Do it yourself

 About a quarter of a century ago, I had just joined a midsized investment banking firm. My team of three people was assigned a mandate for IPO of a real estate company. We worked very hard (of course on our Excel Sheets and without the help of Saint Google) on the mandate and prepared a proposal which suggested that IPO may be priced in the band of Rs12-15. After the initial presentations were made, the team went to the promoter with the promoter of our firm for final presentation. After a detailed slide show was made, our boss told us to excuse them for 10minutes. After 10minutes, our boss came out and instructed, “IPO is in Rs28-30 band, prepare to file the documents for approvals.”

This being my first experience, for a moment I was in a position of shock. I found the pricing ridiculous. I even told my senior that this IPO cannot be sold at this price. My senior who had experienced many such situations before just smiled and told me to shut my mouth and get on the job. Eventually, the IPO was a success and the stock went on to become a compounder for the shareholders.

After reading and listening the expert commentators on various media platforms about the decision of the US Federal Reserve last night, I am getting a strong feeling of déjà vu. Millions of “experts” like me advised the FOMC about what they should be doing in the meeting and what the Chairman Powell should be saying after the meeting. But they have done and said what is most expedient for everyone – markets, government, economy and bankers. The novice may cry foul, but experienced ones know how does it work.

“Dot Plot” is a new buzz word that Indian electronic media has decided to learn. There are zillions of experts who are discussing the dot plot on social media platforms in India. It is heartening to note that we have become buzz word compliant.

“Dot plot” is a simple form of data visualization that consists of data points plotted as dots on a graph with an x- and y-axis. These types of charts are used to graphically depict certain data trends or groupings. US Federal Reserve uses this tool to present how the members of the Federal Reserve Open Market Committee (FOMC) perceive the benchmark bank rate over next few years.

The market experts discuss this “Dot Plot” intensively after every FOMC meeting. There is however little evidence to indicate that the actual trajectory of Fed benchmark rates has followed the dot plot. There is also little correlation between the actual trading positions and dot plot beyond 2days before and after the dot plot.

I like to compare the dot plot with the exit polls of elections in India. These are discussed intensively. They impact the market for two days (between exit polls and actual results). But there is little evidence to suggest that exit polls have a strong correlation with the actual election results; or any political strategy is formed on the basis of the results of exit polls..

The latest dot plot indicates that 13 of the 18 FOMC members believe that there will two rate hikes (from present 0-0.25%) in 2023, i.e., two years from now. 7 of the 18 FOMC believe that rate hike may actually happen in 2022.

I see there are many traders who want to trade on the basis of this dot plot. For all these enthusiast, my suggestions are as follows—

(i)    It is good to be buzz word compliant, but placing trade on these buzz words is not good idea.

(ii)   The actual decision to hike rates is always dependent on real economic data, not perception. Usually the hikes are after the economic activity has picked materially, output gap has shrunk and inflation has started become threatening. A rate hike under such circumstances is healthy.

(iii)  There is strong evidence to indicate that markets have usually done very well after healthy rate hikes.

For the record, FOMC has indicated that the US economic activity is recovering strongly. However, there is not enough evidence to warrant a rate hike in next 12months. A strong US economic recovery is good for global economy and markets; and continuing low rates and comfortable liquidity for next one year should continue to support the risk trade. Rest all is the TV discussion on exit polls.

 One of the few positives of Covid19 pandemic induced lockdown is the rise in birth rate in the Parsi communities. Reportedly, 61 babies were born to Parsi couple in the year 2020. The central government is motivating Parsi couple to increase their birth rate through Jiyo Parsi scheme. Regardless, it is highly unlikely that Parsi community in India may survive to see 22^nd Century, as their population continues to dwindle consistently. The fertility rate of parsi community is now close to 0.5, much below the replacement rate of 2.1, that is needed to keep the population constant. Amongst other minorities the fertility rate of Sikhs and Jains is also materially below the replacement rate as reflected in the decline in their population.

I am mentioning this because of two reasons – (i) the latest popular narrative of population control law; and (ii) the fading prospects of demographic dividend of India, that has formed the basis many investment and business strategies.

As per various estimates, the fertility rate of India has already fallen to 2.1 in 2020 from 4.5 in 1981. The replacement rate in India could be 2.2 (against international standard of 2.1) due to still high child mortality rate, the present fertility rate. Which means the population growth rate of India may have already peaked, or may peak in next 4-5years. The other things remaining the same, the youth character of Indian demography may begin to change in 2030s and the prospects demographic dividend may exhaust in two decades. The talk of a population control law at this stage is as ridiculous as it could be.

The proponent of the population control law are purportedly arguing that Muslim population is growing faster than the Hindu population hence a law is needed to maintain the demographic balance in the population.

This contention needs to be tested with the some facts. As per the census data of 2011, the fertility rate of Hindu women had declined from 3.2 in 2001 to 2.2 in 2011, a decline of 1.0; whereas for Muslim women it had declined from 4.1 in 2001 to 2.7 in 2011. The decline in fertility rate in the 2001-2011 was much sharper in Muslim women as compared to Hindu women. The same is true in case of Hindu backward classes and scheduled caste also. It is estimated that post implementation of Right to Education Act, and a slew of incentive schemes to promote education of minority and underprivileged girls, the literacy rate has improved further amongst Muslim and SC girls. This will certainly reflect in further decline in their fertility rate in 2021-22 census. The census of 2021-22 may explode the myth about disproportionate rise in Muslim population.

In my view, this is high time we focus on exploiting the remaining demographic dividend and maintaining the fertility rate at replacement ratio, rather than wasting time and energy on population control law. We need to learn from Chinese experience, which is now incentivizing people to produce more children.

The balance that needs to be urgently maintained is the regional demographics. The fact is that the population in southern and western states has already to decline. It is the North & Central India (UP, MP, Bihar, Rajasthan, Jharkhand and Chhattisgarh) and north east India where the population growth is happening. These are the areas where most youth population is located, while the most employment opportunities are happening in South and West. This is leading to massive migration of workers from central and North India to the South and West, leading to demographic changes in these states. This is bound to become a cause of civil unrest sooner than later. Especially when the delimitation exercise for parliament seats happens in 2031, the more populous states will get disproportionately high representation in the parliament at the expense of southern and western states. This may cause immense resentment amongst the losing states. More states may follow the Maharashtra example for local reservation and restriction on migrant labour. North vs South and East vs West divide would be more harmful to India Story than the ratio of Hindu and Muslim in the population.

Besides, as I have always been highlighting that the imbalanced economic growth in India needs to be corrected fast by creating meaningful employment opportunities in the most populous states; which incidentally happen to be the poorest also.

The reverse migration of labour back to home states due to lockdown is an opportunity that needs to be fully exploited. A strategy must be worked out to keep this labour home, while incentivizing the industrialized states to invest more in automation to compensate for the loss of labour.

Estimates of TFR for all religions, Hindus, and Muslims across states (excluding Jammu & Kashmir) from Census 2011, and comparison with Census 2001 estimates

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As per the latest data published by Centre for Monitoring Indian Economy (CMIE), the unemployment rate in India was 11.9% (10.18%) in May 2021 (June 2020). The urban unemployment was much higher at 14.73% (11.68%), while the rural unemployment stood at 10.63% (9.49%). As per CMIE data, India’s unemployment rate was 6.5% in March 2021, just before the second wave of Covid19 pandemic hit India. It is therefore possible that the rate of unemployment normalize back to 6-7% range when the economy opens up in next 2-3months, as the intensity of pandemic has already subsided materially.

The more worrisome trends highlighted by CMOE data however are-

(a)   The labour participation rate is beginning to fall sharply after 55yrs o age. It is below 25% for the 60-64 age group –

(b)   Unemployment rate is 35% in 20-24 age group. For youth in 20-29yr age group it is above 10%.

(c)    The employment rate is 19.3% for the persons who have college degree. It is just 0.2% for the uneducated; and 9.3% for persons who have studied upto 10-12^th standard.

(d)   Labour participation rate is below 50% in most of the states. Amongst the most populous states, it is 36.3% in Bihar; 35.2% in UP and 38.5% in MP.

(e)    Haryana and Rajasthan have the highest unemployment rates of 26.4% and 22.4% respectively.

The rise in life expectancy is not reflecting in higher labour participation rate for above 60yr of age. Even in most populous and most poor states like UP and Bihar labour participation rate is close to 35%, implying high dependency ratio. Female labour participation rate is even worse in these states. This also reflects on the cultural and traditional impediments. High income states like Haryana and Goa have much higher unemployment rates as compared to national income.

The worst part is the highest unemployment rate amongst workers with college degree. This could imply two things, among another, i.e., – (i) the skill level afforded with a college degree is quite poor to get employment; and/or (ii) the economy is not adding enough white collar jobs. Most of the incremental employment is happening in low paying low skill jobs.

Further, if I factor in anecdotal evidence collected during my frequent travels to states and hinterlands, I do not feel comfortable with this data of unemployment. In my view, the real unemployment is much higher and wider. There are plenty of youth who are underemployed and unemployed in disguise. There are numerous cases where, two sons work in father’s shop even if the father alone is sufficient to manage it; or a full family of 5 people works on a 3 bigha farm, whereas it needs only two people.

In my view, the better way to estimate the level of unemployment would be assess how many workers are earning at least the minimum wage prescribed for their respective category, e.g., skilled, unskilled, industrial, agriculture etc. On this parameter, my crude guess is that the unemployment rate might be in excess of 20%.

 Presently, a large part of the market analysis and commentary is focused on the stock rally from the low prices recorded in March 2020. The popular narrative is that investors have made extraordinary return on their equity portfolios, in what was a once in a decade opportunity.

In my view, this narrative suffers from a serious lacuna. This narrative assumes that—

(a)   Investment is a discreet process and not a continuous one. Investors make investments only on occurrence of some event and exit as soon as the impact of that event dissipates.

(b)   The economic behavior of a majority of investors is rational. They are able to control the emotions of greed and fear very well.

(c)    Most of the investors have infinite pool of investible surplus, and they are able to invest material amount of money at their will.

Unfortunately, none of these is even half true.

Investment is a continuous process. Most of the investors stay fully invested in markets at most of the times. Usually, they reduce their exposure to risk assets like equity when down trend is fully established. So in March 2020, investors were raising cash not investing fresh money.

The economic behavior of a majority of investors is not rational. They are materially influenced by the forces of greed and fear. In summer of 2020, fear was the overwhelming sentiment. Expecting investors to increase risk in their portfolio at that time is akin to expecting a patient lying in ICU to worry about the sale in neighborhood grocery store.

An overwhelming majority of investors have a finite pool of investible surplus. A large part of this surplus remains invested at most of the times. The crash in March-April 2020 resulted in erosion in the market value of these investments. For the investors who could stay invested in the fall, the erosion has been mitigated by the subsequent rise in prices. The investors whose risk tolerance was breached by the fall would have exited their positions and therefore there losses would have become permanent in nature. Very few investors would have made material incremental investments close to the market bottom last year. Only these investors have some reason to celebrate. For most others, it is business as usual.

Statistically, if we eliminate the fall in March and April of 2020 and subsequent V shaped recovery and assume a market in ad continuum, Nifty is up about 26% from the pre Covid high recorded in January 2020. The past two year (June 2019 to June 2021) have yielded a near normal return of ~13.5% CAGR.

Small cap (55%) and Midcap (52%) have given better return than Nifty (26%) since pre Covid high of January 2020. However, if we consider the return of mid and small cap for past two years, there is hardly much to distinguish.

Most notably, PSU Banks and Media sectors are yet to reach their pre Covid highs. Banks, Realty, FMCG and Services are all underperforming Nifty if we consider data from pre Covid (January 2020) period. Metals, IT and Pharma are the only sector that have outperformed Nifty meaningfully in Past 16 months. These sector put together account for less than 30% weight in nifty.

The point I am trying to raise is that the investors must cut the noise out and focus on their investment strategy, which must be in full consonance with their and aptitude and risk appetite. Listening to the popular narrative and getting overwhelmed with the feeling of missing out (FOMO) will only lead them to make mistake that may cost dearly.

The principle and overriding function of the securities market regulator, The Securities and Exchange Board of India (SEBI) is to protect the interests of the investors in the securities market. The other functions, viz., orderly development and regulation of securities markets are secondary, in my view. However, there is overwhelming anecdotal evidence to indicate that the regulators have given precedence to market development and regulation over the principle objective of investor protection. There are many instances in past 3-4years alone to indicate this. In the episodes of IL&FS, Franklin Templeton, Yes Bank, Jet Airways, Karvy etc., the interests of the investors in these entities were compromised. Moreover, little efforts were made to ensure that prospective investors are given full disclosures about the risk and reward of investing in the securities of these entities.

Recently, we have seen repeat of this tendency. On Monday, the 7^th June 2021, evening, DHFL informed stock exchanges about the resolution plan approved by the Mumbai bench of NCLT. It was clear from the resolution plan that in the successful bid of Piramal Group “No value was attributable to the equity shares as per the liquidation value of the Company estimated by registered valuers”. Besides it was also made clear in the communication to the exchanges that equity shares of DHFL shall be delisted upon completion of the resolution.

Clearly, the resolution plan envisaged zero value for the shares of DHFL Limited. Despite this the stock was allowed to be traded on Tuesday, the 8^th June 2021. To make the matter worse, it was allowed to rise 10% (the maximum permitted as per the applicable price band). Over 14cr shares were traded on NSE alone and investors took delivery of over 9crore shares valued close to Rs200cr. All this money will be lost. No broker warned the investors on Tuesday. The exchanges did not advised the brokers to caution their clients. SEBI did not asked the exchanges to suspend the trading. To compound the mistake, the stocks continues to be traded on both the exchanges despite the company formally informing the exchanges that the worth of equity shares is Zero. About 5 million shares were traded on Wednesday also. To be fair, many brokers did advise their clients on Wednesday.

Many “knowledgeable” investors in DHFL have been allowed to unfairly transfer their risk to unsuspecting gullible investors in past two days.

In this context it is pertinent to note that the model bye laws prescribed for the exchanges require that—

“The Exchange shall provide adequate and effective surveillance and monitoring mechanism for the purpose of initiating timely and pro-active measures to facilitate checking and detecting suspected or alleged market manipulation, price rigging or insider trading to ensure the market integrity and fairness in trading. For this purpose, the Exchange may, from time to time, apply, adopt, determine and implement various measures, mechanisms and requirements, as may be provided in the relevant Regulations and as may be decided by the Relevant Authority from time to time.”

It is therefore also the duty of the exchanges to act proactively to ensure fairness in trading. In this case the exchanges could have easily anticipated that some people have advantage of knowing the details of the resolution plan. An analysis of trading data for Tuesday will clearly show that the trading in DHFL was not fair. Not suspending the trading this stock is even more unfair to “unaware” investors and traders.

 In recent months the critics of the Indian government have spoken much about the achievements of the neighbour Bangladesh more than India. The point that Bangladesh economy may be recording faster growth rate than India has been emphasized to highlight the underperformance of Indian government. I am not sure if this criticism is valid, given the differences in the size and diversity of Indian and Bangladesh economies. Besides, on purchasing power parity India is presently much better Nonetheless, rising beyond politics, I must say that the performance of Bangladesh is impressive. The country has focused on its strengths (primarily agriculture and abundance of cheap labour) and evolved a sustainable economic model that suits it best. It has followed a conventional labour intensive manufacturing led growth model to fully exploit its demographic dividend

As per the latest IMF data Bangladesh has a per capita income of US$2,227, a growth of 9% over previous year. This compares with India’s per capital income of US$1,947 at the end of FY21. However, if we consider on like to like basis, Bangladesh economy resembles more the economy of Uttar Pradesh, Bihar and West Bengal. The per capita income in these states is materially lower as compared the Bangladesh, even if we consider purchasing power parity. In FY20 Bihar has a per capita income of US$659; Uttar Pradesh US$1,043, and West Bengal US$1,634. These three states are home to one third of Indian population, numbering more than 2.5x of Bangladesh population.

Bangladesh population growth rate is now close to 1% down from ~3% at the time of independence in 1971. The median age of population is ~27years, up from 17years in 1971. Given that the fertility rate is stable at the ideal replacement rate of 2.1% for 15years now, the demographics shall remain supportive of growth in mid-term.

Of course, illegal migration helps Bangladesh growth materially. As per the World Bank estimates, every year about 5,00,000 uneducated and unemployed youth illegally migrate from Bangladesh to other countries, ensuring a steady stream of remittances for the economy. Given that the high growth of the economy is sustaining and foreign investment is accelerating, this trend in migration may reverse in next decade.

On social parameters, Bangladesh is faring better than India, and significantly better than the comparable states like UP, Bihar and West Bengal. It has lower infant mortality rates, higher life expectancy and better youth literacy. The urbanization is close to 40%.

The best feature of Bangladesh economy is higher female labour force participation. The Bangladesh labour force comprises 30% female workers; while in India it is only 20%. In India this ratio has deteriorated from 30% in 1990 to 20% in 2020; while in Bangladesh it has improved from 20% in 1990 to 30% in 2020.

The low female participation in workforce is not only an impediment to higher growth. Rather, it reflects poorly on the culture, traditions, and law & order situation in India. Even in the capital city of Delhi, common women are scared to venture out alone after 8PM.

My fear is that if it continues the way it is, in 15yrs “illegal Bangladeshi immigrant” will be part of history. Many of our small businesses and households would have lost a cheaper source of labour; and Bangladesh and Sri Lanka would be implementing their own versions of NRC to prevent “illegal Indian migrants” from entering their land. It might sound seditious paranoia to some, but the point still remains – do we need a national mission on women development or not.

 Do you remember Tulsi Bhabhi, the protagonist in one of the most popular TV soaps on Indian television? The character was adored by all as it was widely considered to be an epitome of quintessential Indian – caring, selfless, affectionate, tolerant, accommodating, and family person. Even though there are plenty of Indians who may not exactly match this description, but a vast majority does find these characteristics desirable to have.

In our cinema and literature, protagonists are not only expected to possess these characteristics; but they are also supposed to demonstrate these in a rather non- subtle manner. Most of the successful and admired product promotion campaigns also target this emotional aspect of Indian populace. The sellers of Insurance, Chocolates, clothes, jewellery, steel, cement, adhesives, real estate, trucks, motor cycles, cars, etc., all try hard to touch the emotional cord of consumer.

I am sure all politicians and bureaucrats are cognizant of this phenomenon. I would therefore expect that the promotion campaign for government schemes and programs must address to this core of the target audience.

This understanding was however not visible in the campaign against the spread Covid19 pandemic. The citizens were told to “protect themselves” by “maintaining distance” and “wearing masks”. The policy makers ought to understand that a quintessential Indian would not work hard to protect himself. They would not wear mask or maintain distance to protect themselves, simply for the reason that the other family members might feel offended and find them “selfish” or overzealous”. The campaign would have been much more successful if it asked citizens to protect their loved ones by wearing masks and keeping distance. Most people would have obliged - if not voluntarily, then just to demonstrate how much they care.

Another policy incongruence that attracted my attention recently, related to the record production of food grain in the country. The agriculture minister recently told media that due to the efforts of the farmers & scientists; and policies of the central government India shall achieve a record production of food grain for the fifth consecutive year.

As per the latest data, rice production is pegged at a record 121.46 million tonne in the 2020-21 crop year as against 118.87 million tonne in the previous year. Wheat production is estimated to increase to a record 108.75 million tonnes in 2020-21 from 107.86 million tonnes in the previous year. In 2020-2021, our domestic wheat and rice consumption are expected to be ~105 million tonne and 107 million tonne respectively.

It is widely accepted that—

(a)   Wheat is not a native crop to India and may not be most suitable source of nutrition for Indian DNA. Most nutritionists attribute the sharp rise in cases of diabetes and obesity to over consumption of wheat. They advise more consumption of native grains like millets and sorghum to stay healthy.

(b)   Over cultivation of rice has depleted the ground water in many states. Most geologists and agriculturists are advising against the rice cultivation in states like Punjab, Western UP, Haryana, MP etc.

Given these circumstances, the government policy should be to —

(i)    discourage the wheat plantation;

(ii)        encourage plantation of native grains like millets and sorghum;

(iii)  run an extensive campaign to promote consumption of native grains due to their health benefits; and

(iv)   Supplement the promotion campaign with adequate incentive schemes to encourage wider cultivation and consumption of native grains.

It is pertinent to note that once considered food of poor people, Bajra (pearl millet), Ragi (finger millet), Jhangora or Kavadapullu (Barnyard millet) Kuttu (Kodo millet) etc. are selling in the market at 2x to 4x of wheat and rice prices. Their availability is also an issue in many parts of the country.

The function of policy must be to—

(a)        promote and propagate what is right for the common people;

(b)        correct the past inconsistencies, anomalies  and mistakes; and

(c)        drive the economy on a faster and sustainable growth path.

Celebrating higher wheat production; higher tax collection driven by fossil fuel, cigarettes etc. may not be the best thing to do for a progressive government.

 Trends in cost of capital in India

A recent survey done by the consulting firm Ernst & Young (EY) and National Stock Exchange (NSE) highlights some interesting data about the cost of capital of Indian businesses. “The Cost of Capital Survey” is an “attempt to understand the threshold cost of equity that India Inc. used for its capital allocation and investment decisions, and the process by which practicing finance professionals in the industry make capital costing decisions.”

The key findings of the Survey are as follows:

·         India’s average cost of equity is ~14%. This has declined by ~100 basis points since our last cost of capital survey, over a period in which interest rates have declined by ~50 basis points.

·         Real estate, healthcare (including pharmaceuticals and life sciences) and renewables command the highest cost of equity, whereas chemicals, media and entertainment and FMCG are at the lowest. ARCs and Startups recorded higher cost of equity on an average than all the other sectors. If ARCs and start-ups are excluded, then the average cost of equity drops further to ~13.5%.

·         The results confirm that the Discounted Cash Flow (DCF) methodology is one of the key approaches for valuation analysis used by corporates, usually in combination with other methods such as peer company multiples or transaction multiples.

·         It was observed that most companies that use the DCF approach typically consider a horizon of five years.

·         The survey emphasizes our learning from the previous survey that “rule of thumb” or an organizational hurdle rate is preferred over objective models such as the Capital Asset Pricing Model (CAPM) to estimate cost of capital.

·         The quantum of subjective company-specific adjustments made to arrive at the cost of capital has remained at similar levels as assessed in 2017. The top factors necessitating such adjustments as suggested by respondents are company/project specific risk factors and uncertainty around projections along with company size and gestation project also forming important considerations.

·         Most respondents acknowledged that an additional risk premium is justifiable when considering strategic investments in start-ups and provided their views on the quantum. The quantum of premium varied across industries, with most sectors capping it at 10%.

·         In using the DCF method for non-finite projects, another key area apart from cost of capital is the terminal value. Respondents were equally divided between using the Gordon Growth Model vs. an Exit • Multiple to arrive at terminal value; the popular long-term stable growth rate used was ~4%, down about 50bps since our last survey.

·         Most of the respondents indicated that they did not make any temporary adjustments to discount rate and the inherent uncertainty arising out of the situation was met by businesses by adjusting their projections or evaluating multiple scenarios instead.

(Source: The Cost of Capital Survey, 2021, EY-NSE)

As an investor I have always been fond of stories. My strong belief has been that if the story is good, numbers will definitely chase it. To the contrary, if the story is bad, no matter how good the numbers look presently, it may not be worth investing in.

Like in any other method of investing, this method also has its own limitations. Sometimes, good stories fail to sustain the momentum and lose the track midway. Sometimes, bad stories change the course and get on the right path with the help of good numbers.

Nonetheless, I like the story method of investing, as it suits better to my aptitude. In following this method of investing, I just need to keep my eyes & ears open to the happenings around me and look for stories worth investing. New product in my kitchen; new appliance in my bathroom, new or larger hoarding on street corner, an attractive advertisement in newspaper, a shopkeeper pushing some product harder than usual, some management on magazine cover, your children or wife insisting too much to buy a particular product, a news about new technological invention, a motivational story about some innovation changing the life of some people, etc. are some of the signs that could lead you to a potential investment story.

This method of investing saves me from bothering about mundane things like monthly sales & production numbers, quarterly accounts, RBI policy announcements, daily price changes in stock markets etc. It also save me from staying awake till midnight to hear what US Federal officials have to say about inflation and interest rates in US.

I also avoid quantitative (or number driven ) approach to investment for two simple reasons—(i) I am not good at mathematical and statistical techniques of analysis (read MS Excel); and (ii) it makes me dependent on other analysts for my investment decisions. If I have to follow this approach, I would rather entrust my money to a professional fund manager and live in peace.

If you are wondering why am I sharing this thought with the readers, let me explain the trigger. Recently, there has been a debate on social media about the portfolio of very famous fund manager. The critics argued that the earnings of the companies included in much spoken about portfolio of this fund manager would need to grow @20-21% CAGR for next 20years to justify the current PE ratio of the portfolio. The critics also highlighted that if the investment time horizon of an investor is not long enough to match the assumptions of the fund manager, the chances of poor returns are significant.

The supporters of the fund manager argued that for his analysis he used “compounding of cash flows” rather than “compounding of earnings” and therefore the criticism is invalid. The cash flow of a business may compound much faster than earnings (profit after tax or PAT). Since the critics are viewing the portfolio from a totally different vista point, their criticism need not be taken seriously.

My point is that when you use the quantitative method of analysis, it is possible to use a variety of tools for analysing a business. The analysts using different tools may get an entirely different outcome. For example, using different method for calculating the terminal value of a business (e.g., GGM vs Exit value) may give entirely different fair value for the same underlying business. This problem is less likely in using qualitative (or story) method in investment decision making. A good mix of these two would though be panacea for an investor. Find a story emotionally and test that mathematically.

The latest GDP data released by the government has evoked mixed reactions. While less than contraction (-7.3% yoy) in overall FY21 real GDP is a matter of comfort, sharp contraction in private consumption and continued weakness in manufacturing (-6%) is a subject to be worried about. The better than expected economic performance has mostly been outcome of strong government consumption expenditure and large subsidies extended as part of various tranches of stimulus.

In the last quarter of FY21, India’s real GDP witnessed a growth of 1.6%. This is in spite of a poor base of mere 3% growth in 4QFY20 (disruption started in the base quarter) and significant relaxations in lockdown restrictions. This clearly indicate that normalization of economic activities might take much longer than earlier estimated.

I have always stated that quarterly growth data has little relevance for investors. It may hold some relevance for the policymakers to assess if any course correction is needed, but for a common investor it virtually has no meaning.

I also believe that extrapolation of annual real GDP growth data to immediate future years may also produce misleading results. The large projects that started in a year contribute to GDP through Gross Fixed Capital Formation (GFCF) head. However, the second and third round impact of these projects takes years to reflect in GDP growth; whereas the second round impact of consumption expenditure are usually visible relatively in lesser time. It would therefore be appropriate to judge the longer term trend in GDP growth to assess the likely growth trajectory in short term, (1-2years). I usually use 5year rolling CAGR in GDP to assess the likely growth trajectory of GDP in next couple of years.

This trend forewarned of a prolonged economic slowdown as early as FY11-FY12 (see chart). The long term (5yr CAGR) growth trajectory slipped below 6% in FY20, even before the pandemic induced slowdown was triggered. If we adjust the growth for FY21 and FY22 for sharp fall in FY21, and assume a 9% real GDP growth for FY22, we may end up with almost no growth during two period of FY21 and FY22. Assuming a further 8% growth for FY23 and 7% thereafter, we shall be able to attain the long term 6% growth trajectory only in FY27. A higher trajectory would be possible only post FY27. This essentially implies the following, in my view—

1.    The fiscal leverage with the government will become incrementally lesser. So unless the government decides to shed its inhibition and increase the capacity of its printing press, sustaining higher government consumption expenditure will become increasingly challenging.

2.    The private consumption demand might not improve materially in next couple of years as real household income remains stagnant. Discretionary consumption growth will particularly be impacted.

3.    The manufacturing growth will largely depend on exports and capacity building for import substitution. Technology leadership would be more important than the capacities.

4.    Construction and construction material sectors will overwhelming depend on government expenditure on capacity building.

5.    For next couple of years agriculture would remain mainstay of economic growth.

 Recently, the government published the progress report on Sustainable Development Goals (SDGs). The “Sustainable Development Goals - National Indicator Framework Progress Report, 2021 highlights the progress made so far by India in attaining SDGs.

The SDGs are a comprehensive list of global goals integrating social, economic and environmental dimensions of development. These goals lay the blueprint for achieving a better and sustainable future for all by providing “an international framework to move by 2030 towards more equitable, peaceful, resilient, and prosperous societies - while living within sustainable planetary boundaries”. United Nation General Assembly adopted the document titled "Transforming our World: The 2030 Agenda for Sustainable Development" consisting of 17 Sustainable Development Goals and associated 169 targets, in September 2015. This agenda came in to force from January 2016.

India is committed to implement the SDGs based on the nationally defined indicators responding to national priorities and needs. A National Indicator Framework (NIF) has been developed in 2018 consisting of 306 national indictors along with identified data sources. NIF facilitates the monitoring of SDGs at the national level and provides appropriate direction to the policy makers and the implementing agencies of various schemes and programs. Besides NIF, guidelines have been provided to the States for developing comprehensive and inclusive SDG Monitoring Framework through development of State Indicator Framework (SIF).

The 17 Sustainable Development Goals are—

1.    No Poverty

2.    Zero Hunger

3.    Good Health and Well Being

4.    Quality Education

5.    Gender Equality

6.    Clean Water and Sanitation

7.    Affordable and Clean Energy

8.    Decent Work and Economic growth

9.    Industry, Innovation and Infrastructure

10.  Reduces Inequalities

11.  Sustainable Cities and Communities

12.  Responsible Consumption and production

13.  Climate Action

14.  Life Below Water

15.  Life on Land

16.  Peace, Justice and Strong Institutions

17.  Partnerships for the Goals

On juxtaposing these goals to the government schemes and programs announced by the Central Government in past five years, it becomes clear that the commitment to SDGs is a major driver of development policy function in India.

All the signatures schemes like clean energy (LPG to poor household, bio-energy and solar), Sanitation (toilets and piped water in every house), financial inclusion (Jan Dhan Account, pension, UBI), agri productivity and income (doubling of farmers;’ income, new farm laws), health mission, Quality Education (New Education Policy and Institutions of Excellence), Gender equality (Triple Talaq law, women directors etc.) Innovation & productivity (startup India, make in India) Sustainable cities (smart cities, metro rail) etc. could be traced back to SDGs commitment.

As per the latest Progress Report, India has made significant progress in some areas, while challenges remain in some other areas. While the citizen can themselves see and feel the areas where significant progress has been made, it is pertinent to note the areas that are lacking. These are the areas that may hold both opportunities and challenges. Some of these are as follows, for example—

(i)    In FY20, 50.66% of population was getting safe and adequate drinking water through pipes.

(iii)  0.15% population was homeless in 2011. Present data is not available.

(iii)  At the end of FY20, number of telephone subscribers were 88.74% of the population. It is down from 93.27 in FY18.

(iv)   100% rural population had access to toilet facility at the end of FY20.

(v)    The proportion of total government spending on essential services 9education, helath and social protection) has come down from 29.87% (FY16) to 29.47% in FY19.

(vi)   The proportion of budget marked for gender budget is down from 5.58% in FY18 to 4.4% in FY22.

(vii)  Proportion of beneficiaries covered under National Food Security Act has come down from 99.01% in FY17 to 97.57% in FY21.

(viii) Gross value added in agriculture per worker has increased from Rs61427 (FY16) to Rs74822 in FY20.

(ix)   Percentage share of expenditure on R&D in agriculture has fallen from 0.44% in FY16 to 0.037% in FY19.

(x)    Net enrollment ration in primary and upper primary education has fallen from 94.11% and 72.02% respectively in FY16 to 89.14% and 68.99% respectively in FY19.

(xi)   Only 32.66% schools has computer for teaching purposes in FY19.

(xii)  Proportion of crime against women to total crimes has risen from 6.99% in 2015 to 7.87% in 2019. 28.1 women per lac faced sexual crime in 2019 (22.2 per lac in 2015). The number of women facing cruelty by husband has also increased from 18.78 per lac to 19.54 per lac. There is no reduction in sexual crimes against girl child.

(xiii) Per capita availability of water has reduced from 1508m³ in 2015 to 1486m³ in 2021.

(xiv) Percentage of households using clean cooking fuel is reported to be 102.11 in FY20 (???). In FY21 it was 99.97%.

(xv)  Renewable energy share in the total installed electricity generation has increased to 13.4% in FY16 to 19.2% in FY19.

(xvi) Annual growth rate of GDP has declined consistently since FY17. Annual growth rate in manufacturing sector has also declined consistently.

(xvii) Percentage of credit flow to MSME as a percentage of Total Adjusted Net Bank Credit has declined from 18.18% in FY16 to 16.39% in FY20.

(xviii) In FY16 2 states had Good coastal water quality index and 7 states were moderate. In FY21 no state has good coastal water quality, all 9 states are moderate.

In past couple of months a number of research reports have expressed concerns over the rural demand in the wake intense second wave of pandemic and subsequent lockdown of economic activities. Some consumer facing corporates have also expressed similar sentiment in their interaction with analysts and investors. The popular views seems to be that unlike last summer, when the rural demand remained resilient despite a wider and stringent lockdown, this year the demand may not show similar resilience. Wider and deeper spread of infection this time is one of the primary reasons behind these concerns. Rising stress in household and unorganized sector is also expected the discretionary spending in check.

In this context, there are few points that need to be noted by investors before forming a negative view on consumption theme.

Record production in crop year 2020-2021

Firstly, as per the third advance estimates for the 2020-2021 crop year, the agriculture ministry has expected record foodgrain production for 5^th consecutive year. India's foodgrain production is estimated to rise 2.66 per cent to a new record of 305.43 million tonnes in the current crop year 2020-21, on better output of rice, wheat and pulses amid good monsoon rains last year.

In the non-foodgrain category, the production of oilseeds is estimated at 36.56 million tonnes in 2020-21 as against 33.21 million tonnes in the previous year. Sugarcane production is pegged at 392.79 million tonnes from 370.50 million tonnes in the previous year, while cotton output is expected to be higher at 36.49 million bales (170 kg each) from 36.07 million bales in the previous year.

Given the remunerative pricing and higher volume of crop conventionally augur well for the overall rural income.

Normal monsoon forecast for 2021

The India Meteorological Department (IMD) has forecasted a normal monsoon for 2021. As per IMD’s latest forecast, Southwest monsoon, starting in June, is expected to be normal at 98 per cent of the Long Period Average (LPA).

This week, the widely-respected Australian Bureau of Meteorology (BOM) has also ruled out the likelihood of the rain-disrupting El Nino phenomenon over the next six months. Meteorologists say that a low probability of El Nino is certainly good news for the monsoon, although the complex weather system depends on many other factors.

A good monsoon usually means another year of good bumper farm production and consequent positive impact on the rural economy and consumption demand.

Second wave weakening and economy unlocking

In past one week, the second wave of pandemic has shown a clear tendency to decline. Further improvement is expected over next couple of weeks. It is likely that the mobility restrictions may begin to ease as the Kharif sowing season approaches. It is therefore likely that the income loss and spending curbs (due to mobility restrictions, health concerns, curtailed marriage spending etc.) seen in 1QFY22 may not spill over fully to the next quarter.

Indubitably, full reopening of economy and normalization of household spending may take at least 3 to 4 more quarter, till a significant proportion of the population is inoculated. Consequently, the economic growth for FY22 earlier projected to be in the range of 11-12%, may get constricted to 7-8%. This implies that Indian economy will attain the FY20 level of economic activity only in 2F2022 only.

My personal assessment of the rural and some semi urban areas in UP, MP, Punjab, Haryana, and Chhattisgarh is as follows:

·         Household finances have been damaged across the state, especially in the lower income group families. Lower income and medical expenses have eaten up savings and overall debt level has risen (most of it informal or friendly). The expenses on education and health have risen for a common household. For 5% households these trends may be structural due to loss of life or permanent employment. Lenders (formal or informal) will have to share some burden of this in near term.

·         The consumer confidence for discretionary spending is materially lower. However, two wheeler and smart phone/tablet may not be discretionary in most cases. Clothing, jewellery, home renovation, wedding, etc are some of the discretionary items that may cut material cuts. Down-trading in staples, personal care, shoes, home appliances, personal vehicles is also clearly visible.

·         The credit worthiness of an average household has diminished. The personal loan segment has been witnessing maximum growth in past few years. A slowdown in this segment may be inevitable.

·         The demand for farm input remains robust. Farm credit disbursement however may have slowed. The worst impact is from contraction in farm credit from informal sources. How efficiently this conundrum is resolved, may have material impact on the growth of rural economy. Implementation of farm laws in letter and spirit would be critical in resolving this situation.

·         The loss of life is unfortunate in any case and under any circumstance. In rural area, the Covid fatality rate is materially more in second wave as compared to the first wave. However, given the disguised unemployment and underemployment, the economic impact may not be as severe as many analysts might be anticipating. Not more than 5% households in rural areas have borrowed money to get treated at private facility in towns.

·         Pandemic has actually resulted in upgrade of healthcare facilities in many tier2/3 towns and villages. Hopefully much of this improvement will stay post pandemic also which will be a major positive for rural economy of India.

·         In rural and semi urban areas there is resistance to vaccines. Much of this resistance is result of misleading propaganda by ignorant, mischievous and/or malevolent elements. So far the institutional effort to counter this misinformation campaign in grossly inadequate. Recover would largely depend on how fast we convince people to get vaccinated and actually vaccinate them.

Based on my assessment I would not be too worried about consumer staples beyond couple of quarters. A material correction post 1QFY22 results could actually be a good entry opportunity. I would be extremely cautious about retail lenders, especially unsecured loans, and sale of premium vehicles. Appliances sales may miss this summer season, but might see a near normal festival season post monsoon.

In July 2007, investment bank Bear Stern announced that couple of its hedge funds have gone bust. These funds were primarily investing in derivative securities with home mortgages as their underlying. It was later unfolded that the underlying for these derivatives were actually a web of complex financially engineered instruments where actual underlying security was of very poor credit quality. This was the first time when “sub-prime” entered the popular market jargon; which essentially meant that though a derivative financial instrument is rated of investment grade, the actual security underlying that derivative is of sub-standard quality.

The market briefly took note of this event correcting sharply. However, the event was soon forgotten as a standalone instance that could not have impacted the overall markets. Subsequent months witnessed one of the sharpest global markets rallies.

In January of 2008 it was realized that Bear Stern was just a tip of the iceberg. The malaise of sub-prime was all pervasive and had impacted trillions of dollars in derivative instruments. What started with Bear Stern, soon engulfed the entire world. Many large banks and hedge funds were found to be infested with this termite. Not only banks, it has hollowed finances of many sovereign governments like Portugal, Iceland, Italy, Greece, and Spain (PIGS) etc.

What followed was total chaos. The global market froze. Trade and commerce was hit as banking channels were shut and credit frozen. The giants like AIG, CITI Bank, The Federal National Mortgage Association (commonly known as Fannie Mae) and Federal Home Loan Mortgage Corp (commonly known as Freddie Mac) etc came to the brink of disaster. Some of the top US investment banks like Lehman Bros, Countrywide and Merrill Lynch etc. could not survive.

To mitigate the disaster, the central banks and governments devised some innovative monetary policies (commonly known as Modern Monetary Theory or MMT). Under these large central bankers started an unprecedented quantitative easing (QE) program, which is nothing but an euphemism for printing new money and buying stressed assets with that money to support the market from collapsing. US Treasury also unveiled a US$800bn Troubled Asset Relief Program (TARP), under which it financed the stressed lenders by infusing equity or extending liberal credit. TARP was unwound in 2014 with US Treasury actually earning some money out of this.

The QE program has been extremely successful in at least one of its stated objective, viz, ensuring financial stability. The sovereign default crisis in peripheral Europe was totally averted. Global markets reopened immediately and credit flow restored. The asset prices were not only normalized but exceeded their fair value in couple of years. The other objective of faster sustainable growth is however yet to be achieved.

The Central Banks, primarily US Federal Reserve (Fed), European Central Bank (ECB), Bank of England (BoE) and Bank of Japan (BoJ), however continued their QE program, though the extent of printing money has been tapered. To mitigate the impact of pandemic, central bankers have again started to expand their balance sheets (printing money).

Back at home, RBI had resisted any QE in the wake of global financial crisis. The stimulus given by the government of India was also very limited, as Indian economy was not directly impacted by the crisis. None of our institutions were meaningfully involved in global Ponzy schemes of sub-prime mortgages and credit default swaps (CDS). Overseas branches of few banks lost some money in forward forex contracts and underwriting sub-prime papers, but nothing to threaten their existence or impact the domestic financial system meaningfully.

The economic crisis due to pandemic is however very different. It has directly impacted our economy and financial system. Besides, the financial system was also struggling with the lingering impact of the large credit defaults of IL&FS etc. RBI therefore has to step in along with the central government. While the central government has done multiple tranches of fiscal stimulus, RBI on its part has started its own version of QE program, with the hindsight gained from the global experience of past one decade.

Through this program, it has successfully managed to keep bonds and currency market stable; supporting the government’s expanded borrowing program, improving the current account and comforting the foreign investors who could be panicked if INR exchange rates fluctuated wildly.

The collateral benefit of RBI’s QE program to the government has been huge interim dividend of Rs911bn for FY21. The RBI would have made huge profit in trading of (a) government bonds (LTRO, Twister etc.) in which it buys bonds of shorter maturities and sells bonds of longer maturities and (b) trading of INRUSD by selling spot USD (to keep INR stable) and buying longer term swaps, or the other way round.

Given that RBI usually buys the asset under some stress (bond or currency), has the ability to print money, and need not bother about the MTM losses on its positions, the chances of it losing money on its trades are remote. It is therefore reasonable to assume that RBI shall continue (and even increase) its trading activities in years to come. It is too easy and lucrative source of income and managing markets to give up easily.

There will be no surprises to see (a) the finance ministers providing higher dividend from RBI in years to come; and (b) senior bankers with rich experience in managing treasuries being at the helm of RBI.