Vijay Kumar Gaba

Friday, September 13, 2013

All rats should become cats

The data released yesterday reveals that the industrial growth in India rebounded majorly in July, growing 2.6% (versus consensus – 0.8%). This should usually provide some more legs to the ongoing market rally. However, given that the market has already rallied hard in past one week and the next week is expected to be heavy in terms of news flow, the immediate reaction might be little muted. We would not like to reject the data as unreliable, given that it had been consistent in its inconsistency.

We still feel there is nothing to suggest in the broader context that in near future liquidity pressure will ease, rates will fall dramatically, inflation pressure will ease substantially, currency will strengthen or investment will pick up in any notable way. This essentially means that in near term the Indian equity market will continue to gyrate in tandem with the FII mood swings.

Insofar as the action drama that inaugurated on 4 September 2013 with regime change at RBI is concerned, we feel it should close in next few weeks, as the final countdown to 2014 elections starts with a round of state assembly elections. In our view, most of the actions henceforth may inflict pain in short term rather than providing relief.

We would like to repeat a story told couple of times earlier also. “Once the king rodent called a general assembly of all rats to discuss the feline threat. Everybody was too concerned and bothered about the menace. After a long deliberation, it was unanimously agreed to appoint a strategic consultant to advise on the matter. The consultant so appointed studied the problem in great detail and came out with this voluminous report, that primarily highlighted that cats are far more powerful, wise and smart animal than mice. Therefore it is extremely difficult for the mice to put up a credible defense against the menacing felines. The only way to counter the threat, the report egregiously suggested, is that all rats should become cats.”

Similar appears to be the case of Indian economy. While everyone is clamoring for government action to spur the growth – nobody is exactly suggesting how to do that. Is it possible to have sustainable growth with high inflation; mindless deforestation and mining; businesses which are not willing to pay for labor, capital, land, natural resources; vast majority of people who do not like to pay taxes; a national conscience heavily biased against any kind of compliance; capital scarcity when risk appetite is waning amongst global investors; and transitioning polity where the emerging federal order is far from established and the extant feudal structure has crumbled.

In our view, India is in transition – socially, politically and hence economically. Expecting sustainable high growth in this phase could only lead to disappointment and despair. The best outcome in next 2 years would be if we could avoid any major civil unrest and major deterioration in balance sheets at all levels – household, corporate, banks, and government.

In case the rating agencies, global research firms and corporates have a better solution than “rat should become cat”, we would like to hear that.

Thought for the day

“Consistency is the last refuge of the unimaginative.”
- Oscar Wilde (Irish, 1854-1900)

Word of the day

Hegira (n)

A journey to a more desirable or congenial place.

(Source: Dictionary.com)

Shri Nārada Uvāca

Shahid Sidiqui, Kamal Farooqui, Azam Khan – Is Samajwadi Party losing traditional Muslim support base?

Some stray birds are tweeting that a tacit SP-BJP understanding could be brewing to keep Mayawati out of contention.

Thursday, September 12, 2013

Lead the change; or you’ll be forced to follow it

“…change is risky. But as India develops, not changing is even riskier.”

Dr. Raghuram Rajan, RBI Governor

In his latest note, famous analysts and economic forecaster Dr. A. Garry Shilling, in a conspicuous shift from his long standing pessimistic outlook on US held for past many years, highlighted the six core strengths of US economy that should further reinforce the economic supremacy of US and therefore USD in the following decades.

Shilling finds that US is much better placed than most peers in the aspects of demographics, entrepreneurial activities, labor relations, domestic debt vs. foreign debt financing, currency strength and energy independence.

Shilling expects US savings rate to rise back to double digits leading to slower consumption, a reverse of what occurred when the saving rate slid from 12% in the early 1980s to 1%.

For every 1% rise in American consumer spending, U.S. imports—the rest of the world's exports—rise 2.8% on average. A rising savings rate will therefore substantially impact the growth of export led economies and lead to narrowing of US trade deficit.

Shilling expects that at a 10% household saving rate, $1.2 trillion would be locally available to finance federal deficits, now less than $1 trillion, as well as business net borrowing. This will essentially means less number of USD in the hands of foreigners. It may cause serious disturbances in many Asian, Latin American and other import-led economies.

Energy independence of US coupled with slower growth in exporters like China and Japan, would essentially mean global energy prices should stabilize at relatively lower level.

In our view, should the scenario envisaged by Shilling actually materialize, India may need to carry out many adjustments in the domestic economy to keep herself out of trouble. For example:

(a) In past decade India’s capital goods import have contributed maximum to the trade deficit. We would need to substantially improve our manufacturing capabilities, besides reducing non-essential imports and augmenting USD reserves. Making bilateral trade agreement with key suppliers could also save some dollars.

(b) With US less dependent of foreign savings to fund her deficit and other developed economies growing at a slower pace, the availability of capital may improve, though at a higher cost. By building a friendly investment environment, including stable and consistent taxation policy and improvement in ease of doing business index we can improve FDI inflows for investment in technology and capital intensive industries to substitute imports.

(c) While higher savings lead to lower consumption demand, the US growth would largely be aided by productivity gains. The demand for highly skilled workers shall rise accordingly. This could be both opportunity (higher demand for Indian engineers) and threat (brain drain) for India.

We continue to advise 10% allocation in gold, and overweight ITeS exporters. The current market rally, in our view, is completely based on latest bout of global optimism and not sustainable beyond few weeks.

Thought for the day

“The length of this document defends it well against the risk of its being read.”
- Winston Churchill (England, 1874-1965)

Word of the day

Disparate (adj)

Fundamentally different or distinct in quality or kind.

(Source: Dictionary.com)

Shri Nārada Uvāca

Will Modi baiters paint Akhilesh Yadav with the same brush?

Wednesday, September 11, 2013

Salvation lies within - II

We have consistently failed in exploiting our strengths and allowed outflow of precious resources both natural and human.

Learning from Switzerland, Israel and China we can focus on our strengths and locally available resources for faster and sustainable growth

We have opined in many of our earlier posts that the Nehruvian model of large industry led growth has failed in achieving desired outcome in past more than 6 decades. Consequently, a strong structural base for the Indian economy is yet to evolve. We have not been particularly successful in the areas such as technological advancement, productivity gains, innovation and localization and mostly continue to be an economy largely dependent on labor & resource arbitrage and trading.

In our view, we have focused too much on our weaknesses and tried hard to overcome by importing technology, energy, intellectual property, capital and consumption patterns. As S. Gurumrthy recently highlighted in one of his writings recently, the primary cause of structural imbalance in trade account appears to be humongous capital goods import in past 10yrs rather than gold or oil import as widely believed.

Instead of focusing too much on weakness, just by focusing on strengths the flow of trade can be reversed to pre British era. The following programs for example, could improve the balance of payment substantially and structurally by 2025 by focusing on our intrinsic strengths like abundant sun shine, large number of middle class youth, amazing landscape, strong and rich tradition & culture:

(a) Energy deficiency had been one of the primary reasons for India’s fiscal and trade deficits. Failure in implementing an integrated energy policy has been a major failure of policy making. It is widely recognized that “roof top solar panel” has the potential greater than the one seen in mobile telephoney in past one decade. Reducing energy intensity of water and developing a world class public transport infrastructure on priority basis, especially in tier II and III cities, and strict legal enforcement of energy efficiency should be considered.

(b) Indians spend approx USD25bn annually on education and related overseas travel. Creating 5 special education zones with liberal VISA, forex, taxation and real estate ownership rules, and allowing foreign institutions to freely set up campuses could reverse this flow. Students from India, far-east, middle-east and Africa who find it difficult to get VISA for US/UK etc. or find that expensive could also benefit from this.

(c) India holds tremendous potential for tourism. However lack of proper infrastructure had traditionally constricted the growth of this sector. On the other hand Indian outbound tourists flow is rising. Developing some world class self contained international tourism centers, e.g., on lines of Macau, Disney, Las Vegas, etc. with liberal VISA, Forex, taxation and real estate ownership rules could reverse these flows.

(d) Vindavan, Tirupati, Varanasi, Gaya, etc. all have potential to be as desirable, venerable and popular destinations as Mecca, Vatican and Jerusalem. Converting these centers of Indian religion and culture into self contained special zones with international airport and annual event calendar could get substantial forex revenue.

These projects also have the potential to generate large scale productive employment opportunity for local talent, besides contributing to economic growth and true globalization of Indian economy.

Thought for the day

“Don't be an art critic. Paint. There lies salvation.”
- Paul Cezanne (France, 1839-1906)

Word of the day

Bauble (n)

A showy, usually cheap, ornament; trinket; gewgaw.

(Source: Dictionary.com)

Shri Nārada Uvāca

Did anyone expect a different outcome to Syrian conflict after Iraq, and Libya?

Tuesday, September 10, 2013

Salvation lies within

Last two weeks have been quite eventful for investors in Indian markets.

First, the Parliament in a completely unexpected show of efficiency passed four landmark legislations, viz., Companies Act; The National Food Security Bill; Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Bill and Pension Fund Regulatory and Development Authority (PFRDA) Bill.

These legislations mark a watershed in India socio-economic history and will certainly have far reaching implications. Moreover, the urgency shown by the legislators in clearing these bills suggests that despite all criticism our elected representatives recognize the economic emergency and are willing to work together in this time of crisis. This should inspire investors in general.

Second, the change of guards at the Reserve Bank of India coincided with announcement of a slew measures to stem the sharp depreciation in INR. The new governor promised a more effective, transparent, calibrated and articulated policy measures. Currency markets took the lead and saw some speculative unwinding. We shall see more of that in coming months. Remember, we have been maintaining that the speculative element in the INR value should correct by year end but there is no visibility on the structural corrections.

Many commentators have been quick to announce anointment of Mr. Rajan as RBI governor as a turnaround in Indian economic cycle and therefore a cause for optimism.

We have maintained that the measures announced by Mr. Rajan are well intended and effective and should help in achieving limited objectives. However, these do not change our strategy premise that structurally the trend growth for Indian economy is 5-6% and not 8% towards which our planning process is geared. Unless the entire planning process is reoriented to this realistic sustainable growth trend, the structural imbalances in the economy cannot be corrected. This premise gains more strength from the above cited four legislations which should promote equitable, sustainable inclusive and slower growth.

Third, the economic data from the developed world suggested that developed economies are now stabilizing and the chances of a collapse are remote at this point in time. Therefore, in foreseeable future a need may arise for correction in the unconventional monetary and fiscal policies pursued since the 2008-09 collapse. This correction will inevitably lead to tighter and expensive money. This may not be good news for capital starved deficit economies like India. It would therefore be prudent to build a strong internal defense mechanism. Putting excessive reliance on global funds is fraught with extreme risks.

Fourth, the chances of a full scale escalation in Syria diminished as western nation failed to build a consensus on the imperative of such action.

As suggested last week, we do not see any need for change in our underweight equity strategy as yet. We shall review it after 20^th September.

In next few days, we shall highlight what could be done to build a strong local defense against likely global rebalancing.

Thought for the day

“Strange as it may seem, no amount of learning can cure stupidity, and formal education positively fortifies it.”
- Stephen Vizinczey (Hungary, 1933)

Word of the day

Ignoramus (n)

An ignorant person; a dunce.

(Source: Dictionary.com)

Shri Nārada Uvāca

The best thing going for India is unfailing democracy. Howsoever chaotic it may seem.

MMS says he is happy to work under Rahul Gandhi.

This reflects on whom – MMS, Rahul Gandhi, or Congress Party?

Friday, September 6, 2013

We will still wait till 20th September

The financial markets are definitely elated by the new RBI governor; and not completely without reasons. He has promised more certainty in policy and therefore less volatility in markets.

Insofar as the measure announced by him immediately after assuming the office is concerned in our view these were focused primarily on two issues:

(a) Building defense against potential outflow of money due to reversal of Fed policy stance, expected sooner than later.

Providing incentive to banks for mobilizing FCNR deposits and issuing foreign currency bonds to boost USD reserve is a good idea. However, it would be prudent to see how the Indian Diaspora and global investors respond.

In our view, people would want to see some macro improvement before they commit any significant amount of money to India.

The downside risk is that with more money in the system and better currency outlook, the resolve to contain fiscal and current account deficits below 5% may weaken, given the political commitments in an election year. In recent times, we have seen similar straying from targets in 2010-12, when large inflows due to QE in US and EU provided unwarranted comfort. In such an eventuality the measures proposed by the new governor may in fact prove to be counterproductive in the medium term.

(b) Strengthening and stabilizing the financial system through some structural changes in the banking system.

In our view, the proposal certainly does not mean CRR and SLR reduction on 20^th September. It also does not mean rate cuts or status quo on rates.

In our view, this means continued tight money policy; stringent prudential lending norms; higher provisioning, frequent stress tests for banks and onerous liabilities for those corporates seeking debt restructuring including change in management. Emphasis on inclusive growth may actually imply more political influence in terms of priority sector lending.

Anyone expecting dramatic shift in RBI policy stance may be disappointed. The disappointment may be exacerbated by the fact that the governor has actually raised expectations sky high. The promise of better communication does not seem to be coming through at least in the opening speech.

It is pertinent to note that the measures announced immediately after assuming the office were obviously not conceived between 4:00PM when Rajan took charge and 5:00PM when he addressed media. RBI obviously was working on these for some time. So believing that these mark any paradigm shift due to change in leadership is premature.

It’s the same as government waiting for the Parliament session to end to raise diesel prices, no matter how much damage will be caused in the interim.

For now, we do not see any reason to change our underweight equity stance.

Thought for the day

“The poison of skepticism becomes, like alcoholism, tuberculosis, and some other diseases, much more virulent in a hitherto virgin soil.”
- Simone Weil (1909-1943)

Word of the day

Vicissitude (n)

Regular change or succession from one thing to another; alternation; mutual succession; interchange.

(Source: Dictionary.com)

Shri Nārada Uvāca

c2009

QE: A recipe for hyper inflation; threat to fiscal stability, a disaster in making, etc. etc.

c2013

QE withdrawal: A threat to global economy; a potential disaster.

Thursday, September 5, 2013

We will wait till 20th September

New governor presents his first policy on 20^th September 2013. Good luck to him.

Once a farmer asked an economist way to the place he wanted to go. The economist answered “to go there I would not start from here!”

This is perhaps what the new RBI governor suggested in his first speech. We believe he would find his starting point at the earliest.

The macroeconomic headwinds to growth, sticky inflation, global uncertainties, low business confidence, falling investments, worrisome fiscal and current account situation all is well documented, debated and largely assimilated by the investors and analysts - notwithstanding the denial and dithering by the government, RBI and the planning commission.

The industry captains have very well demonstrated their low confidence by openly criticizing the government and RBI for inaction. It is not even uncommon to find the common man discussing the problems of current account, subsidies, mis-governance inflation, etc. in the trains and streets.

From the utterances of all authorities in past couple of weeks it is very clear that like every market participant, they are also waiting to see what Ben Bernanke will say on 18^th September.

In our view, it is not important what Bernanke says or does. Because, if Fed believes that US economy is steady and does not need the bond buying at the current pace, that should be good news for the global economy.

The more critical would be how the global investors who invested over 1trn USD in emerging markets over past 4years of QE react to the Fed stance. If they conclude, and not unreasonably, that US 10yr may rise to 3.5-4% in short term, USD may strengthen further, and EM currencies may depreciate further and therefore decide that it’s time for cows to return home – mayhem would be an understatement to describe the market scenario post that. However, if they decide to stay put and an orderly withdrawal ensues over next few years, we may get some reprieve and time to build our defence.

Nevertheless, we expect the economy and market to bottom out in next 12 months. We shall be watching closely for the following signals to mark the bottoming and turn “bullish” on Indian markets:

· Acceleration in asset sale even at distress prices by the infra and real estate companies.

· Capital restructuring by distressed companies, primarily by writing off equity capital.

· “Project credit” growth falling to mid single digits.

· All metal companies and banks trading substantially below book value.

· Expensive consumer stocks giving negative return for a quarter.

· AUM of domestic equity funds falling by over 5% in a month due to redemptions and not price erosion.

· Rise in India VIX over 40 with market falling 7-10% in a week.

Thought for the day

“Success consists of going from failure to failure without loss of enthusiasm.”
- Winston Churchill (1874-1965)

Word of the day

Skedaddle (v)

To run away hurriedly; flee.

(Source: Dictionary.com)

Shri Nārada Uvāca

Another midcourse correction in RBI policy stance “from price stability to inclusive growth.”

Better late than never.

Wednesday, September 4, 2013

It’s not only economics

“An Israeli day care centre found that parents were picking up their children too late, so they introduced a small charge of $3 to try and disincentivise lateness. However, instead of discouraging this behaviour, the payment served to legitimize it and buy the parents piece of mind. The result was that lateness actually increased. “ (Source: Unlearning economics)

This example is used by some economists to suggest that incentives impact the economic behavior of people. They argue that people actually face three different types of incentives: economic, moral and social. In the above cited example, the charges "substituted an economic incentive for a moral incentive (the guilt)", with the implication that the daycare centre simply didn't get the amount right.

In his recent statements Prime Minister Manmohan Singh has urged the fellow citizens to control the consumption of fuel and gold. Previously, finance minister P. Chidambaram and RBI governor Subbarao have also made appeals to curb gold consumption.

There are suggestions to increase the diesel price substantially to incentivize economical use of transportation fuel. Similarly, various disincentives have been introduced to curb consumption of gold.

The mute question is whether these monetary disincentives will work as moral incentives and encourage guilt free consumption?

On political side, curious to find the popular appeal of our political leaders, we did an impromptu check with people across seven states. The response was that of outright rejection, no-trust and disbelief.

The following two responses are especially notable.

(a) The present leadership is no comparison to the genuine Congress leadership. During 1965 war with Pakistan, the then Prime Minister Lal Bahadur Shastri urged people to give away one meal so that starving poor could be fed. Many people gave up two meals instead. A large number of families still carry the tradition by observing fast once a week. People did that because they totally believed in their leadership. But today no one seems to have faith in the country’s leadership. Squabbling within the government is not helping the situation either. (A 74year old Congressmen from Lucknow)

(b) Dr Manmohan Singh shares many similarities with Lal Bahadur Shastri. Both come from a very humble family background. Both have a austere life style and simple habits. Both believe in socialism with greater degree of private participation. Lal Bahadur Shastri initiated green revolution and white revolution. Manmohan Singh is widely credited with unleashing industry from the clutches of unproductive control and financial sector refoms.

However, unfortunately the similarities end there. Shastri bravely fought the wars – against enemy (Pakistan), nature (drought) and within the party – and won. Manmohan Singh on most occasions appeared helpless, escapist, withdrawn and compromising. (A Law professor from Haryana)

Thought for the day

“You are not only responsible for what you say, but also for what you do not say.”
- Martin Luther (Germany, 1483-1546)

Word of the day

Pari passu (adv)

With equal pace or progress; side by side.

(Source: Dictionary.com)

Shri Nārada Uvāca

Agenda 2014-2019

1. A law to establish right to health security for all, with provisions for treatment abroad where needed!

2. A law to establish right to have pucca house.

3. A law to establish right to proper clothing.

Tuesday, September 3, 2013

Prepare for the worst, anything better is bonus

The economic data appears to be worsening every minute. Notwithstanding the sharp rally in stock market, there is little that indicates toward improvement in macro environment anytime soon.

Before investors could digest the below expectation 1QFY14 GDP data released last Friday, manufacturing PMI data for August further clouded the outlook. Indian factory activity shrank for the first time in more than four years last month.

To further weaken the consumption story, latest data suggest that Indian diesel consumption was down 6.6% in Jul'13 and 2% in Apr-Jul'13. It is important to note that India accounted for 38% of global diesel demand growth in 2012 (12% in 2011). Diesel cracks (margins on producing diesel in refinery) are down 35% over last 8 weeks and petrol cracks down 58% over last six weeks.

Moreover, Singapore gross refining margins (GRMs) have completely collapsed over past 6weeks. This might be a reflection of demand collapsing in Asian economies.

This suggests that there is a decent probability of Asian economies revisiting 1997-98 crises. The worrisome part is that unlike 1998 India is no longer an insulated economy.

If US Federal Reserve (Fed) decides to slow down its bond buying program (tapering) as expected, emerging markets would begin to prepare for withdrawal of large pie of US$3.9trn invested in emerging markets over past four years. A disorderly adjustment might cause mayhem in the short term.

In context of India, Fed tapering should generally lead to higher rates globally and a stronger dollar. Theoretically both these trends should neutralize each other insofar as INR is concerned. However, rise in outflows or no inflow during the period of adjustment may cause sharp INR depreciation.

A weakening currency and rising interest rates, when domestic demand, both public and private, is collapsing may threaten a period of stagflation at a time when political establishment would be practically defunct.

In our view, the government and RBI have sensed the storm that is brewing. The helplessness shown by the prime minister indicates to this. Desperate measures suggested by oil minister indicate to this. The vanished trademark smile and missing twinkle in the eyes of finance minister indicate to this.

In all this despondency there is suggestion to postpone RBI policy meet to a date after the Fed meeting on 17-18^th September. In our view, this will tantamount to complete surrender. The message that will go out would be “our monetary policy is now subservient to Fed policy”. A bad precedence would thus be created.

In our view, it is rather the time to anticipate the worst and prepare for that, rather than waiting for Fed to spell out its policy and then react to that or exodus of foreign investors to begin.

Sharing the war plan with investors and businesses would only help the confidence level and anxiety.

Thought for the day

“Girls you've gotta know when it's time to turn the page.”
- ―Tori Amos, Tori Amos: From the Choirgirl Hotel

Word of the day

Auspicate (v)

To initiate with ceremonies calculated to ensure good luck; inaugurate.

(Source: Dictionary.com)

Shri Nārada Uvāca

Have you ever heard of a parliamentary democracy where the head of the government pleads ignorance about whatever ministers of his cabinet do or have done?

Monday, September 2, 2013

Long live hope!

Hope is a powerful therapy, but only for those who admit to the disease and seek cure, in our view.

The official reaction to the 1QFY14 economic growth data was on expected lines – little disappointment and lots of hope. Chairmen of planning commission and PMEAC both exuded confidence that 2HFY14 will be much better and the growth for full year will top 5%.

After travelling across the country this summer and meeting thousands of people from all walks of life we observed that economic activity is slowing considerably and current growth is more likely to be closer to 4% rather than 5% as hoped. (e.g., see here).

Given the environment of complete mistrust and suspicion, we are not sure how many people actually share the hope of the government. Nonetheless, it would be pertinent to consider the following before any investment strategy is constructed based on hope of revival.

By now almost everyone has admitted that there is little evidence of any recovery in 2QFY14. With manufacturing continuing to decelerate overall industry segment is most likely to report negative growth in 2Q. Widespread floods, liquidity squeeze, import curbs, and multiple hikes in fuel prices etc. have certainly further slowed down construction, transportation, trade and finance activities in the country in 2Q. The services sector growth is more likely to slow down to 5.5% this quarter.

Agriculture growth may be better on a lower base of a draught year, but not more than 4% due to floods.

With this maths, 2QFY14 real growth should be closer to or below 4%.

But the problem of investors is not 1HFY14 deceleration in growth. The real problem is that there is little hope for any improvement in next three quarters at least.

The highest contribution to 1QFY14 growth has been from public sector spending. With the government having already spent two third of its targeted deficit there is little help expected from this source. Liquidity squeeze, higher interest rates, higher fuel prices and import curbs shall certainly impact the private consumption.

Model code of conduct coming into effect before elections and thus curbing government spending shall also have its impact. (Usually, a quarter before election has seen slower growth due to spending curbs and lower investment).

The liquidity event in US (tapering) and geo-political event in Middle East shall also have their full impact over next 2-3 quarters. In our view, this should logically reflect in higher rates, weaker INR, higher inflation (especially energy prices), higher import curbs, lower consumption, saving and investment.

The next government will hopefully take charge in May 2014 and present budget in July 2014. Any pick up in economic activity therefore should be expected only from 2QFY15 at the earliest.

Besides, if the new Land Law comes into effect this year, most new projects might be delayed by at least one year. So keep your hopes alive, but preserve your capital.

Thought for the day

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

- Mae West (1893-1980 )

Word of the day

Bulbous (adj)

Bulb shaped, bulging

(Source: Dictionary.com)

Shri Nārada Uvāca

By conceding to the undue pressure of political bosses, has RBI governor undermined the financial security of the country?