Do it yourself

Thursday, December 18, 2014

2015: Household savings - lower inflation offers little respite

Thought for the day

"As much as I converse with sages and heroes, they have very little of my love and admiration. I long for rural and domestic scene, for the warbling of birds and the prattling of my children."

- John Adams (American, 1735-1826)

Word for the day

Bespoke (adj)

Made to individual order; custom-made.

(Source: Dictionary.com)

Teaser for the day

Will someone tell HRD Minister that "It is definitely not about your idea of "what is right for Indian kids".

2015: Household savings - lower inflation offers little respite

In my view change in domestic savings pattern in past one decade is cause of concern for Indian macroeconomic fundamentals.

Traditionally, domestic savings, especially household savings, have been a stable and sustainable source of funding for both private as well public investments. Though liberalization of capital controls has opened the doors for foreign capital. It still is not a major source of funding.

Source: Planning Commission

More particularly, the decline in financial savings of households that begun in early 2000's has accelerated in recent years. This has serious implications for the economy and therefore equity markets.

I believe household investors had began meaningful investment in listed equity in late 70’s at the time of FERA dilution of MNCs. Reliance in 80’s and PSU disinvestment and capital market reforms in early 90’s drew the 2^ndlot of household investors. IT boom of late 90’s drew the 3^rdset to listed equity. In these 3decades households invested 8-17% of their financial savings in capital market related products.

Though the household financial savings started declining from mid 1990’s, 2000 was the key inflection point. Since then household have invested more in physical asserts than financial instruments.

The key cause for this trend could be listed as follows:

(a) Fall in average age of house ownership. Higher income levels in urban areas, rise in nuclear families and rise in real estate prices has prompted people to buy houses earlier in their life cycle.

(b) Rise in personal automobile ownership.

(c) Low growth in white collar employment opportunities as compared to growth in workforce has led to phenomenal rise in self owned enterprises leading to diversion of savings to physical assets.

(d) Rise in gold prices in 2000’s has definitely contributed to the trend.

(e) Persistent negative real rates.

I do not see any reason why this trend will reverse in 2015. In fact there are reasons to believe that household savings may diminish further in next couple of reasons. For example consider the following:

(a) Consumer prices for households will remain high. Expenses on items like education, health, energy, transportation, communication, rental, protein, and fruit and vegetable shall continue to rise disproportionate to rise in income. Hence the savings may decline further.

(b) Implementation of GST will reverse the wealth transfer for at least couple of years. Lower revenue for the government, hence lower social welfare spending growth; higher incidence of service tax; disruption of thousands of household businesses to the advantage of large organized players; employment restructuring as redundancies rise on a massive scale and skill requirement change.

(c) Factors like lower investment growth, higher productivity gains through automation & elimination of redundancies, restructuring of PSUs shall continue to impact the employment growth, especially for skilled labor.

(d) Lower employment opportunity may force more and more people towards self-enterprise, leading to higher household debt.

(e) Given the sluggish credit growth outlook for at least 1H2015, the deposit rate may decline further, thus de-motivating higher savings.

(f) Last but not the least, the trend for changes in consumption pattern shall continue. Bicycle and Transistor Radio have definitely given way to motor cycle and smart phone as essential marriage gift (dowry) in hinterland. The running expenses are to be paid by someone after all - be it the bridegroom, his parents or the bride's parents.

The economic growth will have to find an alternative source of funding (no capital control) or a way to grow household savings (lower taxes, higher rates, cheaper houses/rent, good public health/education/transport, and farm employment).

I have not seen any proposal for either as yet.

Wednesday, December 17, 2014

2015: Investment cycle not seen reviving in 1H2015 at least

Thought for the day

"The happiness of society is the end of government."

- John Adams (American, 1735-1826)

Word for the day

Fait accompli (n)

An accomplished and presumably irreversible deed or fact.

(Source: Dictionary.com)

Teaser for the day

The wheel turns full cycle. "The Parrot" to make its master sing

2015: Investment cycle not seen reviving in 1H2015 at least

Reviving the stalled investment cycle is the key to the myriad of problems Indian economy is facing at this point in time, in my view. Simple, as it may sound; this is the toughest challenge before the government, RBI and the business community.

In my view, the investment cycle in India is stalled not just due to normal economic cyclicality. It is congregation of a number of socio-economic and political factors.

Mostly ignoring sustainability concerns, poor demand assessment, political impropriety and banker-entrepreneur connivance have led to serious misallocation of capital and piling up of unviable projects. Irrational and random political resistance to foreign capital has also impacted the investment environment in the country.

Y2K led global ITeS boom, easy credit led private investment surge, Cheap Chinese import led consumer spending and massive government spend on infrastructure funded by public sector and deficit financing created a mirage of India shining. The unsustainable higher income-higher consumption and savings-higher investment effect of all this reflected in data with a lag during early years of UPA I regime (2004-2007).

The real problem however is that all this liberalization, investment etc. was done (a) without creating any conceptual framework; (b) without instituting adequate and appropriate institutional and regulatory framework; (c) without addressing sustainability concerns; and (d) without making appropriate financial viability study. This all led to:

· Rampant corruption in public offices, as allocation of liberalized national resources to private parties was left mostly at the discretion of politicians;

· Widespread obstructions and delays in execution of mega projects as these projects conflicted with the sustainability objective and environmental concerns;

· Advancement of future investment demand impeding financial viability of projects and creating massive stress in financial system;

· Decimation of domestic SME and household sectors which could not compete with cheap Chinese imports leading to structural pressure on currency; current account and general employment level;

· Unmanageable rise in aspirations of youth population leading to substantial changes in consumption patterns and thus pressuring household savings and consumer prices;

· Sharp rise in rural land prices making food inflation a structural problem.

The consequences are:

(a) Most of the infra developers and operators are facing serious credit worthiness issues. They are not in a position to undertake further projects, while the existing projects are either stalled midway or have become unviable due to a variety of issues.

It is important to note that many of these projects have been unviable ab initio though few would like to admit.

(b) Banks are not willing to extend further credit to core sector. The stated reasons are poor balance sheet and financial unviability of projects. The unstated reason include the fear and extreme risk aversion amongst individual bankers, which is quintessentially an outcome of past excesses.

(c) Erosion of banks' capital base is also a major hindrance in kick starting the investment cycle. Fiscal constraints of the main promoter (the Government of India); persistent failure in labor management (unions resisting diluting government stake) hinder recapitalization of public sector banks.

On the other hand as I write this, a number of large corporate have already reneged or are on the verge of defaulting on their covenants. The amount of accommodation loans masqueraded as restructured loan to protract the default technically are staggering.

A few balance sheets which are strong have the option to choose between acquiring an operating or partially built asset at favorable terms or undertake a green field project. To me the choice is but obvious. So how the fresh investment cycle will get started?

Moreover, we are entering a phase when 2-3years down the line easy credit situation prevalent in western world may cease. The cost of capital will start rising for already troubled businesses.

The long term solution lies in opening the Indian markets to open global competition. The government may provide support to businesses which have demonstrated their capability to compete with global players. The inefficient and incompetent should be allowed to fail.

In the short term however, the government will have to undertake the onus of kick starting investment cycle on itself. The best way would be create social sector infrastructure, e.g., education, skill development, water, sanitation and healthcare. The government has rightly initiated some programs in this direction. The faster and efficient implementation is the key.

Do not expect any meaningful investment happening in 1H2015.

Tuesday, December 16, 2014

2015: 10 things to watch

Thought for the day

"While all other sciences have advanced, that of government is at a standstill - little better understood, little better practiced now than three or four thousand years ago."

- John Adams (American, 1735-1826)

Word for the day

Querulous (Adj)

Apt to find fault; habitually complaining.

(Source: Dictionary.com)

Teaser for the day

Why listenership of "Man Ki Baat" is dwindling with each episode?

Is PM not talking what we want to hear?

2015: 10 things to watch

In my view, regardless of the jitteriness of the markets during last week, it is worthwhile to discuss a strategy for next year or may be two. The exercise may look little less interesting at this point in time; still it is worth undertaking in order to suitably calibrate (a) asset allocation (b) return expectations and (c) sectoral preferences.

In my view, the following 10 key factors are critical for the Indian financial markets, in particular, in next 12-18 months. Investors therefore would want to keep a close watch on these. Prima facie, these factors are very generic and may offer no great insight. But, I would like to watch of these from my colored glasses and see through them the emerging trends.

(1) Revival of investment cycle

In my view, it will depend on a host of factors like credit worthiness of borrowers and project undertakers, extent of bank capitalization, viability of infra sector projects, policy support and investor's risk appetite to name a few.

(2) Household savings

Employment growth and household inflation would be key deciding factors.

(3) Rural Income

Rural wage growth and monsoon are key factors to watch.

(4) Corporate earnings

Pricing power led by demand growth and higher utilization needs to watched.

(5) INR movement

Restoring faith of Indian investors and NRIs in INR strength, USD relative strength and current account management are the key factors that need to be watched.

(6) Bond yields

Credit demand growth & fiscal prudence would be key factor to watch.

(7) Political will

The political will to pursue radical reforms and faster growth agenda would be a key determinate of the future growth trajectory

(8) Global economic growth

In particular price stability and consumer demand growth will be the key.

(9) Global flows

(10) Technical trends

In next few days I shall discuss each of these factors in some detail.

Monday, December 15, 2014

The longest hour

Thought for the day

"Our Constitution was made only for a moral and religious people. It is wholly inadequate to the government of any other. "

- John Adams (American, 1735-1826)

Word for the day

Efface (V, trn)

To cause to disappear by rubbing out, striking out, etc.; to erase; to render illegible or indiscernible.

(Source: Dictionary.com)

Teaser for the day

I dare all champions of Hindu cause to visit Vrindavan during rains!

The longest hour

This morning the financial market place seem more like a war front to me; where the next one hour seems much more critical than the next day and no one seems interested in talking or listening about next one month or next one year. Survival is the key here not the longevity.

Writing a strategy about next one year under the circumstance seems like a hazardous task to me. Nonetheless, moving with the heard, I would like to foresee the events in the womb of time and bet my money on some of the events which I feel are most likely to occur.

I am encouraged by the fact that despite all grave accusation and great provocations, I maintained my NIL weight to commodities, underweight to infrastructure & financial, and overweigh to consumers and exporters stance throughout the year.

I am also satisfied by not getting carried away by the change in government in India and insisting on first seeing the change on ground before betting on my money on broader economic growth trade.

I have always maintained that historically, a large majority of Indian businesses have grown on government patronage and/or resource arbitrage opportunities and have been low on innovation, productivity and scale. The politically advantageous socialistic façade of the government, especially during 1950-1990 led to misallocation of resources, trade and capital controls, demand suppression, and protectionism that promoted low productivity. The conditions have changed in past 10-15years but not sufficiently to make a majority of Indian businesses globally competitive.

The following trends, which are quite likely to strengthen in next few years, would suggest that a large number of small, over protected, less productive, uncompetitive, under-capitalized businesses should become extinct in next decade or so.

In past two decades we have seen this happening with small steel and cement plants, textile manufacturers, petrochemical plants, numerous public sector undertakings, NBFCs, etc.

There is no reason why it should not happen to (a) small and mid-sized engineering and construction companies which purely survive on administrative patronage: (b) ITeS providers who are pure commodity plays solely focused on wage arbitrage opportunities; (c) mid-sized commodity producers who cannot scale up to compete with global corporations in a more open, price & quality competitive and transparent market; (d) intermediaries who are not adequately capitalized and technologically prepared to serve or compete with large global businesses which are highly price sensitive, etc.

Over next few days, I will present my thoughts on various issues concerning investors.

Friday, December 12, 2014

May Sensex tread its own random path

Thought for the day

"Public opinion is the thermometer a monarch should constantly consult."

- Napoleon Bonaparte (French, 1769-1821)

Word for the day

Happenstance (n)

A chance happening or event.

(Source: Dictionary.com)

Teaser for the day

J&K beats Mumbai in cricket!

Will it also do so in democracy, by giving a clear mandate?

May Sensex tread its own random path

The recent CII "in-camera" meeting has evoked considerable interest in media and market circles. The selective leaks and euphemistic explanations somehow reminded me of the Hans Christian Andersen's story "The Emperor's New Clothes".

From what appeared in media, it looks that the Indian industrialists are already skeptical of the capabilities of the new government. Many in industry are apparently beginning to believe that the Modi led government is not doing enough or doing things the wrong way, but no one has the courage to speak up openly.

The cynicism, in my view, is flowing from the fact that at once everyone believed that the PM Modi will be able to implement his Laissez-faire or free market theory based economic model almost immediately at the national level. Regardless of the fact that he could implement the model in Gujarat only with limited success. Even though, unlike many other states, Gujarat has a history of 200years of industrialization and 60mn people who are globally recognized for their enterprising skills.

To give some concession, many captains of industry have advocated grant of reasonable time for bringing effective changes in traditional Nehruvian socialist model to the desired Laissez-faire.

But the zest with which they seek "reforms" almost immediately dissipates when you mention the words "Nira Radia", "Coal Gate", "2-G Spectrum" in front of them.

In my view, considering the present state of socio-economic development of various parts of the country, it is 10-15years too early to test the Laissez-faire model at the pan-India level. Hence, presently, Modi’s Gujarat model may not be of much relevance at the national level.

But at the same time I do not see the Gujarat model as PM Modi's limitation also. PM Modi has very successfully demonstrated his strategy skills in past one decade. It would be totally wrong to assume that he would not be able to adapt to the larger responsibility and formulate an appropriate strategy for integrated development of the country.

However, the proposal like dismantling the Planning Commission without having a concrete idea and or without putting in place a conceptual framework for the alternative mechanism will only erode his credibility.

The daily patterns emerging at Sensex technical chart do not worry me. 30K, 20K, 50K or 100k are just numbers which may temporarily concern a miniscule proportion of population. What worries me is affording too much importance to this number. Anecdotally, I know that too much focus on stock market has only brought many distortions in the policy.

I believe that the new government is merely a reflection of the people's desire for change - change in the way this country and economy has been run so far. The change will take place at the speed and in the direction the people at large are comfortable with. May the Sensex chart tread its own random path.

Thursday, December 11, 2014

Show me the Dollars

Thought for the day

" When small men attempt great enterprises, they always end by reducing them to the level of their mediocrity."

- Napoleon Bonaparte (French, 1769-1821)

Word for the day

Philosophaster (n)

A person who has only a superficial knowledge of philosophy or who feigns a knowledge he or she does not possess.

(Source: Dictionary.com)

Teaser for the day

ET headline yesterday talked about an in-camera meeting of CII, where a critical evaluation of government's performance was made.

Are they scared of Modi?

If yes, why?

Show me the Dollars

In the summer of 2007, I had just moved to the financial capital Mumbai from the political capital Delhi. The mood was as buoyant as it could be. Everyday plane loads of foreign investors and NRIs would alight at Mumbai airport with bagful of Dollars. They would spend two hours in sweltering heat to reach the then CBD Nariman point (Worli Sea link was not there and BKC was still underdeveloped), and virtually stand in queue to get a deal where they can burn those greenbacks.

Mumbai properties were selling like hot cakes. Every day one used to hear some mega property deal. NRIs from middle east, Europe and US were buying properties without even bothering to have a look at them.

Bank were hiring jokers for USD 100 to 500k salary for doing nothing. I was of course one of these jokers!

That was the time, when sub-prime crisis has just started to grab headlines. Indian economic cycle started turning down in spring of 2007, with inflation raising its head. RBI had already started tightening. Bubble was already blown and waiting for the pin that would burst it.

INR appreciated more than 10% vs. USD in first six months of 2007.

INR depreciated over 75% during period from January 2008 to August 2013. This was the time when Fed was printing USD at an unprecedented rate. There was no shortage of EUR, GBP and JPY either.

The point I am making is that in the present times when most globally relevant central bankers are using unconventional policy measures to stabilize their respective economies, the value of currency is seldom a function of demand and supply alone.

Regardless of the economic theory, it is the faith of people in a particular currency that is primary determinate of its relative exchange value.

2005-2007 was the time when the Indians had developed good faith in their currency. Local people were happy retaining their wealth in INR assets, despite liberal remittance regulations and NRIs were eager to convert a part of their USD holding in INR assets.

The situation changed 2010 onwards. There is no sign of reversal yet. Despite huge popularity of Narendra Modi amongst overseas Indians, we have not seen any material change in remittance pattern in past six months. Despite tighter regulations, local people appear keen to diversify their INR assets.

Most of the USD inflows have come from "professional investors" who invest others' money to earn their salaries and bonuses. These flows are bound to chase the flavor of the day, not necessarily the best investment. Whereas the outflows are mostly personal, or by corporates with material promoters' stakes.

In my view, no amount of FII/FDI money can strengthen INR if Indian do not have faith in their own currency. Yield and inflation have become secondary considerations.

Wednesday, December 10, 2014

Cart leading the horse

Thought for the day

"I am sometimes a fox and sometimes a lion. The whole secret of government lies in knowing when to be the one or the other. "

- Napoleon Bonaparte (French, 1769-1821)

Word for the day

Nonage (n)

A period of youth or immaturity.

(Source: Dictionary.com)

Teaser for the day

Lehman Bros. was crucified in the financial collapse of 2008!

Who will it be in the commodities' collapse of 2015?

Cart leading the horse

The elementary principle of economics is that the price of a thing that has any economic value is determined by the forces of demand and supply. Often in the short term a state of inequilibrium does exist leading to volatility in prices. However, the equilibrium is usually restored by operation of a variety of factors.

There is no denial that economics is youngest amongst the scientific discipline and pure scientist hesitate in admitting it as a discipline of science. Nonetheless it is evolving fast and becoming popular.

Not getting into this academic debate, what I have understood is that in popular economics theory:

(a) Price of currency is usually a function of demand and supply of that currency at any given point in time. Higher supply should normally leads to lower exchange value and vice versa. The demand of the currency is determined by the relative real rate of return (interest) and level of economic in the parent jurisdiction.

(b) Price for a particular commodity is determined by the demand and supply conditions of that commodity at any given point in time. The demand of commodities fluctuates as per the level of economic activity in the consuming jurisdiction, export demand and outlook for the foreseeable future. The supply of commodities may fluctuate due to a variety of reason - local to the producing jurisdiction as well global.

(c) Interest rates are usually function of demand and supply of the money in the monetary system. Demand for money is again impacted by the level of economic activity and outlook in foreseeable future. Whereas supply of money is mostly a function of risk perception and relative return.

The traits of human behavior like "greed", "fear", "complacence", "renunciation", and "aspirations" have all been accounted as the balancing factors for demand and supply and not considered as determinates of price as such. This in my view is the cause of most problems facing global economy in the present times.

Consequently, the business of forecasting has become extremely difficult and fraught with risk.

In past two months I have seen hundreds of reports forecasting price of commodities, most notably crude oil; currencies, most notably USD and JPY; interest rates, most notably US policy rates.

Most of these forecast appear mere extrapolation of the current price trend and hence do not inspire any confidence.

In Indian context, exchange value of INR, 10yr benchmark yield and crude oil prices evoke much interest. Interestingly most economic growth forecasts appear predicated on these, whereas logically it should be the other way round.

...to continue tomorrow

Tuesday, December 9, 2014

Kal ho na ho!

Thought for the day

"Never interrupt your enemy when he is making a mistake. "

- Napoleon Bonaparte (French, 1769-1821)

Word for the day

Cant (n)

To talk hypocritically.

To speak in the whining or singsong tone of a beggar; beg.

(Source: Dictionary.com)

Teaser for the day

Declare "Bhagvat Gita" as a National Book!

What does it mean-

(a) Honor Gita and Lord Krishna; and/or

(b) Give recognition to Gita; and/or

(c) Honor India and Indians?

I feel it is a blasphemous idea!

Kal ho na ho!

The Chandershekhar government in 1991 originated the idea of disinvestment in public sector enterprises (PSE) with the stated objective to “broad based the equity, improve management and enhance the availability of resources for these enterprises”. In April 1993 the Rangrajan Committee that was set up to make recommendation on the issue of disinvestment, made some radical suggestions which obviously remained unimplemented. The NDA-II government led by Atal Behari Vajpayee added the term privatization to disinvestment policy in 1999.

During Vajpayee regime some serious work did happen with regard to disinvestment. The best part was that the government of the day bravely and rightly focused more on "Divestment of Monopolies" as against mere "Disinvestment of Minority stake in PSEs".

The government sought to divest its monopoly over core businesses like ports, airports, coal, power, oil and gas exploration and production, roads, mobile telephony, data transmission, etc. It started the process in right earnest. However, the problem was that most of this endeavor lacked any conceptual framework.

Consequently, we constructed bridges where there was no river.

As we discovered a decade later, lack of a strong conceptual and regulatory framework eventually led to huge losses to government, banks, investment and entrepreneurs due to numerous scams, non-viability and unsustainability of projects, and legal hurdles.

It is pertinent to note here that post liberalization of trade and commerce in 1990’s, the maximum employment and investment growth has occurred in private enterprises. In particular self employed entrepreneurs have increased exponentially in the country. This coincided with the sharp fall in public sector employment. The aggregate private sector employment level has not been able to compensate for fewer opportunities available in public and unincorporated private sector. Consequently, the total number of employees on live payrolls has fallen sharply since early 2000’s.

Failure to adequately address the employment issue, i.e., creating alternative opportunities in lieu of declining public sector and government employment, has led to failure of disinvestment plans in once profitable and in demand PSEs like BSNL and Air India. Labor unions have also hindered the restructuring of Coal India (which in my view is sprinting fast to join BSNL in the blind alley), and capitalization plans of most public sector banks.

I have seen that in past five years, many investors have been vary of investing in PSEs. The primary reason is total and utter disregard of minority shareholders by the government, in not running these enterprises strictly on the sound and prudent commercial principles. Exploitation of oil sector companies to meet political ends is just an example in case.

To sum up, my suggestion is that government should DIVEST most of its businesses when going is good with the world swashed with liquidity. For all you know kal ho na ho. Selling 5-10% would not help anyone.