Vijay Kumar Gaba

Friday, July 24, 2015

Interest rates: let the market decide

Thought for the day

"The mechanic that would perfect his work must first sharpen his tools."

- Confucius (Chinese, 551-479BCE)

Word for the day

Risibility (n)

The ability or disposition tolaugh; humorous awareness of the ridiculous andabsurd.

(Source: Dictionary.com)

Malice towards none

Some politician says I will make my God bigger and better than the competition's!

And yet someone else was talking about India as one Nation!!!

Interest rates: let the market decide

I received many interesting comments on my yesterday's post (see here).

Many disagree with my proposition that a marginal rate cut at this juncture will mostly be perfunctory and may not have any material impact on the economic activity. Their argument is mostly based on the premise that rate cut could only stimulate the economic growth by spurring demand, both consumption as well as investment.

I obviously do not agree with them. I believe that Indian economy is already growing at its full potential. To grow at higher rate than the present it would need to change the orbit. This would require escape velocity that cannot be generated by lower interest rates or easier liquidity alone. In fact, this experiment has been tried rather unsuccessfully during 2003-2007 creating a bubble that may take 10yrs to deflate.

Mispricing a critical factor of production (i.e., capital) can only lead to disastrous results. In past six decades of economic planning experience we have experimented with mispricing of labor, materials, land, and capital. The consequences are lower productivity in virtually all economic spheres; systemic as well as commercial inefficiencies; imbalanced and inequitable growth; socio-economic inequalities, and wasteful consumption.

In recent time the system has been moving towards more efficient pricing of natural resources, transportation and cooking fuel, public sector and rural wages, land etc. Not allowing the price of capital to follow the trend by artificially suppressing interest rates may not be appropriate.

It is clear from the trend of past one decade and government's vision that in next couple of decades the growth in India will be highly capital intensive. Even in the traditional labor dominated fields like agriculture and retail trade, capital will a larger role. The demand for capital will obviously be more than the supply; hence the price of capital should remain elevated.

Global supply of capital could help moving the equilibrium to a lower point. But for that our politicians and their allies would need to take a "decision" much faster than their Cuban counterparts.

One reader who is a brilliant student of economics has pointed correctly that the market participants would need to understand that in Indian conditions high growth could co-exist with higher interest rates if inflation remains at moderate levels. Higher price of capital will benefit millions of savers while shrinking margins of few hundred thousand borrowers. It will go a long way in promoting efficient utilization of capital, eliminating the inefficient users and businesses; besides reducing income inequalities.

This is critical, because in the evolving paradigm the level of employment and wage growth is likely to remain low. The capital intensive industrial and rural growth will not generate enough employment opportunities to keep the burgeoning worker population fully employed. The supply of unskilled and semi skilled labor will always exceed the demand.

The interest income therefore will become a critical component of most household's income. So far it has been critical mostly for the pensioners and borrowers. Interest rates will assume a distinct political character; that is if it does not already.

Thursday, July 23, 2015

No enthusiasm for rate cut

Thought for the day

" Life is really simple, but we insist on making it complicated."

- Confucius (Chinese, 551-479BCE)

Word for the day

Criticaster (n)

An incompetent critic.

(Source: Dictionary.com)

Malice towards none

In all likelihood that Nestle will eventually win the Maggi battle.

It may however not press for compensation as a gesture of goodwill towards the government.

But I will certainly seek compensation for the deprivation my kids are suffering due to this unsavory ban.

No enthusiasm for rate cut

As the date for RBI's periodic policy review date draws closer the anticipation regarding the likely move on policy rate is rising. Like most preceding policy reviews, the opinion is divided this time also.

Many believe that strong fiscal correction measures taken by the government, trending lower commodity prices and poor core sector growth should lead the governor to cut another 25bps before hitting a pause button.

While there are others who find the erratic monsoon and rising food & vegetable prices a deterrent to any rate cut on August 4.

Not joining any camp, I continue to strongly feel that RBI is running way behind the curve and any marginal measure (25bps cut) or absence of that is unlikely to have any material impact on the economy.

Nonetheless, I feel that RBI today has little leverage in cutting rates. The failure of last auction indicated that there may not be much demand for government paper at lower yield.

Moreover, the government appears keen to upfront the borrowing program to gather adequate resources for plan expenditure. Lower yields may defeat that purpose. Narrowing of gap with other EM yields with risk of further relative appreciation in INR might impact foreign debt flows also.

In my view, the rate decision of Gov Rajan next month will be driven more by "INR" than "Industry".

Given the elevated level of stress on corporate balance sheets, as evident from the FY15 annual accounts, low demand environment, and poor credit growth despite comfortable liquidity conditions three things are more than clear -

(a) few bankers want to take risk of giving fresh money to a stressed corporate or even a new project;

(b) few corporate balance sheet will justify further lending even if rate fall by 25bps; and

(c) some aggressive bankers may be chasing households with high priced relatively small ticket consumer loans, compromising prudent norms and laying foundation for a credit bubble 4-5yrs down the lane.

Besides, in recent days the short term money markets have anyways been close to or even below the policy rates.

Under these circumstances a 25bps repo cut would be mostly redundant, in my view.

Gov. Rajan would not like to make a bigger cut, as it would risk further strengthening of already strong INR; force more liquidity infusion for buying USD; and thereby weakening the fight against price rise.

From market perspective I am not be too enthusiastic about a rate cut in next policy announcement.

Wednesday, July 22, 2015

Bad economics, poor politics

Thought for the day

"To see what is right and not to do it is want of courage, or of principle."

- Confucius (Chinese, 551-479BCE)

Word for the day

Sidereal(adj)

Determined by or from the stars.

(Source: Dictionary.com)

Malice towards none

Does a common person refer to a police constable as what AK did?

If yes, then AK is true to his positioning.

If not, you are true to yourself.

Bad economics, poor politics

The French President Francois Hollande has again mooted the idea of a United State of Europe (USE). He feels that Geek crisis has weakened the citizens' faith in European project.

To renew this faith it is necessary to strengthen the institutions of governance. “What threatens us is not an excess of Europe but its insufficiency,”, Holande wrote in the Journal du Dimanche weekly newspaper.

The president cautioned that populist movements had seized on Europeans' disenchantment with European institutions and were taking issue with Europe because "they are scared of the world, because they want divisions, walls and fences to return."

With public debt to GDP ratio of close to 100%, ever rising pension liabilities, a struggling economy, diminishing revenue, shrinking market share in global exports, rising youth unemployment, France has been occasionally sending jitters down the market's spine. Some in the market place are therefore seeing this as early signs of rising tendency of escapism, as the French government is struggling to introduce fiscal and labor reforms considered essential for the economy to avoid another Greek tragedy taking place on Paris.

It is commonly believed that the sublime idea behind a common Euro area was to put an end to centuries of conflicts between various European powers which have materially dissipated post second war. The paranoid might therefore smell an attempts to recreate a strategic power that Europe had traditionally been under the garb of an economic union.

I am however not inclined to subscribe to the theory of "Rise of Empire". Consequently, I also do not agree with those who fear an all out war involving Europe or Japan in foreseeable future. I believe that a full war needs "truck loads of youth". With "bed loads of old and infirm" people Europe and Japan cannot afford to go to a full war.

Some other may consider it desirable in order to correct the debilitating imbalances in the Euro area economies. However, considering the long history of rivalry and mistrust between the south and the north Europe, huge economic inequalities and social divergence between the peripheral and the core, thoroughly clouded economic outlook even in the medium term, there seems is little chance that a consensus could be reached.

So, at best the thoughts of President Hollande could evoke some academic discussion of no use, like the one I am doing here!

However, looking at the behavior of political parties in India, one can say that they are trying hard to seize on Indians' disenchantment with national institutions.

By denying consensus on critical economic issues, the politicians may be destroying the future of a whole generation.

And by jeopardizing the functioning of the enforcement agencies and law and order machinery, they might also be endangering the present of citizens.

Tuesday, July 21, 2015

Keep eye on the new dawn

Thought for the day

"Death and life have their determined appointments; riches and honors depend upon heaven."

- Confucius (Chinese, 551-479BCE)

Word for the day

Petrous (adj)

Like stone, especially in hardness; stony; rocky

(Source: Dictionary.com)

Malice towards none

Why media loves to stalk Virat and Anushka these days?

Who does actually care?

Keep eye on the new dawn

Continuing with the theme "To Micro from Macro", I would like to clarify that in my view we are still some distance away from a secular bull market in Indian equities. However, it is likely that the next cyclical recovery that is expected to shape up in 6-12 months may lay a solid foundation for such bull market. So the positioning for this cyclical recovery has to factor in the continuation of good times, of course with material rise in volatility.

I have been rather insistent that the bull market in Indian equities will commence mostly due to domestic reasons. The global factors, primarily liquidity and soft commodity prices may provide some extra impetus.

Therefore, the positioning has to be based on domestic growth drivers. I would therefore suggest the following areas for finding future leaders.

(a) Industrial companies with market and technology leadership, strong brand equity and access to global markets. Solution companies rather than product companies are more preferable as they can sustain margins through pricing power and better customer loyalty. The companies with substantial operating leverage in this space are more preferable.

(b) Consumer companies both in staple and discretionary space which may benefit from rise in consumption demand, stable global economy, weaker INR, and lower commodity prices. Again companies with material operating leverage are preferable.

(c) Local units of global corporations that may see larger participation through more investment, hike in stake or transfer of manufacturing operations for regional exports.

(d) Financials will inevitably participate in any bull market. Reduced financial stress, better yielding bond portfolio, higher credit demand, geographical spread due to deeper financial inclusion efforts, and recapitalization are some ideas that will drive value of financial stocks higher. However, as a matter of strategy we are circumspect about the PSBs. I therefore prefer private sector lender.

Public sector banks may though be better prospects for a short term trade. I would though stay at the top end of this spectrum.

(e) One of the primary premises of our bull case is soft commodity prices. I would therefore not suggest any global commodity exposure. Domestically however cement could see a major spike up due to better utilization rate. Financially unleveraged large players with good operating leverage could be looked upon. I prefer regionally diversified companies to those whose operations are contained in smaller geographies.

(g) The exporters especially IT and pharma should continue to do well. A correction due to cyclical strength in INR would provide a good entry point.

I usually do not get into the midcap - large cap debate. However, some relatively smaller companies that have potential to become big due to material capacity expansion, innovation and better resource management always present great opportunity to optimize portfolio return.

Monday, July 20, 2015

Nifty breaks the shackles. How far will it travel?

Thought for the day

"A gentleman would be ashamed should his deeds not match his words."

- Confucius (Chinese, 551-479BCE)

Word for the day

Fogdog (n)

A bright spot sometimes seen in a fog bank.

(Source: Dictionary.com)

Malice towards none

The Congress' strategy is intriguing.

They are just busy cutting the BJP's line short instead of drawing a bigger line of their own.

The whole campaign is centered on the theme - "whatever we did bad, you are doing worse"!

Nifty breaks the shackles. How far will it travel?

Nifty completed a bullish reverse head & shoulder pattern last week. However the volumes and volatility was much lower indicating slower momentum and lack of conviction.

It is therefore less likely to show the kind of short covering and buying momentum seen usually seen post such bullish breakouts.

Infosys results this week may be a key trend decider. A close above 1060 for Infosys may lead NIFTY into its next resistance zone of 8865-8910.

This morning this looks like a likely scenario.

A close below 8470 only would terminate the current upmove.

The moot question however is will Nifty break past its previous all time high recorded earlier this year.

Sunday, July 19, 2015

Planning the move from Macro to Micro

Thought for the day

"You have no enemy except for yourself."

- Francis of Assisi (Italian, 1182-1226)

Word for the day

Assisi (Italian, 1182-1226)

Word for the day

Allegiant (adj)

Loyal; faithful.

(Source: Dictionary.com)

Malice towards none

The prerequisite for rectifying a mistake fully is honest admission of such mistake.

Have various authorities honestly admitted what went wrong in the case of Vyapam?

Planning the move from Macro to Micro

Continuing from yesterday, I believe that the macro trade that has mostly driven the returns in Indian equities in past one year shall gradually yield way to a cyclical micro trade over next 6-12months.

The cyclical micro trade may be driven by the following five primary factors:

(1) Improved execution led by clearance of stalled and incomplete projects. Prompt clearances and removal of administrative hurdles could unlock a huge amount of capital blocked in these projects.

Industry feedback suggests that there are some positive developments in this direction that should bear fruits in next 6-12months.

Increase in supply of coal and gas likely in next6-12 months shall boost power generation and lead to improved capacity utilization in many industries.

(2) Improved liquidity due to higher government spending on investment and social activities.

The government spending has been limited by the fiscal constraints, especially in past three years. Higher energy, farm and food subsidies have constricted the public investment as well as consumption. With energy price reforms in place and robust indirect tax collections (primarily due to higher service tax and excise duty on transportation fuel) shall enable government to resume investment in social and physical infrastructure, especially roads, energy and transportation.

(3) Improved profitability as the benefit of lower global commodity prices kicks in and inventory levels rationalize.

The export demand may not pick up in hurry given the trends in EU and China. The US could however see decent gains.

The key would however be the domestic private consumption and investment demand.

(4) Bottoming of credit cycle. The credit demand has slipped to multi decade lows in recent months, along with worsening credit quality. Given the inflation trajectory and credit demand, the rate cycle is certainly turning down with likely uptick in savings.

Next 12-15 months may see bottoming of credit cycle with NPAs peaking and credit growth and savings rate bottoming. The corporate leverage may see material correction either through asset sale or conversion to equity.

(5) With Bihar elections out of way, the government will have a window of 6-9 months (before the next cycle of states elections kicks in) to pursue key legislative measures like GST and other tax reforms. This could encourage investments

The key would be to orient the equity portfolio to this shift from macro trade to cyclical Micro trade. More on this next week.

Thursday, July 16, 2015

How long this macro trade can drive the equity returns?

Thought for the day

"Preach the Gospel at all times and when necessary use words."

- Francis of Assisi (Italian, 1182-1226)

Word for the day

Foison (n)

Abundance, Plenty

(Source: Dictionary.com)

Malice towards none

What happens when you spit at the Sun?

How could someone defame me?

How long this macro trade can drive the equity returns?

Wednesday morning the financial markets appeared quite relieved and cheerful. Grexit concerns out of way for now and prospects of further reduction in energy cost on resumption of normal supplies from Iran charged the bulls and bears equally. Bull traders were motivated to take fresh positions as the benchmark indices crossed some key technical resistance levels and bears were pressurized to reduce short positions.

This all occurred despite consensus on poor corporate performance and worsening political landscape clouding the key legislative business like GST and Land Acquisition Bill.

An analysis of the Indian equities' performance in past one year makes it clear that the trade has so far been mostly on the macro side.

Improvement in fiscal conditions has mostly been driven by cut in government's social and administrative spending, lower energy subsidy, delay in implementation of national food security law, higher service tax and higher road cess on fuel sale, and asset sales (including spectrum and coal).

The current account looks better primarily due to lower crude bill, lower capital goods imports, lower gold demand, and higher remittances on rising rate differential.

Retail inflation appears under control - courtesy some deft market management, crash in global food prices, high base impact and to some extent due to moderation in demand. Wholesale inflation is in deflationary mode for past eight months primarily due to lower demand, lack of pricing power with manufacturers, and issues with the construction of the price index itself.

The credit demand is at multiple decade low. Consequently the rates are trending lower. After a gap of many years the real rates are now positive - a good omen for arresting the declining domestic savings.

The macro trade has also been driven to a large extent by the relative strength of Indian economy and political establishment as compared to other emerging markets. Indian currency has been rather resilient as compared to most emerging markets. The growth has collapsed in commodity driven emerging markets (e.g., Brazil, South Africa, Chile, Venezuela etc.) due to global economic slowdown. Many emerging markets (e.g., Indonesia, Thailand) have witnessed political and civil unrest. Recently, Chinese equities have corrected majorly sparking fears of collapse. This may also lead to little higher preference for relatively stable Indian markets amongst global investors.

However, the question will remain "how long this macro trade can drive the equity returns?"

At some point in time, the traders will become pious and try to invoke investment fundamentals. Then the corporate earnings and micro economic conditions would be evaluated at their face value.

This in my view is both an opportunity and threat for the Indian equities. If macro strength finally manages to permeate through the corporate performance, we may see a massive rise in the investors' interest in Indian equities leading to a bubble like condition in prices. Else, the correction is as far as the next negative headline.

Wednesday, July 15, 2015

Over to "Lift"

Thought for the day

"It is not fitting, when one is in God's service, to have a gloomy face or a chilling look."

- Francis of Assisi (Italian, 1182-1226)

Word for the day

Magniloquent (adj)

Lofty or grandiose in speech or expression; using a high-flown style of discourse; bombastic.

(Source: Dictionary.com)

Malice towards none

Do you think the Italian Marines accused of murdering an Indian will (could) ever be put to justice in India?

Should all our politicians just draw a lesson from the episode and let it go.

Over to "Lift"

As of this morning the Grexit has been replaced in cold storage and Iran seems to have got a deal. The global herd of professional traders shall be aggressively looking for the new goose to chase. The most likely candidate is the 'Lift" by the US Fed.

"Lift" is prominent in the discussions since the completion of tapering in October last year. The lines are drawn and people are well positioned on both the side. Trades could occur with ease and abundance.

It is widely accepted that this is an exceptional measure with a definite life span. Consequently, the debate over ending zero rate regime in US is mostly focused on the timing rather than rationale of it. In my view, the sooner it occurs, better it would be for US as well as global economy.

I find the Fed's contention of the decision to "Lift" being data dependent farcical. It is well accepted that the "normalized" level of economic growth, employment and prices in the current circumstances cannot be benchmarked to historical statistics.

In particular for US, it might take a decade, or even two, to normalize the employment conditions. The people, who lost employment in the aftermath of blow up of financial crisis in 2008, may not be skilled or young enough to take up jobs in new avenues. Besides, lower returns on pension funds might have forced lot of people out of retirement to take up jobs not requiring tech skills. The lower end of the job spectrum may thus be overcrowded and likely remain so for quite some time - keeping effective unemployment and wage levels low.

This trend will have a direct bearing on the economic growth in terms of lower private consumption. However, going by the current trend, the government's fiscal conditions may improve materially in next 5yrs and government spending may pick up thereafter.

Lower energy prices are increasingly becoming tricky for US. The opinion is divided as to the cost and benefit of lower energy prices on overall US economy, considering the huge investment made in shale business over past one decade and given that it accounts for a major part of incremental employment.

The incremental strength of USD, consequent to "Lift" and persistent weakness in EUR and JPY, could be yet another cause of concern for US exporters.

I am not taking any side in this "Lift" trade. I believe that like Greece, there are no black swans hiding behind this cloud also. So no major surprises. I am personally expecting an accelerated "lift' initially (may be to 1.5%) followed by a rather longer pause.

I do not see it causing much disruptions in the global markets, except for a last bout of USD carry trade unwinding causing some volatility in high yield markets. Indian bonds could be at the receiving end this time.

The financials will give a last opportunity to buy cheap. Highly indebted infra players would continue to remain in "no-go" zone.

Tuesday, July 14, 2015

About feudal lords and a monkey

Thought for the day

"If a superior give any order to one who is under him which is against that man's conscience, although he do not obey it yet he shall not be dismissed "

- Francis of Assisi (Italian, 1182-1226)

Word for the day

Mimesis (n)

Imitation or reproduction of the supposed words of another, as in order to represent his or her character.

(Source: Dictionary.com)

Malice towards none

May I seek a Fatwa from Ulema that only Rozadaar people have a right to Iftar. To everyone else Iftar is Haram!

About feudal lords and a monkey

This week the legendary artist and my all time favorite Guru Dutt would have turned 90. His classic movie Sahib Biwi Aur Ghulam vividly depicted the decline of a feudal family, which could not manage its affairs in accordance with the evolving realities in post independence era.

The feudal lords continued with their extravagant lifestyle when their primary source of income was drying up. Pain, misery, anguish and vanity was all that got left.

To me the story is resonating in the present day Europe. The European power began to decline sharply in post war era. The huge income drawn from erstwhile colonies in Asia, Africa and Latin America dried up fast. The huge loss of youth life in the war could never be replenished. Socialism replaced monarchies. The genius, research and innovation that heralded the era of renaissance and of industrial revolution since 18th century started dispersing across Atlantic to US. The Asian enterprise (primarily Japan, Korea and China) snatched a lot of initiative and the market.

The consequence was crippling labor unions, consistently rising wages and state welfare spending, diminishing tax revenues and ever rising public debt.

The common market and common currency was to my mind an experiment to collectively protect the slithering market share and geo-political importance of individual countries. The idea might have worked partially. However, presently, the vast socio-economic imbalances within member states more and more appear accentuating the problem rather resolving it.

I am inclined to join the school which believes that European Union is inherently unviable and mostly a failed experiment.

Greece to me is the monkey chosen for clinical trials to test the eventual disintegration of EU. A successful Grexit followed by internal normalcy in Greece over next 5-7yrs, would provide a platform for exit to other countries suffering due to a relatively stronger common currency. On the other hand the failure of this clinical trial would not cause much disruption and Greece will be kept within the Union with even larger support. The round one of trial has of course failed.

The long term sustainable solution to the problem would only come through extensive structural reforms, which includes immigration reforms, labor reforms and subsidy reforms.

In simple terms, the salvation lies in cutting expenses and raising income to reduce indebtedness. Raising income may not be an option in the short to medium term, given the higher dependence ratio in demography, and falling employment opportunities due to technological obsolescence and highly subsidized farm sector. So we come to cutting expenses. That essentially means cheaper drugs, cheaper clothes, cheaper travel, and cheaper workers etc. or in other words India, Bangladesh, Sri Lanka, Philippines, Indonesia, et. al. I would say more of India, because we share the same education, legal, and political system.

In the meanwhile I am not bothering about the monkey on the experiment table. Those in position of power palpably not interested in the success of this clinical trial as yet.

Monday, July 13, 2015

Domestic investors hold the fort amidst global rout

Thought for the day

"Start by doing what's necessary; then do what's possible; and suddenly you are doing the impossible."

- Francis of Assisi (Italian, 1182-1226)

Word for the day

Quixotic(adj)

Extravagantly chivalrous or romantic; visionary ,impractical, or impracticable.

(Source: Dictionary.com)

Malice towards none

What the options with Pakistan are but to keep the dialogue open!

Domestic investors hold the fort amidst global rout

The month of June witnessed about 1% fall in benchmark indices. In July YTM benchmark indices are almost unchanged. However, a further analysis of market internals would highlight that midcap and small cap have continued to outperform the benchmark indices even when institutions have withdrawn to fringes.

June'15 witnessed the lowest turnover in a year in the cash segment. The average trade size also was the lowest, indicating that it is mostly smaller investors who are holding the fort in the market.

The greed obviously is still dominating sentiment. The persistently lower volatility suggest that the global events have not deterred the domestic investors as yet.

It is clear that the Indian markets are in no hurry to follow China.