Vijay Kumar Gaba

Friday, September 8, 2017

Red flags - 4

Thought for the day

"I'm nobody, who are you?"

—Emily Dickinson (American, 1830-1886)

Word for the day

Serotinal (adj)

Pertaining to or occurring in late summer.

Malice towards none

Few of us would believe that Pakistan can mend its ways and become a responsible nation.

So, what you think is the meaning of all this censuring by global powers.

First random thought this morning

My personal assessment is that not more than a few million Indians out of 1.3billion would have heard about Gauri Lankesh before she was brutally killed. Still the country appears divided in condemning this cowardly act.

Unfortunately, the people apologizing for the killers are in overwhelming majority, while those strongly condemning it are mostly from her own fraternity. But this is not the point here.

My point is that 'We vs. They" syndrome that is dividing Indian society on almost every issue now a days could bring disaster of unfathomable proportions, if not tackled on priority basis.

Red flags - 4

India's balance of payment situation has seen marked improvement in past four years. Consequently, India's external sector resilience has improved materially since FY13. As at end of FY17, RBI's India External Sector Resilience Score stood at 1.89 from 1.54 as at end of FY13.

However, this score continues to be materially poorer than 3.68 recorded in September 2008, just before the Lehman Bros collapse triggered the global financial crisis. For example, the bottoming out of international prices of major commodities in 2016 have already eroded gains in India’s terms of trade vis-à-vis the preceding two years. Also, the current account is being negatively impacted by the lower order of net receipts from services and remittances as well as higher outgo on income payments during 2016-17.

In the RBI assessment,

"If terms of trade gains turn unfavourable in tandem with projected higher international commodity prices and the global demand conditions do not improve enough to support export volumes, CAD could increase due to a widening of the merchandise trade deficit. In fact, based on data for 1980-2016, it is estimated that a one per cent positive shock in terms of trade reduces India’s CAD by 0.03 per cent of GDP. Secondly, India’s software exports – a major source of fi nancing merchandise trade defi cit, face heightened uncertainty from protectionist policies being envisaged in advanced economies, especially with regard to H1B visa in the US, which may stress the current balance of payment (BoP). Thirdly, the short-term outlook for remittances fl ows to India largely depends on income conditions in source countries, especially the Gulf region which is facing low growth and undergoing fiscal consolidation, even though the assessment of the World Bank (2017) is more optimistic on this count. Finally, robust FDI infl ows which were at the forefront in fi nancing CAD in the previous three years, entail servicing through higher income payments which could have implications for CAD."

As per a recent UBS report, While external debt increased US$62bn between FY13-FY17, FX reserves rose US$78bn during the same period, indicating that external buffers are being created. FX reserves cover 78% of external debt as of FY17, up from 71% in FY13 but down from 138% as of FY08 (before the credit crisis). Import cover for reserves stood at 11 months as of FY17, much better than the 7 months in FY13 but still below the peak of 14.4 months in FY08.

Indubitably, the capital flows has been strong conditions for FDI flows have improved materially in recent years. Nonetheless, a reversal in loose monetary policies by the central bankers in advanced countries and consequent rise in bond yields could reverse some of portfolio flows.

The global oil markets have remained stable for many months. The consensus is now in favor of global crude oil prices stabilizing at levels above the current levels. A sharper spike though could impact India's current account materially.

Thursday, September 7, 2017

Red flags - 3

Thought for the day

"It is better to be the hammer than the anvil."

—Emily Dickinson (American, 1830-1886)

Word for the day

Bicameral (adj)

Government. Having two branches, chambers, or houses, as a legislative body.

Malice towards none

How long Hindi-Chini bhai bhai bonhomie will last after BRICS summit?

First random thought this morning

A recent report suggest that presently economic inequities in India are highest in almost in a century. The report also highlights that the economic inequalities reduced consistently between 1920-1980, with the share of top 1% population in total income falling from over 20% to 6%. From 1980 onwards the share of top 1% had again climbed to over 20% in 2014.

1977-1980 is a key period in Indian political history. This is the time when the hegemony of Congress party was first defeated by a coalition of motley opposition of right-center-left ideologies. Since then it had been a consistent struggle between Congress and others, until May 2014, when BJP won a decisive mandate. Corruption rose to perilous proportions in this period.

It would be interesting to see if BJP hegemony reverses this trend in rising inequalities by curbing corruption. In hindsight DeMo might come out to be the water shed in Indian economic history, success or failure either way.

Red flags - 3

Fiscal consolidation has been one of the remarkable effort of the government in past three years. Since FY14, the gross fiscal deficit of the central government has fallen from 4.5% to 3.2% of GDP (FY18BE).

The improvement in fiscal expenditure seems to have come entirely on account of cut in Revenue expenditure. The government revenue expenditure has fallen from 12.2% of GDP in FY14 to 10.9% in FY18BE.

There has been no change in net tax revenue (though gross tax revenue has increased from 10.1% in FY14 to 11.3% in FY18BE), non-tax revenue, and capital expenditure.

In my view, the fiscal improvement might have already peaked.

I feel, any further rise in incidence of tax could be seriously counterproductive for growth, especially private consumption growth. Incrementally the growth in tax revenue may moderate considerably as compared to past three years.

Similarly, the rate of government revenue expenditure curtailment may also have peaked. Going forward we may actually see some rise, given the forthcoming general elections.

Given that petroleum subsidies have been mostly rationalized and farm subsidies are getting rationalized fast, the incremental rate of subsidy reduction may also likely moderate.

Stagnant capital expenditure also does not augur well for any acceleration in growth, especially given that scope for any major spike in budgetary allocation for capital expenditure is limited. Compensation to states for GST, elections, lower incremental receipts from auction of spectrum etc. may also constraint the government capital expenditure.

In view of this it is difficult to expect any major increment in support for bullish market argument from fiscal side. For all, it may actually weaken a bit next year.

Also read the following:

Red flags - 1

Red flags - 2

Tuesday, September 5, 2017

Red flags - 2

Thought for the day

"Old age comes suddenly, and not gradually as is thought."

—Emily Dickinson (American, 1830-1886)

Word for the day

Narcotize (v)

To make dull. Stupefy

Malice towards none

When will our studio experts accept that predicting Modi's actions is not their domain!

First random thought this morning

In fact, I do not find anything worth bothering, losing sleep or being elated about the recent cabinet reshuffle. But there is so much of analysis and commentary over it that I almost feel compelled to have a publically stated view on it. So here it is:

I find the portfolio allocation inappropriate. For example, Coal is perhaps the largest customer of railway. Same person holding both the portfolio is a clear conflict of interest. Similarly, energy is a key sector for growth, and neither we have an integrated ministry, nor a full time minister for Petroleum & gas, coal or renewables.

Red flags - 2

One of the primary arguments in favor of underlying strength and resilience of Indian economy is the structural change in inflation trajectory.

The most popular argument is that in past decade or so, the supply side constraints that historically hindered the growth cycles of Indian economy have mostly dissipated.

In most of the previous growth cycles, the rising demand was almost immediately met by high inflation (due to supply constrained) and therefore higher rates. The growth cycles were thus curtailed to 3-4yrs in most cases. The popular argument is that huge capacity addition in past decade or so has obliterated this phenomenon structurally. Large capacities built in core sectors like cement, steel, power, roads, refining, etc., which mostly lie unutilized presently, shall make sure that inflation and therefore higher rates, do not kick in early in the growth cycle; and therefore the next cycle could be longer, steeper and more resilient.

By this popular argument, the prevalent high real rates are not justified and should ease materially - leading to a sustained demand growth cycle over next many years.

To me, broadly the argument sounds valid, but not very exciting; that is If we factor in other structural and cyclical changes also. For example consider the following—

(a) The benefits of capacity addition in manufacturing might get materially neutralized by some structural adjustments in the cost structure of the producers. Rise in cost of compliance, labor, natural resources, etc. may add materially to the pricing pressures.

(b) The efforts made by the global central bankers in past one decade to ease disinflationary pressure seems to have begun yielding results. The inflation thus created shall be imported into India, especially if lower rates force depreciation of currency.

(c) Capacity addition in agriculture is still quite inadequate. Rising urban wage structure and farm subsidy rationalization shall also eventually reflect in farm prices. Volatility apart, we may see a structural upmove in farm produce prices.....to continue tomorrow.

Friday, September 1, 2017

Red flags - 1

Thought for the day

"It is my ambition to say in ten sentences what others say in a whole book."

—Friedrich Nietzsche (German, 1844-1900)

Word for the day

Lineament (n)

A feature or detail of a face, body, or figure, considered with respect to its outline or contour, e.g., His fine lineaments made him the very image of his father.

Malice towards none

FM is absolutely right in saying that the people do not understand the objective of Demonetization.

By the way I forgot, what was that objective?

First random thought this morning

Albert Einstein once famously said, "A person who never made a mistake never tried anything new". Napoleon Bonaparte cautioned, "Never interrupt your enemy when he is making a mistake." And Bapu said, "A full and candid admission of one's mistakes should make proof against its repetition."

I am sure the incumbent government has tried many new things and made some mistakes. The opposition has repeatedly interrupted the government when making mistakes. The government has not admitted to any of its mistakes, and therefore it's ok to expect a repetition.

Red flags - 1

The recently issued Annual Report of RBI, succinctly sums up the macro conditions of the country:

"In the midst of global slowdown accentuated by the vicissitudes of financial markets and the transient impact of demonetisation, the Indian economy turned out resilient, marked by both internal and external stability. While economic growth moderated in 2016-17, there were visible signs of improvement in macroeconomic fundamentals – low inflation, and modest current account deficit and fiscal deficit. Going forward, even as the recent launch of the Goods and Services Tax (GST) gains traction across the country, strengthening fiscal consolidation, particularly at the sub-national level; reviving bank credit, and bringing investment back on rails, remain a challenge."

There are simply too many red flags to be ignored.

First, in my view, proving the resilience of the Indian economy against the global economy, by arguing that we are still growing faster than others has little meaning.

In my view, if the world was an airport, the Indian economy is presently on the runway, taking off. Other economies which are resting at their respective bays, waiting for their turn to takeoff, or taxing towards the runway can afford to stop, slowdown or modulate their speed. But our economy having started to takeoff has only one legitimate option - to accelerate. Any push on the brake pedal at this stage would put the passengers (Indian citizens) in grave danger.

Secondly, the resilience of the economy has to be tested in the context that Indian economy has not seen any contraction since FY80. In these 37yrs we have seen it all - extreme political uncertainty, near default, extreme inflation and interest rates, severe droughts, two Iraq wars and consequent spurt in energy prices, war at Kargil, multitude of scams, at least three major financial market collapses (1992, 2000, 2008), years of insurgency in Punjab, J&K, North East, Central India, two very popular prime ministers brutally killed, extreme controls (FERA, CCI, MRTP) to liberalization, transition from CCI to SEBI and free pricing of IPOs, VAT, LERMS, FEMA, shift from MRTP to CCI, transition to WTO, and many other such events.

The resilience in Indian context therefore has to be tested on the parameter that whether we can grow higher even if there is a temporary disruption or global economy is not supportive.

Thirdly, the whole construct of Indian economy growing at the fastest pace and being resilient seems to be building mainly around five key premise - (a) Lower inflation; (b) strict fiscal discipline; (c) improving current account deficit; (d) reforms like GST, RERA, Bankruptcy Code, Financial Inclusion, digitization, etc.; and (e) political stability.

I would like to share my thoughts on these issues with the readers.

....to continue next week.

Wednesday, August 30, 2017

...and the macro data

Thought for the day

"That which does not kill us makes us stronger."

—Friedrich Nietzsche (German, 1844-1900)

Word for the day

Ruth (n)

Pity or compassion

Malice towards none

Dhirendra Brahmachari

Chandraswami

....

Asaram

Gurmeet Ram Rahim!

First random thought this morning

In past seven decades there have been numerous cases of impropriety, criminality and immorality by the people in religious robes enjoying immense trust of people, common and elite.

Why then is it so that each such instance is managed separately and not as a trend?

Handling this malaise as a trend, would mean taking preventive steps including regular surveillance over security and financial compliance matters.

...and the macro data

The earning season for 1QFY18 is almost over. The consensus is that the outcome has not been encouraging from whatever point you view it.

As per the Morgan Stanley's recent note in the quarter for the broad market (2629 companies) the net profit fell 11% YoY and EBITDA margins contracted 194bp YoY. The aggregate revenue grew by 9% YoY, mostly led by the commodity linked sectors (energy, materials and utilities) and industrials. For Sensex companies revenue and net profit growth of 5% YoY and -6% YoY, respectively. EBITDA margin contracted by 177bp YoY.

As per the report margin compression was conspicuous across sectors with healthcare and consumer discretionary leading the charge. The 11% fall in profit was led by telecoms and consumer discretionary.

The report finds that Financials, Utilities, Technology and Telecoms sector companies did not report impact of GST on their earnings either in their earnings release or the management commentary. Companies in the materials, consumer discretionary and consumer staple sectors reported impact due to channel destocking and dealer incentivization.

As per the consensus estimates, presently the market seems to be expecting 11% profit growth for the full year FY18 (Sensex FY18 EPS of Rs1600 vs 1448 in FY17) and a CAGR of 15% over FY17-FY19 (Sensex FY19 EPS of rs1928 vs. 1448 of FY17).

The data available so far for 2QFY18 is not encouraging either. Which means, the earnings estimates may see further downgrades.

For example, as per the latest Economic Indicator Update of Goldman Sachs, the preliminary July reading of their India Current Activity Indicator (CAI) suggests that growth moderated further to 6.8% qoq ann. from 8.5% in June, suggesting a deceleration in activity (GS India CAI is calculated on a 3month/3month annualized basis).

As per the update, most of the indicators such as two-wheeler sales, car sales, power demand, manufacturing and services PMIs and commercial vehicle sales witnessed slower growth in the three months to July compared to June.

Rural economy indicators like agriculture loans, tractor sales and agriculture exports remained laggards. GS's separate urban and rural economy CAIs indicate that the urban economy grew by 7.5% qoq ann. from 8.3% in June, while rural economic growth fell sharply to 5.1% qoq ann. vs. 9.5% in June. Excluding strong two-wheeler sales most other rural indicators continue to register tepid growth of 4%-5%.

Credit growth continues to remain weak led by subdued credit demand conditions.

The slowdown in economic activity has come on the back of inflation and INR/USD bottoming, and tightening of monetary policy easing corridor.

The markets have overlooked tepid earnings growth due to stronger macro outlook. The point is whether markets are prepared for a macro shock!

Also read Beyond macro data

Tuesday, August 29, 2017

Beyond macro data

Thought for the day

"The lie is a condition of life."

—Friedrich Nietzsche (German, 1844-1900)

Word for the day

Verisimilar (adj)

Having the appearance of truth; likely; probable, e.g., a verisimilar tale.

Malice towards none

BJP lost in Bawana bypoll in Delhi.

Narendra Modi should resign, as he has lost mandate of people.

#AAPSpokesperson

First random thought this morning

As per NSSO survey on housing conditions, the majority of India's population, both rural and urban, may be living in homes with space smaller than the minimum floor area per person recommended for prison cells. Juxtapose this finding to other popular data points, viz., a large number of people still do not have access to toilet, primary health, and poor work conditions and may be living on Rs32/day income.

What you may get that is that Jail, for many of the poor in India might not be an unfamiliar or totally unwanted territory. #RightToLiberty

Beyond macro data

Investors' life in India is much simpler than their western counterpart. There are only 100 odd companies (mostly consumers - staple, discretionary and financing) that have consistently created wealth for their shareholder in past three decades. Then there are 100 odd cyclical businesses (mostly commodities) which have given decent return, if bought and sold between business cycles. Rest all has been mostly a typical Bollywood masala film.

A close study of the investment strategies followed by most successful fund managers shows that almost all of them have kept their life simple by not patronizing Bollywood masala films.

Though some occasionally successful, and not so reputable, fund manager do claim to have consistently discovered new gems (multibaggers in common market parlance) and made exponential returns for investors, very little data is available to verify their claims.

The question that is bothering my mind since past few months is why do we in India need the equity research as so highly ranked and paid profession!

The genesis of this question is the disconnect I am witnessing in the analysts projection of India growth story and the picture I am seeing while travelling through the hinterlands of the country.

Most of the equity research and strategy published in past six months broadly appears optimistic on Indian equities over next couple of years. But unfortunately, I do not see their optimism being shared by a vast majority of the populace.

Wherever I go there is an environment of despondency. Farmers, students, laborers, traders, manufacturers, industrialist, bankers, workers (including government workers), teachers, man, women, youth, old, rich poor - all appear complaining, unhappy about whatever they doing presently, and uncertain about their future.

I grant that some of this despondency may be emanating from the disruption due to regulatory changes having long term positive implications and therefore be very subjective and unsustainable. Some of this could also be attributed to the negative campaign of the dispirited opposition parties and section of media sympathetic to them.

However, that still does not take away my doubts. For once, I see the society divided and disillusioned like never before. The narrative is overwhelmingly "we vs. they". Everyone (class, caste, religion, region) appears to be at conflict with others.

Everyone is non-compliant and must be punished seems to have become the guiding principle of the administration, at all levels.

Lack of direction, poor motivation and incompetence of the machinery responsible for executing the Prime Ministers' grand vision of New India is conspicuous and alarming.

This situation does not augur well for the sustainable economic growth of India, at least in next couple of years. Though markets may do whatever they have to.

Thursday, August 24, 2017

Light in the darkness

Thought for the day

"It is not a lack of love, but a lack of friendship that makes unhappy marriages."

—Friedrich Nietzsche (German, 1844-1900)

Word for the day

Comstockery (n)

Overzealous moral censorship of the fine arts and literature, often mistaking outspokenly honest works for salacious ones

Malice towards none

How Sikka's resignation from Infy is different from Mayawati's resignation from Rajya Sabha?

First random thought this morning

#TripleTalaq reactions

Amit Shah: 50% of Muslim votes are in my pocket!!

NiKu: Thanks god! I escaped the "Secular Ghatbandhan" just in time.

RaGa: Papa why did you do Shah Bano?

MSY: TTT was never an issue. लडकन ते गलती हो जात है|

Lalu & Yetchury : Secularism is in grave danger.

Light in the darkness

Yesterday, I briefly highlighted some of the weaknesses of our judicial system (see here). Though it should be a matter of worry for every righteous citizen, my immediate concern is implication for my investment strategy.

Considering the following trends, I believe that investors need to inbuilt litigation as important factor in their investment strategy.

(a) The businesses in India are entering the regulatory net at an accelerated pace. In next decade, there will be only a few unregulated businesses left, in my view.

In the transitory stage, it is common to have increased litigation, as both the regulator and the businesses adjust to the new regime. We have seen this in cases of TRAI and CCI, for example. In transition, RERA, GAAR, GST etc. will certainly lead to higher litigation.

While companies need to reform their business strategies to adopt to the regulated regime, investors would need to assimilate the impact of litigation in their strategies.

So far we have seen only extreme panic reactions from traders and investors in case a regulatory action is initiated on a company or group of companies. In my view, investors may need to learn to accept litigation and regulatory actions as a business routine rather than as a stigma.

(b) The compliance cost of businesses shall certainly rise materially. The businesses that have the benefit of administrative patronage due to historical or political reasons may suffer worst in this case.

(c) In past, the investor participation in corporate affairs had been minimal in India. With rise in investors' awareness, market participation, institutionalization of holdings, and evolution of strong investor advisory framework, investors participation in corporate affairs shall rise materially in coming years.

This shall certainly help in raising the level of corporate governance from the present standards.

Some good businesses which have historically traded at significant discount to peers, because of poor perception about their corporate governance standards, could benefit from this trend, in my view.

These business under pressure from investors' representatives (institutions, money managers, proxy advisors etc.) shall be forced to amend their ways, hence increasing the returns for investors and rerating of their stocks. We have already seen some such cases in the market.

(d) An easier route to bankruptcy and removal of socio-religious stigma out of financial defaults, may materially change borrower-lender dynamics in the country. Present valuations and business models of many retail banks and NBFCs may not be factoring this change in dynamics. Investors may need to be cautious about this. ...More on this later.