Do it yourself

Wednesday, March 18, 2020

2020 not like 2009

The sentiment on the street eerily looks similar to the one we saw during 2HFY09, post collapse of Lehman Brothers. In those days, the rumors of large banks declaring bankruptcy, sovereign defaults, imminent EU breakup, market freeze, sounded absolutely believable. These were not only market grapevines believed by the common investors. Many senior analysts at global investment banks wrote scary reports about these eventualities. Globally reputable, economists and strategists pained doomsday scenario of global economy slithering into a deep abyss to compete with the great depression post WW-I.

In India, many depositors transferred money from private banks to the public sector banks. Investors summoned their advisers for details of their liquid fund portfolios. The fixed maturity plans (FMPs) backed by bank CDs were pre redeemed by paying penalties. Capital protected structured products were also called prematurely by incurring material losses.

Some of the readers have likened the current situation to the 2009 panic sell off. A few believe that going by the reactions of central banks in the developed world, it appears to be already worse than 2009. Many readers have wanted to know my view as to how much worse it could go before the rock is hit.

To all my readers, I would request that I am no Taleb, Rajan, or Roubini who can assess the gravity of situation and make a prophecy almost instantaneously. I am an ordinary micro investor in the local Indian financial markets, who can access the data relating to past trends with some efforts and roughly correlate that data with the present conditions to make a naive assessment of the situation.

My assessment of the present situation is that presently we are nowhere close to the rout in asset prices seen in 2009. In 2009, Sensex had ended 18% lower than the July 2006 level from where the bull market had started. The BSE Midcap and BSE Small Cap had ended the cycle 36% and 41% lower than the starting point.

The current bull market started from end of February 2016. As of yesterday, the Sensex was higher by 36% from the start date. BSE Midcap and BSE SmallCap were higher by 24% and 16% respectively. Besides, the gains recorded during 2006-2008 were much higher than the gains made during 2016-2018. The severity of the fall in 2008-09 was therefore much more intense and deeper.

In my view, we may not a fall like 2006 this time, because of the following four simple reasons:

(a) Foreign investors had pumped in huge money during 2004-2008 in Indian equities. This time they are huge net seller during 2016-2020 period.

(b) The earnings growth fell off the cliff during FY09 to FY11 period leading to de-rating of Indian equities. This time the earnings growth has remained anemic and has little scope to disappoint materially. In fact it may surprise on the upside from 2HFY21 onwards.

(c) Indian's economic growth has seen multiple downgrades in past two years, unlike 2008-10 when the world had great expectations from India's economy.

(d) Presently, the leverage in Indian stock market is significantly lower than the 2008-09.

Nonetheless, we may certainly fall further from the present level, before hitting the rock.

Tuesday, March 17, 2020

Its beyond COVID-19

While the shutdown of socio-economic activity prompted by spread of coronavirus (COVID-19) is dominating the headlines, there are few more important things that may be impacted larger volatility in markets and decline in asset values.

1. Foreign investors have been net sellers in Indian equities in 5 out 6 years during 2015-2020. In the current year 2020, they have sold net Rs484bn in Indian equities. The FPI selling is certainly not COVID-19 driven. They seem worried about failure in growth acceleration, earnings drought, policy unpredictability, INR depreciation (or USD appreciation), and shrinking yield differential, amongst other things.

2. The corporate earnings growth has been anemic for past one decade. In past 6years, the Nifty earnings have growth at less than 5% CAGR. The visibility of earnings growth for next year has also diminished with recent events.

3. Multiple instances of willful defaults, frauds and regulators' apathy to investors have caused huge losses to the unsuspecting investors. The credit rating agencies and auditors have repeatedly failed in performing due diligence in performance of their duties. The mutual fund managements and fund managers have miserably failed in performance of their fiduciary duties by (a) breaching prudent exposure limits to single company, group, sector etc.; (b) subscribing to suspect quality debt; (c) failing in timely realization of collateral; and (d) failing in disclosing the true nature of the risk in various fund portfolios. Massive losses to the investors due to write down in debt securities of IL&FS, Essel Group, Vodafone, Yes Bank, etc is one major reason for investors' mistrust and disenchantment from financial markets.

4. The unusual weather in past 6 weeks has impacted the Rabi cop at many places in north India. This shall definitely impact the overall rural income; something the market was relying upon for economic recovery.

5. The collateral damage from the business disruption due to COVID-19 may impact many micro businesses materially. One quarter of poor activity may be sufficient for these micro businesses to slip into a debt spiral. The collective impact of damage to these businesses shall be visible in balance sheets of financial institutions and P&L of consumer product manufacturers in near term. We have not seen the regulators and the government rising to the occasion and proactively providing comfort to the stressed entrepreneurs.

In short, there are more worries for Indian markets besides COVID-19. Expecting sharp sustainable bounce in near term may not be an appropriate thing to do at this point in time.

Friday, March 13, 2020

Some random thoughts of coronavirus

An old market proverb is that "markets stop panicking when the government begins to panic". However, the current market conditions appear defying this conventional wisdom. Instead, the panic shown by the government authorities in dealing with the threat posed by the novel coronavirus (COVID-19) has caused deeper panic in the financial markets.

From the statements made and actions taken by various state authorities across the world (including India) to check the spread of the coronavirus, I decipher the following:

(a) The coronavirus has spread to a large number of countries. Even though the mortality rate of patients suffering from the virus may not be high, the transmission is much faster, and it threatens large scale immobility or people and disruption of business. In that sense it is perhaps one of the most disruptive pandemic for the modern generation. The spread of bubonic plague in 19th century (though that had massively higher mortality rate) could be the only appropriate parallel to this.

To this extent, the panic reactions of the government may not be unwarranted or inappropriate. Though many may like to argue that complete ban on travel could have been avoided by comprehensive screening mechanism at the ports of departure as well as the port of entry.

(b) The indications from China is that the Chinese authorities are in full control and new cases of infection are negligible now. The businesses have started the process of normalization and in 4-6 weeks shipments could return to normal level.

Similar, indications have been received from South Korea, Hong Kong, Singapore, Vietnam, Taiwan, Thailand and Malaysia etc.

The number of cases in heavily populated South Asia (India, Bangladesh, and Indonesia) is also well within control.

Regardless of the alarm bells sounded by German Chancellor, WHO, and European Commissioner, the coronavirus may be declared under control latest by the end of April.

(c) The disruption is likely to have significant impact on shipping, travel and hospitality industries. The loss of business for them in this quarter may be permanent in the nature.

(d) So far there is little indication that the spread of coronavirus may have impacted the household income significantly. The impact on household consumption may not be material, or at least not permanent. At worst, we may see some deferment of the demand till the conditions normalize.

(e) As of this point in time, there is little indication that the disruption may cause any significant change in the business practices and procedures. Redefining necessary travel, work from home, virtual meetings, etc are some trends that may not be materially stimulated by the coronavirus. I expect these trends to follow their normal trajectory.

(f) The business disruptions caused by the coronavirus related developments, could prove to be fatal for many micro businesses as well as many large businesses. For example, a small eating joint may default on its debt repayment obligation and face closure. Similarly, many large businesses which are already stressed may breach the fault line and become defaulters. Financial sector will have to deal with this. The role of regulator would be critical in managing this situation. They must proactively allow the banks to assess which accounts to allow relaxation and to which not.

At this point in time, I see no reason to change my investment strategy as discussed couple of weeks of ago (see here). I shall continue to shift my debt and gold overweight to equities over next 3 weeks.

Thursday, March 12, 2020

Solving MSMEs' working capital problem

My numerous interactions with the small traders and manufacturers in past couple of years have highlighted "working capital stress" as one of the key challenge being faced by this key segment of the Indian economy.

Traditionally, this segment had managed their working capital through informal sources. Private pools (popularly known as kitty or committee in local parlance) functioned as economical, stable and sustainable mechanism to fund working capital and small capex needs. Besides, it also helped in providing a large pool of "free" working capital to large corporate buyers.

The process of demonetization in 2016 disrupted this traditional financing mechanism, without offering any alternative solution. This disruption not only impacted the MSME segment, but did also hurt the larger businesses which replied on these MSME as a major source of working capital financing and inventory parking.

In recent past, many government officials and ministers have denied the problem of "delayed payments" and "poor credit availability" to the MSME segment, even though the finance minister has on at least three occasions in past one year promised that all pending payments to the MSME due from government departments and PSUs will be expeditiously cleared. However, no significant delivery on this promise has been seen on the gorund.

Last week, the RBI governor while delivering a lecture at the 15th ASSOCHEM Annual Banking Summit, on the subject "Micro, Small and Medium Enterprises: Challenges and Way Forward" highlighted this problem. Recognizing the importance of MSME in the overall economic context, the governor said as follows:

1. The MSME sector contributes in a significant way to the growth of the Indian economy with a vast network of about 6.3 crore units and a share of around 30 per cent in nominal GDP in 2016-17. The share of the sector in total manufacturing output was even higher at 45 per cent. Taking cognizance of the wider set of benefits that the sector offers to the rest of the economy, the Government has envisioned to increase its contribution to GDP to over 50 per cent in next few years as the country aspires for a ₹ 5 trillion economy."

2. As per the 73rd round of National Sample Survey (NSS) conducted during the period 2015-16, the estimated employment in MSME sector was around 11 crore. Within MSME sector, each of the three sub-sectors, namely, trade, manufacturing and other services accounted for about a third of total employment. Around 50 per cent of the total MSMEs operate in rural areas and provide 45 per cent of total employment.

Interestingly, the micro enterprises account for 97 per cent of total employment in MSME sector. This relates to the problem of what is called the missing middle⁵, which suggests that micro firms have failed to grow into smaller and medium firms and so on over time. This seems to have kept the micro sector bereft of enjoying economies of scale, investment into fixed assets, adoption of technology and innovation.

While counting the challenges for this critical segment of Indian economy, the governor admitted that "delayed payments" is one of the primary challenges being faced by the sector. The governor said, "A large number of MSMEs are ancillary units catering to the needs of large industries, both in the public and private sector. They often face the problem of delayed payments, affecting their cash flow and working capital availability. Most of the time, delay in realisation of such receivables increases their operating cycle and reduces their ability to procure new orders or fulfil the existing ones. A primary survey conducted by Reserve Bank in December 2019 showed that 44 per cent of MSMEs engaged in manufacturing activities faced delay in payments."

The governor mentioned that Trade Receivables Discounting System (TReDS) launched in 2014, could be a sustainable solution for meeting the working capital needs of MSME as well as managing the delayed payment issues. TReDS is primarily an auction based bill discounting platform introduced by RBI. Besides, in the Union Budget 2020-21, the Government has also announced app-based invoice financing products to obviate the problem of delayed payments of MSME. The mechanism may prove complementary to the TReDS platform and would further alleviate the problem of delayed payments.

However, we are yet to see these measures becoming popular with the MSEM and the large corporate and PSUs.

TReDS when (and if) fully adopted, could be a game changing platform in Indian financial services industry. For, it could (a) provide seamless bill discounting facility to MSEM at the most competitive rates, (b) provide a well diversified and cost effective platform to financiers; (c) instill a sense of payment discipline amongst large corporates and PSUs; and (d) help identifying the sign of stress in the corporate buyers at a very early stage, prompting a fast corrective action.

The question is whether all stakeholders are making sufficient efforts to make this happen?