Do it yourself

Thursday, August 22, 2019

1QFY20 Earnings - pain aggravating

1QFY20 Earnings - pain aggravating

The latest earning season has been disappointing on most counts. If we can avoid getting into the nitty-gritty of the performance relative to corresponding quarter of last year or immediately preceding quarter, we shall find the reported earnings much below par across most sectors. The earnings totally belie the high hopes, the street had from FY20 earnings.

There is a stampede amongst analysts to downgrade earnings estimates to bring these in line with the market conditions. The unfortunate part is that the revised earnings estimates also mostly appear driven by the prevailing stock prices and not by the earnings potential and prospects of businesses; and hence may not be reflecting the true state of the anticipated corporate performance.

A significant majority of corporate managements guided caution in terms of near term growth, indicating that the 2QFY20 earnings may also not be encouraging. 2HFY20 outlook is generally optimistic, though no concrete basis has been presented for the optimism.

The key highlights of earnings estimates could be listed as follows:

As per Motilal Securities' Research the Nifty Sales (6.4%), EBIDTA (2.8%) and PAT (5.1%) growth was below estimates. Sales growth was lowest in past 8qtrs. Pertinent to note that EBIDTA was pushed up by change in Accounting Standard for Leases (AS-116).
Highest earnings growth was witnessed in airlines, financials and cement, while metals, auto & auto ancillaries and chemicals reported the highest decline. Cement was the only sector that surprised the analysts with strong numbers as the realization remained strong across regions and costs were under check.
Pharma sector earnings stabilized after declining for many quarters.
As per JM Financial Research, 11/50 Nifty companies cut capex guidance for FY20.
Post earnings, various brokerages have downgraded Nifty earnings by ~5 to 6% for FY20 and by ~3.5-4% for FY21. However, ~18-20% Nifty EPS growth estimates for FY20 and FY21 still look rather optimistic and may see further rationalization post 2QFY20 results. As per Elara Capital Research, Among Nifty 50, 23 stocks saw an earnings beat (actual results exceed estimates by >5%) while 18 saw an earnings miss. The beat ratio (net earnings surprise divided by the total number of stocks) improved from -10% to 10%, largely due to earnings beat in metals, energy and IT. However we consider the broader markets, the companies missing the estimates were much more than the companies beating the estimates.

Wednesday, August 21, 2019

Policy Paralysis vs Policy Haste

Policy Paralysis vs Policy Haste

In 2014, NDA led by BJP's prime ministerial candidate Shri Narendra Modi won a huge majority in the Lok Sabha. "Policy Paralysis" of the extant UPA government led by Dr. Manmohan Singh was one of the primary planks on which NDA election campaign was built.

A large majority of people, especially businessmen and capital market participants, had then celebrated the victory of NDA with great fervor. Assuming that the India's economic model based on Nehruvian Socialism (a distorted version of classical Keynesian model) will pave the way for the so called "Gujarat Model". Though not many people had clarity about what the much talked about Gujarat Model of growth is all about, and whether that template of socio-economic development could also be applied to the rest of India.

Most people had expected that the new regime will at least provide a proactive, clean, responsive, accountable and business/investment friendly administration that will ensure higher economic growth.

By the end of 2018, the general criticism of the PM Modi led NDA government was that—

(i) "Policy Paralysis" of Dr. Manmohan Singh government has been replaced with "Policy Haste". A number of policy decisions having deeper and wider repercussions (especially GST and Demonetization) have been taken without adequate preparation and consultation. This "Policy Haste" has led to the "Execution Paralysis" as the status quo has been disturbed materially without evolving the alternative mechanism;

(ii) NDA government has continued with the extant Nehruvian Socialism model rather than experimenting with the so called "Gujarat Model" at national level;

(iii) Frequent material changes have made the policy direction totally unpredictable, negatively impacting the business and consumer sentiments;

(iv) The key programs of the government are misconceived and poorly defined. Hence the outcome has been poor.

(v) Bureaucracy has been empowered too much without assigning corresponding matching accountability.

Notwithstanding the economic concerns and doubts about the sustainability of the NDA economic policies, the same NDA government returned to power with even bigger majority in May 2019. NDA swept metros like Delhi and Mumbai, industrial states like Maharashtra, Gujarat, Karnataka, and most populace states like UP, Bihar, MP, Maharashtra, and Jharkhand.

Less than 3months into the latest term, the government is again subject to the same criticism as before. It seems that people of Delhi and Mumbai, where BJP made a clean Sweep in 2019 general elections 3 months ago, were under the influence of a magic spell for few months. The spell has suddenly broken and they are finding their portfolio values diminished, property prices down and falling, businesses suffering losses, jobs vanishing, petty crime rising due to rising unemployment, and mood in general stressful.

Under the present circumstances, three points need detailed elaboration, viz.—

1. Whether the "Policy Haste" of the government is leading to "Execution Paralysis" at the operational level?

2. What proportion of the domestic growth slowdown is contributed by (i) policy action (or inaction); (ii) domestic cyclical slowdown; and (iii) global cyclical economic slowdown?

3. Are our economy and markets ready for the "Reset" that is becoming increasingly imminent?

Tuesday, August 20, 2019

Suggestions for stimulating the economy

Suggestions for stimulating the economy

The number of people cautioning about a deeper and longer economic slowdown in India is rising by the hour. Tata Motor's management has guided for double digit fall in automobile sales in FY20 (see here). Most auto companies have announced shut downs; some have also announced significant reduction in the employed workforce. SBI chairman is insisting on urgent need for some stimulus in almost each of his public presentations (see here). Most other senior banks and industrialists have also sounded the caution begul (see here)

The stock markets have corrected sharply in past one year; though the benchmark indices may not be reflecting the correction as yet. The wealth erosion for investors has been material. The market participants are clamoring hard for a stimulus package to bring the economy and market back on path of high growth.

Whereas, most businessmen and market participants have echoed the demand for stimulus, I have not seen many actionable solutions being suggested. Generally the solutions suggested are limited to lending rate cut, GST rate cut, and roll back of tax provision relating to surcharge and long term capital gains.

In my view, roll back of the tax provisions relating to long term capital gains and surcharge on high income non corporate entities may not add to the economic growth in any significant measure, though it might be a short term sentiment booster.

As per the available data, SBI has already cut MCLR by about 30bps post recent repo rate cut of 35bps. Current SBI MCLR (8.25%) is now ~100bps lower than the highest rate seen in early 2016. However, the current interest rate is still 300bps higher than the lowest rates we saw in 2003. Given the persistent low inflation, low money multiplier and global strong deflationary trends, there is scope for meaningful rate cut. To be effective immediately this rate cut must have some shock value. Small doses of 10-20bps cut in lending rate may take much longer to reflect in higher demand and therefore may not qualify as "stimulus".

A material cut in GST rates for automobile etc may stimulate demand. However, the impact may be somewhat neutralized as lower GST revenue shall constrict government's spending ability. In case the government chooses the path of fiscal expansion through additional market borrowing, the private investment may get crowded out. GST rate cut therefore may not be an easy option for the government to exercise.

I believe the government needs to take these conventional stimulating measures steps in adequate quantity. However, to enhance the impact of these measures, a number of additional measure aimed at boosting sentiments and stimulating higher trade volumes and activity level would be needed simultaneously.

The following are some of the illustrative measures that could be considered by the government for immediate implementation:

(a) In most parts of the country, the Ready Reckoner or Circle Rates (minimum property rates considered for levying stamp duty) are much higher than the prevailing rates of property. The government must consider bringing this minimum threshold to 10% below the prevailing market rate to stimulate transactions in property market.

(b) Capital gains of upto Rs25lacs on all constructed properties may be exempted from income tax for two years, i.e., AY21 and AY22.

(c) Capital gains on sale of gold may be exempted, provided the entire sales proceed is invested in buying one or more constructed property (residential or commercial).

(d) Concessional Housing advance by companies to their employees in next 2years may not be treated as perquisites during the term of the advance.

(e) Trading in agri commodities may be exempted from cash transaction limits completely for 2yrs, i.e, till March 2021. Post that restrictions may be applied in graded manners over next 5yrs.

(f) GST input credit for automobile purchase may be allowed for six months, i.e., October 2019 to March 2020.

(g) Upto 50% discount may be offered on power tariffs to all green field industrial units that are approved before March 2020 and begin commercial operation before March 2022.

(h) The payment time for all government contracts and supplies may be cut to 15days from the present 60-180days. All outstanding payments to contractors and suppliers may be released immediately. The arbitration and legal awards in favor of the contractors and suppliers may be honored immediately.

(i) PSU banks may be adequately recapitalized immediately.

(j) Long term corporate bonds (10yrs or more original maturity) may be treated at par with equity for capital gains taxation purposes. Periodic Interest on such bonds may be taxed @10% without any limit.

(k) CSR spend in setting up rural schools and health centers may be made tax deductible at 125% of the amount spend. The operating and maintenance expenses on such schools and health centers may also be made tax deductible.

(l) 25% capital subsidy may be provided to agri produce processing units set up in the rural areas, provided the farmers who would supply agri produce for processing to such industrial unit form a cooperative society; and such cooperative society is allotted 25% equity in such unit free of cost. Gram Sabha land may be leased to such industrial units at nominal rent.

(m) The government may make a solemn promise that the effective rate of direct taxation for any assessee shall not rise for next 3yrs

Wednesday, August 14, 2019

What do we really want?

What do we really want?

To accelerate the economic growth in order to generate more employment and improve the quality of life of Indian populace, the country indubitably needs huge amount of fresh capital.

Various economists, government agencies and expert committees have suggested that to attain optimum level of employment Indian economy would need to grow 8-10% CAGR for next decade or so.

The capital investment required by private sector to create critical infrastructure to support 8-10% GDP growth is pegged in the range of US$10-12trn over next 10yrs. Energy sector alone may need investment of more than US$1trn over next one decade.

It is well recognized fact that such kind of long term risk capital may not be available internally. Foreign investment is therefore a pre-requisite for the process of economic planning, development and growth. Any debate on path, trajectory and sustainability of growth should therefore begin with this assumption that adequate foreign capital would be available.

A pragmatic economic development and growth plan under the current circumstances should therefore acknowledge the following in the preamble itself:

(a) India needs huge amount of long term risk capital to achieve the goal of fast, equitable and sustainable economic growth and development.

(b) Meeting of this goal is materially contingent upon flow of foreign capital.

(c) Despite unprecedented liquidity sloshing the global financial system, the risk capital that could be invested for long term in an emerging market like India is scarce and circumspect.

(d) The long term risk foreign capital will come to India at its own terms and not at the whims and fancy of the politicians and myopic bureaucracy.

...do we want to follow the herd?

However, what is true for long term risk capital (commonly known as FDI) may not be true for the short term arbitrage money (commonly known as Foreign Portfolio Investment or FPI).

This is the money that usually is not invested by the owner of the money. Instead professional investors, who are paid to maximize the returns for owners of the money, exercise the control over such money. Mostly, their interest in the investment is limited to the remuneration they would get. The remuneration is usually based on the relative performance of the money invested over a small period of time (usually 12 to 24months).

In order to maximize their remuneration, these fund managers would chase the relative outperforming assets in a most secular fashion - with no regional, racial or systemic bias. They would go to communist China, chaotic Russia, democratic but unpredictable India, war torn Africa, vulnerable Chile & Columbia, or struggling Venezuela and Argentina.

As most of them usually move in a herd, they are able to cheer the target market by driving up the asset prices with huge collective inflows in a short span of time. They invariably inflict severe pain and cause huge volatility by their ruthless collective exit.

There is little evidence to establish their long term positive impact on the investee market or economy. However, there is enough anecdotal evidence to show the damaging impact of the excessive volatility caused by their collective actions.

The South East Asian economies suffered tremendously at their hands during 1990's. Emerging markets crashed during subprime led global crisis, when some many of them were growing at 8% to 10% annual rate.

India too had have few instances of irrational boom and bust cycle driven by collective withdrawal of FPI money. 1998 post nuclear blast exodus, 1999-2001 dotcom bubble and bust, 2006-2009 easy credit driven boom and bust, and 2011-12 Grexit paranoia led selling are some major instances.

Besides, we have also seen frequent collective actions to pressurize the government and regulators over issues such as taxation (MAT, DTAA, GAAR) and transparency (P. Note disclosures), etc.

On most occasions the government and the regulators have given in to the pressure, deciding to maintain the status quo. Consequently—

(a) Many nagging issues got accumulated to keep the FPIs and agencies at confrontational path for many years.

(b) The message that goes to FPIs is that Indian government and agencies accord significant importance to the stock market indices and are willing to walk extra mile for a few billion dollars of FPI flows.

Currently Indian markets are witnessing yet another instance pressure tactics. This time most of the domestic participants are also pleading with the government to yield to the FPI demands. The indications are that the government will give in yet again.

The question that may still remain unanswered is "what do we really want?"

Do we want long term risk capital that would support out economy in achieving sustainable high growth? Or do we only care for the fleeting arbitrage money that would stay in India only until a better opportunity arises in some other corner of the world.

I am certainly not denigrating the importance and need of FPI flows to Indian securities markets. But I strongly believe that unlike the long term risk capital (FDI) these flows must be on our terms and within the regulatory framework designed to ensure orderly development of securities market.

Also read Modi Says Surplus Global Liquidity An Opportunity To Access Cheaper Funds

Friday, August 9, 2019

India qualified for inclusion in playing XI

India qualified for inclusion in playing XI

In past one century, the global community has done many experiments to find a suitable global order. The year 2017 marked 100yrs of two very important global events.

In 1917, Russian revolution successfully dismantled the Tsarist autocracy and laid the foundation of USSR. In the following decades, many smaller independent European states would become subservient to a mighty Russian socialist army, and together become one pole in the emerging bi-polar world, forever shrouded by the specter of cold war.

In the same year, USA decided to join the War as an associate of the Allies - a development that tilted the scale in favor of the Allies, bringing the War to an end in 1918. In the following decades, USA would evolve into a formidable military and economic power that would lead the democratic allies to become the second pole in the emerging bi-polar world.

The imperialist global order that existed since preceding couple of centuries, began to dismantle. Many colonies of European empires would get freedom. The British Empire that was built in three centuries and covered almost one fourth of the world population and area before the War, would get completely dismantle in the following three decades.

It took three decades for the new order to consolidate. The new order was characterized by UN, NATO, WARSAW, Mao, Israel, NAM, Bretton Woods, World Bank, Cold War, energy cartel (OPEC), et. al. The globalization that was a norm prior to the first War was completely overpowered by the forces of nationalism and protectionism.

The new order lasted till the German Wall fell and USSR disintegrated. This unleashed a new wave of globalization. Global Trade (WTO), Internet, dematerialization of assets, Europe integration into a single market, China's entry into mainstream global trade (through WTO), free flow of capital, G-20, BRICS, numerous FTAs, global war on Islamic fundamentalism, energy security, climate control and global financial crisis, dominated this phase.

The events that have taken place in past one decade indicate that the extant global order may be crumbling under pressure, as the forces of nationalism and protectionism are rearing their head again.

There are two prominent debates that are currently going on. The first debate seeks to challenge the very premise - "whether the current state of globalization is reversible at all?" The second debate accepts the inevitability of the de-globalization, and is therefore focusing on the shape of the new order that would be emerging in next couple o decade. Two economic super powers China and USA are leading the forces of the change.

On previous occasion, when India was mostly a colonial or controlled & closed economy, we just played second fiddle to super powers and suffered some collateral damage from the major changes in the world. In fact one can reasonably argue that two great wars weakened the British Empire considerably, precipitating the independence of India, along with many other countries.

This time however our exposure to the global economy and geo-politics is much wider and deeper; and so would be the impact of any material change in the global order. It is critical that India demonstrates its competence and willingness to play a prominent role in the global affairs, economic, strategic as well as geo-political, to be accepted as a main player in the game. I see the recent events in relation to the state of Jammu & Kashmir in this light.

In my view India has played very well and qualified for inclusion in final playing XI as an all-rounder, i.e., an economic, strategic and geo-political major.

Thursday, August 8, 2019

Another uninspiring act of MPC

Some food for thought

"When a thing is said to be not worth refuting you may be sure that either it is flagrantly stupid - in which case all comment is superfluous - or it is something formidable, the very crux of the problem."

—Percy Bysshe Shelley (English Poet, 1792-1822)

Word for the day

Spondulicks (n)

Money; Cash

First thought this morning

Very few people I know are aware about a place called Punaura exists in Sitamarhi district of Bihar. Sita Kund situated at this place is most popularly believed to be the birth place of Mother Sita. As per Valmiki Ramayana and Kamban Tamil Ramavataram, Sita appeared from the womb of Mother Earth when the King Janak of Janakpur (situated in present day Nepal, about 40miles from Punaura, Sitamarhi) was ploughing a field in Punaura on instructions of sages.

Mother Sita is also known as Annapurna, provider of nourishment and prosperity. The legend says that the kitchen of Mother Sita never lacked adequate food for all. That is a metaphor for the crop that is born from the womb of Mother Earth and nourishes the life on this planet. Reverence for Mother Sita is therefore in fact reverence for Mother Nature, Sustainability, and Ecology. There are numerous instances in Ramayana depicting how Mother Sita cared for environment and sustainability during her exile years with Sri Ram and Sri Laxman.

While the issue of birth place of Lord Sri Ram is ingrained in the consciousness of most Indians, and enormous efforts are being made to construct a grand temple at the place of his birth, little awareness exists about the birth place of Mother Sita, who the Lord himself admitted as equal to him in all respects.

It is high time that we also declare Punaura Dham (Sitamadhi, Bihar), birth place of Mother Sita a monument of national importance and develop it as equally grand pilgrimage as we plan for Ayodhya. This will not only delight the millions of devotees but also convey a strong message to the world about our full commitment to gender equality and sustainability.

Chart of the day

Another uninspiring act of MPC

The Monetary Policy Committee (MPC) of the Reserve Bank of India decided to cut the policy repo rate by 35bps to 5.4%. It maintained "accommodative" policy stance. MPC recognized the growth challenges and cut the GDP growth forecast for FY20 6.9% from 7% earlier, while maintaining CPI forecast at 3.5 - 3.7% range. RBI governor ruled out any CRR cut as the system liquidity continue to remain in surplus.

Besides RBI also announced the following measures to support higher credit growth:

(i) The risk weight for all consumer credit categories has been cut to 100 percent from 125 percent earlier. This excludes credit card receivables

(ii) The exposure limit for single NBFCs has been raised to 20 percent from 15 percent earlier.

(iii) Bank lending to NBFCs for specified agriculture and SME lending will now be eligible for priority sector lending.

An overwhelming majority of market participants and experts were anticipating a repo rate 25bps cut. To that extent the decision to cut 35bps was a "small surprise" (borrowing the expression from the recent Credit Suisse research report upgrading India to "small overweight").

It is evident from the policy statement released by MPC (read here) that the Committee and RBI are fully conscious of the challenges posed to the Indian economy. It is categorically acknowledged that both global and domestic growth environment have worsened materially in past few months. The need to stimulate growth is also admitted, as could be read from the following excerpts from the policy:

"Even as past rate cuts are being gradually transmitted to the real economy, the benign inflation outlook provides headroom for policy action to close the negative output gap. Addressing growth concerns by boosting aggregate demand, especially private investment, assumes the highest priority at this juncture while remaining consistent with the inflation mandate." (Paragraph 20)

In this light, I find the policy stance of MPC seriously lacking. In my view, the situation today warranted a categorical "whatever it takes" commitment from RBI. By making minimal apologetic rate cuts RBI is just wasting bullets while not helping anyone's cause.

MPC appears to be ignoring the fact that the present crisis is as much about confidence as financial stress. Minor rate cuts can ease a bit of financial stress and other measures may improve access to credit, but these are inadequate insofar as business and consumer confidence is concerned.

I would emphatically suggest that the government must consider some changes in the present process of the management of Monetary Policy itself. In my view-

(a) MPC should be converted into an advisory body, which shall be obligated to consider the representations of industry, trade and government before making its policy recommendation to RBI. MPC must record its reasons in detail for disagreeing with the views and suggestions of stakeholders.

(b) RBI Governor should be at liberty to accept or reject, in full or part, the recommendation of MPC. However, RBI governor must record his reasons in detail for any such agreement and disagreement.