Vijay Kumar Gaba

Wednesday, August 14, 2013

Higher growth – unsustainable and unmanageable

We have highlighted in some of our earlier writings (E.g., see I and II) that to achieve higher growth during

2004-2010 India has let structure of its real economy severely tempered, though still not irretrievably.

The rush to accumulate cheap credit and unreasonably benefit from often ill conceived policy relaxations, has lead to excessive debt both at government as well as corporate level and dissipation of resources. This has brought a lot of unmanageable demand forward in time. The consequences are gross and extravagant misallocation of capital and unmanageable changes in consumption patterns.

The following chart shows cyclically adjusted growth (5yr CAGR) since first plan period. After growing 2-4% during 1951-1975, a steady progress was made to 4-6% orbit in next 30years. However, a sudden spurt in growth during FY05 to FY11 has led to serious distortion in macro framework of the country, suggesting that (a) this high growth is unsustainable and unmanageable and (b) the correction or descend back 4-6% orbit is going to be sharp and excruciating.

Some structural deficiencies created by higher growth during FY05 to FY11

· Consumer inflation rose to 7-10% from 3-5%

· External debt rose to US$306bn from US$134bn

· Trade deficit rose to US$131bn from US$34bn

· CAD grew to over 3% of GDP from under 0.5%.

· Subsidies rose to over 2% from 1% of GDP.

· Debt service ratio fell from over 16 to under 5.

· Gross fiscal deficit remained around 7%, suggesting effective tax incidence increased.

Corrections as said earlier, will be sharp and painful.

Thought for the day

“The worst form of inequality is to try to make unequal things equal.”

-Aristotle (384-322BC)

Word of the day

Matador (n):

The principal bullfighter in a bullfight; a torero.

(Source: Dictionary.com)

Shri Nārada Uvāca

Q. How many ministers are there in India’s Union Council of Ministers?

Ans. P. Chidambram; and Umhh…ahh….hmm, that one what’s his name!

Tuesday, August 13, 2013

Do not bother about buying and holding

Indian equities are popularly compared to the fabled Capital Hotel, in which guests can enter but can never exit. Usually high volatility in macro and corporate performance, frequent scams in financial and corporate sector, rampant malpractices and shallow market depth have ensured that no secular bull market evolves. Consider the following:

(a) For buy and hold investors since 1991 the Indian equities returns might have marginally beaten the bank deposits. A monthly SIP in Indian equities (BSE 500 that represents 97% of market capitalization) during January 1991 to July 2013 would have given an 11% CAGR, not much better than debt return, especially if you adjust it for the high risk.

(b) For 1991-95 returns were just 1.6% CAGR. Most of these returns were earned in just six months from Jan92 to Mar 92 which returned ~150% absolute return over Dec92 closing and Nov93 to Jan94 which returned 58% absolute return over Oct93 closing. The real return in this period was hugely negative, considering high inflation.

(d) 2001-2005 was the best period for Indian equities yielding 36% CAGR.

(e) 2006-2010 again yielded positive return of 16% CAGR. Though most of these returns would have come during Sep07-Oct07 and Mar09-May09 periods. Volatility was huge and therefore risk very high.

(f) On annual basis just 10 out of 23 years have given positive real return. And income funds would have beaten equity returns even when not adjusted for risk.

The point we are trying to make is that Indian equity market collectively is a cyclical investment, which could be traded in small proportions during good times, especially when liquidity is abundant and credit is easy to access.

Do not bother about buying and holding as yet.

Also read:

Cyclical vs structural

Thought for the day

“I am patient with stupidity but not with those who are proud of it.”

-Edith Sitwell (1887-1964)

Word of the day

Ravine (n):
A narrow steep-sided valley commonly eroded by running water.

(Source: Dictionary.com)

Shri Nārada Uvāca

Can we?

Monday, August 5, 2013

A forgettable week

Last week was certainly forgettable for the investors in Indian financial markets. Currency, equities and bonds all plunged, inflicting serious losses to investors.

The worst part was that the government still appeared to be under the impression that the current economic conditions are part of a routine downtrend that could be managed by taking some incremental steps like increasing interest subvention on export credit by 1%; hiking import duty on gold by 2%, or tweaking FDI rules etc.

Current account deficit is consequence of some long standing structural problems in the country. But various measures announced by RBI and the government appear to suggest that CAD is a problem in itself that could be resolved simply by kneeling in front of foreign investors. The fact however is that the more they see Indian government genuflecting, more they are turning skeptical about the India story.

RBI took some steps to curb the volatility in currency. But the statement of the governor was so guilt laden that market chose to completely ignore the effort and the message, taking both the INR/USD and bond yields to new closing highs.

Continuing with the tradition set in past few months, few more stocks lost over 50% of their market value in a week. IRB Infra, Financial Technologies and MCX met the same fate as Gitanjali Gems, Wockhardt, Strides Arcolab, etc.

NSEL (National Spot Exchange) fiasco suggested that after 21years, couple of JPCs and humongous losses to investors we have not learned anything from Harshad Mehta and Ketan Parekh episodes. As the popular fear suggests, we might see encore of Bank Receipt scam of Harshad Mehta in this episode. The response of official machinery appeared slow and inadequate thus exacerbating the confusion and jitteriness.

On corporate performance front, there were numerous forgettable results. All PSU banks reported serious deterioration in asset quality and stagnant credit growth. Siemens, Cummins, JPA, Suzlon etc. all highlighted that (a) 5% GDP growth may be too difficult to achieve, at least in first half of the current fiscal and (b) stress on asset quality is only going to rise in coming quarters.

The most noteworthy however was BHEL – once touted as synonym of India’s famous growth story. The results are a serious setback to the argument of value investors.

The question for the week – Will BHEL be the star loser for the week?

On our part, we continue with our strategy of NIL to serious underweight on financials, industrials and commodities (other than cement).

Despite recent gains in telecom stocks, we continue to believe that regulatory interference in the sector shall remain high. Besides, competitive intensity is only going to rise, so is the capital intensity. We are pleased to let this opportunity pass.

Thought for the day

“There are risks and costs to action. But they are far less than the long range risks of comfortable inaction.”

- John F. Kennedy(1917-1968)

Word of the day

Lam (v):

To beat; thrash

(Source: Dictionary.com)

Shri Nārada Uvāca

Ms. Sonia Gandhi takes up the cause of Durga Shakti.

What about Ashok Khemkha?

Friday, August 2, 2013

Investment strategy for August 2013 – March 2014

The 1QFY14 results so far have conspicuously shown some trends that need to be noticed and considered while updating and executing investment strategy.

In particular, we would like to highlight the following trends:

Most consumer companies with their eyes and ears on the ground have discerned the structural decline in India’s growth potential. Accordingly, the companies like HUL, ITC, Dabur, Nestle, IDEA, Bharti, Maruti, Bajaj Auto, Hero Honda, etc. have re-worked their strategy to shift focus from volume growth to margin protection and improvement. Price hikes, cost savings, lower promotion spend, better working capital and inventory management, are clearly visible.

In our view, with consistent margin improvement and ~3-5% volume growth, these companies will more than address the valuation concerns, insofar as currently high P/E ratio is concerned. Moreover, expect payout and ROEC to increase.

We suggest overweight on consumer companies (FMCG, auto, telecom).

Most financials have reported decent growth in income and margins though the asset quality has deteriorated substantially. The market reaction to their results is a clear indicator that investors are not convinced about the sustainability of their profitability.

There is obviously more pain to come in following quarters. We suggest NIL to very low weight on the sector.

The global services businesses like large IT and pharma have guided a challenging but stable demand and pricing environment. The improving data in US and EU is fully reflected in their operational numbers. Besides, lower cost statistics suggests that most of these companies have appeared to tighten their belt. The cost savings appear more permanent in nature.

The trend is however not reflected in many middle and lower rung companies. It is therefore advisable to keep overweight on top rung IT (TCS, Infosys, Wipro, HCL Tech, Tech Mahindra) and pharma (Sun Pharma, Lupin, Dr Reddy, and Cipla) companies.

Results of most capital goods, heavy engineering and infrastructure companies clearly indicate slower order inflows, intense margin pressure, higher working capital cycle, rise in debt and financing cost.

However, remarkably positive commentary about future outlook suggests that many of these companies continue to be denial mode and therefore may not have taken adequate corrective measures.

We suggest NIL to very low weight on the sector.

The commodities results have also indicated lower demand and margin pressures. Most of these have indicated lower capacity utilization and cut in capex plans.

We suggest NIL weight in global commodities and low weight in cement.

Thought for the day

“Wise men speak because they have something to say; Fools because they have to say something.”

- Plato (427-347BC)

Word of the day

Bemused (adj):

Bewildered or confused.

(Source: Dictionary.com)

Shri Nārada Uvāca

Telangana pushed back by 6months.

Is Congress having a rethink?

It just wants to push it closer to election so that full dividend could be reaped!

Thursday, August 1, 2013

Believe it or not!

Finance Minister P. Chidambaram’s obsession with “we are still the second fastest growing economy in the world” seems to growing with every passing day. Despite being reminded by many observers that this not only irrelevant but also factually incorrect. Nevertheless, the tendency to blame the economic troubles on the global challenges and sheltering behind this ‘second fastest’ argument is growing.

Yesterday, FM promised a whole lot of measures to tackle the problems of rising CAD, falling INR, slowing growth. He also promised that he will deliver all this without compromising on fiscal deficit targets. He made the following promises. We leave it to you how much you want to believe.

· We have succeeded in containing fiscal deficit and look forward to a growth rate between 5.5 - 6%.

· Will ease long term External Commercial Borrowings

· Will tackle both deficits; red lines will not be breached

· Expect to fully finance CAD; will not draw into reserves

· Have provided additional funds -- Rs 2,000 crore to boost exports

· Will take steps to up inflows; ask PSBs to invest

· Will ease long term external commercial borrowing

· Looking at some measures to attract long term external borrowings. Propose to liberalise overseas

borrowing norms

· Looking at measures to up NRI investment

· Some import compression will take place on luxury goods

· June - July gold imports down on year basis. Hope to contain gold imports well below last year’s

aggregate

· Sovereign bond issue an option but won't rush into it

· Will provide more money for subsidies, if needed

· Expect Agriculture growth to be better than last year

· Industrial sector presents a mixed picture

· No reason to doubt revenue target

· PSU balance sheets strong enough to issue overseas bonds

· Govt, RBI on same page to contain forex volatility

· Core inflation at lowest level in many years

· Every economy in the world is challenged

· All banks with NRI Accounts to be allowed to raise funds abroad

· FDI in Multi Brand Retail will come in once cabinet takes a decision

· Must address issues related to Safe Harbour Rules; Will be out by August 7

· Must do everything possible to improve exports

· Will urge banks to provide Agri loans in excess of Rs 7 lakh a year (BS)

Thought for the day

“He who has a why to live can bear almost any how.”

- Friedrich Nietzsche (1844-1900)

Word of the day

Residuum (n):

The residue, remainder, or rest of something.

(Source: Dictionary.com)

Shri Nārada Uvāca

Let’s become The United States of India with 50 states and some administrated regions or union territories.

At least some more people will be able to fulfill their aspirations of becoming Governor, Chief Minister, Deputy Chief Minister, Chief Secretary, State Party President, Leader of Opposition, Chief Justice etc. etc.!

3D view of India

In our view, the present state of Indian economy is characterized by Denial, Dithering and Dilemma (3D). Both the government and RBI seem to be in complete denial mode insofar as the growth and macro economic problems are concerned. RBI has been dithering in taking a decisive action since past many quarters and hence letting the situation to exacerbate itself. The government is facing classic democracy dilemma in choosing between convenient politics and sound economics.

The consequences could be serious if immediate corrective steps are not taken. Waiting for the formation of new government could be too late. May be by then we would have lost the whole two decades of progress.

Come out of denial

(a) Both the government and the regulator need to accept that 5% growth is normal and good if it is inclusive and sustainable. Faster we realize this, sooner we will be able to effect necessary structural changes in the planning process and realign the resource allocation accordingly. Raising labor intensity of growth and sustainable exploitation of natural resources would mostly alleviate the problems being faced at present.

(b) Unlike social inclusion, efforts aimed at economic inclusion made during past two decades have at best been partially successful. As the coverage ratio of food security law indicates, years of provisioning for the poor has failed in enabling most of them. Unemployment levels are rising and so are socio-economic disparities.

Stop dithering

(c) Even a plain reading of RBI’s statements unambiguously brings out the dithering in RBI’s policy stance. For example, the latest statement clearly admits that macroeconomic conditions are bad and worsening fast. The hope of recovery later in the year is a plain platitude, not supported by any evidence.

(d) RBI should take a decisive “WHATEVER IT TAKES” stand and guided the financial markets with a firm resolve, rather than making the policy an issue of morality.

(e) Though it has reluctantly admitted to slow growth, it has done little to guide capital flows to achieve inclusiveness.

Shed dilemma

(f) The experience of various democracies world over has proved time and again that sound economics often makes for good politics, but vice versa is often not true.

(g) Secondly, under pressure the government is sounding too desperate vulnerable. In these difficult times, it is willing to compromise on many issues that could have significant long-term implications on growth. For example, relaxing FDI norms in key sectors; allowing exploitation of natural resources in hazardous manner, or ad hoc changes in taxation, subsidies or resource allocation which would be difficult to reverse later.

Thought for the day

“All the powers in the universe are already ours. It is we who have put our hands before our eyes and cry that it is dark.”

- Swami Vivekanand (1863-1902)

Word of the day

Cyclopean (Adj):
Gigantic; vast.

(Source: Dictionary.com)

Shri Nārada Uvāca

Has the division of states on lingual basis outlived its utility?

Should The States Reorganisation Act, 1956 be re-drafted to re-organize states on economic criteria?

Not learning from Chandigarh, Congress proposes Hyderabad sharing.

Tuesday, July 30, 2013

No need to read between the lines

In the first quarterly review of monetary and credit policy RBI presented a very dismal picture of the economy with little hope. Although RBI did express hope of a slow progress going forward in the FY14, it gave little support to the view.

We read some headlines of the documents and see no need to read between the lines.

Global economy

· Global recovery prospects remain weak.

· Global commodity price cycle stay benign, but with upside risks to crude prices.

· Global financial markets have entered into a period of fresh turbulence.

Indian economy

· Slowdown persists in the Indian economy. Slow-paced recovery likely to shape later in 2013-14.

· Aggregate demand continued to remain weak. Improvement in aggregate demand requires overcoming high consumer price inflation and infrastructure bottlenecks. Corporate investment intentions remain subdued.

· Corporate leverage has increased gradually. Contagion from global bond sell off generates stress in Indian markets. Policy recalibration became necessary with increased macro-financial risks. Amplifying macro-financial risks warrant cautious monetary policy stance.

· Risk aversion impacting credit, as asset quality concerns persist. Sectoral deployment of credit indicates deceleration across most sectors.

· Headline inflation moderates but upside risks persist. Revisions in administered prices restrict the moderation in inflation. Pass-through of exchange rate depreciation could offset benefits from falling commodity prices.

· Agriculture growth is expected to pick up.

· Industrial sector growth remains subdued. Supply bottlenecks constraining core industries.

· Services sector signals slowdown in growth.

· Real wage growth moderates in the recent period, driven by higher inflation in rural areas. Employment scenario weakened during 2011-2013.

· Combined government finances budgeted to improve in 2013-14. Fiscal consolidation resumed during 2012-13 mainly through expenditure cutbacks.

· Vulnerability indicators show further worsening. External debt rose further in Q4 of 2012-13. Trade deficit continues to be a concern in Q1 of 2013-14. CAD may moderate in 2013-14, but risks to its financing remain.

To read the full document click on the following link:

http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/M290713FC66587B599.pdf

Thought for the day

“Perhaps in time the so-called Dark Ages will be thought of as including our own.”

- Georg C. Lichtenberg (1742-1799)

Word of the day

Coaptation (n):

A joining or adjustment of parts to one another.

(Source: Dictionary.com)

Shri Nārada Uvāca

Will Haryana police slap sedition charges against the Congress leader who alleged that Rajya Sabha seats are sold for Rs100cr and therefore denigrated the Parliament of the country?

Remember, a cartoonist was charged with sedition for drawing a cartoon of the Parliament a few month ago!

Monday, July 29, 2013

A Nightmare

In past couple of months RBI has taken some steps apparently aimed at stemming the slide in value of Indian currency (INR) against USD. These measures broadly target (a) liquidity in financial system to stem speculative demand for USD; (b) gold imports to control current account deficit; and (c) encouraging capital flows especially through causing debt yields to rise.

Though it may be little early draw any conclusion on the efficacy of these steps in achieving the desired outcome; so far we have not seen much impact. INR continues to be in Rs59-60/USD band and sentiments continue to be bearish on currency.

However, there are many side effects that are manifesting in various measures. For example, gold smuggling has reportedly grown four fold in 1QFY14 as compared to the same period previous year. Rate expectations have hardened substantially as reflected in failed OMO. Rate sensitive sectors like financials, realty and capital intensive debt laden infrastructure have seen massive erosion in their market value. Investors have suffered heavy losses on their debt portfolios.

With cost of capital rising, the stress in financial system is only expected to rise further. The investment climate shall remain challenging for an extended period of time, especially when the political and executive leadership of the country is mostly dysfunctional. Some recent surveys have indicated that situation is not likely to improve in any substantial measure even after general elections next year.

The milieu obviously is worrisome. Many analysts have drawn comparison to the situation in 1990s that was marked by economic turmoil, political instability, geopolitical tension, and global crisis. The consequences were serious like prolonged bear phase in capital markets, virtual collapse of banking system, high rates, inflation and slower economic growth. The god part was serious economic and financial sector reforms.

In our view, we would be pretty fortunate if the situation turns out to be like 1990s only. The nightmare is that we might end up travelling back to 1965-1975 era. For example, consider the following:

(a) With an onerous responsibility to provide cheap food to 800mn people, the food grain trade may likely get nationalized at state level. Rationing, hoarding, black marketing, restriction on interstate trade, crop mismanagement etc may stage comeback. The trial is already on with the government setting up vegetable shops in Mumbai.

(b) Unable to manage stress, most power and commercial road projects could get devolved on financial institutions and thus get nationalized.

(c) With CAD worsening beyond control, import restrictions, capital controls, and currency peg are implemented and smuggling becomes profitable and fashionable. Gold smuggling is already back.

(d) The Hindu rate of growth becomes norm. A couple of days ago Montek Singh feared that 12^th Plan growth may be under 5%.

(e) With control over everything, the government becomes most powerful leading to emergency like conditions. Misuse of CBI and pressure on CAG shows the intent.

The only good part is that Bollywood will also get its themes like Roti Kapda aur Makan, Khoon Pasina, Deewar etc. back.

Thought for the day

“Men are nearly always willing to believe what they wish.”

- Julius Ceasar(100-44BC)

Word of the day

Dispositive (Adj):

Involving or affecting disposition or settlement.

(Source: Dictionary.com)

Shri Nārada Uvāca

LK Advani says BJP will make a new record in next general election.

The little bird murmurs that only record BJP as a national party has - 2 seats in 1984 elections!

Friday, July 26, 2013

As you sow, so shall you reap

On Wednesday evening Swiss cement major Holcim announced ownership restructuring of its Indian operations. In short, Holcim pared its economic interest in ACC from ~50% to ~30% by effectively transferring ~20% economic interest to minority shareholders of Ambuja Cement at ~20% premium to the current market price.

In consideration Holcim got Rs35bn in cash and ~10% additional economic interest in Ambuja Cement. The deal apparently has no tax or duty payout, as it is effected through Mauritius based entity and therefore enjoys the benefits of DTAA (Double Taxation Avoidance Agreement).

The investors, analysts and commentators are crying foul, as they feel that minority shareholders have been shortchanged by Holcim and investment case for both the Indian entities has been seriously damaged.

In our view, the deal (a) does disregard the interests of the minority shareholders of Ambuja Cement; and (b) may erode value of ACC minority shareholders in due course as the stock get de-rated due to likely lower focus from parent entity.

Nonetheless, the deal prima facie appears within the four walls of the extant legal and regulatory framework of the country.

While refraining from commenting on the morality of the deal, we would certainly like to remind the institutional investors and analysts who are crying foul over this deal that only a few months ago they had lambasted the government over implementation of GAAR (General Anti-(tax) Avoidance Rules).

Though the initial protests were related to retroactive implementation, they were mostly convinced that implementing GAAR would be detrimental to the financial markets and therefore investors’ interest. They pressurized the government to defer the implementation.

In our view, this deal structure would have been very different if GAAR was in force as Holcim might have to shell out tax on sale of 20% economic interest in ACC.

In our view, this will certainly be not the only instance where both minority shareholders as well exchequer are shortchanged. We may see many more such deals given the vulnerability of our government. Watch out for notification of relaxed FDI norms in telecom etc. In our view, presently the government is not in a position to do anything that may adversely affect the interest of foreign investors. In any case, even if it wishes, it cannot do anything till next July when the next regular budget will be presented by the new government.

This will not only severely hit the already feeble confidence of equity investors in India, but also have long term policy implications.

As we highlighted yesterday, instead of playing the game of cat and mouse over every news item, policy action, corporate action – investors, particularly institutional investors, should evaluate the situation on the basis of conceptual framework of finance and economics.

Thought for the day

“History will be kind to me for I intend to write it.”

- Winston Churchill (1874-1965)

Word of the day

Grammatology (n):

The scientific study of systems of writing.

(Source: Dictionary.com)

Shri Nārada Uvāca

Could Kohli be Virat enough to become new God of Indian cricket?

Thursday, July 25, 2013

Game of Tom and Jerry

For once every one in the world appears to be playing the game of cat and mouse. All appear to be running in circles, falling, rising, trying hard to outsmart others and in the process hurting themselves badly. The bad part is that spectators who are not in the arena are being forced to pay for these games which are not even funny.

Ben Bernanke is playing with financial markets. Fully aware that his seemingly innocuous comments at some random symposium might cause billions of losses/gains in a matter of few hours – he is not showing any reluctance in making those comments. Markets, fully aware that QE is a matter of fact and could be withdrawn only and only if economic conditions improve substantially to warrant such withdrawal are swinging wildly at each such comment. Ben does retreats to his den after each such wild swing but only to reappear a little later.

The global research and rating agencies are also playing a similar game in a different arena. Fully aware that these random data has no meaning in the present global macro context – they are frequently emitting drivel only to clean it up the next day. The financial markets swing to each such emission, and make poor investor a little more poor. Euro Zone PMI which totally contradicts the employment and trade data, China trade data which contradicts the PMI and consumption data, UK house prices which contradict every other economic indicator are but a few examples of this game.

Financial analysts might be playing against God – trying to foresee things that are not even likely to happen. Many are full time busy guessing the date of QE withdrawal/tapering and rate hikes. Some saw great rotation from debt to equity. Others found great rotation from commodities to equity more interesting. Someone is highlighting great rotation from ‘smart investors’ to ‘dumb investors’ as in USA institutional investors turn largest seller of equities since 2008 and household investors are piling up. Some Gurus have been busy predicting EM to DM great rotation since 2008; and with some Japanese renaissance is the only passion.

We see little problems in attempting to foresee these supposedly long term trends. The problem however does arise when they suggest a trade today based on their hypothesis into eternity.

Back home, RBI and FM are playing an interesting game. FM is promising heaven on earth, fully aware that we are slithering fast into hell. RBI is not buying any of their promises and tightening with singular focus on prices. Befuddled investors and analysts are listening to both, believing both and jumping up and down, losing substantial hope, confidence and money in the process.

The mute spectators, poor household investors have lost money in equity, bonds, treasuries, liquid funds, real estate silver and gold. With CPI at ~13%, the agony could only exacerbate in coming days. At this point cannot even tell them “Cash is King”.

In this melee, the mother of all mayhem could be seen in the ensuing monsoon session of the Parliament beginning 8^th of August.

Thought for the day

“It was only literally hours after the wedding when he felt he didn't have to keep up the facade.”

-Trisha Goddard (1957-)

Word of the day

Sidle (v):

To move sideways or obliquely.

(Source: Dictionary.com)

Shri Nārada Uvāca

Reports suggest that the Royal Baby may support struggling UK economy tremendously.

A study has suggested that he may add £245mn in additional sales, as Britons celebrate the birth of prospective King.

Should Rahul Gandhi take a leaf out of this episode and help the struggling Indian economy?