Do it yourself

Thursday, February 19, 2015

Elephant and the blind folded men

Thought for the day

"Be not astonished at new ideas; for it is well known to you that a thing does not therefore cease to be true because it is not accepted by many."

- Spinoza (Dutch 1632-1677)

Word for the day

Maudlin (adj)

Tearfully or excessively sentimental.

(Source: Dictionary.com)

Teaser for the day

If you are here only to serve people then why do you need the designations like "Deputy CM" (not provided for even in the Constitution)?

Elephant and the blind folded men

The presentation of Union Budget on last working day of the February month every year is one British Legacy we have chosen to retain and nurture. The only change in the practice from the Raj period is that now the budget speech is read at Indian noon against the British noon.

Over the years I have observed the demeanor of various finance ministers carrying that cherry color suitcase containing budget document to the Parliament House and reading the budget speech. Regardless of their social, professional, economic or political background - they bear a distinct feudal look reflecting a sense of "Giver" to the subjects - rich and poor alike.

In my view, giving so much importance to the annual budget of the Union Government itself dissipates the importance of the Budget.

Budgeting is indubitably an important tool of financial planning and management. However, it may prove seriously counterproductive if this exercise in not continuous and dynamic.

It certainly defeats the purpose of an efficient government and good governance if a good and urgent idea has to wait till next April for implementation or a grave mistake in the tax laws has to wait for one year to get rectified.

Insofar as expectations of various sections of people from the Union Budget are concerned, I have concluded, after many years of observation, survey and analysis, that it is exactly like the story of Elephant and six blind folded people. Consider this:

(a) The Union Budget is presented in two parts - (a) The first part is the Budget of the Union government detailing from where the government will raise funds and how these funds will be spent on various administrative, developmental and social activities; and (b) The second part relates exclusively to the tax provision, i.e., how the government proposes to raise revenue from taxation.

(b) The urban middle classes, especially salaried people, are mostly interested in tax rebates on income from salary, house properties and investments. They are usually not keen to know about social sector and development expenditure.

(c) Businessmen are usually keen to hear about concessions in indirect taxes and incentive for investment. They do look for some business opportunities in social and infrastructure expenditure budget. However, most of them who do not see an opportunity for themselves find such expenditure wasteful if it would lead to higher fiscal deficit and hence higher government borrowing and therefore higher rate of interest.

(d) About 90% of the country's population which does not pay any direct tax does not look forward to the Budget. Although they are keen to know what more subsidies are being provided for them, they wait till the "Schemes" are actually implemented to get excited about that.

(e) Economists are interested in knowing a lot of things, but usually watch the figure of fiscal deficit and means to fund that deficit.

Social economists (usually left leaning academicians) are usually not concerned about fiscal deficit and want the government to spend more on poverty alleviation and development of social sector infrastructure in order to impart social justice and minimize economic inequalities.

On the other hand the market economists are seriously concerned about fiscal deficit, government borrowing to fund such deficit and ratio of expenditure on social and physical infrastructure.

Spending US$20bn on food security is a serious reform for the social economists, whereas it might be an unpardonable crime in view of market economists, given the current fiscal gap.

(f) Traders in stock market only wish for lower taxes that may cause a short term bounce in stock prices, even for a day or two. Whereas bond traders expect tight fiscal discipline that will cause a bounce in bond prices in the short term. They hardly care even for three month impact of budget provisions.

(g) Foreign investors look at the budget from an extremely myopic angle. They expect the government to allow them more concessions and freedom to operate in the country. Protection of their investment and promotion of their vested interest is their only concern.

(h) Professionals, regardless of their public posturing, take sadist pleasure in finance minister's silly mistakes in writing the tax provisions. This allows them to explore loop holes to save taxes for their clients. This also triggers more litigation allowing them to make more money.

(i) Politicians from ruling party expect the budget to buy votes for them through populist measures. They could not care less for things like fiscal prudence, etc. Whereas the politicians from the opposition benches

The point I am trying to make here is that "Big Bang Reform" which the people are talking about and expecting seriously, is not the same for all. It has widely divergent and often contradictory meaning for various stakeholders.

It is obviously not possible for any finance minister to please all; though sometime they do try and end up making everyone unhappy. Mostly, however they stick to pleasing their political constituency.

Fiscal discipline, market prudence, investor friendliness, etc. may be incidental and not the desired outcome of the Union Budget.

...to continue

Wednesday, February 18, 2015

The big bang theory

Thought for the day

"Those who are believed to be most abject and humble are usually most ambitious and envious."

- Spinoza (Dutch 1632-1677)

Word for the day

Belie (v)

To show to be false; contradict.

(Source: Dictionary.com)

Teaser for the day

ICC World Cup gives much needed breathing space to AAP and AK.

Media at least is not bothered about what they do, and for that matter do not do, in next six weeks.

The big bang theory

The NDA regime led by Atal Bihari Vajpayee (1998-2004) is remembered, in market parlance, for its big and bold decisions. The tenure started with the big blast (May 1998 nuclear test) and was punctuated by major initiatives like NELP (hydrocarbon exploration), SEZ (key reforms in land, labor and tax laws in select zones), NHDP (highways), PMGSY (rural roads), AAY (food security for poor), SGRY (employment for rural poor), SSA (primary education for all), airports privatization, port privatization, Electricity Act 2003, spread of mobile telephoney, 100% FDI in core sectors, etc.

These initiatives excited the global investors at a time when Indian IT professionals were making big impression on global technology canvass. A supportive regime, Y2K problem, easy credit post LTCM and Asian crisis (rates lowest since 1970s) and depressed commodity prices (inflation lowest in decades) helped big investment initiatives.

The problem was that many of these programs were initiated hurriedly without putting an adequate institutional mechanism in place, thus leaving the scope for misuse (of discretionary powers by minister and bureaucrats), litigation (ownership of natural resources), misappropriation (of natural resources by scrupulous allottees), non-compliance (environment and sustainability norms) and wide viability gaps (in absence of immediate demand) and thus planting the seeds of financial stress, economic slowdown, mistrust and corruption we are witnessing today. Subsequent UPA government watered and nourished these seeds well.

Now, having learned from the mistakes of omission and commission made and follies committed during past two decades, Indian businessmen and investors are hoping (or should I say assuming!) that new leadership will carry further the “big bang” initiatives minus the follies, and thus reinvigorate the Indian economy.

I am fully with them in their hopes and assumptions.

However, the only caveat is that the new leadership will not be able to plant the seeds of prosperity unless the field is cleared of the poisonous crop of mistrust, misdeeds, and misallocations that has taken deep roots. Like Chankaya the new regime will have to first uproot these plants and appropriately inoculate the soil.

This is not going to be easy. It will cause tremendous pain to investors and entrepreneurs, and disruption of business activity and financial stress.

We have seen some glimpses of this cancelling of telecom licenses by the Supreme Court, deallocation coal blocks by the government, de-notifiaction of a number of SEZs, withdrawal of investment proposals by road developers and steel companies and rising financial stress in the economy.

PSB results of past two quarters are indicative of this. We shall see more of these. IDBI, ICICI, IFCI, UTI all stand witness to what happened when last time these correction were carried out.

That is not exactly good news for someone looking for immediate gains in stock market....more on this tomorrow

Finding the disconnect

Thought for the day

"It was the best of times, it was the worst of times."

- Charles Dickens (English, 1812-1870)

Word for the day

Commensal (adj)

Eating together at the same table.

(Source: Dictionary.com)

Teaser for the day

Who should be most worried about the massive anti-corruption, secular, class agnostic mandate in Delhi:

(a) BJP, SAD, SS

(b) Janta Parivar

(c) TMC, NCP, NC, DMK

(d) INC

Finding the disconnect

I always believed that the potential impact of "global crisis" should be assessed in terms of likely human suffering such crisis would cause.

Regardless of the media coverage, financial market volatility and political rhetoric - a geo-political, economic, natural, medical or financial crisis which does not cause large scale human suffering usually does not leave any lasting impact on global order and is forgotten soon.

I would put Y2K, 2008-09 global financial crisis, Nuclear accident in Japan, Storms in US, Ebola breakout etc. in this category.

Remember, the crisis in Iceland, Ireland, Portugal, Greece etc. caused havoc in global financial markets during 2008-2010. But considering the miniscule population of these nations, the impact of that crisis lasted just for a while and caused little change in the global order.

On the other hand, a crisis that causes large scale human suffering have deeper repercussions and usually catalyze lasting changes in global order.

I would put the two big wars, AIDS, struggle in middle east, etc. in this category. These crisis have inflicted serious suffering upon humanity and therefore led to lasting changes in the world order.

The ongoing global crisis qualifies, in my view, to be placed in the second category. The rising unemployment in Europe and most commodity dependent economies in Asia, Africa and Latin America, declining growth in China, rising inequality in developed countries especially USA, substantial cut in developmental aid to least developed nations due to fiscal pressure, rise in incidence of terror related violence is causing widespread human suffering that is likely to only exacerbate in next few years.

Actually I would readily agree, if someone wants to argue that the current crisis is just an extension of the events in 2008-09. This changes nothing in the basic premise; given that during 2008-2011 the emerging markets (which also happen to be the most populated countries of the world) actually did well, the human suffering quotient of the crisis has risen only recently.

I have no doubts in my mind that this will cause material changes in global order in next couple of decades.

If I may take the liberty of applying this ratio to the India's internal conditions, historically the rise in human suffering has caused dramatic changes in the political milieu of the country. We had experienced this in 1970s and 1990s. We are witnessing something similar now.

I would like to examine the loss of TDP in Andhra and NDA at center in 2004, and victories of BJP in 2014 and AAP in 2015 under this light. Remember Chandrababu Naidu (Andhra, 2004) and A. B. Vajpayee (National, 2004) and BJP (Delhi, 2015) went into election as widely acknowledged champions of development and good governance but lost poorly.

Prima facie, their development agenda did not connect properly with the index of human suffering.

Till it happens, I'm staying put

Thought for the day

"The whole difference between construction and creation is exactly this: that a thing constructed can only be loved after it is constructed; but a thing created is loved before it exists."

- Charles Dickens (English, 1812-1870)

Word for the day

Canard (n)

An unfounded, false, or fabricated report or story.

(Source: Dictionary.com)

Teaser for the day

Over to Patna, via Perth.

Till it happens, I'm staying put

Analyzing the current market trends I get few signals that suggest that a major correction (10% or more) though not imminent is certainly on its way.

I say not imminent, because, the sectors that could have caused a slump have already corrected sharply.

From their recent highs (which incidentally happen to be 52w high levels also) CNX Metal Index is down ~30%, CNX Energy Index is down ~20%, CNX Realty Index is down ~25% and CNX PSU Bank Index is down ~18%. These sectors are representative of the poor demand environment, elevated stress in the financial system, global deflationary conditions and poor risk appetite.

Besides, The implied volatility of Indian equities, as represented by India VIX, has almost doubled in past couple of months, with material pick up in option volumes. The cash volumes though remain to their yearly average.

Going by the current trends, a further correction of 10% in the mentioned sectors may cause not more than 3-4% correction in benchmark indices. To the contrary, in strict technical terms, these sectors in fact appear deeply oversold and ready for a bounce back.

It would therefore be not unreasonable to say that the technically market is close to bottom and may stage a traditional pre-budget rally in next two weeks. The traders may however would need to keep a close watch on the development in Europe for any sudden shock.

I also feel that a deeper and more meaningful correction is on its way and may occur in historically weak market period of May and June. I say so for five simple reasons.

(a) The number of large daily movement in benchmark indices on closing as well as intraday basis has increased substantially in past three months.

(Please note large inter/intraday movements of 3-5% preceded the 1991-1992, 2000-2001, 2007-2009 market collapse.)

(b) There are clear category preferences visible in investors' activities along with unreasonably higher valuation in preferred categories. Normally a sign of bubble in the market.

(c) Policy focus is driven by market and market is obsessed with policy focus. Usually this harmony of market and policy is unsustainable - because it leads to misallocation of resources and higher volatility due to political events.

(d) Lower interest rates are driving retail investors to equities. Traditionally a sign of market peaking.

(e) US rate hike discussion will intensify in April-May period causing accelerated reversal in USD carry trade.

I will be happiest person on this earth to be proven thoroughly wrong on this count. But till it happens, I shall hold this view.

Flipping the kart

Thought for the day

"There is nothing so strong or safe in an emergency of life as the simple truth."

- Charles Dickens (English, 1812-1870)

Word for the day

Sinecure (n)

An office or position that requires or involves little or no responsibility, work, or active service.

(Source: Dictionary.com)

Teaser for the day

For those who are overexcited about Delhi results - please note that BJP did not get simple majority on his own in Maharashtra, Jharkhand and J&K.

So what's the big deal!

Flipping the kart

While assessing the political mood of Delhi post exit polls I had a chance to meet group of traders in Delhi. Though mostly in their 30s and 40s, almost all these traders belonged to families which have been engaged in trading business for more than two generations.

Though the subject of discussion was Delhi politics, it somehow took a turn towards the existential threat this group perceives from the phenomenal growth recorded by e-retailing business in India.

All the members of the group felt that the core of the e-retailing business in India lies is the ability to sell cheaper than traditional retail. Convenience, more choice and greater accessibility are supporting factor, but "price" remains the key factor. Nonetheless, most of them have joined the bandwagon as supplier.

I am no expert of retail business in the country. But if the views of these experienced traders are any indication - e-retailing is fast turning India into a traders' and arbitrageur's economy. This is not congruous with the objective of the government to promote manufacturing in the country.

From my little knowledge I understand that e-market places would continue to need huge capital for investing in technology and delivery infrastructure. Given their business model of negative operating cash flows for a considerable period of time, debt may not be a viable option. So these ventures will obviously be high equity and low RoE models. Moreover, the business model is also shifting towards independent logistic support and non-exclusive suppliers, lowering the entry barriers.

The current trends suggest that initial investors may have multiplied their investments already, but eventual investor might be stuck with a business that (a) yields less than bank fixed deposit; (b) has low or no entry barrier; (c) owns little in terms of tangible assets; and (d) remains capital intensive forever.

Stretching the logic a little further - as a high volume but low (presently negative) margin business e-retailing shall keep the manufacturers margin under stress. Unless we have huge factories that can produce good quality stuff at really low cost (an advantage enjoyed by Alibaba in China) e-market places would continue to burn cash and keep economy under pressure.

I am trying to understand the "consumer is winner" notion of e-retailing also. If this business model subsidizes the "product prices" through lower wages, rentals, return on equity, quality of product, & traders' margin, with consistently higher viability risk, on the whole consumer may not be a winner.

Though not strictly comparable, we have seen this in power sector. Unviable price bidding for power projects has not benefitted consumers eventually.

I guess, the business so far has grown in a very localized way, without any holistic planning. This is a brilliant tool to handle the problems of accessibility, congestion, competiveness, logistic inadequacies, supply chain optimization etc. But unless it is fully integrated with town planning, manufacturing, Exim trade policy and taxation regime - the outcome may not be optimum.

Get an idea, Sir

Thought for the day

"It was one of those March days when the sun shines hot and the wind blows cold: when it is summer in the light, and winter in the shade."

- Charles Dickens (English, 1812-1870)

Word for the day

Voluble (adj)

Characterized by a ready flow of speech.

(Source: Dictionary.com)

Teaser for the day

Tell me why Delhi assembly election results should reverberate in Bihar election later this year?

Get an idea, Sir

A friend posted me a recording of December 2012 Lok Sabha debate on the issue of allowing 100% FDI in multi brand retail trade. It is still amusing to see the tears the Members of Parliament shed for the poor street vendors and local grocery stores.

Having switch the sides to the other side of aisle in the Parliament, many who vehemently opposed Wal-Mart et. al., are proud to welcome Alibaba and boast about the success of local Snapdeal and Flipkart (who by the way are mostly funded by foreigners). A multitude of online grocery stores has also mushroomed threatening the business of local grocery store and vegetable vendor. These too are funded materially by foreign funds.

It is widely acknowledged that in India e-retailing is becoming the next big thing after Maruti 800 and mobile telephony. The idea has been embraced by the people at large. There is no political or civil society or popular opposition to the idea. Even though the outcome is not materially different from the likely outcome of allowing 100% FDI in multi brand retail trade.

The point being that the idea whose time has come always drives the policy. The vice versa is seldom true. There are few examples where an idea driven by policy has attained success before its due time.

Those watching the Union budget too closely for "idea driving policies" may note that it is only a matter of time when the government of day will roll out red carpet for Wal-Mart et. al. We have done that in automobile and telecommunication. We shall do that in Insurance, banking, healthcare, transportation, and education also in due course - not because the government wants to drive this idea, but because people would have embraced the idea.

Non-conventional power is one idea that is catching up fast with the people. A road trip across villages of UP and Bihar would show you that "Chinese Power Bank" are the hottest FMCG products for the power starved. These power banks are used to keep mobile phone operational during regular long power cuts.

Small roof top and portable solar panels is one idea whose time has come, in my view. Rising cost of regular electricity and poor availability will continue driving consumers in smaller towns and villages towards this renewable source. I believe this certainly has the potential to become even a bigger market than mobile telephony and Maruti 800.

In my view, instead of bothering too much about fiscal deficit, if the government invests the current savings in fossil fuel subsidies in developing the solar user base on mission basis, it could materially enhance our country's energy security and energy efficiency on sustainable basis.

On Delhi election, I feel - (a) If AAP wins, Congress may lose another state forever like UP and Bihar; (b) If BJP wins, with no power and money AAP will become irrelevant in five years. Delhi elections therefore have been a fight for survival between AAP and Delhi Pradesh Congress. For extrapolating the Delhi results to Bihar and UP, a study of BSP history is suggested.

"Pre-requisites" vs. "perquisites"

Thought for the day

"For one swallow does not make a summer, nor does one day; and so too one day, or a short time, does not make a man blessed and happy."

- Aristotle (Greek, 384-322BC)

Word for the day

Winnow (v)

To separate or distinguish (valuable from worthless parts)

(Source: Dictionary.com)

Teaser for the day

Just as a matter of curiosity, would like to know from AAP - "Is there any political outfit in the country, besides AAP, which is honest and works for common people?" or is it "AAP vs. ALL?"

"Pre-requisites" vs. "perquisites"

The primary lesson of economics is that at any given point of time Price of any object having any economic value is determined by the equilibrium of Demand for and Supply of that object at that point of time.

The incumbent government has shown vision to accelerate India's economic growth by encouraging substantial rise in capital investment. Execution of projects like "Make in India", "24*7 Electricity for all", "Railway Modernization", "Smart Cities", "Rapid Expansion of Expressways", "Development of Waterways", "Development of Coastal Transport Corridor", "River Linking" etc., would need capital investment at a scale not seen so far.

The problem is such capital is not available within the country. Moreover, whatever capital is available, it has (a) low risk appetite and/or (b) better alternatives like buying existing stressed assets in India or outside at a bargain price. The required capital therefore has to come from outside.

Here we need to differentiate between the abundant "global liquidity" due to unprecedented QE by central bankers and "global capital".

The global liquidity is intangible, mostly represented by book entries. It could be used to take advantage of temporary arbitrage opportunities available in global currencies and resources trades in dematerialized form. This liquidity can hardly be invested for 20-30yrs in a infrastructure project in a developing country like India where flows of capital are still controlled by the government and currency is still not fully convertible.

The global capital on the other hand is scarce with very low risk appetite. Apparently, the oppressed savers in Japan & EU, and US corporates flush with cash are the only source of risk capital at present. The sovereign wealth funds of Arab nations which have supplied capital to the troubled world in past decade may not be that potent given the energy price outlook.

Given that in India (a) the demand for capital shall remain materially higher than supply and (b) the risk appetite of global capital may continue to remain low - the price of the capital shall most likely find equilibrium at a much higher level.

The government will have to ensure a higher RoE for equity investment through cheaper resources, lower taxes, and stable currency and/or a higher rate of interest on debt capital. It should also be noted that the ease of doing business and higher capital account convertibility would be "pre-requisites" and not "perquisites".

The RBI governor recently suggested in an interview that domestic interest rates are not likely to rise in next 3-4years. He has also made it amply clear that he is looking for a slightly depreciating currency rather than a stronger currency.

There is still no wider consensus within the government to invite foreign capital at investors' conditions and in sectors they are interested to invest in.

Under the circumstances, in my view, the profitable trade is still on Indian consumer. I am happy to note market is with me on this.