Vijay Kumar Gaba

Wednesday, June 19, 2013

Keep it simple – Equity market returns

Also read other posts in this series:

Keep it simple

INR

QE a matter of fact, not going anywhere.

Economic growth in India

Current account deficit

Interest rates

Thought for the day

“Nothing defines humans better than their willingness to do irrational things in the pursuit of phenomenally unlikely payoffs. This is the principle behind lotteries, dating, and religion.”

- Scott Adams (1957 - )

Word of the day

Phosphoresce (v):

To be luminous without sensible heat, as phosphorus.

(Source: Dictionary.com)

Shri Nārada Uvāca

Most good things keep company with problems.

Good monsoon has disrupted the normal life greatly. Expect June food inflation to spike sharply, before it comes down later.

Tuesday, June 18, 2013

Keep it simple – Interest rates

‘Interest’ is the compensation for one of the most important resource needed for production, i.e., ‘capital’. The rate of interest in short term mostly depends on the forces of demand and supply much like for other sources of production like labor (wages), land (rent) and raw material. However, over a longer period there are many factors that structurally impact the demand and supply of capital and therefore influence the rate of interest demanded and offered for use of such capital.

The benchmark or policy rates established by the regulators or central bankers theoretically play a critical role in determination of interest rate structure in an economy under normal economic conditions. However, in extreme cases policy rates may fail to transmit to the ultimate provider or user of capital.

Indian economy presently is passing through such extreme conditions. Therefore, policy rates established by RBI are not as effective as these should be under normal circumstances.

Banks have not reduced interest rates in past one and a half year despite RBI easing the policy rates. The reason for this failure in transmitting the policy rates are varied and multiple. For example:

(a) The default risk and therefore credit cost for banks has risen substantially in this period. Most of the credit demand is for re-financing of existing stressed loans or working capital loans. Thus increasing the risk premium.

(b) Fiscal profligacy has kept demand for government borrowing higher whereas higher inflation and higher administered small savings rates have led to lower deposits growth (supply of funds).

(c) Precarious BoP conditions have prevented the regulator from aggressively enforcing transmission, as lower rate could impact inflow of much needed foreign capital.

In our view, higher risk, higher demand and lower supply should keep interest rates in Indian context relatively higher for next couple of years at the least.

Also read other posts in this series:

Keep it simple

INR

QE a matter of fact, not going anywhere.

Economic growth in India

Current account deficit

Thought for the day

“The more a sensibilitist I am; The more I seem to want my mountains wild.”

- Robert Frost (1874-1963)

Word of the day

Palinode (n):

a poem in which the poet retracts something said in an earlier poem

(Source: Dictionary.com)

Shri Nārada Uvāca

Jayalalithaa’s googly to BJP – AIDMK supports for communist D. Raja for his Rajya Sabha election.

Monday, June 17, 2013

Impact of rate cuts on equity markets

In past there is virtually no trend as to how market reacts to a rate cut or hike.

However, the only time the rate cut happened after a 5% or more market rally in the preceding month was in January 2009. The market fell 3% in the month following the rate cut.

On four occasions since 2001 Sensex has fallen 5% or more in one month preceding the rate cut. On two of these occasions, Sensex was also down one month after the cut.

In our view, rate decision today will have little impact on the market direction in next one month.

Keep it simple – Current account deficit

Our policy makers, regulators, economic commentators and analysts have all expressed their grave concerns over the swelling current account deficit (CAD) of India. However, we have not seen any concrete steps to address the roots of the problem. Most of the efforts seem to be focused on containing the legal import of gold and attracting more foreign debt so that at least balance of payment could be maintained. Last week the finance minister suggested that if Indians could restrain themselves from buying gold for one year, current account situation will improve dramatically.

Current account measures trade, international income, direct transfers of capital, and investment income made on assets. A current account deficit occurs when a country's government, businesses and individuals import more goods, services and capital than they export.

Theoretically, CAD arising from trade deficit is never a risk in itself. The excess of imports over exports essentially means that our economy is doing better than the other economies who import from us.

However, it could pose a serious risk if it becomes structural and persists for a long period, especially for a deficit emerging market like India. Consider the following:

(a) Substantial rise in social sector spending over past decade has led to unprecedented rise in consumption demand from lower socio-economic strata. Domestic supply has however not been able match the demand. Burgeoning middle class has been demanding more phones, computers, luxury automobiles, textile, food etc. not produced locally, besides leisure foreign travel. Young demography and rising aspirations have led to ever rising demand for global education and training as we have failed in constructing enough global standard institutions. These trends are not likely to change substantially even if our economic growth persists at current low levels.

(b) The structure of our exports has changed in past decade in favor of engineering products and services from predominantly consumer goods earlier; meaning our exports are now highly correlated to global growth, which is not likely to improve in near future.

(c) This structural weakness in trade composition necessitates higher capital inflows so that at least balance of payment could be maintained; meaning we have to maintain our interest rates at relatively elevated level so as to attract higher foreign capital; meaning domestic investment will continue to suffer and supply constraints will persist for longer period.

Only serious structural reforms that attract significant foreign equity capital and other resources to augment domestic supply could resolve this conundrum. The current political structure does not seem to be conducive for such reforms.

Insofar as gold is concerned – the government and RBI need to evaluate, is buying gold worse than splurging on fashion textiles brands, accessories, perfumes, luxury cars and boats, studying in third grade central European universities and holidaying abroad twice a year?

Also read:

Keep it simple

INR

QE a matter of fact, not going anywhere.

Economic growth in India

Thought for the day

“A grievance is most poignant when almost redressed.”

- Eric Hoffer (1902-1983)

Word of the day

Diglossia (n):

The widespread existence within a society of sharply divergent formal and informal varieties of a language

(Source: Dictionary.com)

Shri Nārada Uvāca

In spite of everything BJP and Congress together may still get 35-40% of the votes cast in next elections.

Any front, alliance, strategy that talks about keeping them out of government is undemocratic, undesirable, and unsustainable.

Sunday, June 16, 2013

Third front may wait for another 50yrs.

Today in a significant development the Sharad Yadav and Nitish Kumar led Janta Dal (United) decided to part ways with NDA.

The immediate consequences of this decision include:

(a) Exit of BJP from the NDA government in Bihar. Bihar will now have a solo JDU government. Though technically JDU is 4MLAs short of simple majority mark in the state assembly, there is no apparent threat to the government as some Independent and Congress MLAs would be happy to extend support to the government.

(b) The Congress led UPA II government at the center can breathe easy for the time being as it gets another potential “outside supporter” in JDU, should SP or BSP threaten to withdraw their support. Implying that the elections though look imminent would happen only in 2014.

Though JDU is limited to Bihar only, this move may have larger national implications in future. For example:

(1) As things stand today there could be greater understanding between various non-aligned regional parties like JDU, TMC, BJD, DMK, SP/BSP, TRS, TDP etc. Providing a larger ready block to Congress and BJP post poll, but with a larger negotiating power.

(2) Our ground assessment suggests that JDU may not be able to maintain its tally of 19 MPs without BJP support. Whereas BJP should be able keep its 10-12 MPs from Bihar. This may see the so far covert Sharad Yadav – Nitish Kumar conflict coming to the fore and leading to new equation in the state before next assembly elections. It is not improbable that Sharad Yadav supporters try to work out a split in JDU legislative party and form a government with BJP, which is just 30 short of half way mark, after 2014 parliament elections.

(3) BJP now has no option but to come together and put its entire weight behind Narendra Modi. With Shiv Sena still split and BJP faring badly in Punjab assembly(to the discomfort of SAD), BJP has only AIDMK as a large potent pre-poll ally. This implies that failure to reach 175+ mark on its own would cut Narendra Modi to much smaller size and emergence of Rahul Gandhi as undisputed National leader.

(4) The key battle for the government will therefore be fought in UP. Expect a violent fierce battle there as all four (SP, BSP, Congress, BJP) try to get maximum out of 80 seats at stake. In this context Amit Shah, Narendra Modi, Uma Bharti, Kalyan Singh and Varun Gandhi (a potent mix of Hindutva, backward, OBC, Youth, development) become critical. BJP will go all out to polarize non-Muslim votes.

(5) MP, Rajasthan, Delhi and Chhattisgarh election later this year will make things more clear. A 4/4 BJP win will accelerate the polarization process. Whereas a split of honors with Congress will accelerate the infighting within BJP.

In our view, as things stand today, Congress is marginally better placed to maneuver a majority in next general elections. A 4/4 verdict in assemble election will definitely tilt the scale in BJP favor. In both the cases expect a stable, lasting and better looking government in May 2014.

The third front will have to wait at least for another 5yrs, may be 50yrs.

Read our special series Mandate 2014

Anxiously Indifferent

Karnataka & Delhi

Goa, Punjab and Haryana

20 Program: Agenda for 2014 election

Modi Vs. Rahul

Corruption Matters, Alas! Not the way it should

Reforms ain’t mean the same for Delhi and Sangli

Thursday, June 13, 2013

Keep it simple – Economic growth in India

In our view India has a potential grow 6-6.5% on sustainable basis over next decade. This rate of growth is excellent provided we make it inclusive and sustainable.

Hopes of getting back to 8%+ growth trajectory on sustainable basis would only fuel frustration and motivate inaction.

In prelude to general election no government would want to admit a serious economic collapse, but the fact is that after growing over 8% (seasonally adjusted 5yr CAGR) during FY08 to FY12, the Indian economy has slowed down to more sustainable 6- 6.5%.

The optimists would want to believe that low growth is a temporary phase and we would soon get back to 8%+ trajectory. However, there is small section that accepts that 8% growth in current context is not only unsustainable but undesirable also. We are in the second school.

In our view, Indian economy and people are not yet prepared for higher growth, for the simple reasons:

(a) The current status of basic infrastructure, both social and physical, cannot sustain more than 6-6.5% growth. A forced higher trajectory would only lead to (i) crumbling of even this grossly inadequate physical infrastructure; and (ii) heightened social strife as the system will not be able to complement the burgeoning aspirations.

(b) The brief incidence of higher growth has only led to larger income disparities. With 5% people earning, saving, consuming, investing – we can reasonably expect to grow only 5%-6%. For 8-9% growth we would need 25-30% participation, which seems a distance dream as yet.

(c) 6% growth is not bad per se, provided it generates employment. This could happen only if additional productive employment is generated in rural economy and industry. 8% growth with little additional employment is completely unsustainable.

(d) On more philosophical note, we need a different mindset to sustain higher growth. Corporates not willing to comply with law and governance standards and blatantly refusing to share wealth with other stakeholders; total civic disobedience on citizens part; and badly fragmented society and hence political establishment – certainly do not constitute a conducive background for sustainable higher growth.

Also read:

Keep it simple

Keep it simple – INR

Keep it Simple - QE

QE a matter of fact, not going anywhere.

Thought for the day

“Cynical realism is the intelligent man's best excuse for doing nothing in an intolerable situation.”

- Aldous Huxley (1894-1963)

Word of the day

Spelunk (v):

To explore caves, especially as a hobby.

(Source: Dictionary.com)

Shri Nārada Uvāca

Infosys has explicitly admitted to poor management, by effecting multiple senior level changes.

The more important question would be how fast the “new management” would be able to regain the ground lost to competition like Congnizant etc., that is if at all they could do it.

Wednesday, June 12, 2013

Keep it simple – Quantitative Easing (QE)

In past couple of weeks, the financial and commodities markets world over have been spooked by mere hint of tapering of US$85bn/month bond purchase program of US Federal Reserve (Fed). The popular media debate these days is completely engrossed in highlighting the ‘disastrous impact’ it might have on global asset prices should Fed reduce the bond buying by let’s say US$10bn/month.

In our view, the debate is little premature and somewhat misdirected. We could not find data about how much bond buying Fed has actually done in past three months, but there is enough evidence to suggest that since beginning of Operation twist in US (September 2011), OMT in EU (August 2012) and Abenomics in Japan (4Q2012) – developed market equities have given positive return while much larger markets, viz., commodities, bonds and currencies have lost ground. US economy has shown some random signs of recovery, while growth has definitely decelerated in Europe, Japan, BRICS, Australia, etc.

In that sense, the two fold objectives of QE – stability in financial markets and faster, sustainable economic growth have been met only in small proportion. The debate over withdrawal or reducing it and fears emanating out of such debate therefore are premature.

To put it most simple terms consider the following:

A person was critically ill, suffering from multiple organ malfunctioning. A team of expert doctors started the treatment. They operated on him multiple times and put him on high dosages of life saving steroids. After tremendous effort they could stabilize his vital functions and put him on life support system. The patient is now stable but has not completely recovered. The team of doctors treating him now proposes that they should calibrate the steroid dosages, as prolonged use could have long term negative implications for his health. They explained the proposal to relatives of the patient suggesting that they want to reduce the dosage gradually. However, they would watch the condition very closely. Should there be any deterioration, they would immediately restore (or increase if need be) the dosage. There was no suggestion whatsoever that the doctors are less confident of their line of treatment or they want the patient to die. The relatives however got panicked and started debating how long the patient will survive and started preparing for the funeral!

The current popular debate over QE tapering is sound something similar.

We had suggested in one of our earlier posts that QE is a matter of fact, not going anywhere. It will remain here till it completely outlives its utility – not likely in next 3yrs at the least, most likely till the time EU economy shows definite signs of revival, Japan achieves its objective of creating nominal inflation in the economy and gets out of decades of stagnation, and global trade rebalancing especially in relation to China makes steady progress.

For records, TARP – the US government US$750bn response to Lehman collapse, has more or less been withdrawn. No one talks about it. No one sulks over its withdrawal.

Also read:

“QE a matter of fact, not going anywhere”

Thought for the day

“If you procrastinate when faced with a big difficult problem... break the problem into parts, and handle one part at a time.”

- Robert Collier

Word of the day

Codger (n):

An eccentric man, especially one who is old

(Source: Dictionary.com)

Shri Nārada Uvāca

Ashwini Kumar, Pawan Bansal, Navin Jindal…at the end of the day, Congress Party will seriously regret messing with the caged parrot.

Tuesday, June 11, 2013

Keep it simple — Indian rupee

In deference to the popular debate and pronounced concerns over sharp depreciation in INR value versus

US dollar, we thought it appropriate to begin this series with a simplistic view and outlook of INR.

Portfolio investment of few billion dollars may not have any lasting impact on the exchange rate.

We do not expect any meaningful rise in inbound FDI till the new government takes charge and spells new rules of the game. This may take at least 15months.

Bharti and HUL transactions may though help a bit in short term, provided RIL or some other entity does not make a large overseas acquisition.

Like any other tradable thing, the exchange values of a currency vis a vis other currencies depends on the relative demand and supply of these currencies at any given point in time.

The recent sharp depreciation of INR vs. USD in recent months indicates that the demand for USD vs. INR has sharply outpaced the supply. There are several reasons for this higher USD demand versus INR. For simplicity, we may classify these reasons in three categories (a) structural, (b) cyclical and (c) speculative. Some examples are as follows:

Structural reasons

(a) There have been some significant changes in the composition of foreign trade of India in past one decade or so leading to structurally higher demand for USD.

The structure of our imports has changed in favor of consumer goods as the domestic supply has failed to meet the burgeoning consumption demand. A large part of this demand has in fact been generated through massive government social spending and failure to rationalize fuel and food subsidies. The imports and therefore demand for USD is mostly inelastic to economic growth.

On the other hand the composition of exports has changed in favor of engineering goods, from dominantly consumer goods (tea, tobacco, leather, spices, textile, jewelry etc.). This has increased the correlation of exports to global growth which is not likely to improve dramatically in near future.

(b) A spate of scams, scandals and policy flip flops in past 5-7yrs have seriously dented the credibility of the Indian political establishment and administration. This has certainly led to increase in risk premium for INR denominated assets. Besides this has also prompted higher outbound FDI. There is nothing to suggest that this trend will reverse in near future.

(c) Serious infrastructure and procedural constraints have impacted India’s export competitiveness especially relative to China, thus resulting in slower exports growth.

Cyclical reason

(d) Persistently high inflation and huge fiscal deficit has led to higher rates and therefore higher value of INR in past few years. With inflation easing and fiscal deficit in control, the interest rates are forecast to come down. This may adversely impact capital inflows and therefore BoP. The recent sharp fall in INR could be attributed to this factor alone.

Speculative reason

(e) The Fed Chairman’s recent remark about tapering of QE has led to widespread speculation about rise in US bond yields and USD value. This has led huge speculative short positions in EM currencies (including INR), that have seen large USD inflows in recent years, anticipating outflows.

In our view, we shall see correction of speculative and cyclical fall in INR over next 6months. In 2014 INR shall stabilize in 52-54 range.

Thought for the day

“My mother wanted us to understand that the tragedies of your life one day have the potential to be comic stories the next”.

Nora Ephron (1914-2012)

Word of the day

Spang (adv):

Directly, exactly

(Source: Dictionary.com)

Shri Nārada Uvāca

Jairam Ramesh finds Rohan Murthy entry into Infosys ‘a conflict of interest’!

What about Rahul Gandhi’s appointment as Congress VP?

Monday, June 10, 2013

Keep it simple

Making profitable investment perhaps did never sound so complicated and complex as it does today. A plethora of often contradictory data emanating from diverse sources on hourly basis seems to be confounding even sophisticated investors.

The raging debate over implications of continuing with or withdrawal from the ‘tiger ride’ called quantitative easing (QE); consumption squeeze due to European austerity and US sequester; proverbial great rotation from bonds to equity; gold vs. risk assets; developed markets vs. emerging markets; credibility of Chinese growth data and its sustainability; will Abenomics succeed in bring Japan out of economic abyss; how will the new normal slower growth period impact the “commodities’ world” especially Australia, Canada, Russia and host of developing LatAm and African economies; and above all are we heading to a massive currency crisis much bigger than mid 1990’s, is keeping investors perplexed.

Adding to the intrigue is the geo-political tensions brewing in middle-east, Korean peninsula, Chinese sea, Afghanistan, Iran; and civil unrest brewing in Europe, China & some Latin American nations.

In our domestic context many factors, including but not limited to, like poor governance (both corporate and political); low historical returns and collapsing new employment opportunities, persistent high inflation etc. are keeping domestic household savings away from equity markets.

The professional investors are also wondering whether the 8%+ growth period of 2004-2008 was an aberration in more attainable growth trend of ~6% and therefore they should be reworking their investment strategies away from growth to consumption and scale down their return expectations.

In this milieu, in our view, the only way to make profitable investment is to keep things simple. We feel where economic fails (as certainly is the case at present) we must look at philosophy for solutions. Which means it is better to get back to old traditional school of investment.

In the coming days we shall be presenting a highly simplistic view of various investment considerations like economic growth trends, inflation, rates, currency, global liquidity conditions, corporate fundamentals, equities’ market and political uncertainty etc. that in our view might help provide some direction to household investors in structuring or restructuring their asset allocation.

It is a common saying that keeping things simple is often most complicated thing in life. From our empirical study and anecdotal experience we have concluded that more often than not keeping things simple works best in making profitable investments.

We shall commence third phase of our ‘Discover India’ tour with a trip to southern states of Tamil Nadu and Andhra Pradesh next week and shall also be covering the eastern states of Odisha, West Bengal and Bihar in this phase.

Thought for the day

Massive inequality, we have learned, isn't the best way to run an economy after all. And when you think about it, it's also profoundly ugly.
Thomas Frank (1965 - )

Word of the day

Wonk (n):
A stupid, boring, or unattractive person.

(Source: Dictionary.com)

Shri Nārada Uvāca

Does L. K. Advani have better ‘secular’ credential than Narendra Modi? “Post Babari” history is in fact more bloody than “post Godhra” history.

Friday, June 7, 2013

Mandate 2014: Chhattisgarh – perplexing

Our team travelled to Chhattisgarh in last week of May’13 and was in the capital Raipur when Maoists ambushed the convoy carrying many Congress party leaders and killed over 25 people. We visited 11 districts of the state. We could not visit the southern tribal districts of Bastar, Dantewada, Bijapur and Narayanpur due to security reasons.

On first impression, we found the state full of paradox and perplexing. It took some real deep probing the common man to find some of the answers.

For example more than 2/3^rd of the state’s population comprises of SC/ST and dalits. The industrial infrastructure is largely public sector. But the political forces like BSP, SP and communists have only marginal presence in the state – not only at legislative level but at the ground level also. This seemed counterintuitive in first instance.

We probed over 250 people from various walks of life to find the reason. What we discovered is that the state has an extremely deep rooted Sufi tradition. A substantial large part of the poor and backward population subscribes to numerous Sufi sects and therefore believes in equality, contentment and non-violence. In fact, we found no sympathy for the Maoist and Naxals amongst common people.

The key observations during our Chhattisgarh trip include the following:

(a) The economic disparities in the state are overwhelming. The quintessential Marwari owns almost all private enterprise. Local population mostly depends on agriculture, forest produce and industrial/construction labor.

(b) The social structure is mostly feudal. Resources are mostly owned by a few and the majority depends upon them for provisions.

(c) The society is mostly harmonious with little internal strife on caste or religious grounds. Gender prejudices are relatively much lower.

(d) A large majority of the population appeared politically indifferent. However, the current administration enjoys tremendous goodwill of the people. The incumbent Chief Minister is very popular both with people and administration – a rare feat in Indian context.

(e) The economy retains the colonial structure. The economic structure is mostly based on exploitation of local natural resources for exports to other states as well as foreign countries, especially Japan.

(f) Despite being rich in minerals, sufficient in power and availability of local labor the state has not made much progress in industrialization and urbanization. The strong allegiance of local populace and administration to sustainability is cited as the primary reason. Naxal violence may also have prevented development of large private enterprise.

(g) The best part is that the whole state is very passionate about education. With impeccable execution of food security, the state administration has enabled people to strive for education. The tribal population in non-tribal districts was found to be most enthusiastic.

(h) The modern consumerism has not yet made any significant inroads in rural and semi-rural areas, though the road network has improved substantially.

Read our special series Mandate 2014

Anxiously Indifferent

Karnataka & Delhi

Goa, Punjab and Haryana

20 Program: Agenda for 2014 election

Modi Vs. Rahul

Corruption Matters, Alas! Not the way it should

Reforms ain’t mean the same for Delhi and Sangli

Thought for the day

Between two evils, I always pick the one I never tried before.

-Mae West (1893-1980)

Word of the day

Hadal (adj):

Pertaining to the greatest ocean depths

(Source: Dictionary.com)

Shri Nārada Uvāca

Fully knowing that the delivery mechanism for food security legislation is far from ready, Congress Party would be more interested in failing to pass the Bill and put the blame on opposition rather than passing the Bill and facing the flake for failing to deliver the promised food.