924.4. Our estimates are higher by 1.6/0.8/0.3% for FY22/23/24. NIFTY is currently trading at 21.8x 1-year forward EPS which shows 6.3% premium to 10 year average of 20.6x. Past 3 dips show that NIFTY has bottomed out around 10 year average PE except in March 20, when it bottomed out at 23% discount to 10 year average. (Prabhudas Liladhar)

Margins Compression

3QFY22 net profits of the Nifty-50 Index increased 24% yoy versus our expectation of 20% increase and EBITDA of the Nifty-50 Index increased 17.5% yoy versus our expectation of 15.5% increase. All the consumption sectors saw further compression in gross and EBITDA margins due to continued high raw material prices and limited ability of companies to raise prices fully. (Kotak Securities)

EBITDA margins (excl financials & commodities) compressed significantly on YoY basis, by 236bps. Major compression was seen in Paints (753bps), Tyres (913bps), Utilities (712bps, mainly from the gas price increase), Pharma (535bps) and Cement (756bps). However, on a sequential basis, significant margin improvement was seen in Chemicals (194bps) and Paints (288bps).

Notable sectors below the 5-yr peak are Travel (by 11pps), Tyres (7ppt), Media (9ppt), Paints (5ppt), and Automobiles (5ppt). Notable companies below 5yr peak are Eicher, Godrej, Welspun, Mahanagar Gas, MRF and Torrent Pharma. As for the EBITDA margin above the 5-yr peak, some notable names are IRCTC, Cyient, TVS, Jubilant FoodWorks, and ACC. (IIFL Securities)

Upgrade vs Downgrade

The biggest downgrades happened in Cement and Tyres (7ppst each), Financial services (6ppt) and Business services (5ppt). Some notable companies with the biggest downgrades are MRF, Whirlpool, Dalmia Bharat, JK Cement, Lupin and Dixon. The highest upgrades were seen in Paints, Real Estate, Telecom and Discretionary − all in the 2-3% range. Some notable companies with the highest upgrades are Blue Dart, Canara Bank, SRF, and Titan. (IIFL Securities)

Deleveraging

Aggregate interest/Ebitda is broadly stable, at 10% levels, led by both, improved Ebitda and cash flows, down from 24% in the Mar-2020 quarter. Significant deleveraging during the pandemic, coupled with low interest rates, has helped in reducing the interest burden on companies. On an aggregate level, interest costs are down by 8% on a 2Y CAGR basis. Going forward, though, interest rates may rise again on the back of acceleration in credit. The current corporate bond yields have cut the gap to their prepandemic levels to some extent and central banks across the globe too are looking at rate hikes, to initiate normalisation.  (IIFL Securities)

Rural Demand

Recent commentaries by several corporates indicate to slowdown in rural demand. The slowdown has been observed in select FMCG categories, 2 Wheelers, cement and post Diwali durables demand has also been tepid. Rural slowdown has many reasons- Rural slowdown has been triggered by 1) higher increase in the cost of Agri inputs than the outputs potentially impacting farm incomes which are roughly 30% of rural income 2) Poor spatial distribution of monsoons 3) Lower remittances from urban workers to their families as labor is yet to fully migrate to cities for work 4) High Inflation in essential commodities like fuel, edible oil, tea and other daily essentials due to global disruption in supply chains. However we believe bumper wheat harvest and rising job/work opportunities led by Infra development, housing, artisans, carpenters, painters, truck drivers, factory workers etc. will boost income and demand. However given high inflation the earliest a rural seems likely is from the middle of 1Q23, with 4Q demand being also under pressure. (Prabhudas Liladhar)

Key sector trends

Private Banks, NBFC, Logistics, Retail and Utilities reported higher-than-estimated PAT growth, while Autos, Cement, Consumer Durables, Healthcare and Metals reported PAT below our estimates in 3QFY22.

Technology – 3QFY22 was a good quarter for Indian IT Services as companies under our coverage reported an overall QoQ topline growth of 4.6% (in USD), despite seasonality due to furloughs. The demand remains strong in the medium term.

Private Banks and NBFCs – asset quality trends improved. Most of the banks posted a decline in their NPL ratios, led by controlled slippages as well as healthy recovery and upgrades. NBFCs saw sharp improvements in disbursements and collection efficiencies.

Consumer – discretionary companies (Paints, QSR, Titan, Liquor, etc.) delivered strong double-digit topline growth while staples’ performance was muted as rural showed visible slowdown and margins were hurt by RM prices.

Cement – the sector was adversely impacted by weak volumes owing to unseasonal rains while high energy costs took a severe toll on margins and profitability.

Healthcare – after 12 quarters of growth, 3QFY22 marked the first decline in profits as rise in raw material costs due to supply disruption in China and continued price erosion ins US depressed profitability. (MOFSL)

Conclusion

Overall 3QFY22 earnings were encouraging, given the context of inflationary pressures, tightening liquidity, supply chain bottlenecks, adverse weather conditions; fiscal constraints impacting cash payouts in rural areas and fresh Covid breakout.

The management commentary post earnings have been mostly optimistic; though some companies have raised concerns over consumer demand. So far most analysts appear to be sticking with their FY23 earnings estimates. The geopolitical concerns, energy prices and impact of interest rate hikes on global commodity inflation are some of the key variables to be watched in the next 3-4 months. Most important among these would be easing of global inflation without hurting the growth materially.

Some random thoughts

This world is like a prism. You see different pictures, colours and hues depending upon from which angle and under what light you are viewing the world. Therefore, while all views and colours are equally valid, your "truth" is always what you see from the point you are standing at a given point in time and under the current light.

In the past few months, inflation has become one of the driving narratives of monetary policy world over. From Brazil to Britain, and Australia to the Eurozone, the central bankers have expressed concerns over rising prices. Over 30 central banks have actually raised policy rates in the past 12months to control inflation. The US Fed is also widely expected to embark on a path to accelerated rate hike from next month onward.

Insofar as the monetary policy impact on inflation is concerned, in my view, in the latest episode, inflation (rate of increase in the prices) is not the only problem. It is the current price level that is hurting people severely. Hikes in rates will only curtail demand. This may not necessarily bring down the prices. The effort needs to either increase the income of common people or materially augment the supply of essential goods to bring down the prices from the current levels.

I have spoken to a number of people from various sections of society in the past one month to understand how inflation affects their lives. Not surprisingly, all of them had different perceptions about inflation. Obviously, they all view the issue from their own angle and under the light of their own circumstances. If I could extrapolate the feedback of these people—

(a)   For almost half the population, primarily living in rural areas, ideally food inflation ought not be a matter of concern. A farmer should gain maximum from the food inflation. Given that over 60% of the population is engaged in the farming and related activities, theoretically consistently high food inflation should result in transfer of wealth from non-farm sector to the farm sector. But this has not been the case in any of the high food inflation episodes in the past seven decades. The gap between rural and non-rural income and wealth has been consistently widening.

The reasons could be un-remunerative prices for the crop and higher than food inflation in healthcare, agri input, energy and transportation.

(b)   Urban, semi-urban households suffer from a variety of inflation. Prominent amongst these are education, health, energy, transportation, communication, rental, protein, fruit and vegetable. The political rhetoric and central banker's focus exclude many of these critical elements in their fight against inflation. Lack of good public healthcare, education and transport services, energy efficiency, affordable housing, and better employment opportunities closer to home is hurting this class the most.

The expense on food for a typical Indian middle class family is about 30-40% of their income. A typical middle class household saves 20% of his income. If food inflation is 10%, a 3-4% rise in nominal income would be needed to offset that. Besides, they would need sufficient rise in nominal income and asset prices and interest rates to offset the erosion in real value of their savings. This perhaps has not happened in the past many decades, implying that the nominal rise in asset prices and interest rates have not been consistent with the general rise in price levels. The wealth is thus consistently getting transferred from savers to borrowers.

(c)    Debt laden infra and realty developers are more concerned with inflated cost of capital and wage inflation. Energy and transportation costs also bothers them. This section needs better execution standards, simpler administrative procedures, automation, good corporate governance structure, stricter compliance norms and a vibrant retail debt market to alleviate the problems they face. Vegetable and edible oil prices do not bother them much.

One could argue that transfer of wealth from farmers and the urban middle classes to traders & indebted industrialists is a function of risk they take. But if we consider the history of NPA cycles, and exploits by moneylenders this argument gets weaker. Large borrowers have been consistently transferring the risk to public sector banks, and hence the common public, through frequent defaults. The money lenders in the informal sector have been fairly successful in exploiting the household and farmer borrowers, not allowing any benefit of inflation to them.

Actually, maintaining the negative real rates for households (household inflation minus term deposit rate) for a long period is the biggest scam perpetrated on the poor people of this country. The inflation tax, as I call it, paid by poor and middle class savers for cheaper financing of “crony socialism” and unscrupulous businessmen, has after all caused serious damage to the basic fundamentals of the Indian economy.

For a common man like me on the street, who is blissfully ignorant of the principles of economics and public finances, inflation is nothing but an enigma. The rising prices do hit him hard, but that also lead to a rise in his nominal income and hence social stature. Higher nominal interest rate on his savings, higher notional value of his house & jewellery; and higher rental for the spare room on the top floor does provide him some psychological comfort.

For a common man, inflation might be more of an income inequality issue. For many decades, inflation has been a medium of wealth transfer from common man to the rich. The current raging debate over rise in prices of food therefore has to be seen from this angle also.

Faith vs Logic

I firmly believe that faith is a better decision making tool than logic. Faith lets you unconditionally accept or reject things. It makes it easier to believe or doubt the things you are thinking about - making the decision making easier and faster. Logic, on the other hand, agitates the minds as it questions the beliefs and raises doubts. It often leads to protraction (and often prevention) of the decision making. It is of course subjective opinion and could be challenged by logical thinkers. Regardless, my experience in life is that whether the decisions are right or wrong is only known in hindsight. There is little empirical evidence available to me, to prove beyond doubt that the impulsive decisions are less or more effective than the decisions taken after applying deep logical thinking. So, I usually take the easier route to the decision making that saves me from thinking and

The context for mentioning this is a little complex. It is widely expected and accepted that the Federal Reserve of the US will soon embark on the path to accelerated rate hikes. For the record, the Fed policy rate remained at 0 to 0.25% from 2009 to 2016. It was gradually hiked to 2.5% between 2016 and 2019 and then sharply cut back to near zero during 2019-20. The analysts are scrambling to adjust their valuation models to accommodate a 2% to 2.25% hike in Fed policy rates in the next 12-15 months. The portfolio managers and investors are also struggling to reorient their investment strategy to be in sync with the new monetary policy regime.

As per the latest survey of global fund managers done by the investment strategy team of Bank of America Securities, a majority of the fund managers believe that central bank tightening remains the top risk for the global markets in 2022. Also, the “underweight on tech sector” is highest since 2006, even though the “long technology” is the most overcrowded trade. The fund managers are underweight assets that are vulnerable to interest rate hikes such as emerging markets, tech and bonds.

Fund managers also believe that inflation and asset bubbles are the other two top risks for markets in 2022.

I believe that analysts and fund managers are experts in the field of finance and usually have a strong understanding of economics, especially the impact of monetary & fiscal policies on businesses. They must therefore have strong reasons for their strategy and positioning, supported by logical reasoning and analysis. They must be using complex and elaborate algorithms and analysis tools for decision making, especially since their decisions involve the investors’ money held in trust by them.

However, from where I stand, they appear to be suffering from indecision, lack of conviction and agitated thought process.

With the benefit of hindsight we know that the previous two Fed rate hikes have not been immediately negative for emerging markets. For example, during 2004-2008 Fed rate hikes (1% to over 5%) Sensex gained more than 200% (from 6000 to 20000). During 2016-2019 Fed hikes (from 0% to 2.5%) Sensex gained over 75% (from 24000 to 42000). Even the US equities had also gained materially during those periods. The market corrections happen much later and not necessarily due to rate hikes. Global market freeze post Lehman and lockdown due to Covid actually caused market corrections.

In particular, I would like to highlight the “bearish tech” stance due to Fed rate hikes.

I have strong faith in the digital transition of global trade and commerce. The significant rise in the digital intervention in common men’s life is inevitable. Technological evolution shall continue to impact every aspect of life and business for many years to come. The share of technology in all aspects of life – education, health, entertainment, relationships, trade, manufacturing, services, construction, management etc., shall continue to rise for the next many years. I therefore believe that technology is a good business to invest in for the next one decade at least.

I also believe it is highly inappropriate to classify online retailers and fintech companies, which are large consumers of IT services as technology companies. By this logic, Infosys must be classified as a real estate sector company and Indian Railways as a steel sector company.

I find that most of the global technology companies have net cash surplus on their balance sheets. Higher interest rates would normally mean higher treasury for these companies and higher dividends for shareholders.

Moreover, higher cost of capital should normally encourage most businesses to invest more in technology to enhance productivity; implying higher business growth for IT services companies.

An investor which paints Infosys with the same brush & color as IT services consumers PayTM & Zomato; or highly indebted mobile phone manufacturers, because his algorithm classifies all these companies under technology sector may end up making incorrect decisions. But, someone who has faith in the prospects of technology services may not face any dilemma in decision making.

Time for tortoise to chest the tape

In yesterday’s post I had highlighted that the previous two market cycles had not ended well for the broader markets (see here). By the time the cycle had ended, a large majority of stocks (smallcap and midcap) had given up much more than what they had gained on their way up. Only a couple of hundred stocks ended the cycle with some gains.

This is however not to take away anything from the fact that many stocks like Havells, Escorts, Page Industries, PI Industries, IndiaMart, APL Apollo, L&T Tech, SRF etc. changed their orbit and moved sustainably higher in the previous two market cycles. Also, many stocks either moved to the lower orbit or just vanished as the market cycles were coming to end. JP Associates, ADAG Group stocks, Suzlon, Jet Airways, DHFL, IL&FS, are some of the examples. This is the story of every market cycle and there is nothing unusual about this. This story will inevitably be repeated in the current market cycle also. By the time cows come home, some companies would have transcended to the higher orbits; many would have been relegated to the lower planes; and some would have made an ignominious exit from the markets.

The issue to examine at this point in time however is where do we stand on the current market cycle - Has the cycle peaked and the indices have commenced their descent? Is the market taking a pause and a lot of climb is still left? Have indices already completed their journey downhill and are close to their base camps?

It is of course beyond my sphere of competence to portend where the markets are heading in next few months. Thus I would know the answer to the above only in hindsight.

However, as I hinted in yesterday’s post (see here), the empirical evidence indicates that the current market cycle may be far from over. Therefore, we have either just started the descent and have a long way to go down; or it is just a pause in the climb.

If someone forces me to take a bet, I would bet on the “pause”, for the following five simple reasons:

1.    The Indian corporate sector is embarking on a major earnings growth cycle, led by financials, after more than a decade. The valuations are nowhere in the vicinity of the “red line”.

2.    The global central banks have already embarked on a major monetary tightening cycle. There is no reason to believe that their united effort would be defeated by inflationary forces. All central banks acting in unison shall be able to defeat inflation in next 6-9 months, as the logistic constraints due to Covid-19 have already started to ease materially. Lower inflation (or deflation) and smooth supply chains shall help both the consumption and manufacturing in India.

3.    Higher policy rates and tighter liquidity shall impact the growth more in advanced economies as compared to the emerging markets. This shall reverse the direction of global investment flows towards emerging markets, as has been the case in the past tightening cycles.

4.    The inflated (bubble like) valuation like new age businesses are a very small proportion of the Indian public market. A vertical crash in these valuations may not have a crippling impact on Indian markets.

5.    In the past 5 years, Indian corporates have deleveraged their balance sheets materially. Most of the “large” bad accounts have been identified and the restructuring process is either completed or is ongoing. The probability of a major shock to the financial system stands significantly reduced.

In other words, for the markets to collapse from here we would need major disappointment in earnings; collective failure of central banks in reigning inflation; a global recession and collapse of some major enterprises. To me these events are less probable.

So how do I see the market moving in FY23?

I believe once the markets assimilate the impact of Fed lifting rates and geopolitical noise subsides in the next couple of months, we are more likely to witness a “bore” market rather than a “bear” market. The exhilarating “hope” trade (new age businesses, macro improvement, China+1, EV, PLI etc.) shall pave the way for the “patient” value trade that shall benefit from controlled inflation, positive flows and sustainable rise in earnings trajectory.

There is nothing to suggest that the existing stock of domestic money in the stock market may fly out in the next couple of years; even if the fresh flows slow down. As the breadth narrows down, the AUM of mutual funds and portfolios of investors may get more concentrated in top 150-250 stocks keeping the benchmark indices high, even though the broader market indices struggle at lower levels. In the past we have seen this kind of market during 1995-96; 2001-03; 2010-12, and 2018-19.

To sum up, FY23 may be the time when the tortoise may chest the tape while the hare lags behind.

A visit to the markets

 The markets have been in a punishing mood for the past couple of weeks. Especially after the “path breaking budget”, the markets seem to be adjusting to the RBI’s rather tepid growth forecast for 2HFY23. Obviously, the RBI does not share the enthusiasm of the government over public sector capex triggering a virtuous cycle of growth led by private sector investment.

The narrative of geopolitics (Russia-Ukraine conflict) and Fed tightening scaring the markets does not sound credible.

Russia and Ukraine have been at war for three decades, since the dismantling of the USSR. Eight year ago, in 2014 Russia annexed one of the larger provinces of Ukraine (Crimea) and markets have not cared much about that, just like it has learned to live with the perennial conflicts between Israel and Philistine; US and Iran, South Korea and North Korea, India and Pakistan; etc.

The US Federal Reserve started winding up its asset buying program (QE) last year and announced its intent to hike policy rates once QE ends in March 2022. There is no surprise for markets in this. There is overwhelming empirical evidence to suggest that Fed rate hikes that control inflation but do not hurt the growth have been usually benevolent for equity markets, especially emerging markets. The most hawkish forecasts are projecting the Fed policy rates to peak at much lower levels as compared to previous rate cycles. Building a disastrous outcome for markets like the 1980s or 2000 due to Fed rates may be inappropriate since in those cases rates peaked at 20% and 6% respectively, as against 3.5% worst forecast this time.

The argument of money debasement and hence rates peaking at lower level is actually favorable for equities, since it allows higher valuations to sustain for longer.

Another popular narrative on the street is that the ongoing correction may be a great opportunity to buy. Millions of experts on social media are saying with the benefit of hindsight that all such corrections in the past were great investment opportunities which people regretted later.

I see their point, but would like to understand where we stand in the current market cycle? If the current market is not complete yet, we may experience material pain in the coming months. In the past two market cycles (2006-2009 and 2016-2020), the market had given up most of its gain towards the end. In fact, the smallcap indices ended both the cycle with net losses. In the current cycle we are close to 10% off from highs recorded so far in the cycle. Both Nifty50 and Nifty Midcap are more than 100% higher from the starting point whereas Nifty Smallcap is 200% higher from the starting point. Never have the market cycles have ended like this.

We certainly have a long way to go in this market cycle. If the peak has already been recorded, we may see 25-50% correction in broader markets; else we may have some distance to move north. More on this tomorrow.

 

…Aaj phir marne ka irada hai

The Reserve Bank of India (RBI) made its last policy statement for the current fiscal year FY22. The statement is unambiguous on all four key issues:

1.    The inflation is likely to peak in the current quarter and fall to the RBI’s tolerance range from next quarter onward.

2.    The overall growth has recovered to the pre-pandemic level, but private consumption is lagging. The risks to the growth are on the downside and 2HFY23 growth should moderate to ~4.5%.

3.    The Monetary Policy Committee (MPC) is unanimously of the view that in view of the present growth vs inflation dynamics, there no case for a hike in the policy rates.

4.    The growth recovery is fragile and requires monetary policy support. Hence, MPC has decided to keep the policy stance accommodative by a majority vote of 5 to 1, as was the case in the previous two policy statements.

This accommodative stance of the RBI in total defiance of the global trend of monetary tightening led by inflation concerns is not surprising, given the fact that the RBI has been solely focused on growth for past 3years, since the incumbent governor has assumed the office.  In the post meeting press interaction also the governor and his deputy sounded calm, defiant and confident.

Obviously, the RBI knows much more than most of the market participants and commentators and is certainly in a much better position to decide the best course of action. From the policy statement and officials’ replies to the press it appears that RBI is relying significantly on (i) the outcome of the monetary tightening by global central bankers and consequent cooling down in global inflation; (ii) a favorable monsoon; and (iii) full success of government’s plan to catapult private capex and consequent pickup in private consumption. The RBI also appears to be assuming that “India’s inflation” is different from the “global inflation”, and it will ease without any monetary policy intervention.

The argumentative Indian in me is restless to explore between the lines and find what has not been said and what could wrong. I am sure a trader who takes the governor’s statement at face value and places his bets accordingly would make more money than someone doubting the words of the governor and taking a deep dive to explore the words that were not said.

Citing the first part of a verse from famous Shailendra song from Movie Guide raises suspicion whether the governor is gambling with Knightian Uncertainty. He only mentioned “Aaj phir jeene ki tammna hai (Today I wish to live again), signifying strong survival instinct. What he did not say was ‘Aaj phir marne ka irada hai (…even if I have to die for it today) signifying the willingness to take high risk.

Regardless, I would like to argue that the RBI is worried about—

·         A prolonged growth recession. 2HFY23 growth projection of below 5% is not in consonance with the projection made by the Economic Survey and professional forecasters.

·         Rise in cost of borrowing for government and consequent interest burden on the budget.

By completely side stepping the large borrowing program of the central government in the policy statement, the RBI has opened the doors to the speculation of a significant balance sheet expansion (QE in simple words). The reliance on foreign funds for financing the deficit is also seems high, implying that RBI is expecting the yield differential between developed market bonds and Indian bonds to remain attractive and also inclusion of Indian bonds in global indices.

The RBI has categorically accepted the subordinate role of monetary policy to the fiscal policy; though the statement claims “equality” of two policies.

Both the government and the RBI might be hoping and praying that Russia-Ukraine conflict is averted; US and China growth cools down and OPEC+ agrees to increase the oil production materially so that the global energy prices cool down materially. Else, the government may be forced to take the incremental fuel prices on its fiscal account, either by way of duty cuts or subsidy to the OMCs. This not only takes the BPCL disinvestment off from the table, but also brings a downgrade of India’s sovereign rating in the frame.

Notwithstanding, what the RBI statement reads, the inflation projection chart of the RBI is sufficient to raise suspicion. From 0 to 8% inflation range would render any forecasting method meaningless. It is reasonable to suspect that “hope” is one of the horses pulling the policy cart.

 

The steep yield curve that allows short term borrowing at 3.75-4% vs long term borrowing at 68% to 7% .This is obviously encouraging borrowers to borrow more through short term instruments. The risk of ALM mismatch that played havoc with non-bank lenders and real estate developers in recent past is thus increasing. By not doing anything to flatten the yield curve, the RBI perhaps has stretched its luck little too far.

Last but not the least, “staying put” is the best strategy when in doubt. The complete status quo in the RBI policy, when the things have changed so much since the last policy statement, signals a banker in doubt and not a confident policy maker as the governor has pretended to be.

RBI Policy - Beyond growth vs inflation conundrum

The Monetary Policy Committee of the RBI has been consistently facing the growth vs inflation challenge for past three years at least. However, the conditions have become significantly more challenging and complicated for the MPC in the recent months. Hence, in the past couple days MPC may not have spent much time on resolving the growth vs inflation conundrum.

Since, the issue of adding to monetary stimulus is no longer part of the current agenda, the MPC deliberations might have been pinned around three issues –

1.    How to pace the liquidity normalization so that it does not hurt the fragile recovery?

2.    When to begin hiking policy rates?

3.    How to manage the large government borrowing?

Price stability may certainly have received some attention. But notwithstanding what the prime minister may have claimed in the Parliament, the MPC might have expressed helplessness in controlling the price volatility, especially the prices of essential items like energy, and seasonal fruits & vegetables.

In past couple of meetings, the RBI has made it unambiguous that while MPC continues to maintain its accommodative policy stance to support the growth, RBI shall continue to withdraw excess liquidity from the financial system through variable rate reverse repo auctions (VRRR) and other available means. No change is expected in this stance.

The market consensus believes that a 25-40bps hike in reverse repo rate (presently 3.35%) would be in order to guide the call money and short term rates higher and prepare the markets for an eventual repo hike later in 2022.

Even though the benchmark yields have spiked more than 50bps since last MPC meeting in December 2021; inflation is persisting close to upper bound of RBI tolerance range; and global bond yields have also spiked sharply - no one is expecting a repo hike today.

In the past couple of years, RBI and public sector banks (PSBs) have absorbed a material part of government issuance, since RBI was in the liquidity infusion mode and PSBs were struggling with poor credit offtake and extreme risk aversion. Both these conditions no longer exist. The RBI is in the process of unwinding the excess liquidity and PSBs are gearing for pickup in credit demand. Besides, the RBI has also allowed banks to prepay the outstanding under TLTRO and additional 1% of NDTL allowed under MSF since 2020 has been withdrawn from January 2022.

Arranging to execute a much larger government borrowing program would therefore be a challenge for the RBI, especially when the benchmark yields are already at uncomfortable levels. The RBI may therefore be more concerned about exploring the additional avenues of demand for government securities so that the benchmark yields could be pinned down and less disruptive repo hikes could be planned. As Morgan Stanley highlighted in one of their recent reports, one of the additional sources of demand could be issuance of “Fully Accessible Route (FAR) bonds, leading to India's inclusion in global bond indices. The resultant bid on long bonds could depress yields in addition to easing pressure on banks to fund the fiscal deficit.”

Private capex has seen steady growth, acceleration may not be imminent

 In the latest union budget presentation, the finance minister placed special emphasis on the need to encourage private sector investment. The finance minister highlighted that catalyzing (crowding-in) private sector investments through public capital expenditure is one of the key goals of the government in its endeavor to attain its long term vision “India at 100”.

In the past one year there have been some brokerage reports emphasizing that a virtuous private capex cycle in India is on the anvil. Most asset management companies also emphasized on revival of economic cycle led by For example consider the following:

2022: The Year of Capex - IIFL Securities

“India is on the verge of a strong capex led growth acceleration, helped by a multitude of factors including a supportive domestic policy environment and a strong commodity cycle. “

“India should see industrial capex pick up in 2022, helped by a pro-business and reforms govt stance, catch up after a long period of underinvestment in the economy, improved RoEs and fortified balance sheets in companies and banks, favourable global commodity prices, and improving central govt fiscal situation enabling capex spending with multiplier focus.”

India Strategy 2022: Enter Economic Supercycle - Jefferies

“Our analysis of the six key components of the economic cycle suggests that conditions are ripe for a repeat of a 2003-10 style (7.3% GDP CAGR then) upturn. Housing upcycle is now in its second year of upturn following a seven-year down-cycle. Pre-sales are booming, while inventory is at eight-year lows. We see housing to be at least a 5-year upturn, capable of driving the broader economy. The other cycles that have convincingly turned are bank NPLs (topped out, banks well capitalized) and corporate profitability. Corporate leverage is at a cyclical low as well. Interest rates will likely move up, but it's unlikely to impact investment activities a-la 2003-10. A gradual increase in the risk appetite among corporate and banks will lead to a broader capex cycle eventually by CY22 end.”

Year ahead 2022: Contrasting narratives and volatilities – HSBC Global Research

“1) Many macro indicators are painting a positive picture for economic recovery (GDP growth rates, tax collections), and prospect of the beginning of a stronger overall growth phase. 2) Prospect of a new phase of investment led growth (which has been largely muted in the past decade). 3) Continued momentum of investments in start-ups and new age companies and even successful public market listings of many such players has the potential to kick start a virtuous cycle of risk taking and adding to the ‘risk on’ momentum of the market, in our view. 4) FY21 recovery has been better than expected and FY22 and FY23 earnings growth outlook seems strong.”

India Economics: On path for a full-fledged recovery – Morgan Stanley

“We expect a full-fledged growth recovery with all drivers firing and macro stability indicators remaining in the comfort range. We believe that a pickup in investments underpinned by structural reforms will help to create a virtuous cycle of sustained high productive growth.”

Some brokerages though warned against unfounded exuberance for the private capex. For example, Edelweiss and JM Financial did not support a meaningful pickup in private capex.

 

The primary argument behind higher capex projections are (1) Significant deleveraging of corporate balance sheets; (2) Need to upgrade in view technology advancement and popularization of digital channels; (3) government incentives (PLI etc.); and (4) better risk taking capacity of banks; (5) strong housing cycle led by lower rates and improved affordability; (6) Focus on import substitution; (7) Climate change driven new capacity building; and (8) China+1 policy of western nations driving export growth from India; etc.

Whereas the arguments against any material acceleration in private capex are rather simple – (1) Lack of a driver for consumption growth which usually catalyzes investment cycle; (2) rate cycle already bottoming; and (3) poor capacity utilization levels.

Notwithstanding the arguments, it is important to note that many sectors in India have already witnessed meaningful capacity addition in the past 5-6years and may not need new capacities in midterm. Some industries like steel and renewable energy have announced major capacity additions in the last couple of years, execution of which might happen in the next few years.

A cursory analysis of 740 listed companies with over Rs 100cr of gross block as on 31 march 2021, suggests that one third of these companies have added more than 100% to their gross block in the past six years. Another one third have added 50% to 99% to their gross block in the past six years. The rest one third have added 10% to 49% to their capacity. Cement, Chemicals, steel, textile, sugar, pharma, auto ancillaries, and consumer durable have seen maximum capacity addition in this period. Besides, tyre, paints, paper, packaging and IT services have also seen meaningful capacity building.

Overall, the gross block of these 740 companies increased from Rs21.56trn to Rs42.42trn, an addition of Rs20.85trn. This is not very different from the gross budgetary support for capital expenditure in the central budget.

The point is that private capex has been happening at a steady pace for the past six years and it may not be a good strategy to expect any meaningful acceleration in next couple of years.

 

 The Capex conundrum

One of the most praised features of the Union Budget for FY23 presented last week is the emphasis on capital expenditure. The government, industrialists, bankers and many market participants have highlighted that the sharp rise in allocation for capital expenditure in the budget shall catapult the economy into a higher growth orbit and accelerate the employment generation.

Incidentally, the allocation for capital expenditure in the budget is also one of the most criticized items. Experts have highlighted that the higher allocation for capital expenditure in the budget is not only an optical illusion but may also be misdirected as it is mostly focused on the transportation sector and defense and completely ignores priority sectors like tourism, food processing, bio technology, higher education, sports & youth affairs, etc. The opaqueness in the matters of capital expenditure also raises doubts over the government's commitment to transparency in accounting.

What the finance minister said

In her budget speech, the finance minister gave an impression that the allocation for the capital expenditure in the union budget for FY23BE is being sharply increased to 2.9% of GDP.  This is an increase of 35.4% over FY22 and more than 2.2x the allocation for FY20. She also emphasized that investment taken together with the provision made for creation of capital assets through Grants-in-Aid to States, the ‘Effective Capital Expenditure’ of the Central Government will be 4.1% of GDP.

“…the outlay for capital expenditure in the Union Budget is once again being stepped up sharply by 35.4 per cent from Rs5.54 lakh crore in the current year to Rs7.50 lakh crore in 2022-23. This has increased to more than 2.2 times the expenditure of 2019-20. This outlay in 2022-23 will be 2.9 per cent of GDP.

With this investment taken together with the provision made for creation of capital assets through Grants-in-Aid to States, the ‘Effective Capital Expenditure’ of the Central Government is estimated at ` 10.68 lakh crore in 2022-23, which will be about 4.1 per cent of GDP.”

What budget documents says

Actual FY23BE capital expenditure provision is hardly any growth over FY22RE

The total capital expenditure of the central government includes four components – (1) Capital expenditure by central government department and ministries; (2) transfer to states for centrally sponsored schemes; (3)Loans to states; and (4) capital expenditure by the public sector enterprises through internal accrual, borrowings and budgetary support.

As per budget documents, the FY22BE provided Rs11.37trn for capital expenditure. As per FY22RE, the capital expenditure was lower at Rs11.05trn, as PSEs capital expenditure was revised down from Rs5.82trn (BE) to Rs5.02trn (RE) , a shortfall of Rs800bn.

Besides, the provision for transfer (Loans) to the state governments has been increased by Rs916bn from Rs218.18bn in FY22RE to Rs1.134trn in FY23BE.  It is pertinent to note that the state governments are allowed to borrow from the markets upto 4% of their respective state’s GDP. In past decade it had been a practice for state governments to borrow from the market and the central government’s loans were limited to very specific purposes.

Adjusted for loans to states, FY22RE capital expenditure is Rs10.83trn. This has been increased to Rs11.06trn, an increase of 2.1% only.

Transportation, Defense, BSNL 5G account for almost 72% of proposes capex

FY23BE provides 43.3% for transportation (Railways, Roads and Highways); 21.4% for Defense and 7.2% (mostly BSNL for 5G roll out).

As the former finance secretary Mr. S. C. Garg, highlighted in FY22 NHAI incurred a capex of Rs1.22trn in FY22. This investment was funded by Rs573.5bn budgetary support and Rs650bn borrowing and other resources raised by NHAI. FY23BE provides Rs1.34trn for NHAI. This means the government has substituted NHAI’s borrowings for capital expenditure. Thus, while the government account depict Rs636bn higher capex on roads in FY23BE, in fact the rise in actual capex may only be Rs120bn over FY22.

Besides, FY22BE provided Rs141.15bn for BSNL capex. However, FY22RE shows that the government did not provide any assistance for BSNL. FY23BE provides for Rs447.2bn for BSNL capex, the entire amount. This means like NHAI, BSNL may also be finding it hard to raise resources for their capex.

The green bonds proposed in the budget are primarily borrowings for PSEs like NHPC, NTPC, IREDA etc. to fund green energy projects. Earlier these entities used to borrow on their own books.

Given that there has been hardly any private capex in the roads sector in the past 7yrs, and now NHAI becoming dependent on the central government for all its capex, the quality of overall capex is likely to deteriorate only. The fall in overall PSE capex and failure of the government in disinvesting these PSEs is going to be a major challenge for the government.

Key sectors get nothing for capex

The finance minister said in her speech “For farmers to adopt suitable varieties of fruits and vegetables, and to use appropriate production and harvesting techniques, our government will provide a comprehensive package with participation of state governments.”

The budget allocation for capex on Food Processing is Rs ZERO.

Tourism has been one of the favorite sectors of our prime minister for growth and generating employment.

The budget allocation for capex on the tourism sector is Rs ZERO.

The finance minister said in her speech, “Implementation of the Ken-Betwa Link Project, at an estimated cost of ` 44,605 crore will be taken up. This is aimed at providing irrigation benefits to 9.08 lakh hectare of farmers’ lands, drinking water supply for 62 lakh people, 103 MW of Hydro, and 27 MW of solar power. Allocations of `4,300crore in RE 2021-22 and `1,400crore in 2022-23 have been made for this project.”

The budget allocation for Jal Shakti ministry is merely Rs4.2bn. This includes allocation for the ambitious Nal se Jal (Tap Water) program.

Electronics & IT (Rs3.9bn); Science & technology (Rs0.95bn); Agriculture (Rs0.4bn); Education (Rs 0.18bn); Renewable Energy (Rs0.12bn)  Sports (Rs0.05bn); etc. are some of the departments that get paltry allocations contrary to the government’s stated priorities.

Obviously markets are regretting their instant reactions to the budget.