Do it yourself

Wednesday, June 19, 2019

Get ready for the transformation

Some food for thought

"There are two freedoms - the false, where a man is free to do what he likes; the true, where he is free to do what he ought."

—Charles Kingsley (English clergyman, 1819-1875)

Word for the day

Caterpillar (n)

A person who preys on others; extortioner

First thought this morning

By choosing Shri Om Birla, Member of Parliament from Kota-Bundi in Rajasthan, for the post of Speaker of 17th Lok Sabha, BJP has given many messages that the Congress Party must learn from. For example—

(a) This is the second high profile appointment by BJP that has surprised the people authoritatively claim to know almost everything about Indian politics. Very few of these studio experts may have imagined elevation of Shri Ram Kovind and Shri Om Birla to high constitutional posts. Till yesterday there was no mention of Shri Birla as favored candidate for the post of speaker.

Congress Party totally lacks this element of unpredictability.

(b) BJP leadership has been consistently giving message to its present and prospective members and cadre that anyone of them can rise to higher posts. Despite the strong media campaign about Modi-Shah stranglehold on the Party, the message from the party had been unambiguous, strong and very effective.

Congress Party has consistently failed in trying to empower the cadre or even giving this message. Consequently, it has become largely a party of leaders not connected with people at large.

(c) BJP is effectively conveying to people that there is no dearth of leaders in the party and therefore succession should not be an issue, should PM Modi decide to follow "retire at 75" rule in 2024.

Indecision on Rahul Gandhi's resignation is highlighting that there is no one willing to take the mantle in Congress Party.

Chart of the day

Get ready for the transformation

On Monday, lenders of the grounded airline company Jet Airways, led by SBI, have decided to begin insolvency proceedings against the company as all attempts to revive, what was the largest airline in the country just ten years ago, failed (see here). Earlier, last month promoter family of Jet Airways was denied travel permission by Indian immigration authorities.

Similarly, ICICI Bank has reportedly moved NCLAT to expedite the insolvency plea against Jaiprakash Associate (JPA), which was amongst the top five infrastructure builders in the country just a decade ago. (See here) Earlier, the Supreme Court had sought details of personal assets of the directors of the group company Jaypee Infra and directed them not to part with any of the assets till further orders.

In yet another incidence, UCO Bank has declared Yashovardhan Birla (heir of RD Birla branch of larger Birla clan), chairman of Yash Birla Group, a willful defaulter in a Rs670million loan default case.

HDFC AMC has been forced to take Rs5bn worth of Essel group debt from schemes managed by it to its own book.

From the mentioned incidence, the following three things are quite clear to me:

(a) The government is mindful of the political risk of allowing any potential defaulter or fraud accused to travel abroad. It does not want any repeat of Malaya, Modi, Choksi episode.

(b) Bankers are now willing to act against large promoters without impunity. This must bring substantial change in the behavior of promoters, especially the traditional ones who are used to political and therefore patronage.

Juxtaposing with rising use of technology, increasing competition as the entry barrier for small banks is removed, and willingness of the government to allow lateral entry of professionals at the top level in public sector banks, I see these trend as key structural positive for Indian economy, businesses and therefore markets.

In my view, in next 5years we shall definitely see inter alia the following trends emerging in our financial system that will make future credit cycles different and more predictable.

(1) Breakdown in notorious banker promoter nexus.

(2) Improvement in credit discipline of promoters as the tendency to over leverage dissipates.

(3) Lower credit cost of lenders may allow them to lend money at relatively cheaper rates.

(4) Faster and efficient IBC process, allowing prompt and better recovery of stressed assets either through resolution or liquidation.

(5) Evolution a vibrant retail debt market for high yield paper, as lower rated businesses find it tough to get money from banks, NBFCs or mutual funds. This market shall supplement the fixed income mutual funds.

I my view, it is critical that various stakeholders like bankers, borrowers, auditors, credit rating agencies, investors, investor advisors etc need to take cognizance of these emerging trends and accordingly prepare themselves.

Especially, investors and investment advisers need to acquire necessary skills for investing in high yield bonds. After all this retail debt market, that has eluded Indian investors for more than two decades, will be much larger as compared to equity market and offer more opportunities, albeit with higher associated risk.

Tuesday, June 18, 2019

Making a puncture proof economy

Some food for thought

"Have thy tools ready. God will find thee work."

—Charles Kingsley (English clergyman, 1819-1875)

Word for the day

Lulu (n)

Any remarkable or outstanding person or thing.

First thought this morning

Last weekend, I had an opportunity to attend a career counseling event for the students who have just passed their 11th or 12th standard exam. The objective of the event was to create awareness amongst students and their parents, about various options available to them for further study and/or training.

On the face of it the objective appeared quite noble and useful. However, as it turned out, the real motive was to—

(a) Attract the "residual" students and their distraught parents and motivate them for taking admission in private universities/institutions charging astronomical fee, or take professional "coaching" for another year and reattempt admission in engineering, medical or other good colleges and institutions; and

(b) Convince the existing 12th class students that without professional "coaching" their chances of getting admission in any good course or college/institution are quite bleak.

The "career counselors" there were young sales representatives of "coaching centers" or "private institutions", mostly inexperienced and in search of a regular job.

I got a chance to interact with many parents, out of which the following three were noteworthy:

(1) A college dropout owner of a decent sized corrugate box making unit who wanted his son to get admission in 3yr BBA or 5yr integrated MBA program. He was sure that a management degree will help his son handle the business better.

(2) A Chartered Accountant managing his own real estate development business, whose son got 69% in 12th class and wanted to pursue a degree in management before joining his family business.

(3) A graduate owner of a travel agency, whose son unsuccessfully tried for 2yrs to get admission in a good engineering college.

None of these young aspirants admittedly had any clue about their family business. Their studies so far were limited to cramming the text books and passing board school exams.

Would it not better if our schools give option to these aspiring businessmen an option to learn things that would help them in handling their family business better, rather than learning subjects, like advanced mathematics, that are of little use to them and wasting precious time preparing for examination of subject that they never wanted to learn in the first place.

Chart of the day

Making a puncture proof economy

As per media reports, the French tyremaker Michelin is introducing a puncture proof vehicle tyre. As per The Economist article (see here) "punctures can be extremely dangerous, especially if a tyre blows out at high speed on a motorway. For decades carmakers have sought various solutions, but with new materials and novel manufacturing methods, a genuinely puncture-proof car tyre has finally appeared."

When I shared this news item with some of my contacts, the reactions were mostly predictable. Few admired the innovation. Most expressed worry about the employment of millions of people engaged in puncture repairing occupation.

Hypocrisy of the car owners worrying about the puncture repairing boys apart, this must trigger a larger debate in our country, where rising unemployment is certainly the single most critical socio-economic issue.

In my view the policy makers must focus, inter alia, on the following factors while devising economy policies for next 2-3 decades at least.

(a) As per the latest global trend, unskilled and semi skilled jobs in manufacturing and services shall be increasingly handled by technology itself. The new employment opportunities shall therefore mostly arise in the fields of developing and managing the technology.

(b) Increased focus on farm sector infrastructure (power, water, technology and equipments) and empowerment of farmers shall result in large scale redundancy of underemployed (or employed in disguise) labor in the farm sector.

(c) The demand for semi skilled construction and other labor in traditional markets like Middle East may ease in future as automation of processes picks up.

(d) Sectors like telecom, modern retail and ecommerce that have added most of the incremental employment in past 10-15yrs, shall saturate in next decade or so. This will be the period when maximum number of new workers will join the Indian workforce.

(e) Incrementally, the number of female workers joining the workforce may increase faster as various programs aimed at increasing the share of female population in economic activities begin to yield results.

I fully appreciate that creating productive employment in a developing country like India, at present juncture, is much more complex problem then most would like to believe. The policy makers need to focus on enhancing productivity and global competitiveness, open the economy to global competition, while

I would suggest the policy makers to consider, amongst other numerous things, the following three in devising a sustainable economic policy that aids creation of adequate employment opportunities.

1. Human resources must be treated as a precious natural resource. Indian government must consider itself a custodian of precious human resources for the entire humanity. Adequate effort and resources must be invested in prospecting, development, maintenance, utilization and preservation of this resource.

It must be appreciated that human resource is to us what crude oil is to Saudi Arab, Diamonds are to Botswana, Copper is to Congo, Gold is to South Africa and Alps is to Switzerland.

2. We may emphasize more on skills that people would usually not like to be replaced by technology. Instead of wasting resources on developing skills that are more likley to be replaced by technology in near future, it is better to invest in technology that eliminates the need for these manual skills. Nursing is one skill that may remain in demand. Pakora making (cooking) may still be liked with human touch. Spiritual teachings, storytelling, etc are some other in my mind.

3. Since Industrial Revolution and World Wars, the global economy has travelled many million miles. The classical economic development model where unskilled and semi skilled labor moves to industry from farms as the share of agriculture in incremental GDP growth falls and then skilled labor moves from industry to services, may not work in our case.

Despite primarily being an agrarian society, the share of agriculture in our economy is close to 13%; even though more than 50% of our workforce is still employed in agriculture and allied activities.

The manufacturing sector accounts for less than 17% of our annual GDP. All incremental growth in manufacturing shall mostly be capital intensive and therefore not expected to add proportionately to the additional number of jobs. The new jobs therefore must come mostly from the services sector.

Therefore, as a matter of policy, the government must add larger emphasis on promotion of services rather than industry.

Emphasizing on industries that could be developed as a partnership between farmers and small entrepreneurs and located at the farm itself would be an ideal solution for mass job creations. Enhancing purchasing power through targeted cash subsidies may ensure substantial local market for the produce of these small industries to make them sustainable.

Friday, June 14, 2019

Open the black box

Some food for thought

"A man may learn from his Bible to be a more thorough gentleman than if he had been brought up in all the drawing-rooms in London."

—Charles Kingsley (English clergyman, 1819-1875)

Word for the day

Hangdog (adj)

Browbeaten; defeated; intimidated;

First thought this morning

The Pakistan economy is facing one of its worst crises in past 7 decades. Growth is collapsing, unemployment rising, inflation is high, interest rates are prohibitive, current account is worsening despite massive currency devaluation, and reserves are ominously low.

While the government is negotiating a rescue package with IMF, the people at large may not be willing to take the pain associated with such package, e.g., fiscal tightening, higher taxes, further devaluation of currency, cut in government spending (including the sensitive defense spending), restructuring of Chinese Belt & Road debt etc.

The moot point is whether India is taking advantage of the situation to sort out pending issues with Pakistan!

I would like to answer this in affirmative. It is visible that funding starved mercenaries and their support groups in J&K are being neutralized at accelerated pace, despite some desperate last ditch attempts by them. Persistent refusal of Indian leadership to engage with Pakistan counterpart must also be adding to the pressure to act Indian pre condition of eliminating terror camps. Efforts to isolate Pakistan at various multilateral fora are also visible.

Some may believe that it is not adequate and we must use this opportunity for some direct action. I feel we are doing fine.

Chart of the day

Open the black box

In past 2yrs, since the IBC process started with RBI marking 12 largest default cases for immediate resolution, the progress has been rather mix.

Only 3/12 (Bhushan Steel, Monnet Ispat and Electrosteel Steel) of initial cases have been fully resolved so far. 2/12 cases (Lanco Infra and ABG Shipyard) have been declared irresolvable and undergoing liquidation process. The resolution in rest 7/12 cases has been impacted by frequent judicial interventions, poor NCLT strength, and/or lack of credible bidders. Technically, all these cases must have been resolved in maximum 180+90 day period. Currently, about one third of the total 1140 odd cases pending for resolution under IBC are facing delay beyond the statutory resolution period of 270days.

On positive side, by end of FY19, over 700 cases had been resolved under the IBC process. In FY19 alone lenders realized ~Rs660bn from the resolved cases. It is estimated that the recoveries may exceed Rs800bn in the current year FY20.

In 4QFY19 about 350 new cases have been filed for resolution under IBC. As number of new cases is increasing and resolution process is getting delayed, the market is naturally getting jittery. Any news (even unsubstantiated and unconfirmed) of delay or default in repayment of debt and/or interest due thereon is causing panic in market. It has led to irrational value destruction for investors in many cases.

This will surely be seen as an excellent opportunity by handful of "smart investors", but value destruction at this scale has weakened the overall structure of the market. Market participants at large are losing faith in market, threatening the whole "revival of domestic investors' interest in equities" prognosis that supported the markets well for past 3years. Diminishing flows in equity mutual funds in past 3months is just a small reflection of this.

The market reaction to a totally frivolous petition filed against India Bulls Housing Finance company also highlights the frightened state of market participants. Sharp fall in prices of all public sector banks after the brokerage firm UBS published a theoretical worst case scenario in NPA accretion a couple of days ago is also a case in point.

Most of the lenders have indicated in their recent commentaries that the NPA cycle may already have peaked in FY19, and from the current year a gradual improvement must be visible. Even some worst case scenario reports are indicating that NPA cycle may peak in the current year.

As an investor, I am faced with two questions here:

(a) Should I buy PSBs which in my view are definitely on their way up to recovery?

I believe yes, I must invest. The reasons are rather simple - most large PSBs are trading at valuation much lower than their long term averages; earnings are improving; asset quality looks set to improve; processes and controls are much stronger now as compared to 5yrs ago; government has show commitment for professionalization of management (BoB is a good sample case); consolidation has begun and is encouraging (SBI and BoB are good examples); CAR is improving and clarity on RBI capital reserve position after Jalan committee submits its report will improve further visibility of fresh capital infusion; credit market is reviving; they may regain some of the market share lost to NBFCs; setting up of more NCLT benches and evolution of judicial precedents may expedite resolution process of default cases, etc.

(b) How the market may be insulated from frequent knee jerk overreactions?

This is little complicated. I think the market participants, regulators and experts need to work together on this. So far the financial sector stress has been presented to the market as a black box.

This box needs to be opened, and investors and traders need to be informed about the precise current situation, potential risks and implications for the market.

For example, market participants must know the "Equity" part of the stressed debt and the "leveraged" part of it.

When a mutual fund scheme invests in the bonds of a corporate, it is effectively the same as investing in equity shares of that corporate. The asset management company that manages the MF Scheme is under no obligation for service or repayment of corporate debt. It is only an agent of the investors who have subscribed to the MF scheme. The risk of default by corporate in servicing the debt is completely borne by the investors. I refer to this as 'Equity" part of the stressed debt. Same is the situation with fixed deposits and NCDs directly subscribed by the investors. Any default in these has no implication for any other publically traded entity, unless such entity is an investor in these instruments.

On the other hand, when an NBFC or Bank lends to a corporate from the money borrowed from other lenders and depositors, the risk of default is borne by the respective bank or NBFC. This is the "Leveraged" part of the stressed debt. Any default in this part of the debt has implications for the investors in the lender, as it remains liable to pay to its lenders and depositors. Any default in leveraged part of the debt could have cascading impact and affect a number of publically traded entities.

So, if a default is made to a MF Scheme, ideally markets should not be rattled as much as we have seen in recent past.

Secondly, if the market is transparently informed that the total amount at risk in the six popular cases (Essel group, Jet Airways, DHFL, India Bulls, ADAG, Adani group), that have been frequently rattling the market, might not be more than 2-3qtrs profit of lenders, the chances are that market may not overreact to the news of a 7 days payment delay.

Another analysis that needs to be done is the notional gains made by the buyers of stressed assets vs. the losses incurred by the lenders.

For example, company X buys a stressed cement plant at 0.5x the replacement value of Rs120bn, while the lenders lose 60% of the Rs100bn due to them. Since the buying entity is a healthy going concern, the market should assess whether it should celebrate Rs20bn notional gain to the buyer, Rs60bn (0.5x of Rs120bn) additional business to the lenders or it should mourn loss of Rs100bn to lender 75% of which was already provided in previous years.