Vijay Kumar Gaba

Continuing from yesterday (Farm Sector Reforms)

Before commenting on the three specific agriculture sector reform related bills passed by the Parliament recently, three points need to made clear:

A.    The farm sector in India is in dire need to major reforms. These reforms are not only critical for the farm sector alone, but for the overall economic growth of the country. The solution to most macro economic problems, e.g., large scale unemployment, dwindling household savings, volatile food inflation (and therefore unpredictability of inflation and interest rate trajectory); fiscal discipline of the governments etc would come through these reforms only.

B.    The recent legislative changes are intended to address only two small pieces of the entire rural sector puzzle. Land reforms and social reforms are perhaps the two bigger pieces.

C.    The new legislations do not seek to change the status quo materially as most the procedures and systems provided in the new legislations are already in practice in most of the states for past sometime. The systems like eNAM, routing of payment through government agencies, have made some positive difference for farmers. But these improvements are mostly insignificant for a large majority of farmers who fall in small and marginal category.

Now coming to the first piece of legislation, i.e. The Farmers' Produce Trade and Commerce (Promotion and Facilitation) Bill, 2020.

This legislation basically provides for three things:

1.    Farmers can sell their produce to any person having a valid Permanent Account Number (PAN) in the territory of India.

2.    Any person (other than individual), including Farmer Producer Organization (FPO) and Agriculture Cooperative Society, may establish and operate an electronic trading and transaction platform for facilitating trade and commerce of scheduled farmers’ produce in any area outside the State APMC infrastructure.

3.    The resolution mechanism for disputes arising from the trade in farm produce outside the State APMC framework. In the two tier resolution mechanism, the first step would be conciliation (arbitration) at a panel constituted by SDM of the area. The second step would an Appeal to Appellate Authority (Collector). No civil court would have the jurisdiction over disputes relating to the trade specified under this law.

To understand the implications of this law, it is pertinent to understand the existing system of trade and commerce in the country. Especially the following points are noteworthy.

• Agriculture and trade & commerce in farm produce is a state subject as per the constitution. The states have power to frame laws, rules and regulations for trade & commerce in farm produce. Most states have enacted laws to constitute Agriculture Produce Marketing Committees (APMC) in their respective jurisdictions. These APMCs appoint authorized commission agents ((Adhatiya) and provide market infrastructure to farmers and traders. The trade is facilitated by the commission agent for a fee. APMC also charge fee on each trade executed within their infrastructure. The total cost of trade varies from state to state is usually between 5-9% of the trade value. The cost is usually born by the buyer. In case of inter-state trade, at many places both states involved charge the APMC fee.

• The commission agents usually act as de facto guarantor for counter party default. They pay the farmers even in cases the counter party defaults on payment. The commission agents also provide working capital credit to both the farmer and the trader. This credit may be at a cost or interest free.

• In 2003 the central government had proposed a model law to reform the APMC system. The States were requested to enact laws in their respective jurisdictions to allow private trade and commerce (outside the APMC infrastructure) and establishment of electronic platforms. More than 20 States and Union Territories have already adopted at some part of the model law. For example, UP, Bihar and Delhi allowed establishment of trade areas outside APMC many years ago. In UP, the wheat procurement is mostly through government agencies only. The payments are now done through direct cash transfer to farmers' account and payment comes within 3-7 days.

• The disputes relating to payments are now minimum. Since either the commission agent or the government agencies act as effective counter party for farmers.

• MSP of farm produce should acts as the base price for farmers. The market price should be closer to MSP. But in practice it is usually not the case. The small and marginal farmers (who constitute majority of the total number of farmers) who are located at a distant from the designated APMC or other market place cannot afford to transport their produce to the market place. The aggregator comes to them and buys their produce. In such cases the price offered to these farmers is much lower than MSP. For example, the wheat MSP last year was Rs.1925/quintal. But the price realization for most small and marginal farmers was Rs1600-1650 only.

Now assuming that the new system is implemented fully and private market place for farm produce develops, the following changes would be experienced.

• APMCs, though legally allowed to co-exist may eventually become unviable. The large farmers and traders may use the services of private markets places, electronic platforms, and direct selling. APMCs may therefore lose large chunk of their revenue.

• The farmers may have to make alternative arrangement for working capital financing, which was so far available through commission agents.

• The implicit settlement guarantee of commission agent or government agencies may not be available under the new system. The disputes may rise. The resolution system available under the new law would entail inconvenience, delay and cost for farmers.

• MSP may stop functioning as effective base price in the new system. The price volatility may rise materially, both in case of bumper and deficient crops.

• Marginalization of APMC in due course will make the farmers dependent upon large traders and consumers. We must therefore evaluate this law together with the other two laws to determine the full impact.

  ...to continue tomorrow

Last week, the Parliament passed three important piece of legislation with stated objective to reform and liberalize the production, trade, and pricing of agriculture produce in the country.

The Farmers' Produce Trade and Commerce (Promotion and Facilitation) Bill

This law purports to allow farmers the freedom to sell their produce outside the regulated Mandi (APMC) framework. The idea seems to be enable development of a new ecosystem where farmers and traders would enjoy freedom of choice in sale and purchase of agri-produce; and the control of state over trade in agriculture produce would reduce to minimum.

It is important to note that this reform was initiated in 2003 with introduction of Model Act. Many states and union territories have already de regulated marketing of fruits and vegetable, trading on electronic platforms like e-NAM, setting up of agri produce markets (Mandis) in private sector, direct marketing of agri produce etc. The reason behind this new law therefore could be lack of adequate response to model law on part of many state governments.

The Farmers' (Empowerment and Protection) Agreement on Price Assurance and Farm Services Bill, 2020

This law aims to permit farmers to enter into supply contracts with large buyers. These contracts could be exclusive and long term and provide more predictability to income of farmers and help them plan better in terms of adopting better technology and inputs.

This bill effectively facilitates large scale contract farming, whereby large corporate consumers can engage farmers to exclusively produce for them as per given specification and at pre determined price. The bill provides for pegging of prices to the Mandi prices. The famers adopting this arrangement may not avail the protection of minimum support prices as they would be bound by the terms of the contract. All such contracts are proposed to have civil jurisdiction and breach of contract shall have no criminal implications.

Essential Commodities (Amendment) Bill 2020

This bill essentially allows large business consumers to maintain stock of agriculture commodities, purportedly to meet the objective of price stabilization. This may also help in building post harvest infrastructure like warehouses and cold storages etc.

The opinion about the long term implications of these bills is vertically divided.

The supporters of the proposed regime believe that these changes would bring transformative changes to the agriculture and food processing sectors in India. The noted agriculture economist Ashok Gulati, equated these proposals to the industrial reforms and liberalization in early 1990s. It is argued that removing the shackles of state controls and allowing private businesses and farmers to collaborate will lead to significant acceleration in development of farm sector in India, and aid sustainable and faster overall economic growth of the country.

The people and organizations opposing the legislative changes believe that the proposed laws are ill conceived and are being enforced without adequate consultation with the stakeholders. In their view, many of these provisions are already present on the statute book and have not brought any meaningful change to the farmers' conditions in past decade.

It is also argued that these changes will bring back the pre independence colonial model in the Indian agriculture, where the large corporates will decide the crop and prices. The farmers will continue to be exploited; and the shield of MSP will also be removed.

In my view, the intent behind the proposed legislations is good. The farm sector in India definitely needs urgent and transformative reforms. But for reforms to have the desired impact, these needs to be comprehensive and holistic, not selective as proposed....to continue

US Federal Reserve Chairman Jerome Powell tried to set many speculations aside in his statement post the recent meeting of the Federal Open Market Committee (FOMC), Powell made the following three things very clear:

1.    US Fed policy Bank Rates, and therefore general rate environment, shall stay low till at least 2023.

2.    There is no threat of material rise in inflation in near term, and 2% inflation target shall remain valid till 2023. Even a temporary violation of 2% inflation target before 2023 shall not impact the decision to keep rates near zero till 2023.

This is in sharp contrast to the forecasts made by many global strategists, economists and fund managers, who believe that inflation could become a serious problem in 2021-22. In fact Powell expressed his concerns about the disinflationary pressures persisting.

3.    The job market is expected to improve and below trend unemployment rate of 4% shall be achieved by 2023.

The Federal Reserve however refrained from announcing any additional liquidity enhancement measures, including increasing the bond buying.

The consensus is reading the Federal Reserve's latest policy statement to mean that (a)   USD weakness may persist for some more time at least; (b) The market may continue to drive the Federal Reserve's action insofar as the monetary support (bond or stock buying etc) is concerned; (c) Powell backstop is there but may not be as strong as Draghi backstop.

This long term guidance by Fed must comfort markets and fuel the risk appetite of market participants. I would not like to read too much into the sell-off in markets post the Powell comments. It might be due to unwinding of the positions taken specifically for this event. No announcement related to enhancing Fed's asset purchase program may have disappointed many who were expecting Powell to announce this. But this is most likely a knee jerk reaction.

In this context, the recent statement of RBI Governor Shaktikanta Das is pertinent to note. Addressing to the National Executive Committee of FICCI, Das emphasized as follows:

"On the back of large policy stimulus and indications of the hesitant economic recovery, global financial markets have turned upbeat. Equity markets in both advanced and emerging market economies have bounced back, scaling new peaks after the ‘COVID crash’ in February-March. Bond yields have hardened in advanced economies on improvement in risk appetite, fuelling shift in investor’s preferences towards riskier assets. Portfolio flows to EMEs have resumed, and this has pushed up EME currencies, aided also by the US dollar’s weakness following the Fed’s recent communication on pursuing an average inflation target. Gold prices moderated after reaching an all-time high in the first week of August 2020 on prospects of economic recovery.

Financial market conditions in India have eased significantly across segments in response to the frontloaded cuts in the policy repo rate and large system-wide as well as targeted infusion of liquidity by the RBI. Despite substantial increase in the borrowing programme of the Government, persistently large surplus liquidity conditions have ensured non-disruptive mobilisation of resources at the lowest borrowing costs in a decade. In August 2020, the yield on 10-year G-sec benchmark surged by 35 basis points amidst concerns over inflation and further increase in supply of government papers. Following the RBI’s announcement of special open market operations (OMOs) and other measures to restore orderly functioning of the G-sec market, bond yields have softened and traded in a narrow range in September."

The governor was very guarded in his outlook for the economy. he stated, "high frequency indicators of agricultural activity, the purchasing managing index (PMI) for manufacturing and private estimates for unemployment point to some stabilisation of economic activity in Q2, while contractions in several sectors are also easing. The recovery is, however, not yet fully entrenched and moreover, in some sectors, upticks in June and July appear to be levelling off. By all indications, the recovery is likely to be gradual as efforts towards reopening of the economy are confronted with rising infections. (emphasis supplied)

Obviously, the incumbent governor does not concur with one of his predecessors Dr. C. Rangrajan who appears quite buoyant about the economic recovery in India.

What does it mean for Indian investors?

• Unless there is a Lehman type moment in global markets, the Indian equities may continue to remain supported.

• Precious metal trade should take a hit.

• The bond yields may remain stable, and RBI may maintain yields around current levels even if the food inflation shoots up in next couple of months.

• MPC may maintain status quo on policy rates in its next meeting, while continuing to maintain accommodative stance.

• Economic growth and therefore corporate earnings may not see a sharp recovery even in FY22.

In recent days the following three global trends have evoked much interest amongst market participants:

1.    The production, consumption and import of commodities in China have increased materially.

2.    The USD weakness is persisting. The China letting CNY appreciate against USD is noteworthy.

3.    BP in its yearly outlook virtually declared "peak oil" demand, stating that the oil demand growth may not be seen through 2050.

These three trends are important in my view as these could materially influence the markets in short term.

For past two decades, China has been a major driver of the commodities' demand and hence prices in the global market. The slowdown in Chinese economy in past 5years has led to correction in commodity prices, impacting a large number of commodity driven economies like Australia, Canada, OPEC countries, Brazil etc. This is cited as one of the reasons of sustained deflationary pressure on US, Japan and EU economies. The central bankers in these economies have been able to unabashedly print money to support their fiscal profligacy as the inflation has not been a concern.

As per the latest reports that trend might be about to change. As per a recent ING Bank research report, "Domestic demand is driving China's economic growth. Retail sales returned to positive growth. And new-infra and traditional infrastructure investments increased, which matched the growth in these items in industrial production. But external circulation may remain a challenge to growth." The reports further highlights that "China’s new-infra plan and traditional infrastructure projects in transportation have led overall investment spending. Fixed asset investment (FAI) shrank only -0.3%YoY YTD in August from - 1.6%YoY YTD in July. The "computer, telecommunication" category, which represents new-infra investment plans, grew 11.7%YoY YTD, which results in part from China’s push towards self-reliance in technology. Rail transportation investment also grew 6.4%YoY YTD.

These growth numbers are high compared to the headline growth rates, which means these are the engine of investment growth in China currently."

The Chinese monetary authorities recently allowed CNY to appreciate below 6.8/USD level. This could be seen as a reconciliatory gesture by Chinese authorities to the global community. China has allowed CNY to weaken even above 7/USD level in the trade and currency war with USA and Japan. The international relations of China have worsened materially after the outbreak of COVID-19 pandemic. This reversal of CNY could be seen as first, though small, sign of China wilting under global pressure. This could be comforting news for the global markets.

British Petroleum's (BP) annual outlook fo energy market is respected world over. Last year, BP forecasted demand for fossil fuels could peak by 2030. However, in 2020 outlook, BP has made a major shift in its assessment. As per the energy major, peak demand for oil may have already happened. The report implies that global crude demand may never again surpasses 2019’s average of around 100 million B/D. A natural corollary to this is that that 2019 could also mark the peak of carbon emissions from energy use.

This may potentially change many things - global trade balance, sustainability investments, geopolitics, cost of doing manufacturing, etc. Arab world countries making conciliatory moves towards Israel may, for example, be just one of the effects of this. BP announcing major investment plans with RIL in renewable energy sector to support electric mobility is another.

The September 2020 Global Fund Managers' survey conducted by the Bank of America research team found that 58% of the global fund managers believe that global equities are now in a bull market. This percentage is materially higher than the 46% in August 2020. The proportion of fund manager who believe it to be a bear market rally has reduced in September 2020 to 29% from 35% in August 2020.

An overwhelming proportion of fund managers believe that "Long US Tech Stocks" is the most crowded trade. Though, the fund managers believing gold to be a crowded trade has reduced materially in September, as compared to August. "Short USD" trade is also seen gaining some popularity .

Continuing with the theme, JP Morgan Research (as quoted by Niels Jensen of Absolute Partners), finds that S&P500 is now pricing in almost 0% probability of a recession in US; while 5yr US Treasuries are pricing in almost 100% probability of a recession.

In his latest communication to investors, Niels warns that investors (and fund managers) may be flirting dangerously with TINA (There is No Alternative) in their chase for equities, especially US Tech Stocks. As per Niels, One of the most reliable predictors of long-term equity returns is the starting earnings multiple. When earnings multiples are in the low 20s, the best you can hope for over the next ten years is low single digit annual returns. As you can see, 10-year returns turn negative when the starting multiple is about 25 or higher.

Niels highlights that, as per Shiller's Cyclically Adjusted  P/E Ratio (CAPE), S&P500 trades at massive 32x earnings multiple, which means apocalypse may just around the corner and the investors must be running to the hills.

In a later post, I would like to evaluate where India stands in all this.