Vijay Kumar Gaba

Wednesday, November 6, 2019

RCEP - politics, geo politics and trade

India has reportedly decided not to join the Regional Comprehensive Economic Partnership (RCEP). The decision, as per the External affairs ministry’s secretary (East), Vijay Singh Thakur, reflects both the government’s assessment of current global situation and of the fairness and balance of the agreement.

The Regional Comprehensive Economic Partnership (RCEP) is a proposed free trade agreement (FTA) between the ten member states of the Association of Southeast Asian Nations (ASEAN) (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, Vietnam) and its FTA partners (China, Japan, South Korea, Australia and New Zealand).

The process of forming RCEP was initiated in the August 2011 ASEAN meeting. The formal negotiations were launched in 44th ASEAN summit in August 2012. Since then 27 rounds of negotiations between officials and three summits of the leaders of the proposed participants have taken place. In December 2014 on the sidelines of the 6th round of negotiations held in New Delhi, the Government of India had held an outreach event with their business community to educate them on the goals of RCEP, showing keenness to join the partnership.

Had India joined RCEP, it would have been the largest trade agreement in the global economy, involving over one third of world's GDP and more than half the world's population.

In his speech at the 3rd RCEP Summit, PM Modi said “The present form of the RCEP Agreement does not fully reflect the basic spirit and the agreed guiding principles of RCEP”, adding that "India’s farmers, traders, professionals and industries have stakes in such decisions." Citing the economic principles of Gandhi Ji, the PM said, "When I measure the RCEP Agreement with respect to the interests of all Indians, I do not get a positive answer. Therefore, neither the Talisman of Gandhiji nor my own conscience permits me to join RCEP."

The present format of RCEP agreement, required India to abolish tariffs on 74% of goods from China, Australia and New Zealand, and 90% goods from Japan, South Korea and ASEAN.

Apparently, the decision to withdraw has been taken in the interest of India's poor, farmers and to give an advantage to India’s service sector, as the Indian negotiators felt that India may become a dumping ground for cheap Chinese goods, devastating millions of small and medium Indian enterprises, especially in the manufacturing sector.

As the things stand today, the RCEP agreement is likely to be finalized and signed in 2020. Chinese officials have been quoted as saying that India is welcome to join the RCEP later.

The right wing ideologues of the ruling BJP, like Swadeshi Jagran Manch, RSS etc have welcomed the decision. The principal opposition party the Indian national Congress (INC) has also welcomed the decision (though they claim that the government was forced by them to withdraw from RCEP). The reactions of the economists, business analysts and political observers have been rather ambivalent.

In my view the decision has to be viewed from the domestic politics, geo-political and economic angles.

The domestic political establishment was vertically divided on the issue of joining WTO in 1995. There were widespread farmers' protests and even violent demonstrations. Regardless, the minority government led by PVN Rao took the decision to become full member of WTO. There is little evidence to indicate that Indian agriculture, manufacturing and trade would have performed better had India not joined WTO in 1995 full member.

Geo politically, the decision to withdraw from RCEP might be viewed as India siding with the USA in Sino-US trade conflict.

Tuesday, November 5, 2019

Keep the wheels of economy in motion

In one of his recent interview, Brian Coulton, the Chief Economist at Fitch Ratings, emphasized that the persisting credit squeeze in the Indian economy may hurt the economic growth much more than the present estimates. Brian cautioned that the GDP growth in FY20 could slip to 5.5%, much below the current RBI and government estimates of 6%+ growth.

For records, the Indian economy grew at the rate of 5% in the first quarter (April to June 2019) of the current fiscal year, the slowest in more than 6 years. The slowdown was visible in all sectors of the economy including agriculture, manufacturing and services. Within services, the growth in finance, insurance and real estate sectors was cited as particularly worrisome, as it highlighted poor credit conditions.

Besides, the credit availability, the high cost of credit is cited as one of the constricted factors. Despite 135bps cut in policy rates in the year 2019, the real rates are found to be still elevated, constraining the growth.

The GST collections for the month of September have reported at Rs 95,380cr a year-on-year decline of 5 percent and 3 percent lower than the monthly average of Rs 98,114 crore for FY19. The GST collections in FY20 have been consistently below the budget estimates. Juxtaposed to the shortfall in income tax collection, it does not augur well for the fiscal balance. The scope for the fiscal stimulus as widely anticipated by the market participants appears very limited. In fact, the government may actually be forced to increase the effective taxation for the affluent section of the society in the forthcoming budget.

Reportedly, housing sales declined 9.5 percent during July-September period across nine major cities to 52,855 units on low demand as economic slowdown and liquidity crisis weighed on buyer sentiment. As per the PropEquity data quoted by Bloomberg, Chennai saw the maximum fall of 25 percent in housing sales at 3,060 units during July-September 2019 as against 4,080 units in the year-ago period. Housing sales dropped 22 per cent in Mumbai to 5,063 units from 6,491 units, followed by Hyderabad that saw 16 per cent decline to 4,257 units from 5,067 units.

Notwithstanding some encouraging sound bites from the corporate leaders this Diwali, the recently released data on core sector growth belies the optimism. The growth in India’s core sector output contracted 5.2% in September 2019, its worst performance since 2005. All sectors in the core index, with the exception of fertilisers, posted a contraction. The data indicates the economy may have slipped further in the 2QFY20, confirming the fear of rating agencies and economists. As per some estimates the GDP growth rate for 2QFY20 could be closer to 4% rather than 6% as widely anticipated.

Two short points I would like to make here are as follows:

The growth slowdown is real, persistent and widespread. A part of this is certainly cyclical, but treating the entire thing as such may be misleading. The structural part of the downward shift in growth curve needs to be acknowledged, identified and treated separately.
The adhoc stimulus must be directed at boosting both consumption as well as investment demand. The measures like corporate tax rate restructuring, and ease of doing business shall have impact only in due course; and for these measure to have any impact the wheels of the economy must be kept in motion.

Friday, November 1, 2019

Keenly watching the Quality vs value debate

Presently, the collective wisdom in Indian stock market appears divided at least on two issues over the consideration of appropriate equity investment strategy.

The first point of division is over the sustainability of the stock markets at the present levels.

A smaller but influential segment, which primarily includes economists, development bankers and strategists, believes that the macro conditions in Indian economy may not improve materially from the current level at least till FY21. The political and fiscal constraints shall limit the government's ability to stimulate the economy through fiscal incentives and material increase in infrastructure investments. The private investment may not see any significant improvement in the absence of large scale new employment opportunities; occurrence of which looks improbable unless radical reforms in labor and land laws are executed earnestly and immediately. Regardless of the initiation of the resolution process for many large struggling businesses in the core sectors (power, roads, cement, steel, mining etc), the financial stress remains elevated and is percolating to other sectors and households. Under these circumstances expecting any material improvement in corporate earnings would be unreasonable. The recent performance of the Indian equities which is mostly based on PER re-rating may not be sustainable and a correction may set in 2020 itself.

The larger segment, comprising of asset managers, analysts, large investors, and intermediaries, believes that the measures already initiated by the government, e.g., GST, IBC, RERA, corporate tax rate restructuring, etc. shall result in marked improvement in the macro as well as micro environment. Initiatives to encourage foreign investment in manufacturing and the government's thrust on building massive infrastructure shall generate large number of employment and demand for private investment as well consumption. Lower interest rates shall ease the financial stress; and resolution of stressed cases shall bring many valuable idle assets back into the business. This group is quite optimistic about the opportunity being provided by the Sino-US trade conflict, assuming that India shall be able to attract many western conglomerates that may be looking to relocate from China to other friendly jurisdictions. The corporate earnings therefore should see a steady rise from the present levels and may grow upwards of 20% in FY21.

The second and more intensely debated point of disagreement is about the choice between the large cap stocks (quality) vs the mid cap (value & growth) stocks. The debating parties here are mostly analysts and fund managers. The market appears vertically divided on this issue. The number of people arguing from both the sides is almost equal.

The group favoring stocks with expensive valuations but higher visibility of earnings growth, sustainability, quality of balance sheet and product and technology leadership argues that the present strength of these companies shall automatically enable these companies to dominate the market in the future helping these to attain higher and faster growth trajectory. The apparently expensive current valuations are therefore totally justifiable and should not be a matter of concern for the investors.

The other group however finds a bubble in the large cap valuations, as most of these stocks have failed to deliver a growth commensurate with their valuations in past many years. In their view, the assumption of faster and higher growth trajectory therefore is mostly untenable and needs to be rejected. This group sees tremendous value and growth opportunities in the second tier companies which have delivered consistent results in challenging environment.

I am watching this debate keenly. However, so far I have not found any argument compelling enough to inspire a change in my investment strategy.