Vijay Kumar Gaba

 Struggle with nature has been an integral part of the evolution of homo sapiens. The Man has not only braved the inclement natural conditions for a million year, but also emerged victorious under most circumstances. They have crossed oceans; scaled mountain peaks; tamed raging rivers; built oases in deserts; braved extreme cold at the poles and extreme heat at the equator; and still survived and continue to evolve.

Cockroaches are an insect group that is believed to have originated 300-350 million years ago. They have shown extreme tolerance for a variety of climate – from arctic cold to tropical heat, and thrived.

The common saying is that only the human race and cockroaches may manage to survive an Armageddon due to their adaptability and strong survival instincts.

Many young investors may not have heard the term “peak oil”. This term was popular till the global financial crisis in the later part of the first decade of this century. The term was essentially used to denote that crude oil supply will soon peak out to catastrophic consequences for the global economy; which relies heavily on fossil fuels for their energy requirement. The term has however become redundant in the past one decade. Most producers have cut the production of fossil fuels in the past few years, as most economies have started to move away from fossil fuels towards cleaner sources of energy. The factors like demographic changes in developed countries and technological advancements may also have contributed to lower fuel consumption.

I clearly remember discussing this with a group of investors in mid-2008. This was the time when top global brokerages were aggressively selling the theme of hyperinflation. Brent crude was trading at US$130/bbl and Arjun N. Murthi, an analyst at Goldman Sachs, had just created a sensation by forecasting the crude oil prices to top US$200/bbl in the not so distant future. Fortunately, most of the assumptions made by Mr. Murti did not materialize and a few months later, in December 2008, the research team at Goldman Sachs cut their 2009 crude price target to US$45/bbl. (Actually, oil prices peaked in July 2008 at US$148 and fell to US$37/bbl by end of 2008).

In mid-2008 when oil prices had crossed US$125/bbl for the first time, the Indian economy was struggling with the mounting oil subsidies, impact of global financial crisis and rise in bad loans at banks. The group of investors I was interacting with was unanimous in their view that oil will be the nemesis of the Indian economy in particular and global economy in general. “Peak Oil” was the Bogeyman scaring them. I narrated this small bit of history of Man and Cockroaches to the group. My point was, if we are not worried about the pile of Nuclear weapons with hostile neighbours like Pakistan and China, why should we be worried about “Peak Oil”. The human race which has never accepted defeat from nature, how would it lose to dirty fuel! My view was that the world will find an alternative much sooner than what most people might be expecting presently.

No surprises that less than 15 years later, no one even hears the term “peak oil” any more. Non-fossil sources are already beginning to dominate the energy landscape of many developed economies. Many large emerging economies are targeting to become carbon neutral in the next 25-30 years.

I considered narrating this instance at this point in time to draw attention towards the euphoria building in Electric Vehicle space. The prices of Lithium, carbon, rare earths used in Lithium batteries, stock prices of EV makers/potential makers and their ancillaries/potential ancillaries have seen sharp rise in the last one year.

I fail to understand how transition to electric mobility will increase the sale of cars. For how many customers, the only criteria for buying a car is the fuel cost; because this is the only potential increment to the customer base.

Assume lower fuel cost adds 20% to the existing customer base. A car manufacturer which sells 10000 conventional fuel cars a year, other things remaining the same, it may potentially sell 12000 cars 10years later if we transition completely to electric mobility. As of now it is not clear, but if we assume 20% higher manufacturing margins for electric cars, this would mean 40% higher profit after 10 years. ROCE may not rise as much due to incremental capex required for the complete transition.

This sounds like a great proposition for the OEM as well as ancillaries. But what if technology changes in 10 years? Hydrogen cells become more viable and popular and battery cell fuelled vehicles meet the fate of Nano. Multiple experts have already mentioned that Lithium based batteries may not work for truckswith over 50tonne capacity.

I would consider that transition to electric vehicle manufacturing is a survival endeavour for most of the OEMs, rather than a more profitable diversification. It is the same as your local Kirana store owner putting up a computer in his shop for accounting and billing. Insofar as gains are concerned, this would be a transformative transition, the gains of which will accrue to the entire economy, not only the auto sector. For example, saving on fuel cost may boost spending on health and entertainment.

Some more thoughts on the new disruptor ‘ Green Hydrogen” tomorrow.

 If we consider the returns given by various global equity indices in the past one year period, the MSCI Czech Republic Index tops the chart with 45% return. MSCI Turkey with ~34% return and MSCI Argentina with ~31% return share the podium with Czechs. In the past five years—

·         The Czech economy has grown at less than 5% CAGR; inflation has averaged ~3%; interest rates have risen from near zero in 2017 to 3.75% presently. Youth unemployment rate has ranged between 5% to 12%.

·         The Turkish economy has also grown at less than 5% CAGR; inflation has ranged between 10% (2016-17) to 36% (present); interest rates are ~16%; and unemployment rate is above 11%. Turkey has witnessed violence, political instability, and Lira collapse.

·         The Argentina economy has hardly grown in the past five years. The inflation rate has ranged between 15% to 60% (presently 50%). Interest rates have ranged between 25% to 85% (presently 40%). Financial and political stability of Argentina has been under severe stress. The Peso collapsed.

(In comparison, MSCI India Index has been the fifth best index with ~29% return. Indian economy has grown above 5% CAGR; inflation has averaged below 6% and interest rates are around 4%.)

Prima facie, this selective set of indicators would imply that the stock market performance is mostly alienated from the economic, social and economic realities, at least in the short period of one to two years.

Someone can argue that the outperformance of Turkish and Argentinian equities must be seen in the light of past underperformance and hopes of recovery in near future.

To that my answer would be – (a) MSCI Turkey Index has been amongst the top 10 performing global indices in past 3years; and (b) if hope is one of the primary criteria for investing in equities, regardless of the prevailing hopeless condition, then perhaps the whole discipline of equity research and analysis may be redundant. Investors should buy assets that have suffered from hopelessness in the recent past. This strategy has worked very well, for example, in the case of Greek, Italian, Portuguese and Spanish equities & debt post global financial crisis.

This implies that the key to make money in financial markets lies in “hopelessness” and not in “hope”. Perhaps that is what drives investors to buy stocks of hopeless companies like DHFL, JP Infratech, BILT, Sintex etc. However, the investors bothering about non-events like union budget and state elections and reacting in the hope of a “lottery” outcome and markets staging a pre-budget rally complicates the narrative.

Regardless, I do not prefer to hinge my investment strategy on hope alone. I would like to explore if there is some method in equity outperformance in the present period of socio-economic distress; and whether the asset prices in general are actually reflecting the ground realities.

I would in particularly like to test the following hypotheses:

(a)   Are the rising inequalities world over resulting in larger businesses growing faster at the expense of smaller and unorganized businesses?

If this is true, in Indian context it may mean 1000 odd listed companies gaining market share at the expense of lacs of micro and small enterprises. So greater the stress in MSME, better it may be for the larger listed entities and therefore for stock markets.

(b)   Are citizens losing faith in state controlled assets like currencies and public debt?

This may reflect in less preference for cash and treasuries and rising preference for unregulated assets like private equity, cryptocurrencies, NFTs, private realty, corporate debt etc.

(c)    Is equity becoming the most preferred inflation hedge with household investors?

Does this explain the underperformance of Gold, a traditional inflation hedge?

(d)   The past decade has seen two phenomena – (a) a sustained rally in equity prices and (b) remarkable rise in the role of technology in business.

Does this mean the new average jobs now require high skills, leaving very low paying jobs for average skilled or poorly skilled workers, pushing the youth in 20s and thirties who have seen only a bull market in equities towards “lucrative” business of equity trading that is commonly assumed to require low skills?

I would love to hear the views of readers on these propositions. I shall be sharing the result of my exploration in due course.

As per the latest reported data (7 January 2022), RBI was holding a total of US$632.7bn in non INR assets. This includes US$569.3bn foreign currencies, US$39bn gold, US$19.1bn SDRs and US$5.2 reserve position in the IMF.

Considering our emotional attachment to gold, I would like to categorize it as emergency reserve only. So effectively, RBI has US$569.3bn worth of foreign currency to meet the regular demand.

Considering an expected trade deficit of US$200-220bn for FY23, we appear adequately covered for monetary tightening by global central bankers and consequent unwind of USD carry trade potentially leading to FPI outflows.

Assuming, that the global central bank monetary tightening is able to reign the runaway inflation, and India inflation remains at midpoint of RBI target range, we may end up with 2-2.5% INR depreciation for the year, implying end FY23 exchange rate (INR/USD) of 75 to 75.5; of course, not a matter of much concern.

Some recent news headlines have drawn attention to the impending redemption of US$256bn foreign debt in 2022 (see here). This is ~44% of the total last reported US$596bn external debt (September 2021). Some reports have presented the situation as challenging, given the tightening monetary conditions overseas.

Some analysts have drawn attention to the fact that the pace of forex reserve accretion has slowed down in 2021. RBI added US$124bn to its kitty in 2020, while 2021 addition was only US$48bn. Material outflows on account of net negative FPI flows resulting in larger than presently anticipated current account deficit could potentially result in a mini crisis; though not to the tune of what we saw in 2013.

In this context the following points are noteworthy:

(a)   Private commercial borrowings (ECBs) are largest component of this debt with ~37% share; followed by NRI deposits ~25% and short term trade credit (~17%).

(b)   Only about 52% of India’s external debt is denominated in USD. Over ~33 is actually INR denominated debt. Rest is ~6% (JPY); ~3.5% EUR) and ~4.5% (SDR).

(c)    Non-Financial companies owe ~41% of India’s foreign debt. This includes top private and public sector corporations. Deposit taking lenders owe ~28%; government ~19% and other financial corporations owe ~8%. About 5% is intercompany lending.

(d)   Of the total debt due for repayment in 2022, about 40% is owed by deposit taking lenders (Banks and NBFCs). Most of this is long term debt maturing in 2022. Obviously, these borrowers would have made adequate arrangements to repay/renew this debt. About 50% is owed by other corporations and mostly comprises of short term trade credit that mostly keeps on renewing automatically.  (See details here)

I would also like to draw attention towards the following recent headlines:

Ø  RIL raises US$4bn in 10 to 40yr debt at coupon rate ranging between 2.8% to 3.8%. The offering was oversubscribed 3 times. Out of this US$1.2bn will be used to repay the debt becoming due for repayment in 2022. (see here)

Ø  Including RIL, a total of US$6bn debt has been raised in first two weeks of January alone. Corporations like SBI, JSW Infra, Shriram Transport Finance, India Clean Energy etc. have been able to reduce their borrowing cost by 30-35bps in these renewals. (see here)

Ø  The global arm of UPL Limited has raised US$700m to repay its older debt at 35bps lower cost. The proceeds of the loans will be used to repay part of the debt it had raised to fund the $4.2-billion acquisition of Arysta Life Sciences in 2019. The company has redeemed US$410m debt recently and plans to repay more in 4QFY22. (see here)

Obviously, raising money overseas may not be a challenge for corporate India. Reduction or complete elimination of QE money may not be a significant credit or currency event for Indian economy in 2022. Insofar as the lower addition to new forex reserve by RBI in 2021 is concerned, it may be due to change in RBI stance toward liquidity (buying USD from market involves increasing INR liquidity). Net FPI outflows were not much as secondary market selling was mostly offset by primary market buying.

The real potential challenge for Indian Economy and INR could come from the following:

1.    The Central Bankers fail in reining the inflation despite monetary tightening, as the inflation presently is mostly a supply driven phenomenon. India’s crude cost import cost crossing US$100/bn could put a serious pressure on current account.

2.    Persistent erratic weathers across the globe could further deteriorate the food supply situation leading to further rise in global food prices.

3.    A major geopolitical even could cause temporary supply restriction further worsening the present logjam at major ports hampering exports and exacerbating supply challenges.

4.    Outbound FDI outpacing the incoming FDI, as more Indian businesses look to establish local presence in foreign jurisdiction to counter hyper nationalism or continued mobility restrictions.

In the first few trading sessions of the calendar year 2022, the benchmark Nifty has gained close to 5%. This rather sharp up move has surprised many market participants, considering that macro conditions have deteriorated in the past two weeks. The inflation has increased. The global energy prices have risen sharply. The US Fed commentary has become particularly hawkish. The NSO has moderated the GDP growth estimates, forecasting it to be lower than the recent RBI estimates. The RBI has announced OMOs aimed at draining more liquidity from the market. The Corona cases have grown exponentially in the past two weeks, leading to stricter mobility restrictions. The latest IIP data has pointed to deceleration in economic growth momentum. Politically also, the ruling BJP may have lost some popularity points in the five states going to election from next month.

This less expected strong performance of the markets has evoked mixed reactions from the market participants.

One section of the market participants has grown extra cautious, fearing that this strong start to the year may fizzle out soon as the economic realities begin to hit harder and investors caught at higher levels may have to bear greater pain.  

The other section finds the strong start to the year a good omen for the rest of the year. The experts in this section believe that strong domestic flows will continue to drive the markets in 2022. They feel that the global markets shall adjust to the new monetary policy in the next couple of months and USD may begin to flow towards emerging markets like India.

Yet another section believes that the Indian markets may spend most of the year 2022 consolidating their position, moving in a broader range. It is felt that presently we may be at the midpoint of the range and hence the market offers a balanced risk reward equation at this point in time.

Personally, I am not a fan of market level forecasting and like to work on individual business where I would like to invest my money. Trading in equity markets is a highly specialized skill that requires strong technical skills, understanding of short term business cycles, high risk appetite, and good liquidity position. Incidentally, I possess none of these prerequisites to the successful trading enterprise.

Regardless, to satisfy my curiosity I did some star gazing, and noticed the following trends that may interest the short term market traders.

1.    In the past 10 years (2012 to 2021) Nifty has given a positive return in 9 years. Only in 2015 Nifty yielded a negative return of -4.1%. The annual positive return has ranged between 3% (2016) to 28.6% (2017).

2.    In 7 out of the past ten years, the sum of the returns in the best 3 months was higher than the annual Nifty returns. This implies that in these 7 years, the sum of returns in the rest 9 months was negative.

3.    January has appeared 4 times in the best three months of the year. Two of these years (2012 and 2017) were amongst the best 3 years of the decade. However, the other two years (2015 and 2018) were amongst the worst 3 years of the decade.

4     February and August have appeared only once in the best 3 months of the year (2021). This was one of the best 4 years of the decade.

5.    Whenever January has appeared in the list of best 3 months of the year, February and March were not in that list.

6.    July has appeared 4 times in the list of 3 best months. On three of these four occasions (2015, 2016, 2018), Nifty peaked in July and August and the annual returns were lowest in the decade, ranging between -4.1% to 3%.

If the current rally sustains for the month of January and the past is any guide to the future, then there are 75% chances that the year 2022 may yield a low single digit return and the months of February and March may not be great months in terms of stock returns.

Do you believe in this data jugglery? Well I do not. The basic idea of sharing this statistics is to show that it means literally nothing.

 Chart for the day

Thought for the day

“The only thing that interferes with my learning is my education.”

—Albert Einstein (German Physicist, 1879-1955)

Word for the day

Corvine (adj)

Pertaining to or resembling a crow.

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The Publisher of this note do not offer any portfolio management, brokerage, money management, equity research or investment advisory services of any kind. Please take advise of a qualified and registered investment advisor before taking any investment decision.

Material from these reports may be copied freely, without any need for permission from the Publishers. This is however subject to copyright consideration of the contents of third parties.

Please refer to the attached PDF for full report important disclosures.

 

 

 Wishing all readers on the auspicious occasion of Lohri, Makar Sankranti, Maghi, Poush Sankranti, Pongal, Surya Uttarayan, Bhogi, Tusu, Bihu, Pedda Panduga and much more. 

May this auspicious transition of Sun God may empower the universe with divine energy and light and protect humanity from all demonic forces.

Happy Earning Season

Technically the quarterly result season starts from first day of every calendar quarter. However, the formal festivities begin with the IT Services major announcing their quarterly performance 10-13 days later. This season, perhaps for the first time in history, the top three IT service players chose to kick start the festivities together on 12^th January. Obviously it was an auspicious start to what is popularly anticipated to be an extremely fruitful earnings season.

Near consensus on corporate performance

There is near consensus on corporate performance during 3QFY22 in particular and FY22 as a whole in general. Post 2QFY22 a majority of brokerages have upgraded their earnings estimates for Nifty for FY22 and FY23.

Sector wise also, there is near unanimity on (a) continuing strong earnings momentum in IT Services and chemical sectors; (b) compression of spreads and decline in profitability for metal companies; (c) strong growth in BFSI segment with further improvement in asset quality and NIMs; (d) sequential improvement in auto numbers even though overall performance may be weak; (e) lackluster performance of pharma and consumer staples and (f) sequential improvement in consumer discretionary.

The following excerpts from brokerage commentary on quarterly performance are noteworthy:

Nifty PAT to grow 20% yoy (Kotak Institutional Equities)

We expect net profits of the Nifty-50 Index to increase 20% yoy and 3% qoq; and estimate EPS of the Nifty-50 Index at Rs726 for FY2022 and Rs844 for FY2023.

Sector wise - (1) banks (steady sequential decline in slippages, lower provisions, better performance of large banks), (2) metals and mining (higher realizations and volumes on a yoy basis, but weaker sequentially), (3) oil, gas and consumable fuels (higher qoq and yoy realizations for upstream companies, improved marketing and refining margins for downstream companies sequentially) and (4) retailing (strong volume growth led by increase in footfall and operating leverage-led margin expansion).

Expect decline in the net income of (1) automobiles (production issues, RM headwinds) and (2) construction materials (weak demand environment, higher fuel and power costs) sectors.

Earnings strong but breadth weak (MOFSL)

After two strong quarters of earnings growth, we expect MOFSL Universe to register another healthy quarter of 22% YoY growth in 3QFY22 on a high base of 33% YoY growth in 3QFY21. While the aggregate growth is impressive, it is narrow and driven by just four sectors – Metals, BFSI, O&G and IT. Two-thirds of the incremental growth is steered by Metals and Oil & Gas (O&G) sectors, with the Financials sector driving the remainder. However, the breadth of earnings remains weak with 42% of companies likely to post YoY decline in earnings while 38% are expected to post>15% earnings growth. The key 3QFY22 drivers are: a) Metals – likely to post 60% YoY profit growth and contribute 35%/35% to incremental MOFSL/Nifty earnings growth for 3Q, respectively; b) O&G – high Brent crude prices and demand led to higher GRM’s and volumes for OMCs; c) BFSI – higher loan growth due to improved economic activity and lower slippages leading to asset quality improvement and d) IT – strong demand backed by multi-year growth tailwinds on Cloud migration to drive topline growth. The key inhibitor is Autos – likely to drag down the earnings aggregate as it is impacted by semiconductor shortages for PVs amid demand concerns for 2W and tractors.

Nifty FY22E EPS has seen an upgrade of 2% to INR743 (v/s INR730), while Nifty FY23E EPS has remained almost unchanged at INR872 (v/s INR873). We introduce FY24E earnings and estimate Nifty FY24 EPS to be at INR993.

IT Services – growth to defy seasonality and remain strong (MOFSL)

The strong demand environment is expected to continue in 3QFY22, with Tier II players again outgrowing Tier I companies within our coverage universe.

Despite adverse seasonality, Tier I companies should deliver revenue growth in the 3.2-4.8% QoQ CC range, while Tier II players will have a wider band of 3.6- 7.1% (excluding PSYS, which will benefit from inorganic growth).

We expect a strong initial outlook for FY23E, with companies maintaining their view of multi-year growth tailwinds on the back of Cloud migration. Guidance for 4QFY22 is also expected to be positive on the back of continuing deal wins.

We see margins for most companies (excluding company-specific factors) to be in a narrow range as supply pressures (attrition and hiring) are offset by operating leverage. Among Tier I players, EBIT margin will be in a tight (-20bp to +40bp QoQ) range, although they will see a steep decline v/s 3QFY21 profitability.

Critical quarter for BFSI sector (Axis Securities)

The Banking sector will continue to deliver growth driven by a growth in the retail segment. Moreover, asset quality is expected to remain under control and challenges should further moderate on a QoQ basis. NIMs are likely to remain stable and might even see marginal improvement on a sequential basis. Moving forward, key focus areas will be growth prospects and fueling the corporate segment which is currently seeing some sluggishness. We will watch the top four banks very closely for growth guidance. The smaller banks are expected to continue focusing on maintaining asset quality in light of significant deterioration seen during the last one year. NBFCs will also be closely watched for asset quality. At this juncture, we

believe Q3FY22 will be similar to Q2FY22 for NBFCs and funding costs will remain manageable. Overall, earnings prospects should improve for the BFSI sector during the quarter and management commentary on growth would be a key monitorable.

Cement – demand recovery and softening costs (Emkay Equity Research)

Industry EBITDA/ton declined 11% YoY in Q3CY21 and remained under pressure in Q4CY21 due to input cost inflation and soft demand. However, cost inflation should ease off from early CY22E with a softening in input prices (down 15-40% from recent peaks). After a ~50% increase in the past two years, industry EBITDA/ton is expected to remain flat in CY21 but is likely to increase by 4-5% in CY22E.

Expect demand to likely grow by 8-9% YoY in CY22E (vs. 6-7% long-term historical average), driven by higher infra spending, pick-up in the housing segment and revival in urban real estate activity. The South and West regions should see 8-9% growth on a low base, while the North regions may clock 6-7% growth. While demand has been impacted in the past few months by heavy rainfall, construction bans in North, sand mining issues in East and limited labor availability, it should pick up in the coming months with the onset of a busy construction season and easing inflation in construction costs.

Maintain our positive view on the sector based on robust earnings compounding and a structural RoIC reset, with medium-term demand growth visibility and calibrated supply additions.

Speciality Chemicals – strong underlying trend

Estimate our chemical coverage universe revenue to grow at 42% YoY (7% QoQ) during Q3FY22 on sharp rise in prices due to input cost inflation. However, gross profit is also expected to grow 29% YoY which indicates strong underlying trend.

Steel – Margins to normalize (Prabhudas Liladhar)

Expect EBITDA of steel companies under our coverage universe to fall sharply by 19% QoQ due to lower volumes and contraction in margins. Sales volume is expected to contract by 6.5% QoQ due to subdued domestic demand. Steel realisations would increase by 2.5% QoQ/Rs1,500/t, falling short of expected rise of 10% QoQ/Rs4,500/t in costs on account of higher coking coal cost. Owing to higher costs partially offset by increase in realisations, EBITDA margins would fall by 14% QoQ/Rs3,130 to Rs19,880.

Chinese steel demand is estimated to fall by 4.7% YoY in CY21e at ~955mnt due to weakness in housing and auto sector, compounded with little support from Govt’s spending.

Margins came off sharply QoQ in Q3FY22e due to 2x increase in coking coal cost and soft realisations coupled with weak demand in both domestic and exports market. Factoring US$50 drop in steel prices offset by US$15/t lower coking coal prices, we expect EBITDA/t to stabilise at normalised level of Rs15,000/20,000 for non-integrated/integrated producers in Q4FY22e. Even after the fall, normalized margins are 33% higher over the historical average.

Capital Goods – Mixed bag (IIFL Securities)

While short-cycle industrials continue to lead with healthy growth, the pace of rebound in the long-cycle portfolio has remained soft in 3QFY22, partially marred by headwinds in construction activities and by inflation. Recovery in government ordering has been muted, resulting in bunch-up for 4QFY22, with likelihood of slippages; yet, overall inflows have increased QoQ. Investment sentiment across private & infra projects remains positive and will not be deterred by Covid 3.0.

Inflationary headwinds and resultant delay in order finalisation from the govt. sector persisted in 3QFY22 too, adding risks of order slippages to 1HFY23. Ordering in Defence, Metro, O&G pipelines and the water segment was better, while remaining muted in rail, road and T&D. Private-sector ordering in both, short-cycle as well as projects in B&F, FGDs, WHR, data centres and manufacturing sectors, continued to show an uptick.

Real Estate – affordability remains high, demand robust (HDFC Securities)

3QFY22 seems to be promising for the Tier 1 developers. Despite an inauspicious period, holiday season toward Dec-21 second half and emergence of Omicron, 3QFY22 presales remained healthy. Whilst Jan-22 second half was expected to be launch heavy, we believe that Omicron driven COVID-19 wave three will push back the launches towards end of Q4FY22.

Our recent channel checks with leading real estate channel partners suggest that demand momentum remains strong and Tier 1 developers continue to gain market share. Affordability driven demand, rising income levels and near low mortgage rates are some of the factors contributing to the sales. Whilst globally interest rates are expected to harden, a 25-50bps increase may not result in demand destruction. Developers remain accommodative on pricing as most of them are holding historical land bank besides commodities prices are off highs. Whilst we expect property prices to re-rate it may be on the back of more sustained economic recovery and positive sentiments on consumption.

We expect the aggregate revenue/EBITDA/PAT for the coverage universe to grow sequentially by 2/2/5%. The impact of commodities’ prices will smoothen over the project completion period as companies will take the hit once projects complete. Overall, taking price hikes may derail recovery and developers may not go ahead with the same.

Auto – Weak due to demand and raw material headwinds (Nirmal Bang Equities)

We expect 3QFY22 earnings of Auto & Auto Ancillary companies in our coverage universe to be relatively subdued due to sustained input cost headwinds and muted demand (weak festivals, supply chain constraints and moderating rural growth). We anticipate gross margin contraction of 10-40bps on a QoQ basis due to continued RM cost pressures. However, with major commodities showing signs of stabilizing/moderating prices at current levels, we note that further impact on gross margins could be limited. EBITDA margins should witness softer trends on YoY basis, but will be partially supported on a QoQ basis by positive operating leverage, price hikes and tight cost controls across most companies. We surmise that current issues of supply chain constraints and rising covid cases are dynamic, but we see them leading to subdued demand and weak profitability in 4QFY22 too. For 2Ws, narration on demand revival and electrification transition efforts would be a key monitorable while a sustained demand recovery in 4QFY22 is critical for CVs.

Chart for the day

 

Thought for the day

“Common sense is the collection of prejudices acquired by age eighteen.”

—Albert Einstein (German Physicist, 1879-1955)

Word for the day

Skookum (adj)

Large; powerful; impressive.

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The Publisher of this note do not offer any portfolio management, brokerage, money management, equity research or investment advisory services of any kind. Please take advise of a qualified and registered investment advisor before taking any investment decision.

Material from these reports may be copied freely, without any need for permission from the Publishers. This is however subject to copyright consideration of the contents of third parties.

Please refer to the attached PDF for full report important disclosures.

 

 

 State of the economy

The National Statistical Office (NSO) recently issued the first advance estimates (FAE) of GDP for FY22. This event is considered important, because these estimates are essentially used as input for preparing budget estimates for the next year (in this case FY23). The estimates are derived by extrapolating the previous year (in this case FY21) final estimates using the performance of sector indices in the first 7 to 9 months of the current financial year. These estimates may be subject to substantial revision in case of a material event that may impact the economic performance during the fourth quarter of the current financial year, e.g., lockdown during March of FY20.

FY22e Real GDP to grow 9.2%

NSO has estimated FY22 GDP to grow at 9.2% (-7.3% in FY21), lower than the recent estimates of RBI (9.5%).

Although the FAE accounts for slower growth (~5.6%) in 2HFY22 against 13.7% in 1HFY22, these estimates may not have fully factored in the impact of recent surge in cases of Covid and consequent mobility restrictions. Thus, there is a risk that the actual GDP might be slightly lower than FAE.

The GVA (GDP + subsidies on products – taxes) growth is expected to be 8.6%. This implies that NSO has factored in continuing buoyancy in tax collections in 4QFY22 also.

Most of the higher growth rate in FY22 could be attributed to the low base. As per the FAE, the real GDP for FY22 could be just 1.3% higher than the real GDP for FY20, implying less than 0.7% CAGR for 2years (FY21 and FY22).

Elevated inflation to reflect in higher nominal GDP growth

Elevated price pressures are expected to reflect in higher nominal GDP growth, which is expected to be 17.6% in FY22 (-3% in FY21). It is noteworthy that price pressure has remained elevated in FY22 across goods (food, fuel and others) and services.

 Private consumption continue to be sluggish

NSO has estimated private consumption expenditure to grow at a sluggish rate of 6.9% in FY22. This implies that the private consumption in FY22 will remain ~3% below the pre pandemic level (FY20). At 54.8% of GDP, the share of private consumption in real GDP is expected to be lowest in 8 years.

Besides, the key GDP component of Trade, Hotels, Transport and Communication is also expected to remain ~9% below the pre pandemic level (FY20).

It is pertinent to note that higher inflation of FY22 has so far not resulted in significant monetary tightening. Though the benchmark yields have seen significant rise in FY22 (from 6.05% in March 2021 to 6.6% presently), it has so far not reflected in lending rates. For example, SBI MCLR has remained unchanged during FY22 for most tenure.

Government consumption also to slow down

The consumption demand in the economy has been mostly driven by government consumption in crisis time. In FY22 government consumption expense is expected to slow down to 11.6% of real GDP from 11.7% in FY21; though it shall remain higher than 10.6% seen in FY20.

In absolute terms, government consumption is expected to grow 7.5% (at fixed prices) over FY21 and 15% in nominal terms.

Investment growth healthy

Investments are projected to grow at a healthy pace in FY22. NSO expects investments to be 29.6% of FY22 estimated nominal GDP, which is the highest level since FY15. In FY22, investment (Gross Fixed Capital Formation or GFCF) is seen growing 29%. It is also expected to be 18% more than in FY20

Economy expected to grow faster in 2HFY22

NSO expects over half of the projected growth in agriculture, industry and services to come through in 2HFY22. Considering the current state of pandemic led mobility restrictions, these estimates may have some downside risk.

For example, NSO estimates factor in 60% of the projected annual growth in the hospitality sector to materialize in 2HFY22. Clearly this forecast is at risk.

Similarly, 58% of the over agriculture output is expected to materialize in 2HFY22. Considering the inclement weather conditions across North and East India, this estimate may be at some risk.

External risk could rise

Though the balance of payment remained in surplus during 2QFY22, the external risks could rise if exports fail to pick up materially in FY23.

In FY22, BoP has been supported by a capital account surplus of US$40bn (5.3% of GDP) led by higher SDR allocation by the IMF; increased FPI debt inflows; FDI inflows, external borrowings and NRI deposits. However both FDI and FPI inflows have slowed down in recent months.

As per various estimates, a wider trade deficit ($190bn FY22e and $200bn FY23e) is expected to lead the current account deficit to 1.7% in FY22. Kotak Equity Research expects CAD to be 1.7% of GDP, and cautions that for every US$10/bbl increase in average crude price, CAD may increase by US$17 bn (0.5% of GDP). These estimates also assume inclusion of India in global bond indices and consequent $25bn debt inflows. Failing which, the pressure on INR may increase forcing RBI to intervene more aggressively.

Fiscal deficit contained

The government has been to contain the fiscal deficit in April-November 2021 period with the help of lower revenue expenditure, higher tax collections and dividends, and spectrum receipts. However, the disinvestment receipts are significantly lower than the budget estimates.

The lower fiscal deficit allows some leverage to the government to increase investment and consumption expenditure in the last quarter to support demand during the current phase of pandemic restrictions. If this is the case, the yields may continue to stay elevated and pressure on INR will sustain.

Conclusion

Though the Indian economy has recovered well from the shock of pandemic, the recovery is not broad based and continues to be fragile. On the supply side, the two key drivers of growth, i.e., manufacturing and exports continue to lag; whereas on the demand side private consumption continues to be vulnerable. This makes the policy making function rather challenging. Continued supply side constraints may keep the pressure on prices high; tightening the hands of RBI. A rate hike on the other side may hit the already sluggish demand even harder.

FY23 could be a struggle to attain balance between these counter pressures. Obviously the government will have a larger role to play in this and fiscal policy will become more relevant than monetary policy.

Last week, I mentioned that unemployment in India is a multidimensional problem and it would require a multipronged strategy. The traditional “industrialization” strategy may not yield much significant results in the modern Indian context as the industries are now mostly capital and technology intensive and offer significantly lower opportunities for unskilled and semi-skilled workers, which form a large part of the Indian workforce. Implementing the traditional Keynesian model of creating employment through public spending is also challenging due to stressed fiscal conditions, focus on privatization of public enterprises, and diminishing labour intensity of construction activity.

In the past fifteen years MNREGA (Rural capacity building) and PMGSY (Rural roads to improve accessibility) have been extremely successful in generating rural employment. These two schemes have not only supported the rural economy during the period of stress, but also created much useful capacities in the rural areas. Especially, the connectivity provided through roads built under PMGSY has been transformative for the economy of numerous villages in hinterlands and remote hills. However, these jobs are mostly seasonal and meant for unskilled rural labour. Their productivity and sustainability has been questioned by various studies.

Surfing through social media for a couple of hours, one could easily find out how the youth of our country are dissipating themselves in frivolous activities. It is therefore imperative that more productive and sustainable solutions are found to solve the unemployment problem of the country.

I would like to make the following three suggestions for improving the employment situation in India. Admittedly, these are random thoughts based on my personal explorations and understanding of India’s socio-economic milieu. In a typical bureaucratic manner, these ideas could be rejected as impractical or even flimsy. Else, these could be evaluated as starting points for developing something useful.

1.  Bring factories to farms

The employment elasticity of growth in manufacturing, agriculture and construction sectors has been decreasing consistently. This trend shall only accelerate in future. Most of the growth shall come from higher productivity through automation, innovation and consolidation. Elimination of redundancies and economies of scale shall lead the growth effort. The number of jobs, especially unskilled and low skill jobs shall remain limited.

Implementation of a common GST, nationwide agriculture market, ecommerce, automation (AI) etc., is leading to business consolidation in a major way. This may also potentially eliminate millions of unskilled and low skill jobs in the next decades or so.

The historical transition of farm workers to industry during the developing stage of growth may not work in the current Indian context. The so-called developed economies have transited the labour from farm to factories, when industry and mining were still labour intensive and global competition was not much. The productivity gains were immediate and tangible. It is no longer the case. The industry in India is already capital intensive. Even traditional labour intensive industries like gems & jewellery, textile, leather, mining and construction are becoming increasingly automated to stay viable against the global competition.

The ambitious Make in India program mostly aims to substitute imports. We are trying to compete with manufacturing powerhouses like China, Vietnam, Taiwan, etc. This defies the basic principle of making economic decisions, viz., everyone should do what they can do best to optimize the resource utilization.

Emulating China model may not work in India, as our political and economic model is entirely different. Moreover, the skill and training requirements for modern industry do not allow a straight farm to factory transition. So the options get limited to unskilled construction sector jobs and building industry around farms where the skill of the farmers could be suitable employed.

While MNREGA and the ambitious rural road program is taking care of unskilled construction jobs, there is little effort to take factories to farms. Encourage industry to partner with farm cooperatives to set up food processing units at the farms. The farmers' cooperative allots land and provides farm produce, whereas the entrepreneurs contribute capital and undertake marketing and sales responsibilities. Both share the profit in pre-agreed ratio. This should maximize profit of both the industrial enterprise as well farmers, and create ample employment opportunities close to villages.

Allow corporates to develop waste and barren land for farming purposes. For example, many corporates from India and the Arab world may be interested in developing Rajasthan and Gujarat desert and barren lands for growing dates, palm, aloe etc.

2.  Initiate public sector agriculture

Since independence the government has focused on development of industrial infrastructure in the country. It has actively participated in the endeavor through a large number of public sector enterprises; besides offering a myriad tax and other concessions to the private entrepreneurs. Now, the country has a reasonably strong industrial base. Many of our industries are globally competitive. We have a strong set of entrepreneurs and risk takers. It is therefore high time when the government should reset its priorities and turn its primary focus on agriculture. To meet this end, the government may consider:

·         Exiting all industrial and banking activities and actively undertake agricultural activities. It should develop barren lands; develop water bodies and irrigation facilities; develop and use technology for enhancing productivity; give employment to landless farmers; take risk with new technologies & crops; partner with marginal farmers in consolidating their land and do farming on that land - just the way it undertook industrial activities immediately after independence.

·         Undertake, on mission basis, the task to re-skill the underemployed farmers and farm labor. The farmers and their family members may be trained as dairy workers, domestic help, nurses, tourist guides, artisans, etc. Expecting the construction sector to absorb all surplus farm labor is a bad idea.

·         Develop at least 5 very large special agri export zones in rocky and desert areas of central and western India and undertake export of farm produce as a commercial activity. These zones may be developed in public, private or joint sectors. Besides, it may acquire farm assets, especially rice farms, overseas to reduce water intensity of Indian agriculture.

·         Encourage various states to make bilateral or multilateral agreements for procurement, processing and trading of farm produce and movement of labor within states.

·         Nationalize all rivers. Develop a national water grid. Set up a national water regulator, who shall work out a water sharing formula for all states and union territories every three year and maintain adequate provisions for managing droughts. The idea should be to ensure that not a drop of river water flows into sea from India. Develop a water distribution grid on the models of roads and power grids on a mission basis.

It has taken seven decades for Indian industries to reach a stage where the government may consider fully exiting the industrial activities. It may take 2-3 decades for Indian agriculture to reach a stage where the government will be able to exit farming activities completely.

Please note that I am also not suggesting nationalization of the agriculture sector. I am just saying that the government should undertake the activity on a commercial basis to provide the sector with much needed escape velocity in terms of capital, technology, and risk taking capability.

3.  Engage youth in nation building

The government must on priority prepare a comprehensive strategy for engaging youth in the nation development endeavor. A nationwide MNREGA type scheme may be launched for youth, whereby they could be engaged in socially useful productive work (SUPW). Millions of jobs like traffic management, night patrolling in areas susceptible to crime against women, enforcement of cleanliness of public areas, old age care, social forestry, teaching & skilling to unschooled, etc. could be assigned to the youth not having a regular job. This shall help in developing a sense of nationalism, belongingness, and responsibility amongst youth, besides keeping them occupied in productive jobs rather than leaving them on their own to waste time or take to the path of crime and unlawful activities.

Also read

Five shades of unemployment

Unemployment – misdirected policies

Few random thoughts on unemployment in India

 As I mentioned yesterday (see here), unemployment in India is a multidimensional problem. Unemployability (skill deficit), underemployment, disguised unemployment, gender disparity, regional disparities, are some of the contours that define the state of unemployment in India. The genesis of the reasons responsible may be traced to traditions, education system, colonial legacy, economic policies, and demographics. Obviously, the solution for a multidimensional problem also needs to be multidimensional. The classical solution, i.e., industrialization alone is definitely inadequate for managing the complex unemployment situation in India.

Employment framework in India

As per 6^th Economics Census (2013), there were 58.5mn business establishments (excluding public administration, crop production & plantation, defense and compulsory social service activities) operating in the country. Of these ~96% establishments were privately owned while just ~4% were government owned. These establishments employed 131.29mn people (52% in rural areas and 48% in urban areas).

·         About 60% of business establishments were in rural areas while about 40% operated in urban areas. Out of these, about 78% establishments were engaged in non-agriculture activities, while ~22% were engaged in agriculture related activities (excluding crop production and plantation).

·         During the 8yr period between 2005-2013, the business establishments grew by ~42% from ~41mn to ~58mn. In this period agriculture establishment grew ~116% while non-agriculture establishment grew ~29%.

·         Out of total ~58mn establishments about ~72% were Own Account establishments (meaning with no hired worker). These Self Owned Establishments (SOEs) grew 56% during 2005-2013. About 63mn people (48% of total employed people) are employed in these SOEs.

·         About 96% of establishments had less than 5 workers. Another 3% have 6-9 people employed.

·         The government or public sector employed only 7% of the people. 79% people worked in proprietary establishments. Organized private and cooperative sector employed only 14% people.

·         About 36% of business establishments were operated from the home of the Self Owner, while another ~18% were operated from outside the home without any fixed structure.

·         Livestock accounted for ~87% of the agriculture activity.

·         Retail trade (~35%) and Manufacturing (~23%) were dominant non-agricultural activities.

·         Out of 1.87mn handicraft/handloom establishments, employing 4.2mn people, 79% were family affairs without any hired worker.

From this data, I decipher that—

(a)   About 96% establishments have less than 5 workers. Another 3% have 6-9 people employed. Only three states - Tamil Nadu (13.81%), West Bengal (11.07%) and Maharashtra (10.02%) have more than 10% establishments with 10 or more workers.

Most of the legislations relating to employment and social security provisions (ESI, EPF, Gratuity, Bonus etc.) apply only to the establishments with 10 or more hired workers. Implying that only ~1% of the total private workforce is eligible for statutory social security benefits. Even the new labour code (The Code of Social Security, 2020 that would subsume most of existing laws) covers only the establishments with 10 or more workers.

(b)   Livestock accounts for 87% of the agri sector related establishments. The whole of it cannot be dairy farming. Obviously, meat (including bovine meat) is a big business in terms of employment.

(c)    Out of 1.87mn handicraft/handloom establishments, employing 4.2mn people, 79% were family affairs without any hired worker.

From my experience I know for sure that a large number of these establishments employ household children as workers. In my knowledge none of the legislative provision or policies designed to prevent child labour and promote child safety and security deals adequately with a parent employing his child for his business, as the child is not a hired worker in this case.

The worst part is that if the parent business is impacted due to any adversity, the children are affected most, as they are mostly unemployable in other businesses.

(d)   About 36% of business establishments were operated from the home of the Self Owner, while another ~18% are operated from outside the home without any fixed structure.

From my experience I know that most of these business establishments may not exactly be "authorized" from civic and town planning view points. This creates a number of problems from everyone. Grocery and other daily need shops operating from homes; tailoring shops; automobile repair shops create nuisance for the neighborhood; pose environment and safety hazard; put pressure on civic amenities like power, water and sanitation; motivate corruption; and above all lead to serious problem of child labor, underemployment and disguised unemployment. Town planners, civic administrations, and government often fail to recognize & accept this phenomenon and therefore are unable to find acceptable solutions.

(e)    Retail trade (~35%) and Manufacturing (~23%) are dominant non-agricultural activities in the country.

Organized retail and automation in manufacturing are a potent threat to these traditional sources of employment to traditionally skilled and semi-skilled workers. The redundant traditionally skilled and semi-skilled workers would obviously be competing with the unskilled labour in construction and “gig work” space, leading to massive underemployment, mis-employment and unemployment.

Some more on this on Tuesday.

Trivia

Regardless of the government data, the telecom sector may have created most of the incremental employment opportunities in India in the past two decades. From Gangotri to Kanyakumari and From Tawang to Kutch, wherever you go, it is common to find small shops selling telecom products (prepaid cards, mobile phones and accessories) and phone repair services. Telecom is also at the core of the entire new economy and startup ecosystem. However, unlike the traditional employment provider textile, the government has never promoted the telecom sector. To the contrary, efforts have been made to weaken the sector.