Vijay Kumar Gaba

Saturday, September 13, 2014

Mythology of bubbles

Thought for the day

”I have been impressed with the urgency of doing. Knowing is not enough; we must apply. Being willing is not enough; we must do."

- Leonardo da Vinci (Italian, 1452-1519)

Word for the day

Geep (n)

The hybrid offspring of a goat and a sheep

(Source: Dictionary.com)

Teaser for the day

If BJP makes a government in Delhi and works for common good, in 2018 no one will remember how the government was formed.

For all you know AAP may not even be there to remind people!

Mythology of bubbles

In Hindu mythology, once the forces of good (Sura) and evil (Asura) had a protracted battle. The battle lasted so long that both the groups exhausted all their resources and valor. Completely tired, wounded, frustrated and exhausted, they approached the savior Lord Vishnu. The Savior advised them to go and explore the great ocean to find new resources and vigor to make a fresh beginning.

Following the advice, both the groups went to the great ocean and explored it extensively. During their exploration they discovered huge amount of wealth and resources that included the nectar that would immortalize the consumer and venom that would destroy whoever consumes it.

Realizing that if the evil forces get the access to nectar and other resources found during the exploration it would seriously jeopardize the interest of the forces of good, Lord Vishnu tricked the forces of evil and appropriated the entire nectar for consumption by the forces of good.

Lord Vishnu also requested the almighty Lord Shiva to absorb the venom so that it does not harm anyone and the balance of the universe is maintained. Obliging, Lord Shiva drank the entire venom and preserved it in his throat.

Post this the forces of good became more powerful. But whenever they deviated from the path of common good, they were overpowered by the evil forces and dethroned. Each time only after a great deal of repentance they would be rehabilitated with the help of Lord Vishnu, Lord Shiva or the Mother Supreme.

Over the years I have realized that it is not just a mythological story to be heard during religious ceremonies and forgotten immediately thereafter. It is also not a usual morality emphasizing victory of good over evil. It is much beyond. This applies to all aspects of life, even economics.

In modern economic parlance, the ocean exploration is akin to the period of irrational exuberance that eventually lead to building of a 'bubble' in the economic sphere.

Bubbles are initiated when all the participants get tired, frustrated and exhausted from prolonged economic weakness. At that point in time, all the stakeholders muster the courage and supported by the 'authority' do things they would never do in normal times. They do excessive and seemingly irrational borrowing, investing and spending. Capacities are built to the scale unfathomable during normal times.

The nectar or the good that emerges from these bubbles is shared by all. However the venom is consumed only by the financial investors who invariably end up poorer after every bubble is burst.

If you are not able to correlate to what I am saying - imagine would India be a ITeS superpower without Y2K or technology bubble during late 1990s! Had we built so many houses, roads, malls, power plants, cement plants etc. during last decade but for a credit bubble! Would capital be so easily and cheaply available to Indian entrepreneurs without a QE bubble in the west! ...to continue tomorrow

Friday, September 12, 2014

Yet another midway diversion proposed

Thought for the day

”If you can look into the seeds of time, and say which grain will grow and which will not, speak then unto me."

- William Shakespeare (English, 1564-1616)

Word for the day

Maudlin (adj)

Tearfully or excessively sentimental.

(Source: Dictionary.com)

Teaser for the day

Does Arvind Kejriwal know that you could only buy the things which are put on sale by the present owners!

Yet another midway diversion proposed

A recent Deutsch Bank research report highlighted that India is witnessing emergence of a "clear and internally coherent economic model" that includes "export oriented manufacturing, heavy infrastructure building and urbanization". in a material shift away from "India’s current services-driven growth trajectory" This emerging model is found akin to "an East Asian growth model based on the mass deployment of labour and capital".

The DB analysts believe that "The new strategy will require keeping the Rupee weak and dramatically expanding the financial system. International experience shows that the model can generate growth and jobs, but sustaining such rapid financial expansion is not without risks."

The report highlights that while India's export growth so far has been driven by services, auto sector has demonstrated that with right kind of policy support Indian enterprise could do well in global manufactured product market also.

The key to shift would be our ability to substantially augment energy supply to the industry and "ability of the domestic financial sector to sustain rapid expansion".

The Prime Minister Narendra Modi in his public discourse has strongly emphasized on the need for expansion of manufacturing sector to create jobs for millions of youth joining the work force every year. In fact during his election campaign Congress leader Rahul Gandhi had also echoed the same sentiments.

In April 2013 in a series of five articles (see side bar) I had expressed my concerns over frequent midway diversions on core issues taken by Indian policy makers.

I still feel that he current socio-economic mess in the country is outcome of total adhocism in policy and program formulation & implementation, non compliance with the comprehensive socio-economic structure conceived in the Constitution, and lack of committed leadership, especially in past three decades.

The political establishment has so far mostly failed in justifying the midway diversion from the prescribed socialist framework taken in mid 1980’s. The obduracy shown by successive governments in relinquishing enormous amount of discretions enjoyed by political establishment has been a consistent obstruction in the way to evolve the intended quasi capitalist or neo-socialist policy framework that would lead to sustainable and faster growth.

A brief spell of high growth, which many may find accidental in hindsight, has probably misplaced the popular aspirations and thus added to the complexity of the problem.

I feel the country needs to comprehensively review the constitutional framework for evolving a wider consensus on the policy direction for sustainable socio-economic development in the current context. Blindly following East Asia model of capital and energy intensive growth may not be ideal in our context.

I will write more on the current flavor "Make in India" next week.

Related articles

A midway diversion to nowhere

A midway diversion to nowhere - Disinvestment

A midway diversion to nowhere – Foreign capital

A midway diversion to nowhere – Energy policy

A midway diversion to nowhere – youth policy

Thursday, September 11, 2014

Some books to finish and few places to visit

Thought for the day

”Maids want nothing but husbands, and when they have them, they want everything."

- William Shakespeare (English, 1564-1616)

Word for the day

Plebeian (adj)

Vulgar; common; crude or coarse in nature or manner.

(Source: Dictionary.com)

Teaser for the day

TRS chief says "Will bury anyone who dares disrespect Telangana"!

What could be worst disrespect to the motherland than suggesting that it is capable of being disrespected by any tom dick harry?

Some books to finish and few places to visit

In past few days, I have outlined my thoughts on hurdles Indian economy faces in achieving a sustainable 8%+ growth path.

Positively, many readers have appreciated that there is little on the ground which could kick start the virtuous cycle of "higher income - saving - consumption - investment - income" in near term.

Most also agree that morning star is now visible and signs of a brilliant dawn are emerging on the horizon.

Some active participants in the equity markets have however suggested that hurdles in achieving higher savings and investment rate should not be deemed as "no profit making opportunity" in the market in near term. I could nothing but agree with them. I receive plenty of "stupendous trade" ideas every morning. Many of them actually go up 2-20% for several days.

Every day morning I find a slew of companies which traded at their all time high levels. Admittedly, I have never heard about 70% of these companies. A preliminary enquiry shows a large number of these "multi baggers" have little to show in their financial statements. Surprisingly, their profits jump with investor's sentiments and ebb accordingly. Obviously I am not at all excited about these "circuit hitters".

The tremendous response to some recent IPOs also reminds of exuberant times seen during 1989-90, 1994, 1999, 2005-07.

But what is catching my attention is small bubbles on the surface of services sector suggesting a strong undercurrent and high temperature underneath. Retailers, e-commerce platform providers, logistic services, pharma R&D, ITeS, telecom, entertainment, E&C contractors have all seen their market value burgeoning exponentially. Many players in this space have been able to raise risk capital at rather elevated valuations in recent past. Though comparatively smaller in overall macroeconomic context, this space appears to have decoupled and moving ahead alone.

I am a big fan of enterprise, innovation, large scale and ideas that directly touch of people. However, I do not like to invest in businesses (a) I fail to understand; (b) where visibility of positive cash flows is low; or (c) where valuations are high just on hopes.

I would therefore be very selective in venturing in this space. I guess I have enough time at my hand to make the selection. The nagging feeling I get from conditions in Europe provides me comfort that soon there will be an opportunity to buy at my will. I need stand in long queue at the upper circuit freeze level to buy any stock.

This soon however may not be tomorrow morning or next week. But that is fine with me. I have some books to finish and few places to visit. I can therefore wait little longer without getting bored.

For those getting itchy I would suggest studying the market behavior during July 2007 when subprime problem first hit the market and September 2008 when Lehman actually collapsed. The yield curves across Europe are also depicting a story.

Wednesday, September 10, 2014

On the brass tacks -IV

Thought for the day

”I am not bound to please thee with my answer. "

- William Shakespeare (English, 1564-1616)

Word for the day

Taciturn (adj)

Habitually silent; not inclined to talk.

(Source: Dictionary.com)

Teaser for the day

After Uttrakhand last year, it's J&K this year!

Is anyone listening what Mother Nature has to say?

On the brass tacks -IV

Historically, a large majority of Indian businesses have grown on government patronage and/or resource arbitrage opportunities and have been low on innovation, productivity and scale. The politically advantageous socialistic façade of the government, especially during 1950-1990 led to misallocation of resources, trade and capital controls, demand suppression, and protectionism that promoted low productivity.

The conditions have changed in past 10-15years but not sufficiently to make a majority of Indian businesses globally competitive.

Consequently, we have a multitude of businesses that are usually unable to survive a cyclical downturn on their own. Invariably, public sector financial institutions and the government have to bail out the ailing businesses. The problem is these businesses are never allowed to fail.

The instant cyclical downturn has also seen severe stress in the financial system due to failure of patronized entrepreneurs in managing their affairs adequately.

Unfortunately, most of these businesses happen to be in the sectors considered critical for revival of economy, viz., infrastructure, energy, and resources. These are the sectors which could absorb huge investments, generate large scale employment and enable consumption demand to grow at a faster rate.

As we discuss it here, a number of large corporate have already reneged or are on the verge of defaulting on their covenants. The amount of accommodation loans masqueraded as restructured loan to protract the default technically are staggering. Their balance sheets are destroyed to an extent that they can take no further business. Their equity stakeholders are too distressed to provide them further support. The only way out for them is to sell their assets.

A few balance sheets which are strong have the option to choose between acquiring an operating or partially built asset at favorable terms or undertake a green field project. To me the choice is but obvious. So how the fresh investment cycle will get started?

Moreover, we are entering a phase when 2-3years down the line easy credit situation prevalent in western world may cease. The cost of capital will start rising for already troubled businesses.

The long term solution lies in opening the Indian markets to open global competition. The government may provide support to businesses which have demonstrated their capability to compete with global players. The inefficient and incompetent should be allowed to fail.

In the short term however, the government will have to undertake the onus of kick starting investment cycle on itself. The best way would be create social sector infrastructure, e.g., education, skill development, water, sanitation and healthcare. The government has rightly initiated some programs in this direction. The faster and efficient implementation is the key.

Tuesday, September 9, 2014

On the brass tacks -III

Thought for the day

” Lawless are they that make their wills their law."

- William Shakespeare (English, 1564-1616)

Word for the day

Bevy (n)

A group; an assembly or collection.

(Source: Dictionary.com)

Teaser for the day

Surprisingly Congress Party does not appear to be making much effort to ask voters, who have rejected it, what went wrong!

The leaders are audaciously persistent with their claim that gullible and innocent voters were misled by the false propaganda of BJP

On the brass tacks -III

Capital and enterprise are two most critical elements for sustainable growth in any economy. At present Indian economy is facing inadequacy of both.

Capital adequacy

Capital could be in the form of risk capital (equity) or fixed return capital (debt). For long gestation high risk infrastructure projects in a developing economy where capacity to pay for services is always questionable usually risk capital should be preferred. But the model adopted in India relies heavily on debt capital. This narrows down the problem to (a) lending capability of the banking system and (b) managing capability of entrepreneurs.

In my view the lending capability of Indian financial system is lacking in all three aspects, viz., (a) capital adequacy; (b) technical expertise and (c) transparency and accountability.

As the following chart from Business Standard (4 Sep'14) shows, the capital adequacy of Indian banks has consistently declined past 6years.

Many recent cases have also highlighted that even leading financial institutions have failed in performing due diligence in several large debt deals. Even more bizarre is the fact that the failure has been recurrent in many cases.

Lack of an active broad debt market has also limited the capability of borrowers to raise money at efficient price.

Capital controls in various forms have also limited the ability of overseas investors to invest in capital starved infrastructure sector.

A sustainable growth path would thus prerequisite serious reforms in financial sector, including but not limited to a zero based review of FDI regulations, making banking sector adequate in terms of capital, technical expertise and accountability, and change in low equity model infrastructure development.

The new government has shown some promise in this direction, but implementation is yet to be seen..to continue tomorrow

Sunday, September 7, 2014

On the brass tacks -II

In past 15years or so, great emphasis has been placed on building of physical infrastructure by private sector enterprise. The private public partnership (PPP) model has been aggressively promoted for building infrastructure assets and public utilities like roads, airports, rapid urban transport system. Many projects under PPP model have failed to produce desired results. Besides a large number of projects are mired in controversies. The reasons are many and varied.

Administrative delays in granting necessary approvals, failure in evolving and implementing an appropriate compensation and rehabilitation policy leading to frequent public protests, stalling of work and judicial intervention are some popular reason cited for partial failure of PPP model.

In my view, inadequate or no attention to social costs and sustainability concerns are bigger reasons. For example, consider the long jams at toll booths across cities. A detailed social audit might suggest that in many cases the time and fuel wasted at toll booths is often more valuable than the toll collected.

Besides, in general economic terms, we have failed in making distinction between the “need” and “demand” for infrastructure. There is no denying that the need for infrastructure is colossal. To meet the ends of social justice, economic equality, sustainable economic growth and regional balance, development of social (e.g., education and health) and physical infrastructure (roads, communication, power etc.) is imperative. But at the stage of development where India stands today, the demand (ability to pay to fulfill one’s needs) for infrastructure is abysmally low.

Moreover, first the rush to accumulate cheap credit and then fiscal misadventure in the name of stimulating the economy post Lehman crisis did lead to excessive debt both at government as well as corporate level in past 10years. This did bring unmanageable demand forward in time.

For example, over 50GW power projects were initiated and fertilizer policy was made when the feed stock supply chain to fuel the power and fertilizer plants was far from ready. The capacity to pay unaffordable toll was not there when over 5000km of toll roads were commissioned. Regulatory framework for sustainability was not ready when mining rights were awarded for numerous coal, iron ore and bauxite mines.

Many of these power plants are lying idle and so are numerous industrial projects conceived based on supply assumptions from these plants. Many toll roads have become unviable or are lying uncompleted. Most coal and other mines are yet to start commercial production and KG basin is producing only 1/5^th the assumed gas production.

The infrastructure development therefore needs to be mostly socio-political effort rather than an economic proposition, in my view.

The efforts to make roads, power and airports projects economically viable by bundling land and coal resources in past 15years have proved rather counterproductive. The evolving socio-political paradigm indicates that in foreseeable future it would not be possible to masquerade land and mining mafia deals as infrastructure development projects. ....to continue tomorrow

Thought for the day

”How oft the sight of means to do ill deeds makes ill deeds done! "

- William Shakespeare (English, 1564-1616)

Word for the day

Cupidity (n)

Eager or excessive desire, especially for wealth; greed; avarice.

(Source: Dictionary.com)

Teaser for the day

Modi is establishing direct communication with various sections of the society, e.g., youth, women, businessmen, foreign leaders etc.

The frustration of media persons and studio experts is understandable!

Watch keenly, if "Mama Modi" takes the "Children Day" away from "Chacha Nehru".

Wednesday, September 3, 2014

Why bother about things you can't help

Thought for the day

” Let the one among you who is without sin be the first to cast a stone. "

- Jesus Christ

Word for the day

Cavil (int. verb)

To raise trivial objections; also, a trivial objection

(Source: Dictionary.com)

Teaser for the day

If religion of Sanskrit is Hindu, what is the religion of English, Urdu, Tamil, Bangla, Malyalam, Sindhi, Gujarati, Marathi, Punjabi, French, German....?

Why bother about things you can't help

I am fortunate to have critics who are most charitable in their criticism. For past two weeks especially they are leaving nothing to imagination., Some of them have even picked up selective Punjabi expletives to express their frustration with me.

Their main objection is to my nonchalance to seemingly exciting events and data, e.g., Ukraine, Pakistan, Gaza, ECB stimulus, Fed tightening, etc. My point is that anything which can be clearly seen by the last person standing on the street (that is me) is not worth bothering about. So is not which even the likes of Yellen and Draghi cannot see.

I like to factor in my strategy all that is known and/or expected, whether quantifiable or not, and keep enough flexibility to accommodate any black swan that may chose to visit unannounced. This saves me from reacting to every news headline or getting excited over every hint of trouble.

I understand it is unfair to use this column to take on my critics, but who said life is fair!

Now coming back to normal business, I have been emphasizing that the Indian economy may not sustainably return to the path of high growth (8%+), in next 5years unless the virtuous cycle of "higher income - saving - consumption - investment - income" gets kick started. So far we have not seen any evidence of this happening.

The upward revision in growth estimates so far is coming from expectation of faster execution and administrative efficiencies. New investments are not on the horizon of analysts and economists so far.

The corporate profit growth in past couple of quarters is also mostly driven by cost efficiencies and better export demand. There is no evidence of pricing power returning to producers or material rise in consumer demand.

In my (over) simplistic assessment the following pieces need to fall in place before the virtuous growth cycle led by investment and credit is kicked in.

(a) More money needs to flow in the hands of consumers so that consumption demand and household savings could grow at faster rate.

(b) Credit worthiness of enterprise engaged in high gestation capital intensive infrastructure projects needs to improve.

(d) Enabling industrial, fiscal and sustainability policy environment needs to be firmly put in place.

(e) Monetary policy needs to ensure that the foreign flows are not used to feed asset price bubble like during 1991-1995 and 2003-2007 but are strictly channelized to built productive assets and social & physical infrastructure.

In next few days, I shall discuss these points in some more detail. All suggestions, comments and views (even with expletives) are welcome at vijaygaba.investrekk@gmail.com

Tuesday, September 2, 2014

Solve the puzzle

Thought for the day

”For if you love those who love you, what reward have you? Do not even the tax collectors do the same?"

- Jesus Christ

Word for the day

Bletting (n)

The ripening of fruit, especially of fruit stored until the desired degree of softness is attained.

(Source: Dictionary.com)

Teaser for the day

Pakistan gets its own AAP moment.

There are lesson for all - Anna, Quadri, Kejriwal, Imran, Manmohan, Sharif and Modi!

Solve the puzzle

In past couple days some market commentators and analysts have made seriously buoyant forecasts about Indian equity markets, almost disregarding the global unease about the bond and equity rallies in developed markets. It certainly feels good to hear calls for 10000 Nifty level in next 6-7months translating into 25% return from the current levels.

The latest trigger for the bulls is the GDP data for 1QFY15, which came at 5.7%, though not unexpectedly. As I suggested yesterday, the stream of latest data, including GDP data for 1QFY15 and PMI numbers for past 6months, support optimism about "worst is over". There is however little to suggest that the virtuous cycle of higher savings, investments, credit and consumption is likely to get kick started tomorrow morning.

I feel the latest GDP data needs to be seen in this context. Even a prima facie look at the CSO press release of 1QFY15 GDP data raises some questions. For example, consider the following:

(a) Good rabi crop is reflected in strong Agriculture growth. But this number is corroborated by private consumption which fell, continuing the trend of past many quarters.

(b) Strong growth in construction sector growth did not reflect in banking and real estate sector growth. From other data we know that infrastructure construction, especially roads, has not done well in that period.

(c) Government consumption expenditure rose, perhaps due to election related spending. However, considering that over 60% government spending is done on social sector, the decline in social sector growth is difficult to explain.

(d) Rise in investment also is not corroborated by decline in financing, banking and insurance sectors. The credit growth number for the corresponding period also do not confirm this.

(e) Gold might have contributed much to lower imports number. Oil import is also lower. Both these are not sustainable.

(f) Mining growth is purely due to lower base, as the coal and iron ore production data does not confirm this sharp rise.

(g) The shortages in power supply belie the spectacular rise in electricity and gas production.

(h) Rise in manufacturing and exports could be due to other economies doing well rather than Indian economy doing well. Lower consumption number confirms this.

I would like this puzzle to get resolved before changing my investment strategy from overweight consumption and exports to overweight investment and credit. For now I am sitting tight. I shall though look at rebalancing my portfolio this month to take care material outperformance in certain stocks.