Vijay Kumar Gaba

 It was a sunny afternoon in winters of 1991. I was enjoying coffee at a famous public café in Connaught Place (New Delhi) with couple of my friends. All of us were waiting for our CA Final result, which was to be announced in couple of weeks. My friends were senior to me and were already working, having completed their articleship two years ago. We were discussing the economic changes that were getting unleashed in the country by the new regime that had assumed office a few months ago.

The economic changes had not impacted me in any positive manner by then. INR devaluation had led to inflation spike disturbing our household budget. Some of my close relatives who were running micro and small industries (then called SSI) were deeply worried about sustainability of their business as they were now exposed to competition from larger businesses and imports. My cousins had their own set of worries. The implementation of Mandal Commission recommendation was reaffirmed. The competition to get government jobs and admission into public educational institutions had intensified for general category candidates. The aftershocks of former Prime Minister Rajiv Gandhi’s brutal killing, gulf war, Punjab terrorism, were still being felt in Delhi. Overall things were not looking great from where I was standing that afternoon.

My friends who had started investing in stocks were however in high spirits. They had earned very good profits by trading. Their employers had promised them promotions if they pass their final exams. They already had a new Idol in (now infamous) Harshad Mehta to look up to. That afternoon, they could not see anything wrong. Arguably, this was their best time in life.

Our discussion was obviously not harmonious.

About an hour later, a middle aged man with very ordinary personality entered the scene. Tarun, my friend, excitedly jumped out of his seat to greet him. “Meet Mr. Hemant Pandey, my stock broker. Hemant ji advices me and also helps in executing my trades at Delhi Stock Exchange. He also knows brokers who can execute trade at BSE”, he proudly introduced the man to us.

And here begins the story.

On enquiry, I found that Hemant, a college dropout, was an “authorized agent” of a “sub-broker” of DSE broker. A friend of his friend was a remisier (a person authorized to go on trading floor) of a broker at BSE. He was therefore able to place orders of his “clients” to brokers at DSE and BSE. Though it could usually take upto 4 days to execute a trade and get confirmation of trade. The brokerage charged ranged between 2% to 5%; and only “market price” orders were acceptable. Delivery of physical share certificates with a valid transfer deed was not guaranteed. It was mostly on “best effort” basis.

That was the situation of Indian financial markets when the liberalization started 30years ago. Having direct access to a stock brokers’ office was sufficient to make someone “important” in his/her social circle. Something similar to if you have direct access to a Minister’s office today.

The people in their 20’s and 30’s who are spammed daily by multiple brokerages to open a trading account at zero brokerage, would never be able to fathom what it was like to be a stock trader or a “retail investor” in pre 1994 days.

Democratization of financial market is one of the most understated reforms of past three decades. The impact of democratization of society in past three decades is visible in almost every sphere. People belonging to the bottom of the pyramid have done particularly well in politics, administration, sports, entertainment, business & professions and science.

However, the easy and free access to financial and banking services has been the most remarkable achievement. Financial inclusion, as we call it popularly, is one of the core pillars of the entire socio-economic development endeavor in past three decades. Technology (especially digitalization) and Telecom Infrastructure are two other strong pillars which have supported the financial inclusion as well.

The tendency to overregulate is one of the undesirable aspects of modern democracy, as it promotes chaos, rebellion and anarchy. Since, the global financial crisis we have witnessed this tendency to overregulate dominating the financial markets also. As a natural corollary, the chaos (heightened volatility), anarchy (unassimilated assets trading at unfathomable valuations) and rebellion (rejection of conventional wisdom in favor of untested experimental ideas) is also prominently visible in markets. May be time is approaching fast when the democratization of financial markets that started three decades ago would also need an affirmative agenda for renewal.

Like Robinhood Markets of US, which pioneered commission-free investing model which allowed many people to start investing, including those who otherwise would never have ventured into stock markets, many platforms have emerged in India also. Zerodha, for example, is now the largest stock trading platform in India in terms of number of clients.

There are multiple platforms for trading of unconventional financial products like cryptocurrencies (e.g., Bitcoin) and Non-fungible tokens (NFTs).

Advent of new technologies, new products, new set of investors, new methods of valuations and different risk profiles perhaps require a fresh approach to the financial markets regulatory framework.

So far the regulators and governments have adopted an incremental approach for regulating the emerging developments in financial markets. This is apparently resulting in overregulation, misregulation, rebellion and chaos.

Margining and disclosure norms which are not in synch with the current market realities; abundant trading in unregulated (grey) markets; mushrooming of unregulated crypto & NFT exchanges and platforms; participation of large number of individual investors with inadequate financial literacy and risk tolerance etc. are some of the problems that are plaguing the markets.

Some of the problems that may require a totally new approach to regulations could be illustrated as follows:

·         Under pressure from market forces, the market regulator SEBI has been forced to defer the implementation of proposed tighter margining norms.

·         The managements are disclosing so much irrelevant and redundant information to the market, on the pretext of regulatory requirement. The relevant information many a times is getting lost in this overwhelming deluge of redundant information.

·         There are numerous cases of offer for sales (in guise of initial public offers) where the existing investors have exited at apparently unjustifiable price. The managers of these issues owe no accountability to the gullible investors who may lose substantial money.

·         Trading in new assets (Cryptos, NFT etc.) so far is unrestricted. There are numerous traders who may not be adequately skilled to understand the risks. There is no visible effort from regulators so far to improve the literacy and awareness level of these traders. It is therefore desirable that for the time being the trading is restricted to the discerning traders only.

President Biden stated on the International Day of Democracy, “No democracy is perfect, and no democracy is ever final. Every gain made, every barrier broken, is the result of determined, unceasing work.” He has made it clear that renewing democracy in the United States and around the world is essential to meeting the unprecedented challenges of our time. He brought the global leaders from government, civil society, and the private sector together to a global democracy summit, to “set forth an affirmative agenda for democratic renewal and to tackle the greatest threats faced by democracies today through collective action.”

It is imperative that this principle is applied to the financial markets also. The promised new code for the regulation of financial markets must take a fresh approach to regulation rather than adhering to the usual incrementalism.

The media headlines are implying that the foreign investors have been incessantly dumping Indian equities; and this could be one of the primary reasons for currently ongoing correction in the equity prices.

Though there is no evidence of any strong correlation between Nifty and foreign flows over medium to long term (3 months and beyond); these flows have been seen increasing the volatility in near term.

In particular, if the correction in prices is sharper, the selling by foreign investors is highlighted prominently, adding to the nervousness of the non-institutional investors. It is therefore important to know the actual trend of foreign flows; and analyze whether the selling is part of any structural change in their view or just a trading tactics to enhance their return.

The market participants, who track the daily foreign flows closely and get influenced by the provisional net flow data released by SEBI every evening, must note that—

·         “Foreign portfolio investors” (FPIs or FIIs) is not a uniform class of investors. This includes a variety of overseas investing entities with divergent investment objective, horizon, and strategies. These include, pension funds having a very long term horizon; hedge funds and alternative investment funds with short term investment horizon; dedicated India funds which raise money from individual investors for investing in India only; emerging market funds which invest in all emerging markets including India; ETFs which track benchmarks like MSCI Emerging Market Index; MSCI India Index; iShare Asia ETF; iShare EM Dividend ETF etc.

All these overseas investing entities usually do not act in unison and mostly have different approaches to investment. Their universe of stocks to invest could also be different.

·         The provisional data of FPI net flows, released everyday evening by SEBI does not represent the actual net FPI flows into India. This is just provisional data of net flows into secondary markets as reported by the custodians to SEBI. The real net flows include investment in primary market and debt securities also.

·         Many FPIs just run an arbitrage or long short book. They take self-cancelling positions in equities of various regions (e.g., Europe vs Asia), categories (e.g., emerging vs developed), countries (e.g., ndia vs Indonesia) or segments (e.g., cash vs derivative) to take advantage of short term trading opportunities. Their positioning usually does not reflect their fundamental view on a country, region, or category.

·         Forex rates could be an important consideration in many FPIs’ investing strategy. Thus, many a times net foreign flows could be influenced by FPIs view on INR exchange rate rather than the equity valuations.

·         Selling by FPIs does not necessarily mean outflow from the country. Many times, it is just an asset allocation call between equity and debt; a short term tactical trade; or sale in secondary market to buy in primary market.

An analysis of the trend in FPIs flows for past 10years, and in particular, since the first lockdown (March 2020) due to Covid-19 pandemic, highlights that FPIs have remained consistently positive on India. Despite multiple downgrades of Indian equities by global brokerages like Morgan Stanley, CLSA, Credit Suisse, Goldman Sachs etc., no significant selling has been seen so far. Though, on relative basis the flows to India as compared to other emerging markets might have slowed in past few months.

It is pertinent to note that the sovereign rating upgrade by the global rating agency Moody’s a few months earlier also did not have any noticeable impact on the foreign flows into Indian securities – equity or debt.

In fact, the domestic institutions have invested significantly lower amount in Indian equities in past 10yrs as well as during the period since March 2020, as compared to the net flows of foreign investors.

The following are the key data relating to the foreign and domestic flows:

FPIs’ risk reward is different from Indian investors

In past one decade, Nifty 50 has yielded a return of 215% in INR terms. However, USD denominated Nifty 50 has returned less than half (~106%). The USDINR exchange rate has deteriorated from Rs53/USD in December 2011 to Rs75/USD presently. The yearly average exchange rate of USDINR in past 10years has been Rs66.7/USD. The risk reward of overseas (USD) investors there is very different from Indian (INR) investors. They have to manage the currency risk, in addition to the market and business risks of Indian equities.

FPIs investment in Indian equities consistently more than DIIs

In past 10years, the net investment of overseas investing entities has been mostly higher than the investment made by domestic institutions. Even during the Covid period (since March 2020) FPIs have invested more than the domestic institutions.

In past 10yrs, FPIs have invested a net amount of Rs7.15trn in Indian equities, as compared to Rs2.07trn investment made by domestic institutions. Since March 2020, FPIs have invested a net amount of Rs2.08trn in Indian equities, as compared to Rs26.6bn net investment by domestic institutions.

40% of FPI equity investments are in primary market

Over past 10years, FPIs have net invested Rs7.15trn in Indian equities. Out of this, Rs2.92trn has been invested in primary market and the balance Rs4.23trn in secondary market. On net basis, FPIs’ flow have been negative only once in 2018. However, if we consider secondary market alone, FPIs have been net sellers in 3 out of past 10 years, i.e. 2015, 2018 and 2021.

FPIs sold Indian debt in 2021 despite rating upgrade

FPIs have invested Rs1.69trn in Indian debt securities in past 10years. Since March 2020, they have net sold Rs921bn worth of Indian debt.

The lower FPI investment in debt, despite high yield differential with developed markets, could be a matter of concern. Lower rating and lower FPIs quota in government securities could have been couple of many reasons for the low interest in Indian debt. However, even a rating upgrade few months ago and materially increase in quota during past few years has not resulted in flows into Indian debt securities.

Interestingly, FPIs have been net sellers of Indian debt in 5 out past 10 years.

FPI flows and Nifty poorly correlated

As mentioned above, FPI net investment is significantly larger than the domestic institutions’ net investment in Indian equities. However, there is little evidence to indicate that FPI flows materially influence the market direction over a longer period. Even on monthly basis the correlation between FPI flows and volatility is poor.

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Conclusion

FPIs are not a uniform class of investors. However, collectively they have been positive on Indian equities for long. There is no evidence to indicate that they are dumping Indian equities or causing unusual volatility in Indian markets. The headlines like “Foreign Investors dumping Indian Equities” therefore are best ignored. As per Prime Database, FPIs are presently invested in 1370 listed companies in India, an all-time high number. It would therefore not correct to say that FPIs invest in only a specific set of stocks; or only large cap stocks etc. Also, presently FPIs hold ~21% of all NSE market cap as compared to ~7.3% for all mutual funds in India. Thus after promoters (~51%), FPIs collectively own the largest share in listed Indian companies.

 India’s GDP grew 8.4% yoy in 2QFY22, ahead of most estimates. RBI had expected the GDP to grow 7.9% last quarter. This better than estimated growth is some relief at times when worries about worsening of Covid-19 conditions.

The growth was largely driven by Agriculture (4.5%), services including construction (9.9%) and exports (19.6%). Manufacturing growth (5.5% yoy) was below estimates, dragging down the overall industry sector growth to 6.7% yoy. While all segment of services grew at a decent pace, public services and defence were the largest contributors, growing 17.4% yoy.

Business sentiments are at multiyear high, but consumer sentiment is not improving. The household outlook on income is still below pre covid level.

The government has done a good job in managing the fiscal conditions. Subject to the government completing the promised disinvestment, the FY22 fiscal picture may be much better than the budget estimates.

The Covid management is performing very well, with the number of infected people falling to 18month low level. The vaccination program is also progressing well. The new Covid variant has certainly created some uncertainty, but as of now it does not appear that we shall see prolonged and/or extensive mobility restrictions in domestic area.

Pandemic wasted two years of growth

Statistically speaking, FY22 GDP may end up close to FY20 level, registering almost no growth for two years. In fact, 1HFY22 real GDP is about 4.5% (Rs3.17trn) less than 1HFY20 GDP. The nominal GDP of 1HFY22 is just about 7.3% higher than 1HFY20 nominal GDP.

More notably, the contribution of manufacturing; construction; trade, hotel, transport, communication; financial services, real estate & professional services etc., in 1HFY22 is lower than 1HFY20.

The latest macro data, e.g., GST collections, PMI, mobility indicators, labour participation rate, etc. indicates that the momentum has continued in 3QFY22 also. If the concerns about Covid-19 subside in next few weeks, Indian economy may record over 9% yoy growth for full year FY22; and we may achieve the FY20 level of GDP, even though the recovery may continue to be skewed and driven by government expenditure and external trade.

Consumption continue to lag behind

Both private consumption (PFCE) and government consumption (GFCE) spending are still much below the FY20 level.

1HFY22 PFCE at Rs37.32trn is about 7.7% lower as compared to 1HFY20 PFCE of Rs40.44trn. Similarly, 1HFY22 GFCE at Rs7.83trn is about 5.3% lower as compared to 1HFY20.

Even in nominal terms, PCFE has grown just 2% in 1HFY22 as compared to 1HFY20. The nominal government consumption has however grown ~9% over this period.

Investment too below FY20 level

The amount of real investments (Gross Fixed Capital Formation or GFCF) in the economy during 1HFY22 was about 8.2% lower than 1HFY20 level. Even in nominal terms, the GFCF was merely 1.5% higher in 1HFY22 as compared to 1HFY20.

5yr of 8-9% plus growth will take us to long term pre Covid growth trajectory

Pre Covid, India’s long term growth trajectory (5yr rolling CAGR of GDP) was close to 7%, which is closer to the estimated potential growth level of 7.5-8%. The trend was declining since FY18, indicating impairment of potential growth.

Indian economy would need to grow at 8-9% CAGR for next 5years to achieve the pre covid long term growth trajectory of ~7%. To achieve the potential growth rate of 7.5%-8, much higher growth would be needed on sustainable basis.

This would need much more than the higher government support to farmers and manufacturing. Structural reforms that increase the employment opportunities, improve energy security, stabilizes food prices, make tax structure progressive, and improve social and physical infrastructure sustainably must be accelerated.

Headwinds developing for 4QFY22

Though the latest macro data is encouraging, some dark clouds have gathered at the horizon, obfuscating the visibility of growth in 2022.

·  The inclement weather in the ongoing Rabi season, and fertilizer shortages have likely impacted the agriculture sector.

·  Though the overall consumption growth has been lagging; the rural consumption has remained resilient in past one year. The latest data indicates that the resilience of rural consumption maybe breaking.

·   In view of the threat presented by the new variant of Covid-19, many countries have recently imposed fresh mobility restrictions. This may impact exports, which has been one of the key drivers of the growth.

·  Recently, the US Federal Reserve Chairman has indicated that they may consider unwinding the bond buying program (QE) faster than previously forecasted. This faster unwinding is widely expected to result in at least two rate hikes in 2022. Back home, RBI has also started tightening money supply through OMO and other means. The tighter money supply conditions may also impact the growth in 2022.

·  As evident from the recent commentary of consumer goods companies, the persistent inflation, especially energy and food, is beginning to impact the consumption demand.

 After topping ~18600 in October 2021, the benchmark Nifty is now back to ~17000, the level where it was 12 weeks ago. In general statistical sense, it could be said that market has not yielded any return since August 2021. However, during this 3200 odd point up and down journey of Nifty, the actual outcome might be very different for various investors, depending upon their portfolio positioning and activity during this period. The portfolio of a monthly SIP investor may not have changed much in this period; whereas someone who got greedy at the peak and invested larger amount in mid and small companies may have lost 10-25% of his latest installment of investments.

Of course, 12 weeks is an extremely short, and mostly irrelevant, period to account for the return on investment in equities. However, it could be a useful timeframe to assess if the market is changing its course.

Having quickly recovered all the losses from panic reaction to the pandemic, and moving about ~50% higher than the pre pandemic Nifty highs of ~12500, the Indian equity markets now appear tired and indecisive.

The indecision and tentativeness may be emanating from a myriad of factors. For example—

·         Indian markets have outperformed most of the global peers in past 20months. The global investors are now looking at the underperforming markets in search of better returns. Many global brokerages like Credit Suisse, Morgan Stanley, CLS, Goldman Sachs etc., have downgraded the weight of Indian equities in their portfolios to allocate more to China etc. The global flows to India may therefore slow down further.

·         Indian economy and corporate earnings have so far failed to match the exuberance of Equity prices, making the valuations of Indian equities relatively expensive, at least on the conventional parameters like price to earnings, EV to EBIDTA, price to book value, etc.

·         The inflation continues to be a significant concern in India. Despite repeated reassurances by RBI to remain growth supportive, the market participants continue to expect monetary tightening. The interest rate and liquidity sensitive sectors like financials, real estate and auto may be struggling due to this anticipation.

·         Many regions have recently witnessed fresh surge in Covid-19 cases. Market participants are watching this development closely. A significant worsening leading to fresh mobility restraints and logistic holdups could impact the markets adversely.

·         In past few months the activity in unlisted securities which are expected to be listed for public trading in next 3-12 months has increased materially. The money invested in these securities is typically locked up till 6-12month after the security is listed. Some active money has thus ventured out of the market.

·         The global money market is widely expected to become tighter in 2022, with many central bankers tapering the pandemic stimulus. The market participants may be unsure of the likely impact of this. A stronger USD due to fed tightening may led to outflows from emerging markets like India. However, a growth shock in developed markets could lead to surge of flows towards emerging markets.

·         The logistic constrains that prevailed in past 20 months are easing fast. The non-agri commodity prices have started to correct accordingly. The availability of semi-conductor chips, that hampered the manufacturing across the globe in past six months, has also started to ease now. The shipping rates are also in the process of normalizing. All this could have implications for the equity markets.

The sectors like metal users, merchandise exporters, auto makers that have suffered due to high commodity prices and logistic constraints, could see their operations and cost structures normalizing, whereas the firms which have made exceptional gains, like metal producers, may also see their profit margins normalizing.

Once the market participants are able to assess the impact of these factors on future earnings and market performance, we shall see the new leadership emerging in the markets.

For making a directional up move, the market needs a near consensus on the new leadership; which has been lacking so far.

The directional down moves usually occur on failure of a basic premise which has been near consensus (bubble burst); some unexpected event causing panic amongst investors (sighting of black swan); a prolonged economic recession; and/or major change in policies making significant negative impact on large number of existing businesses (transformational reforms). Nothing of this seems to be occurring at present.

It is therefore more likely that market may spend some more time at the cross roads, searching for a direction. Recent jump in implied volatility is just one confirmation for this premise.

Markets indecisive

Implied Volatility inches higher, but still moderate

Sectoral divergences stark

…thus Alpha strategies working best

Net flows subdued

India Outperformance normalizing

Net flows subdued

(See also Market at crossroads)

 Historically, at some point in time copper, gold and/or silver coins had been legal tender in India; and in many other economies as well. Traditionally in Indian society, these metals have enjoyed acceptance as ‘sacred metals’ having religious, medicinal and economic importance.

With the rise in its industrial usage, copper may have lost its ‘precious’ status, but gold and silver still continue to enjoy ‘precious’ status, even though these are no longer legal tenders in India; and most other jurisdictions. With advancement of technology and globalization of Indian socio-economic milieu, the ‘sacred metal’ aspect of gold and silver is also diminishing gradually.

In past few years, the government of India has made significant efforts to encourage people to own gold in non-physical form, through sovereign gold bonds (SGB). These bonds offer interest income at the rate of 2.5 percent annually, beside capital gains benefits to the holders. In recent years, the digital gold has also been gaining popularity due to ease of transaction and holding. This comes after many decades of discouraging the gold for investment and consumption.

Cryptocurrencies (e.g., Bitcoin) are relatively new phenomenon in the global financial ecosystem. Unlike their nomenclature, these are not exactly currencies so far. Only El Salvador has declared Bitcoins as legal tender; whereas there are some jurisdiction (e.g., China, Indonesia, etc.) that have put a total ban on use of all cryptocurrencies as medium of exchange.

Crypto NOT currency as yet

To achieve ‘currency’ status, cryptocurrencies would need to gain much wider and deeper acceptance; which usually comes with time and awareness. Gold took centuries to gain wide acceptance as medium of exchange and ‘valuable asset’ status. Few cryptoes may gain this status in next few decades, simply because modern technology has made things much faster.

In India, the cryptocurrencies have gained tremendous popularity in past five years. It is estimated that there are over 100 million people in India owning one or more cryptocurrencies; the largest number for any country in the world. This number is materially higher than the number of people owning publically listed shares in India. The value of cryptocurrencies owned by Indian citizens is estimated to be close to US$900bn.

Regulating cryptocurrencies

The government has proposed to introduce a Bill in the forthcoming session of the parliament to regulate cryptocurrencies. The Bill titled ‘The Cryptocurrency and Regulation of Official Digital Currency Bill 2021’, aims to “create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India” and prohibit all private cryptocurrencies in India, with certain exceptions to promote the underlying technology and its uses."

Earlier, a high level inter-ministerial committee had suggested ban on private cryptocurrencies in India, except any virtual currencies issued by state. However, the government refrained from pushing the legislation in the Budget session. It was felt that a balanced approach is required in the matter, for which wider consultation with all stakeholders is important.

The Standing Committee on Finance recently highlighted many serious concerns over the obscurity of cryptocurrencies, operations of crypto exchanges and impact on the economy.

The stakeholders like RBI, Finance Ministry, Home Ministry, Blockchain and Crypto Assets Council (BACC) and industry and commerce bodies, the CII and ASSOCHAM, etc. made detailed presentation to the prime minister regarding opportunities and threats posed by cryptocurrencies and the need for appropriate regulatory framework.

Most significantly, the BACC represented that crypto assets could be treated as “utility”, “security”, “property tokens”, “intangible commodities”, or “virtual assets” that would ensure that the usage of tokens was governed appropriately and they were not confused with legal tender.

From the indications available so far, it appears that the government is totally against the use of cryptocurrencies as a medium of exchange (legal tender), but it supports the development and use of blockchain technology. It is therefore likely that a regulatory framework may be provided for ownership, transfer, sale and taxation of (select or all) cryptocurrencies. In that case the permitted cryptocurrencies may be treated as “capital assets” under the taxation laws.

It is also likely that the proposed legislation may permit a digital currency based on blockchain technology, to be developed by RBI or any other public agency. Obviously, such currency will not have the traits like Bitcoin, which is a decentralized and distributed digital token with finite supply. RBI’s digital currency will most likely be a centralized currency with infinite supply, just like fiat currency. In simple terms, RBI’s digital currency may be a dematerialized currency note that is delivered as a book entry in the receivers’ account.

Therefore, a fiat digital currency should not be confused with a decentralized and distributed cryptocurrency.

An idea whose time has come

In every democracy, especially the socialist ones, the governments have the natural tendency to regulate every innovation; simply because most new innovations make few people richer than the rest. With every new innovation, the fear of rise in inequalities also rises. The tendency to overregulate the innovations is therefore usually driven by the concerns to assure the majority of population that stays at the bottom of the pyramid.

A classic example of this was the attempt of British government to ban the use of cars on public roads in early years of automobiles. The argument was that this may have negative implications for the employment of poor people running horse carts on streets of London.

The good thing is that there is no historical evidence of a government regulation killing an innovative idea which was ready for adoption by the wider sections of public. Expansion of organized retail is a classic example in recent Indian context.

The dematerialization of securities is inarguably the single most important reform in the history of Indian capital markets. The idea was initially opposed by the market participants and bureaucrats. Computerization of banks and stock trading were other ideas that were not accepted easily by various stakeholders.

Failure to self-regulate is also a major catalyst for the overregulation. Securities’ market in India was mostly self-regulated for first 100 years. It was the colossal failure of self-regulation during late 1980s and early 1990s that pushed the government to intervene. BSE, a self-regulatory organization (SRO), that enjoyed more than 50% market share in a 29 players market till mid-1990s, is now contended with less than 10% market share in 2 player market.

“Most of the cryptocurrencies may not pass the test of time and fail, causing material losses to investors” is not a valid argument against cryptocurrencies. During 19^th and 20^th century, thousands of banks and insurance companies failed causing instability in markets and material losses to investors and depositors. More recently, many private airlines, telecom companies, infrastructure builders, private & cooperative banks, NBFCs, HFCs etc have failed in India causing huge losses to investors, lenders and the exchequer. Would anyone accept this failure as valid argument for banning these activities in private sector!.

Cryptocurrencies a bad omen for Gold

A well regulated market for cryptocurrency could be a bad omen for demand for the traditional “valuable assets’ like gold and silver. Arguably, the factors like popularity and spread of technology in common man's life; rising fascist and communist tendencies due to worsening socio-economic disparities; rise in electronic transactions (personal, social and commercial) thus lower risk (less travel, less physical transactions & deliveries); emergence of new articles of luxury to serve the vanity needs of the affluent; stronger and deeper social security programs; demise of monarchy and feudalism; popularity of spiritualism over rituals; dissipation of church & temples, etc., are all leading to sustainable decline in traditional demand and pre-eminence of gold. There is nothing to suggest that this trend may not continue in near future.

The following table makes it clear that gold and cryptocurrency are comparable assets in most respects. Some experts are arguing that gold has “intrinsic” value whereas cryptocurrencies have none. In my view, the intrinsic value of gold has developed over many centuries of wider acceptance by the state and religion. This intrinsic value has been on the decline for past few decades.

Insofar as the volatility is concerned, in past two centuries, gold has seen many bouts of wild volatility, correcting over 50% on many occasions. From December 1987 high of ~US$500/oz to February 2001 low of ~US$250, Gold yielded a negative return of 50% over a period of 13yrs. Falls of similar magnitude were rather quick during 1974-1976 and 1980-1982.

In January 2021, the 22^nd biannual Financial Stability Report (FSR) of RBI had raised many red flags over the Indian financial markets. The report, inter alia, highlighted the uneven economic recovery, accentuated credit risk of firms and households, and divergence between economic activity and asset prices. Commenting on the findings of FSR, the RBI governor had then cautioned investors and financial institutions that “The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India” and “Stretched valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system.”

Incidentally, the benchmark Nifty has gained ~24% and total market capitalization of NSE has increased ~38% since release of last FSR in January 2021.

The economics team of RBI, in the latest monthly bulletin of RBI, has reiterated, “The Indian equity market has outperformed major equity indices in 2021 so far. The spectacular gains have raised concerns over overstretched valuations with a number of global financial service firms turning cautious on Indian equities. Traditional valuation metrics like price-to book value ratio, price-to-earnings ratio and market capitalisation to GDP ratio stayed above their historical averages. The yield gap (difference between 10-year G-sec yield and 12-month forward earnings yield of BSE Sensex) at 2.47 per cent has far outstripped its historical long-term average of 1.65 per cent.”

Expert opinion divided

Some prominent global brokerages have recently turned cautious on Indian equities. They have advised their clients to reduce exposure to Indian equities. For instance—

The global strategy team of CLSA advised lowering of India exposure to 40% underweight, citing 10 reasons for booking profits on India. It said, “We call time on the 20-month rally in Indian equities, lowering our exposure to India within an AC APAC ex Japan portfolio to 40% underweight. Our concerns range from elevated energy and broader input price pressures applying downward pressure to margins, the current account balance and thus currency outlook, the withdrawal of RBI stimulus, and a lack of upside implied by Indian equities’ typical macro drivers. Rich valuations, a high probability of earnings disappointment, and a potential lack of marginal buyers add to our motivation to book profits on India.”

Goldman Sachs lowered Indian equities to market weight after region-leading 31% gains in 2021. It said, “After gaining nearly 31% ytd and 44% since our upgrade in November last year, and being the best-performing regional market in 2021, we believe the risk-reward for Indian equities is less favorable at current levels. While we expect strong cyclical and profit recovery next year and remain medium-term constructive amid increasing digitalization in the index, we think the recovery is well priced at current peak valuations. We, thus, take profits on our India overweight and lower it to market weight within our regional allocations.”

Morgan Stanley also advised booking profit in Indian equities, despite retaining a structural positive stance. It said, “We move tactically EW on India equities after strong relative gains - we expect a structural multi-year earnings recovery, but at 24x fwd P/E we look for some consolidation ahead of Fed tapering, an RBI hike in February and higher energy costs.”

The “lower weight on India” is however not a consensus call. There are investors who are willing to look beyond the near term concerns and potential draw down in stock prices, and increase allocation to Indian equities. 

Mark Mobius, whose emerging market fund has over 45% allocation to Indian and Taiwanese equities, sounded extremely bullish on India, in a recent media interview. He said, “India is on a 50-year rally even if there are short bouts of bear markets.”

Another veteran, Chris Wood who writes famous ‘Greed & Fear’ report, recently wrote, “If GREED & fear is Overweight China, GREED & fear also remains structurally Overweight India. GREED & fear repeats the point that if GREED & fear had to own one stock market globally for the next ten years, and not be able to sell it during that period, that market would be India.”

Foreign investors continue to sell

Regardless of these divergent views on Indian equities, the foreign portfolio investors (FPIs) have been net sellers in six out of past seven months. So far in 2021, FPIs have net sold ~Rs240bn in Indian equities.

…as global investors’ preference veers towards developed markets

In fact, the global investors have been increasing weight on developed market equities for past many months. The latest global fund managers’ survey conducted by Bank of America (BofA) global research indicates that the global investors now have highest overweight on US equities since 2013

Promoters remain sanguine about their businesses

The recently concluded earning sessions did not throw up many surprises. The earnings were mostly in line with analysts’ estimates. The revenue growth was offset, to some extent, by higher raw material prices. The lower margins prevented any meaningful earnings upgrades. IT services companies witnessed strong earnings momentum and upgrades; while automobile manufacturers; insurance companies and chemical 7 paint companies witnessed downgrades. The results of financial stocks were also mixed.

As per MOFSL, “Key drivers of 2QFY22 performance: [1] IT- Indian IT services delivered one of its bestever quarterly performances with a sequential revenue growth of 4.8% (USD). Moreover, stable deal wins and the upbeat commentary on overall tech spending provide high visibility for future growth. [2] Oil & Gas (O&G) – The performance of OMCs was driven by a better-than-expected margin performance, led by both higher reported GRM and higher-than-estimated marketing margins. Sales volume witnessed a demand recovery post the second COVID wave. [3] Autos – High raw material inflation and operating deleverage impacted the sector’s 2QFY22 results. OEMs (MSIL, Bajaj and TVS) reported a commodity cost impact of 2-4pp QoQ, but expect semiconductor supply to improve from the 2QFY22 levels.”

The brokerage kept the Nifty EPS for FY22/FY23 largely unchanged at INR 731/INR873 (from INR 730/874).

A majority of the market participants however seem to be of the view that the present earnings estimates may be little ambitious to achieve and we may see more downward revision in 2HFY22.

Given the mixed signals from investors, corporate performance, policy makers et. al., the Indian markets have turned indecisive in past few weeks. The benchmark indices are moving in a narrow range waiting for clear signals to choose a direction. Volatility has increased and volumes are plunging much below the 12month average. Institutional participation is diminishing. The sectoral movements are sharp and random. Accordingly, the divergence in sectoral performance is stark. The strong response to expensively priced IPOs has added to the randomness of market behavior.

Next week, we shall have a look at market internals to discover more about the market behavior and likely outcome in the short term.

 The “Young India” may soon begin to age. As the era of demographic dividend wanes, many new business and investment opportunities may arise. It may be the right time for investors to anticipate these opportunities and begin taking positions.

Presently, India is home to the largest number of youth. With close to half of her 1.4bn people below 24yrs of age, India is like a vast reservoir of youthful energy. However, this distinction might not last for long. India is expected to become a middle aged country in next 15years and an old country by 2050 - since with the faster economic development over past three decades, India has managed a consistent decline in crude birth rate (CBR), total fertility rate (TFR) & infant mortality rate (IMR); and improved healthcare facilities, better access & improved affordability have also resulted in a consistent rise in life expectancy of an average Indian to about 70yrs.

As per a 2019 report of the Technical Group on Population Projections for India and States 2011-2036, set up the Government of India, the below 24yr population is expected to fall from 50.1 percent in 2011 to 34.7 percent by 2036. The average age of Indians is expected to be of 34.7 years in 2036 as compared to 24.9 years in last census (2011).

TFR is expected to decline to 1.73 by 2036, much below the ideal replacement TFR of 2.0. This implies that Indian population will begin to grow “old” at a faster rate. Over the next 15yrs, the population of India is likely to witness material rise in the number of old people (60yr and above) and number of potential workers (15 to 59yrs), while the school going children (5-14yrs) will decline materially.

By 2036, the share of old people in the total population may increase to 15 percent (230 million) from 8.4 percent (100 million) in 2011; the number of potential workers is expected to rise to 65.1 percent from 60.7 percent in 2011; and the school going population may decline to 14.9 percent from 19.3 percent in 2011.

It is critical to note that the regional demographic imbalances shall continue to exacerbate in future. By 2036, about 23 percent of the population in southern state of Kerala may be old, as compared to just 12 per cent in northern state of Uttar Pradesh. The median age in the Eastern State of Bihar is expected to be 28.1yrs in 2036 (19.9yrs in 2011), while in the southern state of Tamil Nadu, it would be 40.5yrs (29.9yrs in 2011). Andhra Pradesh may have a CBR of 9.9 per thousand in 2036 (15.2 in 2011) whereas Bihar’s CBR may be 19.6 (27.5 in 2011).

With the projected rise in population to 151bn by 2036, the density of population shall also increase to 462 people per square kilometer from the present 368 people per square kilometer. This shall lead to further acceleration in the trend of urbanization of India. Of course, the urbanization trend will not be uniform across India. Delhi and Kerala will lead with 93-100 percent urbanization rate, with Tamil Nadu, Telangana, Gujarat, Maharashtra, Karanataka etc following with 50-60 percent; whereas Himachal, Bihar, Assam and Odisha will lag with 10-20 percent urbanization rate.

With the decline in number of school going children, the focus will shift from primary and secondary education to higher education and skill building. Beside more parents will be available for working. Skilling and managing this new set of workers could be a good business opportunity.

The global experience suggests that rise in middle ages urbanized working population invariably results in rise in demand for civic amenities like housing, public transport, sanitation, communication etc.; recreational activities like entertainment and travel; personal use items like clothing, footwear, cosmetics and fashion accessories; and consumer durables etc. Rise in demand for healthcare, social & financial security, elderly care etc. is a natural corollary of the aging demography. The age related pharmaceuticals and devices, chronic disease management, pension management, nursing care, estate planning, old age homes, usually see significant rise in demand as the demographics shift to the higher age. Obviously, we shall see sustainable investment opportunities arising in these areas over the course of next few decades.

Personally, I believe that the demographic shift in India offers immense opportunities in the financial services segment. The demographic changes shall inevitably result in significant widening and deepening of the financial services. With the evolution of earning, savings and spending patterns, the financial product mix, design and their delivery will also have to evolve. Significant opportunity shall arise in the businesses like financial planning, lending, insurance, asset management, etc.

One of the economic positives of Covid-19 pandemic is material rise in digital payments and e-commerce. The steep rise in adoption of digital payments by household consumers and merchants in past one year should have arguably led to lower currency in circulation. However, the recent data released by RBI indicates that the cash in circulation is highest in 6 decades relative to GDP. In absolute terms also, the cash is materially higher than the pre demonetization levels.

It may be argued that holding more cash during the times of distress (e.g., Pandemic) is natural instinct; and this trend has been seen globally. Nonetheless, in the Indian context, the issue needs deeper examination by the policy makers.

Digital payments rising exponentially

The initial public offer (IPO) by One 97 Communication Limited, the owner of India’s largest payment brand PayTM, celebrates the exponential growth in digital payment in past few years. As per NASSCOM, digital payments in India have grown ~10x in five years, from Rs352cr in FY15 to Rs3435 in FY20. The apex body of IT Services Industry in India, expects, the digital payment volumes to grow another ~16x to Rs54,800 crores by FY25. The fastest growth during FY20-FY25 is expected to be in UPI payments, which are expected to grow 26x, from rs1251cr in FY20 to Rs32,500cr in FY25. Payments using Aadhar enabled payment system (AePS) are also expected to grow 23x to Rs3800cr over this period.

The NASSCOM’s 2020 Country Adoption Report for digital payments, highlighted that all economic segments (Individuals, Merchants and Enterprises) have high adoption maturity, insofar as the preference for digital payments is concerned. But the adoption maturity is limited for digital payments for business transactions, government transactions and higher value transactions. In 2020, about 75% of digital payments were Rs5000 or below; and only 1% transactions were over Rs1,00,000.

…triggered by Covid-19 pandemic

The lockdown forced by the Covid-19 pandemic has definitely given a strong push to the digital payments in India. As per the available data, the digital payments have increased to 25% of the private consumption expenditure in 1QFY22 from mere 4% in FY15.

As per a recent report by brokerage firm Sanford C. Bernstein, “The pandemic has changed user behavior – more people are buying things online. This has given a boost to online payments. Further, buyers are shifting towards digital payments for in-store purchases as well. Mobile payments, driven by UPI, has been a big factor in the rising adoption of digital payments in India during the pandemic. 

Digital merchant payments stood at ~25% of PCE for Q1FY22 in India. The number stood at ~22% for Q4FY21, and at ~18% for FY20. The first boost to penetration came from demonetization when higher denomination currency notes were discontinued for three months. The rise of UPI has supported the increased adoption over FY18-20. The pandemic has provided another step-jump in the adoption of digital payments by merchants and consumers. The rapid adoption growth comes from the rising share of mobile payments, mainly from UPI. UPI has grown from 3% of PCE in FY20, to 9% of PCE in Q1FY22.”

Informal economy is shrinking

As per a recent note released by SBI Research, share of informal economy in India may have shrunk to 20% from 52% in 2018. The note “estimates that currently informal economy is possibly is at max 15%-20% of formal GDP. There is wide variation across sectors, though, with formal sectors like finance and insurance expanding post pandemic.”

Though many experts have challenged the data and method used by SBI Research to assess the formalization level in the economy, it cannot be denied that the level of formalization of economy has increased in past one decade or so.

“For India, post 2016 plethora of measures which accelerated digitisation of the economy, emergence of gig economy have facilitated higher formalisation of the Indian economy - at rates possibly much faster than most other nations”, the note reads.

The note highlights that “E-Shram is a big step towards the formalisation of employment as our calculation indicates that till date the rate of formalisation of unorganised labour due to E-Shram is around 17% / Rs 6.8 lakh crore / 3% of GDP in just 2 months. Even in Agriculture, the usage of KCC cards has increased significantly and we estimate Rs 4.6 lakh crore formalisation only through KCC route, with more marginalized farmers coming under the banking sector ambit through such usage. The total number of insurance and pension accounts that have been opened across several schemes for the unorganised as well as organised is as much as 68.9 crore.”

Paradoxically currency in circulation is highest in six decades

The currency in circulation (cash in pocket) grew to six decade high of 14.7% of GDP by the end of FY21. The currency in circulation grew at staggering 17.2% in FY21 to Rs28.6trillion. The amount was Rs16.63trillion five years, before the demonetization of higher denomination notes in 2016.

Moreover, the proportion of high denomination currency (Rs2000 and Rs500) has also increased to 85.7% in March 2021, against 83% share of Rs1000 and Rs500 currency notes in November 2016.

Financial inclusion progressing at modest speed

Financial inclusion has been one of the primary thrust areas for successive governments in past two decades. Indubitably, the access to basic banking services has improved materially in past one decade. Nonetheless, in absolute terms, the access to basic banking services is much below optimal levels and growing at very modest speed. The rate of improvement in accessibility to banking services has actually declined in past five years as compared to the previous block of five years.

Denominator (Nominal GDP) growing at much slower rate

Rise in election spending

Corruption might be rising again

After declining sharply post 2014 general election, India’s positioning on the Corruption Perception Index, published by Transparency International, has begun to worsen again. Though the methodology used for this Index is questionable, it does give some sense of the situation on the ground.

The sharp rise in corruption perception in past couple of years, could be one of the explanations for rise in the cash in circulation.