Do it yourself

Thursday, December 12, 2019

Check whether you need professional intervention in investment strategy review

A lot of people have enquired about the dichotomy in the market, i.e., the benchmark indices are ruling close to all time high levels, while not many portfolios have returned positive returns during 2019.

I would say, the return of a portfolio of equity stock is function of its construct and efficiency of management. The returns may vary dramatically depending upon the stock selection and quality of the management. So it would not be fair for me to comment on the performance of any particular portfolio. Nonetheless, the following data points may be pertinent to note in this context.

(a) At Tuesday closing level, Nifty is higher by 9.2% YTD. But, the market capitalization of NSE is higher by ~4% during this period.

Given that Nifty represents about 70% of the total market cap, it is safe to assume that most of the companies outside Nifty have lost their value during the year.

Moreover, 28 of the 50 constituents of Nifty have yielded negative return during the year, the market breadth appears even narrower than what Index performance may indicate.

(b) YTD, Nifty Small Cap 100 has lost ~14% value and Nifty Midcap 100 Index has lost ~8% value.

(c) Of the 1600 odd stocks regularly traded on NSE, only 25% have returned positive yield YTD. 75% stocks have lost their value during the course of 2019.

(d) To make the situation even worse, over 28% of the stocks regularly traded on NSE have lost more than 50% of their value during the course of 2019. This set includes frontline stocks like Reliance Capital (-95%), Reliance Infra (-93%), Jet Airways (-93%), Yes Bank (-75%), Vodafone Idea (-72%), IndiaBulls Housing (-69%).

(e) Out of the 18 major sectoral indices, 10 have returned negative yield YTD. Media (-32%), PSU Banks (-22%) and Metal (-20%) are the worst performing indices. Auto sector yielded a negative return of -16% YTD.

(f) Private banks (driven mostly by HDFC Bank, ICICI Bank and Kotak Bank) outperformed with a 13% YTD return. Energy (driven mostly by Reliance) also returned 13% YTD yield.

(g) In true sense, Realty was the best performing sector that returned 20% YTD return. The reforms (RERA) and lower rates perhaps helped the sector.

Considering this, in my view—

(i) Anyone who could protect his/her capital and cover the opportunity cost of investing in equities (6% in liquid fund or fixed deposit) has performed well during 2019.

(ii) Investors who could also cover the inflation (4%) by earning ~10% must be considered above par.

(iii) Investors earning more than 10% by design (and not purely by chance) must evaluate, whether they took unnecessary risk for earning that kind of return. If not, they are rock stars.

(iv) Investors who have lost more than 10% value in their portfolio may need professional help for reviewing their investment strategy.

(v) All others are well placed and need not worry too much.

Wednesday, December 11, 2019

Industry and Services sector transformation agenda implemnetation still at take off stage

In the three year agenda released in 2017, NITI Aayog noted that "unemployment is the lesser of India’s problems. The more serious problem, instead, is severe underemployment. A job that one worker can perform is often performed by two or more workers. In effect, those in the workforce are employed, but they are overwhelmingly stuck in low-productivity, low-wage jobs...Therefore, what is needed is the creation of high-productivity, high-wage jobs."

The action agenda therefore emphasized on increased emergence of larger, organized-sector firms that can create high paying jobs. To meet this end, promoting exports was considered a better option rather than trying to substitute imports by producing in India.

The agenda paper accordingly highlighted that "A focus on the domestic market through an import-substitution strategy, however attractive it may seem, would give rise to a group of relatively small firms behind a high wall of protection. They will not only fail to exploit scale economies but also miss out on productivity gains that come from competing against the best in the world. The electronics industry offers a case in point. Our domestic market in electronics as of 2015 is only USD 65 billion. In contrast, the global market is USD 2 trillion. Our policy of import substitution under high protection has given rise to a group of small firms none of which is competitive in the world markets. In contrast, a focus on the global market can potentially result in output worth hundreds of billions of dollars and hence a large number of well-paid jobs."

NITI Aayog underlined the demographic advantage and wage competitiveness of India vis a vis China, while spotting an attractive opportunity in shift of businesses from China. It noted "Today, with Chinese wages rising wages due to an ageing workforce, many large-scale firms in labour-intensive sectors currently manufacturing in that country are looking for lower-wage locations. With its large workforce and competitive wages, India would be a natural home for these firms. Therefore, the time for adopting a manufactures- and exports-based strategy could not be more opportune. Keeping this context in view, the Action Agenda offers detailed proposals for the implementation of an exports-based strategy. Among other things, it recommends the creation of a handful of Coastal Employment Zones, which may attract multinational firms in labour-intensive sectors from China to India. The presence of these firms will give rise to an ecosystem in which local small and medium firms will also be induced to become highly productive thereby multiplying the number of well-paid jobs."

The Action Agenda in particular offered "specific proposals for jumpstarting some of the key manufacturing and services sectors, including apparel, electronics, gems and jewellery, financial services, tourism and cultural industries and real estate."

After two and half years, the implementation of the agenda is found lacking on almost all fronts.

(a) Industrial production growth has slipped.

(b) Work force participation rate has slipped to multi decade low. Unemployment rate is highest since 2011. Labor productivity growth is at lowest level in a decade.

(d) No significant progress is seen on coastal zones, increase in port capacities. The work on dedicated freight corridor has progressed but still running much behind the revised schedule.

(e) Some impressive projects have been announced by some major global manufacturers. However, on ground little progress is visible. In 2018 the import of telecommunication equipments was highest in five years. FDI has been lower in 2018 and 2019 as compared to 2017.

Tuesday, December 10, 2019

Agriculture sector transformation agenda implemnetation is lacking

Continuing from last week - 3yr transformation agenda - did it work?

The NITI Aayog's 3yr agenda for transformation for agriculture sector recognized that "Enhancing agricultural productivity requires of efficiently using inputs, introducing new technologies and shifting from low to high value commodities."

The data available for first two years (FY18 and FY19), indicates that little progress has been made in implementation of the proposed transformation agenda. The following points are pertinent to note in this context:

(a) The share of agriculture sector in total GVA has fallen from 17.9% in FY17 to 16% in FY19. In Fy15, it was 18.2%.

(b) The horticulture crops' production grew from 300643MT in FY17 to 313851MT in FY19, an average annual growth rate of ~2%, much lower as compared to ~3.5% growth seen food grain production in FY18. Fruit production and productivity both fell in FY19. The productivity of vegetables, flower and plantation crops also declined in FY19.

(c) The growth in total GVA in agriculture and allied sectors moderated from 7.9% in FY17 to 6.9% in FY18 and further to 6.5% in FY19. Within this the agriculture, forestry and fishing GVA growth fell from 6.3% in FY17 to 2.9% in FY19.

(d) The share of expenditure on agriculture research and education in agriculture GVA fell to 0.32% in FY18 from 0.36% in FY17, before recovering to 0.37% in FY19. By any standard this allocation to research and education is dismal given the poor productivity levels and urgent need for transformation in agriculture sector.

(e) The investment agriculture sector fell from 15.6% of Agriculture GVA in FY17 to 15.2% in FY18.

(f) The MSP for staple crops has been increased by 6% to 19% during FY19. Paddy saw an increase of 13%, Wheat 6%, Soyabeen 11% and Maize 19%. UP government has not increased SAP for sugarcane for sugar season 2019-2020. To double in 5year, the farmers' income must grow at a compounded rate of 14.5%. As of now, the target looks quite challenging.

(g) The production/availability of certified/quality seeds improved less than 5% from 3802904MT in FY17 to 3988899MT in FY19.

(h) India met 56.57% of its domestic demand for vegetable oil through imports in FY17. In FY18 the share of imports had risen to 59.31%.

(i) The consumption of fertilizers increased by 2.4% to 265.91 lac ton in FY18, though it was still lower than the consumption of 267.53 lac ton in FY16. Urea production fell from 306.35 lac ton in FY16 to 298.94 lac ton in FY18.

(j) The funds released under the flagship Soil Health Management (SHM) decreased from Rs95.5cr in Fy17 to Rs71.67 crore in FY19. In FY18 the funds released were just 41.18crors.

It can be reasonably construed from above selective data points that the government is lagging behind in implementation of its ambitious agenda for transformation of agriculture sector.

(Data Sources: Annual Report FY19, Department of Agriculture, Cooperation and Farmers Welfare, Economic Survey for FY19 and CEIC)

...to continue tomorrow

Thursday, December 5, 2019

3yr transformation agenda - did it work?

In 2017, NITI Aayog released a three year action agenda to transform all three major sectors of economy, namely agriculture, industry and services. The agenda was supposed to be implemented over 3year period FY18-FY20

For the farm sector, the agenda highlighted that "Farmers make up nearly half of India’s workforce. Therefore, for India to flourish, its farmers and the farm economy must prosper."

Accordingly, the Action Agenda outlined a strong programme for agricultural transformation, including numerous measures to raise farm productivity, bring remunerative prices to farmers, put farmers’ land to productive uses when they are not able to farm it themselves and improve the implementation of relief measures.

The Draft offered an ambitious agenda for empowering the rural population through improved road and digital connectivity, access to clean energy, financial inclusion and “Housing for All.”

The Draft recognized that "Enhancing agricultural productivity requires of efficiently using inputs, introducing new technologies and shifting from low to high value commodities."

It also highlighted that higher farm productivity would require expanding the scope of irrigation to increase crop intensity, improvement in access to irrigation, enhancing the seed replacement rate and encouraging the balanced use of fertilizers.

The Draft agenda emphasized that "Precision farming and related new technologies, that allow highly efficient farming and conserve resources, must be spread through appropriate policy interventions."

Reforming APMCs, redefining the system of support prices for crops, land reforms to make the landholdings of marginal farmers viable, and adequate social security program for farmers to deal with stress due to natural calamities etc. were some of the key suggestions.

The agenda stressed that to achieve the goal of doubling farmers' income by 2022, "Conditions conducive to shift into high value commodities such as horticulture, dairying, poultry, piggery, small ruminant husbandry, fisheries and forestry need to be created."

For the industry and services sector, the agenda found that underemployment and hence lower worker productivity is a more serious problem in India, rather than unemployment, which has remained mostly consistent between 5-8% through past many decades.

Accordingly, the Draft, emphasized on creation of high-productivity, high wage jobs. To meet this end, it was highlighted, that focus must be on measures necessary for the increased emergence of larger, organized-sector firms.

While recognizing steady progress in the services sector, the Agenda offered specific proposals for jumpstarting some of the key manufacturing and services sectors, including apparel, electronic goods, gems and jewellery, financial services, tourism and real estate.

Now as we draw close to the end of the target three year period, it would be worthwhile to assess the execution status of the ambitious agenda. I shall examine the actual implementation of the agenda over next few days, but prima facie two things appear rather conspicuous to me:

(1) The replacement of the Planning Commission with the NITI Aayog needs to be evaluated by the CAG. In the interest of transparency and accountability, the government must also consider issuing a White Paper on this issue. The way NITI is building its bureaucracy and organizational staff, there appears almost no difference.

(2) Like other things, the execution level of this agenda may also be below par.

Wednesday, December 4, 2019

Derisking political risk

The first thing what the incumbent Chief Minister of Andhra Pradesh did after assuming charge of office was to order cancellation of many projects awarded by the preceding government (see here). The Andhra Pradesh Government also decided to reopen power purchase agreements (PPAs) inked under the previous TDP government, that could potentially bring 5.2GW solar and wind energy projects with an estimated debt exposure of over INR21,000cr under stress (see here). The state moved ahead with this proposal despite strong request from central government (see here) and order of the High Court (see here).

Subsequently, the World Bank decided to "drop" funding of “Amaravati Sustainable Infrastructure and Institutional Development Project”, seriously affecting the future of the project which has already swallowed Rs 45,000 crore worth of public money with less than twenty per cent of the work completed. (See here) Following the World Bank, the Asian Infrastructure Investment Bank (AIIB) also decided to withdraw from funding the project. The multi lateral agencies took the decision to withdraw funding after the Central Government withdrew its request for funding of this project. Last month, the state government finally decided to abandon the project leading to severe financial loses to many contractors and the state exchequer.

If a number of small and medium contractors are to be believed, the Chief Minister Office has also ordered a hold on payments due to them for various projects under execution, and some even fully executed, pending investigation of any irregularity in awarding of contracts by the preceding government.

The incumbent Chief Minister of Karnataka had also expressed his intention to review the decisions taken by the preceding government, jeopardizing financial interests of numerous contractors and vendors.

Reportedly, the new government in Maharashtra is also treading on the same path. They have already ordered suspension of the Metro rail shed project for which most of the ground work has already been done. Apparently, Chief Minister Uddhav Thackeray has told media that he has ordered a review of all on-going development projects in the state, including the Mumbai-Ahmedabad bullet train. Interestingly, in this case the party of the incumbent Chief Minister was also part of the outgoing government.

This practice of cancelling or suspending ongoing projects and harassing the contractors & vendors is certainly not a good sign for the economy. On one hand, this shall dissuade many small and medium sized vendors from participating in the government business; while on the other hand it shall cause totally avoidable delay in execution of projects, in many cases impacting the viability of the project itself.

I think there is an urgent need to rework the standard government contracts to provide for protection to the contractors and suppliers against any such review, suspension, cancellation etc. unless the charges of corruption in award of the contract are conclusively proved in a court of law.

In my view, a better solution for de-risking the projects from political risk would be to create a middle layer that cushions all the third party contractors and vendors from political changes. All the state governments and the central government may be required to form a specialized project executing company. Once the government finalizes the project after obtaining all the approvals etc, the government should award the project to this company through an irrevocable contract and transfer necessary funds to it in the form of cash and marketable government securities. This company in turn should sub-contract it to the third parties. The intermediary company should be responsible for making timely payments to the contractors and suppliers, and ensuring timely execution of the projects.

Tuesday, December 3, 2019

Demonetization, GST major culprits for growth slowdown

As expected, the GDP growth data for 2QFY20 came out to be poor. In the quarter ended September 2019, India's real GDP grew 4.5% and GVA grew 4.3%, the lowest rate of growth in 6years. The latest economic growth rate of India is now lower than China, Indonesia, Myanmar, Vietnam, Philippines, and similar to Malaysia.

The supply side data explains that the slowdown is pervasive and all sectors of the economy are struggling. Industrial sector was stagnant with manufacturing recording its first quarterly contraction in a long time. Services grew less than 7%, the lowest pace in 2years. Despite above normal monsoon, the agriculture growth at 2.1% was also lowest for the second quarter of a fiscal in many years.

On the demand side, private consumption grew 5.1%, slightly better than 3.1% in 1QFY20, but dismal in comparison to historical trends. Investments grew barely at 1%. Both exports and imports contracted for the first time since 2016. Import contraction of 6.9% despite weaker rupee further highlights the poor demand conditions.

This poor GDP growth data was supported to a great extent by the government expenditure which grew at 11.6%, highest rate in 6 quarters. Given that the government has already surpassed its fiscal deficit target for FY20, the tax collections continue to be sluggish and the nominal GDP is slipping at a faster rate than real GDP, it would reasonable to assume that the slowdown may persist for few more quarters at the least.

Regardless of what the government spokespersons and some enthusiastic market analysts may say, it is highly likely that we may end up FY20 with sub 5% growth. Given the fiscal challenges and intensifying global slowdown and deflationary pressures, we may struggle to grow more than 6% in FY21 as well, despite lower rates, taxes, and base effect and improving credit availability.

Based on an informal survey of traders, SME and professional, I am inclined to conclude that this sub 5% growth trend may persist for at least next 3 to 4 quarters. The key feedback from the survey could be listed as follows:

(a) The growth rate shall slip further as the government continues to be in denial mode insofar as the most important cause of slow down is concerned.

(b) Most respondents highlighted that lingering effects of demonetization and serious faults in GST processes are reasons for the slowdown.

(c) Demonetization has hit the small businesses very hard. It has destroyed the traditional sources of short term financing for traders and small businesses, increased the working capital cycle, constricted the inventory holding and business expansion capacity and increased the cost of doing business. Many of these SME businesses were critical part of the supply chain of the larger businesses. It has therefore affected the larger businesses also indirectly. Poor business conditions for large number of small businesses have obviously impacted the employment and consumption demand conditions. There is nothing to suggest that these conditions shall correct on their own in near future.

(d) The implementation of GST has been hasty and seriously flawed. More than 75% of GST assesses must be facing problems of reconciliation, wrongful disallowance of credit, defaults, harassment, corruption, and/or delayed (or no) refunds. A careful examination indicates that the system is even more problematic and cumbersome than the erstwhile Excise, VAT and Sales Tax regime. Unless the GST system and processes are streamlined for seamless flow of credits and payments, any meaningful acceleration in growth rate looks highly improbable.

Friday, November 29, 2019

It's an economic emergency, almost

The economic data for 2QFY20 will be released today evening by the Central Statistics Office (CSO). There is a near consensus that this data may not be good. The estimates of various agencies and institutions are ranging between 4% to 4.8% growth in real GDP over 2QFY19 (vs. 5% in 1QFY20). 2QFY20 is expected to be the sixth straight quarter of decline in growth rate, the longest span of decline since 2011-2012.

Since this data belongs to the quarter ended September 2019 and the financial performance of the businesses for that quarter is already in the public domain, it is reasonable to assume that the financial markets have assimilated the poor growth numbers quite well. However, the growth estimates for corporate revenue and profit for 2HFY20 may not be factoring a negative surprise.

Going by the forecasts of most analysts and economists, the growth estimates of 2HFY20 are not very encouraging; though the consensus is expecting the second half of the year to be better than the first half. It is estimated that the measures taken by the government to stimulate the growth, lower lending and tax rates, likely bumper Kharif crop, low base effect, inventory rebuilding in key sectors like automobile, cement, steel etc., shall have positive impact on the 2HFY20 data. The overall FY20 growth is expected to be in the range of 5.4 to 5.8%, implying a growth rate of ~6.5% in 2HFY20.

The non-profit think National Council of Applied Economic Research (NCAER) recently released its mid-year review of India’s growth prospects. NCAER has presented the lowest estimates so far, forecasting that the economy will grow at just 4.9% in the financial year 2019-20.

India may therefore lose the claim of "fastest growing economy" in next six months. The statement made by the finance minister in the parliament on Wednesday clearly indicates that the government is not oblivious to this fact. That is perhaps why the finance minister changed the narrative from the usual "slow but still the fastest growing" to "slow but no recession" (see here).

A section of commentators is insisting that on ground the Indian economy may already be witnessing a shallow recession. (see here, here, and here)

Even if we ignore these rather pessimistic opinions, one thing is clear - the impact of slowdown is highly skewed. The lower and middle socio-economic strata, which consist of over 70% of the population is facing recession like conditions. This is adequately reflected in (i) consistently falling private consumption since 3QFY18; (ii) shrinking household savings and (iii) rising household debt. The rich who form less than 10% of the population are contributing more than 50% of the growth.

Under these circumstances, the economic policy response, in my view, must be non conventional. A gradual, piecemeal stimulation may not be effective in these circumstances, which in fact has been the case in past one year. The response has to be immediate, accelerated, and massive. The policy makers need to acknowledge the situation as an economic emergency and accordingly use exceptional methods.

For example, instead of caring excessively about the fiscal deficit at this point in time, the government must consider a classical Keynesian response. Similarly, the monetary policy response also needs to be dramatic. This incremental 25-35bps rate cuts may not bear the desired impact. A sharp rate cut 100-125bps with rationalization of USDINR and REER may be necessary. Negative real rates, competitive exports and incentive to borrow & invest.

The proposal to initiate a TRAP like program is welcome. But the bureaucracy must be sanitized to make sure that the effort must be "how the coverage of such an initiative could be maximized" rather than minimized as the case has been tax rate cuts and real estate rescue plan.

Thursday, November 28, 2019

Why "public servants" are treated like Kings and Lords in India

If someone wants to understand the "unease of doing business & living" in India, a 45-50km drive in and around the city these days is a great idea. You would find long queues of vehicles at FASTag distribution counters.

Last late evening, I found many poor taxi and small commercial vehicle drivers waiting for their turn to obtain a "prepaid card". A couple of them said that they joined the queue at 7:30 in the morning. Their turn did not come till 10AM. They left and rejoined the queue at 8:30PM. They were not sure if they would get it by the night.

In principle, the FASTag is a "prepaid card" that is used to pay toll charges across the country. This is a substitute for cash payment at toll booths. The primary purpose of this facility is to reduce the time spent by vehicles at toll booths.

The secondary objectives may include (i) preventing the leakages in the toll collection; (ii) encouraging digital payments; (c) making toll collection process efficient and economical; and (iv) reducing the carbon emission by minimizing the traffic jams at toll booths.

Using this card as a vehicle tracking device is certainly not one of the stated objectives of this facility. The government agencies in fact clarified on this issue also. However, the KYC process for buying a FASTag implies that tracking the movement of the vehicle is one of the primary objectives of this facility.

To use this facility, the users need to furnish (i) copy of registration papers of the vehicle; (b) photograph of the vehicle owner; and (c) KYC documents of owner such as ID and address proof of the vehicle owner, alongside the FASTag application.

I totally fail to understand why and how FASTag is different from a prepaid Metro Card? Considering the rules for concessions (e.g., for special vehicles and vehicles owned by citizens living close to toll booths etc) it may be important to identify a unique FASTag to such vehicle. But then the KYC requirement must be on exception basis for vehicles or persons seeking concessions, rather than requiring everyone to go through this process. Besides, why vehicle owners' KYC is needed for FASTag is difficult to comprehend.

In my opinion, this means either of the following two things:

(a) The government does want to track the movement of all vehicles but does not want to admit this for the fear of litigation. This is clearly an invasion in the privacy of the people. I am not a legal expert, but I do believe that this invasion in citizens' privacy is clearly a violation of the constitutional guarantees.

In the famous Aadhar case (Justice K.S. Puttaswamy (Retd) vs Union of India) the 9 judge bench of the Supreme Court unanimously declared that "The right to privacy is protected as an intrinsic part of the right to life and personal liberty under Article 21 and as a part of the freedoms guaranteed by Part III of the Constitution."

The opinion of the SC judges in the said case clearly established that the "privacy of citizens is a fundamental inalienable right, intrinsic to human dignity and liberty."

Justice Chandrachud noted that "Formulation of a regime for data protection is a complex exercise that needs to be undertaken by the state after a careful balancing of requirements of privacy coupled with other values which the protection of data subserves together with the legitimate concerns of the state." For example, the judge observed, "government could mine data to ensure resources reached intended beneficiaries."

Obviously, the policy makers and bureaucrats who framed procedures for FAStag are fully aware of the consequences of the privacy violation concerns, but still want to snoop on peoples' movement, without disclosing to them that they are being tracked toll plaza to toll plaza; or

(b) The government does not intend to use this facility as a tracking mechanism, but the bureaucrats who were assigned to frame the rules and procedures could not get out of their idiosyncratic "controlling mindset"; and mechanically prescribed maximum possible paper work. Otherwise, in this digital age, why the government or any of its authorized agencies should be required to collect registration paper (RC) of a vehicle that is registered with the government motor vehicle department and the RC and KYC documents of the owner have already been submitted to the government at the time of registration.

The bigger issue in my view is the mindset of the executive. The public servants in our country steadfastly refuse to believe their status as such. They love to continue with the colonial legacy of British with the "the master servant relationship" deeply entrenched in the psych.

(To fully assimilate what I am trying to imply here one must witness the visit of elected representatives, civil servants, senior police officers, senior army officers and their family members to a temple. These people are usually escorted to the deity ahead all hundreds of common people waiting in queue, as if they are Kings of the Land and everyone else is a poor subject.)

While making policy and procedures the convenience of the citizen and businesses is perhaps the last thing in their order of priorities. For example, if FASTag policy and procedures were ease of doing business oriented, these would provide door step delivery of FASTag to anyone who sends an SMS (within 48 hrs) to the designated agency from the mobile registered with motor vehicle department at the time of registering the vehicle or making driving license, on cash on delivery (CoD) basis.

To ensure "ease of doing business" and "ease of living", the government must change the basic template of policy making. The new template must accept supremacy of "the people" over "public servants". Any new policy or procedure, or change in existing policy or procedure, must pass the test of "ease of doing business" and "ease of living". Even one hour of likely inconvenience to any citizen must be fully justified in writing.

Wednesday, November 27, 2019

A trip to motown

To understand the current state of automobile market in India, we met numerous people in the supply chain, users and prospective buyers over the last few days. Both rural and urban markets were covered in 4 states - UP, Haryana, Punjab and Delhi.

The key takeaways from my discussions could be noted as follows:

(a) A sizable number of existing 4W passenger vehicle (4WPV) users has postponed their replacement decision in past one year. Most of the users who have replaced their vehicles in past one year have up traded. SUV still remains a preference in rural area.

(b) Almost 65% prospective 4WPV buyers (mostly first time buyers) of entry level vehicles have postponed their decision to buy. Most of these prospective buyers are not likely to buy in next 6 months also. The postponement of decision is due to a variety of decision - economic uncertainty (job, profession or business), poor availability of credit, buying vehicle decision linked to buying or shifting house which has got postponed, wait for new model, were some of the common reasons.

(c) Only 20% of the prospective 4WPV buyers of higher variants have postponed their buying decision. Most of these prospective buyers plan to buy a new vehicle in next 6 months. Most prominent reason for their decision postponement was cited as waiting for new model.

(d) Less than 30% existing and prospective 4WPV users were aware of the impending changeover to BSVI emission norms.

(e) Fuel price does not appear to be a key factor in decision making for anyone. However, insurance cost is a matter of concern, though not a deterrent.

(f) The situation in 2W passenger vehicle (2WPV) is quite the opposite. Here a small minority of the existing users have postponed the replacement decision; while almost 60% of prospective buyers have postponed their buying decision. Economic uncertainty and poor credit availability are cited as the primary factors in postponement decision. Nonetheless, most of the existing users seeking replacement and prospective buyers have expressed their intention to buy a new 2WPV in next 6-12months. Only 18% of 2WPV users indicated that they may up trade to a 4WPV in next 12 months.

(g) All the local motor repair workshops reported material decline in business in past 12 months.

(h) All dealers of second hand passenger motor vehicles indicated 30-40% decline in transactions over past 12 months. Most local dealers are yet not worried about the impact of the growing presence of large national players in this trade.

(i) The spare parts dealers reported huge jump in sale of unbranded and spurious parts post GST. Almost all dealers reported 25-30% fall in revenue over past 12 months. It is felt that there may be 20-25% elimination in this space before the business normalizes in next 6-9months.

(j) The dealers of both 4WPV and 2WPV indicated sizable rundown in inventory over past 3months. However, only a few of them indicated intentions to rebuild the inventory in next 3 months. Almost all of them highlighted decline in NBFC finance to be one reason for poor demand. About 20% of these dealers indicated intentions of quitting the business over next 24months.

For commercial vehicles and tractors the sample we got was meaningless.

We intend to cover the states in west and south over next three months for taking a view about investing in auto sector stocks.

Tuesday, November 26, 2019

Lack of commitment as investment strategy

There are usually three types of customers for any product or service:

(i) Dog type - The customers who are attached to the people and/or the brand. For example, the people who prefer their hairs to be cut by the same person in a large saloon; to be served by the same waiter/waitress in a restaurant; to buy the same brand of clothes, food, etc. These customers would usually not mind paying higher price or waiting longer to get the product or service of their choice.

(ii) Cat type - The customers who are attached to a place rather the people or brand. For example, the customers who prefer to shop from a specific store, watch movies at a particular theater, spend their whole life in one house, etc. These customers also usually would not bother about the offerings of the competitors.

(iii) Rat type - The customers who are always looking for a favorable deal. They usually have no loyalty to any place, brand or people. They keep actively looking for the best deals and buy the products/services from the places/people who offer them best value for their money/effort.

In past couple of decades, the proportion of the third type of customers (Rat type) has risen disproportionately, almost everywhere.

Employees are less attached to their jobs and employers are less attached to their employees.
People do not mind changing places (cities, states, countries) in search for better professional opportunities.
Cheaper Chinese products are preferred to expensive German products, despite poor durable life.
Cheaper and lighter MDF furniture is preferred over heavy long lasting pine wood or sheesham wood furniture.
Easy to install and change ceramic tiles are more preferred to marble flooring.
Ready to cook & eat food and beverages are gaining currency even in traditional societies.
The youth prefer live-in relationships over matrimony as the intensity of commitment is much lower in such relationships. Even the jurisprudence is evolving to accept such less committal relationships as valid contractual obligations for parenthood and property sharing and inheritance.
Politicians have given up commitment to any particular ideology and are willing to go to nay extent for getting a better "deal".
The house or private labels of the large retail formats (Big Bazaar, Spencer, Reliance Retail etc.) are growing faster than many established FMCG and textile brands as these invariably come at cheaper prices or with attractive deals (1 for 1 free!).
Many successful business models are purely based on this rise in "deal seeking tendency" of customers, e.g, MakeMyTrip, Trivago, Zomato, Policy Bazaar, Paisa Bazaar, etc.

If we apply this theorem to the investing in equities, we shall see a sustained decline in buy and hold strategy and higher trading. The people who cannot do the frequent churning by themselves might increasingly entrust the job to professional traders and fund managers.

At this point in time I am avoiding any opinion on the issue of Buy & Hold vs. Active Investment vs. Passive Investment. But I guess It'll be not long when I am forced to take a stand on this.

Friday, November 22, 2019

My take on popular market narratives

I find the following four narratives are presently dominating the financial market research in India:

(1) Slowing economic growth

India's economic growth hit a six-year low of 5% in 1QFY20. The consensus estimates indicate that the growth may further slip even to below 5% in 2QFY20. Some estimates are forecasting that the 2QFY20 GDP growth, to be announced next week, may be closer to 4% rather than 5%. The full year growth number, after accounting for base effect and recovery in 2HFY20, are also expected to remain closer to 5% rather than 6%.

The slowdown in economic growth is widespread, encompassing all the segments and sectors of the economy. Agriculture, industry and services have all slowed down. Investment and consumption demand is multiyear low; and so are savings, investments and credit growth.

The financial research is adequately capturing the slowdown since August when 1QFY20 GDP growth numbers were announced. However there are still differences about the future outlook. A significant section of the market appears convinced that the slowdown shall bottom out in 2HFY20 and a sustained recovery may be seen from FY21. On the other hand, many economists still have doubts about the FY21 recovery. This section appears convinced that road to recovery is bumpy and to regain a 7% growth trajectory, India would require many structural reforms over next 2-3yrs.

In my view, based on my interactions with various stakeholders, any meaningful recovery in the economy may not begin before 2QFY21, and FY21 growth will be closer to 6% rather than 7%. Unless of course the government changes the denominator by making FY18 as the base years.

(2) Divergence in economic growth and equity prices

While the economic growth is sliding to multiyear low, the benchmark equity indices are trading close to all time high levels. This divergence of economy and equity prices is a popular topic of discussion amongst various market participants.

I have no view on this issue. Nonetheless I would like to highlight the following two small points:

(i) The total market capitalization of stocks listed at NSE was Rs15.2trn in January 2018. Almost two years later, it was at the same level yesterday.

(ii) The nominal GDP of India grew 24% during two year period FY17-FY19. The market capitalization of NSE grew by the same percentage from April 2017 to March 2019.

So the argument that equity prices are outpacing GDP growth may not be entirely true. It is the skew in the market cap that is perhaps the cause of intrigue for research analysts.

(3) Fiscal challenges

The consistent decline in household savings and rise in household debt; poor GST collections; and rise in social sector spending and urgent need for the fiscal stimulus has made the task of fiscal balancing very challenging. It is therefore a subject of intense debate how the government will be able to manage to increase the public spending to stimulate the economic growth. Large scale disinvestment, release of RBI reserves and perhaps new avenues of taxation (estate duty etc.) are some of the ideas being discussed.

In my view, higher effective of taxation seems inevitable, even if the government is able to execute its ambitious disinvestment program. However, I am not overly worried about fiscal deficit number, so long the government is transparent about the accounts (deferred subsidies, withheld refunds and suppliers' payments, direct borrowing by NHAI and Railways etc. and revenue earned through book entries, e.g., through PSU buyback, inter se sale of PSU stakes etc.)

(4) Earnings revival

The 2QFY20 corporate earnings have been mostly in line with already moderated estimates. The tax cut announced in August did help to some extent. However, the corporate commentary has remained downbeat and does not inspire much confidence for earnings revival in the coming quarters. The common theme therefore is that we may likely see further moderation in the earnings estimates for FY21 and even FY22.

There are few analysts who believe that earnings revival is imminent, but majority does not appear to be concurring with that. Earnings growth is therefore mostly a contrarian idea.

In my view, the earning revival will be very stock specific. Active investment may therefore be a better idea in FY20.

Thursday, November 21, 2019

A paradigm shift

The recent order of the Supreme Court may finally end one of the ugliest chapters in the corporate history of independent India. With sale of Essar Steel Limited to ArcelorMittal S. A., the new paradigms in the Indian corporate business and financial market spheres that had been taking shape since past few years may get formalized and gain wider acceptance.

The businessmen shall accept that they may no longer remain in control of their businesses if they fail in honoring their debt commitments; and shareholders shall realize that if lenders of a business lose money, nothing shall be left for the equity shareholders.

There is a lesson for the small investors who buy stocks of defaulter companies because they are trading at very low price. Under the new paradigm the equity shareholders should expect to get anything only and only if the lenders are able to realize full value of their loans. The theoretical definition of equity shares (Upon liquidation of a business, the equity shareholders are entitled to receive the value left after satisfying all the liabilities) may stand true under the new paradigm.

In this context, it would be pertinent for the readers to rewind the story of Essar Steel

Promoted by the Bombay based Ruia family, Essar Steel initially commenced operations of as a construction firm in 1976 as Essar Constructions. Its name was changed to Essar Offshore & Explorations in May '87 and later to Essar Gujarat in Aug.'87. It became Essar Steel in 1995. It was supposed to be one of the most modern steel plants in the world at that point in time. The company issued equity shares to the public at a huge premium.

However, despite getting huge amount of interest-free money through share premium, the company consistently reported huge losses, (while the main competitor Tata Steel was showing good profits) resulting in erosion of the entire networth of the company. The company became sick and went for a CDR (corporate debt restructuring) program. 40% equity capital was written off under the CDR scheme. The CDR package of Essar Steel was popularly termed as the worst ever from lender/shareholder point of view and best ever from promoter point of view. Many lenders had not only to forego all interest amounts but had also to compromise on principal amount.

Post CDR, company started showing profits but, much lower than market expectations considering very low interest cost and highest ever realization in steel. The company had a paid up capital of over Rs. 500 crore, book value of over Rs. 25 and a net profit of over Rs. 700 crores, but it did not pay any dividend after 1997 thus managing to keep the share prices suppressed. The Promoters subsequently increased their stake in the company to over 74%.

It is interesting to note that promoters did not infuse any fresh capital to revive Essar Steel but kept on increasing their share holding in the telecom venture Hutch, which was sold later to Vodafone at very high profit.

Moreover, the promoters managed to buy a second hand Steel Plant in Korea at a very attractive price. This Plant was placed under an unlisted group entity Essar (Hazira) Ltd. and not brought under Essar Steel Limited. At the same time the promoters also made investments in other steel plants abroad in their unlisted company Essar Global Ltd.

The regulatory paradigm shall also change to adapt to the new circumstances. Since the chances of any recovery for equity shareholders of defaulting companies are insignificant in most cases, it would be better if a special window is created for trading in shares of all companies which are under IBC process or facing winding up proceedings. The traders (I am deliberately not using the word investors here) who wish to buy lottery tickets must know upfront what they are getting into.

Wednesday, November 20, 2019

How not to transform India

Last month the hon'ble President of India issued a very important piece of subordinated legislation titled "the National Institution for Transforming India (Staff Car Driver) Recruitment Rules, 2019" (see here). These rules have been issued in suppression of "the Planning Commission (Staff Car Driver) Recruitment Rules, 2010". The objective of issuing these Rules apparently is to prescribe the method of recruitment, age limit, qualifications and other matters relating to the recruitment of car drivers for the staff members of the National Institution for Transforming India (NITI Aayog).

As per the rules, the entry level driver needs to be 10th pass with a valid driving license and 3yrs driving experience. Experience of serving as home guard or civil volunteer for 3yrs is desirable but not mandatory.

The only disqualification prescribed is that the candidate must not have practiced bigamy, unless the Central Government is satisfied that such marriage is permissible under the personal law applicable to such person and the other party to the marriage and that there are other grounds for so doing.

As per the pay scales prescribed under the said rules, the starting salary of the drivers of NITI Aayog shall range between Rs29,000 to Rs45,000 depending on the scale he is recruited in.

For me, the key take away from the above are as follows:

(a) The government certainly does not believe in less government more governance.

(b) NITI Aayog is no different from the erstwhile planning commission insofar as the bureaucracy is concerned. No transformative efforts may be expected from the National Institution for Transforming India.

(c) Of all things, prescribing bigamy as the "only" disqualification for a driver requires serious amount of explanations. I am unable to fathom any rationale of choosing bigamy over all other crimes.

(d) A cursory glance through matrimonial column of Sunday newspaper would show that the average salary of management and engineering graduates with 5-6yrs work experience is not more than Rs1,00,000-Rs125,000. A high school driver of NITI Aayog may also get similar salary after 10yr of tenure. There has to be something terribly wrong somewhere.

This prompts me to reiterate the following from what I had said couple of years ago:

"Two news items have frequently dominated the media headlines in past few years.

(a) How many thousand post graduates, people with professional degrees etc. have applied for a handful of clerical or subordinate (peon) job in various government departments.

(b) What new communities have raised demand for being classified as "backward" to become eligible for reservation in government jobs. Many times their protests have turned violent, disrupting public life and damaging public and private property.

The first item is interpreted by the public at large, either as an indication of the massive unemployment prevalent in the country; or as a symptom of the craze for jobs with opportunity for corruption. The second item is interpreted by various people to indicate different things. For example—

(i) he ruling party takes it as a conspiracy of opposition parties to destabilize the government and polarize the voters of the community demanding reservation, e.g., Jat community in Haryana, Patidars in Gujarat, Marathas in Maharashtra, and Gurjars in Rajasthan.

(ii) The communities already covered by the scheme of reservation, take it as a conspiracy of "upper castes" to undermine their rights and privileges.

(iii) The communities seeking reservation benefits do so to demand fulfillment of the constitutional guarantee for equality and life.

(iv) The others claiming to the victims of reservation policy, see it as a likely further infringement of their right to equality and diminished number of opportunities in higher education and jobs.

What I discovered after discussing the matter with a variety of people and stakeholders, is as follows:

1. The average salaries in government departments and PSUs have meaningfully higher than the private sector. Besides, the government jobs offer job security that is not available in most private sector jobs. The entry level subordinate job starting salary is close to Rs19000 these days. Not many MBAs and Engineers can get this kind of salary in private jobs.

2. For the highly qualified, entering the system as a subordinate is relatively easier. Once inside the system, they can easily move forward, as the insiders get preference over outsiders in almost senior level vacancies.

3. The increasing number of communities seeking reservation in jobs is directly linked to higher salaries, better career prospects and job security in government jobs.

4. Fiscally challenged government with only partially success in growing the tax base, has not been able to increase the number of jobs in government or public sector. In fact the government and Public sector jobs have been consistently shrinking in past two decades. This has further intensified the competition, hence greater political interference.

5. The government (past, present and future) has literally no solution to this problem.