Vijay Kumar Gaba

Recently, some RBI officials reportedly told the parliamentary standing committee on Finance that RBI fears increased “dollarization” of the Indian economy due to popularization of cryptocurrencies. The representatives of the central bank reportedly testified before the committee that “…almost all cryptocurrencies are dollar-denominated and issued by foreign private entities, which may eventually dollarize a segment of the Indian economy. The cryptocurrencies could be a medium of exchange and replace the rupee in financial transactions, both in domestic and cross-border transactions, affecting the monetary system and undermining the RBI’s capacity to regulate capital flow.”

In this context it is pertinent to note that—

(a)   As per the latest available World Bank data, foreign trade accounts for ~38% of India's GDP. A substantial part (~86%) of this trade is invoiced and settled in USD; whereas only 5% of India’s imports are from and 15% of India’s exports to US.

(b)   It is estimated that approximately 60 to 65% of India’s foreign currency reserves are held in US dollar assets.

(c)    At the end of FY21, India had about ~US$570bn of external debt; about 21% of GDP. Out of this ~18% was short term debt (due for repayment in 12months). Though the composition of this debt is not readily available it is safe to assume that a significant part of this debt is denominated either in USD or currencies that are pegged to USD or are closely linked to USD, e.g., CNY, AED, SAR, SGD etc.

(d)   In the recent consumer price inflation (CPI) data (April 2022), about 20% of the total CPI inflation was imported inflation, caused by rise in global prices and depreciation of INR against USD.

This implies that a substantial part of the Indian economy is already “dollarized”. To that extent, the concerns of the RBI are valid and understandable. This also explains the “go slow” policy on rupee convertibility and stricter control over capital account.

As per Gita Gopinath, renowned economist and Deputy Director IMF—

“The greater the fraction of a country's imports invoiced in a foreign currency the greater its inflation sensitivity to exchange rate fluctuations at both short (1 quarter) and long (2 year) horizons. For the U.S. with 93% of its imports invoiced in dollars the consequences are far more muted than for a country like India that has 97% of its imports invoiced in foreign currency (mainly dollars).

When a country's currency depreciates the expectation is that it will stimulate demand for the country's products as it lowers the relative price of its goods in world markets. This is unlikely to be the case for many countries that rely on foreign currency invoicing for their exports. This does not imply that exporters in non-dominant currency countries do not benefit from a weaker exchange rate. They do, but it mainly works through increases in mark-ups and profits even while the quantity exported does not change significantly. The benefits of higher profits in a world with financial frictions can of course be large and raise production and export capacity in the longer run.”

The question is what India should do to avoid dollarization of the economy. Obviously, banning cryptocurrencies and controlling foreign currency transactions may not be sufficient. We would need to materially increase the invoicing of our exports in INR.

The Nobel laureate Robert Mundell propounded the Mundell-Fleming paradigm in 1999 to address this issue. As per this paradigm, to gain from the weakness in local currency (vs other currencies), the exports must be invoiced in local currency.

For example, if Indian exporters invoice their products/services in INR, their prices do not fluctuate often. In this case, depreciation of INR against the importers’ currency will immediately result in cheaper cost for the importer and therefore lead to demand shift towards Indian products/services. However, if Indian exporters price their products/services in USD (as is the case presently) the shift to Indian producers will depend upon the equation between USD and Importer’s currency.

The key for India therefore is to develop more bilateral relations where the trade could be conducted in local currencies, e.g., India exporting in INR and importing in the currency of suppliers. The bilateral FTA route being adopted by India in the recent past is perhaps the best way to achieve this goal.

The most interesting part of this changing paradigm would be how the bilateral trade relationship between India and China develops. China is one of our largest trade partners. Trade relations with China are obviously critical for India’s overall economic growth and development. The ideal outcome would be if we can reduce our trade deficit with China through mutual agreements, e.g., by increasing export of services, food etc.

 The macro economic data released last week produced further evidence of the Indian economy struggling with stagflationary conditions; notwithstanding the denial by various authorities.

Inflation impact widening and deepening

The consumer price inflation date for the month of April 2022 was a negative surprise. The consumer prices escalated at a rate of 7.8% (yoy) during the month. The higher inflation was, to a large extent, a consequence of imported inflation which added almost 2% to the headline inflation number. Though, the inflation due to rise in domestic prices at 6.4% was also no comfort.

With worsening current account (and depreciating INR); continuing supply chain disruptions; protracting Russia-Ukraine conflict; extreme weather conditions and tight fiscal conditions (little chance of duty cuts) and rising cost of capital – it is unlikely that we shall see any material easing in prices in the next few months; even though the headline inflation number begins to ease from October 2022 due to statistical reasons, as the high base kick in.

Contracting consumer demand constricting the growth

On the other hand, the recent data about the growth in Industrial Production raised many red flags. The IIP growth for 4QFY22 has come at a dismal 1.6% (vs 2.1% in 3QFY22).

The consumer goods production (both durable and non-durable) contracted 4.3% in March 2022, recording its sixth consecutive decline. This clearly shows the stress in the consumer demand. Growth in capital goods was a poor 0.7%. Manufacturing growth in March was also poor at 0.9% yoy. 

Normalizing for the sharp dip in 2020 due to the pandemic induced lockdown and subsequent sharp spike in 2021, India’s Industrial Production has been dismal in the past decade.

Poor suffering the most

Notwithstanding the claims of some politicians, the poor seem to be hurt most by the rising inflation and slower growth. As per the latest NSO data, the inflation rate is much higher in most populous states like West Bengal (9.1%), Madhya Pradesh (9.1%), Maharashtra (8.8%), Uttar Pradesh (8.5%0, Odisha (8.1%0 and Rajasthan (8.1%). These states may be home to a large proportion of the poor population in the country.

Kerala (5.1%) and Tamil Nadu (5.4%) are suffering relatively much lower inflation.

Besides, the real interest rates have fallen deep into negative territory in the past couple of years, as monetary stimulus to mitigate the pandemic effects has brought the rates lower while inflation has stayed high. Obviously the poor savers and pensioners who rely on meager interest income for survival are suffering a great deal.

The conventional wisdom guides that roads are meant for moving forward and trampolines are meant to get momentary high without going anywhere. Usually, the chances of reaching the planned destination are highest if the traveller takes a straight road. The chances are the least if they ride a trampoline. Walking on ropes may sometimes give you limited success.

Investors who jump up and down with every bit of news are only likely to lose their vital energy and time without moving an inch forward. Reacting instantaneously to every monthly or quarterly data, every policy proposal, corporate announcement, market rumor are some examples of circuitous roads or short cuts that usually lead us nowhere.

The developments in global financial markets in the past couple of years highlight that presently very few persons are interested in taking the straight road.

Taking the straight road means investing in businesses that are likely to do well (sustainable revenue growth and profitability); generating strong cash flows; maintaining sustainable gearing; timely adapting to the emerging technology and market trends; and most important consistently enhancing the shareholders’ value. These businesses need necessarily not be fashionable or be in the “hot sectors”.

In the Indian context, finding a straight road is rather easy for investors. Of course there are different viewpoints and strategies; having their own merits and inadequacies. It is possible that the outcome is different for various investors who adopt different strategies or take a different approach to invest in India.

For example, consider the case of investment in the infrastructure sector in India. Prima facie, it looks like a rather simple strategy. In an infrastructure deficient country like India, the case for investment in this sector should be rather simple and straightforward. But it has not been the case in the past 20 years.

Infrastructure has made money only for few

Infrastructure inadequacy of India has been one of the most common investment themes for the past few decades. However, more people may have destroyed their wealth by investing in infrastructure businesses or stocks of infrastructure companies than anything else. Especially in the past two decades, that have seen phenomenal development in infrastructure capacity building, the value destruction for investors in this sector has been equally remarkable.

There is no dearth of infrastructure builders who have become bankrupt with near total erosion of investors’ wealth who invested in their businesses. JPA Group, ADAG Group, Lanco, IL&FS, GVK, IVRCL, Gammon etc. are just a few examples. Their lenders, and the investors in their lenders, have been a colossal collateral damage too.

The fallacy in this case lies in the fact that while everyone focused on the “need” for infrastructure, few cared about the “demand”.

Indubitably, the “need” for infrastructure, both social and physical, in India is tremendous. However, despite significant growth effort in the past two decades, and manifold rise in government support for the society, especially poor and farmers who happen to constitute over two third of India’s population, the “demand” for infrastructure may not have grown at equal pace. The affordability and accessibility to basic amenities like roads, power, sanitation, education, health, transportation, housing etc., has improved a lot, but it still remains low.

As per a recent government admission almost one third of the population cannot afford to buy basic cereals at market price and therefore need to be subsidized. Only about one third of the adult population has access to some formal source of financing. Ever rising losses of state electricity boards and free electricity as one of the primary election promises, highlight incapacity or unwillingness of the people to pay for their power bills. The losses incurred by some of the most famous highway projects, e.g., Yamuna Expressway, highlights the low affordability to pay toll tax for using roads.

The optimism on the infrastructure sector in the decade of 2001-2010 might have been a consequence of overconfidence and indulgence of administration and corporates who sought to advance the demand for civic amenities to make abnormal profits. This was not only a classic case of capital misallocation, but also misgovernance by allowing a select few to take advantage of policy arbitrage. This has resulted in huge losses for investors, lenders, local bodies and eventually the central government also.

The investment in infrastructure companies’ stocks for a small investor is therefore a tight rope walk. They may achieve some success after a stressful balancing act to normalize the forces of greed and fear.

With over two third of the population struggling to meet two ends, all those statistics claiming “low per capita consumption or ownership” of metals, power, housing, personal vehicles, air travel etc. is nothing but a blind man holding the tail of the elephant. If we find per capita consumption of electricity of the population that has access to 24X7 electricity and can afford to pay full bill for this at the market rates, we may be in the top quartile of per capita electricity consumption.

The politics of “competitive majoritism” has also led to irrevocable government commitments towards profligate welfare spending. This has certainly provided some sustainable spending capability to the expansive bottom of the Indian population pyramid. This clearly indicates that the government finances are likely to remain under pressure for a protracted period. Therefore, in my view, capex and infrastructure themes may work sustainably in Indian markets only when necessary corrections are carried out. Till then it is the trampoline ride that will continue to give investors momentary highs, without taking them much distance.

The investors and traders, who jumped on this trampoline after listening to the enthusiastic budget speech in February 2022 promising trillions of rupees in infrastructure spending, would understand the best, what I am trying to suggest here.

I have been married for more than two decades now. In all these years I have deliberately maintained a safe distance between my personal and professional life. My wife Anandi, a post graduate in Hindustani Classical music and an amateur poetess has never shown any interest in the matters relating to finance. She finds it too “dry and mundane”. Last few days though have been a little different. To my surprise, Anandi herself started a discussion on stock market. At once, I could not fathom why she would be suddenly interested in what she always believed to be the mired world of finance and investments. But soon I realized the catalyst of this change- it was her cousin brother Anuj, who has apparently lost heavily in the recent collapse in the stock market.

If we have to list the reasons for the loss of growth momentum in our economy in the past decade or so, the following three would be amongst the top reasons:

There is an old legend. From time to time, numerous versions of this legend have been narrated by wise people to highlight the adverse effects of not admitting the mistakes early enough; indecision; and failure to assess the gravity of an adverse situation. One version of the legend goes like this—

Once a thief was caught stealing a sack of onions from a farmer’s house, and was produced before the magistrate. On asking, the thief first pleaded “not guilty”. After a trial the magistrate found him guilty of stealing and allowed him to choose his punishment from the following three options – (i) Pay five gold coins to the farmer; (ii) eat hundred onions from the sack he tried to steal; or (iii) get whiplashed hundred times.

The thief chose to eat the hundred onions, without giving it a thought, assuming it to be the easiest one. However, after eating just twenty five onions, he was in tears. His stomach started to burn and refused to take anymore. He begged the magistrate to change his punishment to a hundred whiplashes. The magistrate allowed his request and ordered his men to whiplash the thief a hundred times. After taking twenty five lashes his skin started to come off and pain started to become unbearable. He again implored the magistrate to stop his men and allow him to eat onions. The magistrate agreed to his request. He ate another twenty five onions and could see the grim reapers (Yumdoot) standing right in front of his eyes. He now pleaded to the magistrate to allow him to pay five gold coins. Had you stopped for a couple of minutes to think about the options presented to you, you would not have suffered so much the magistrate chided him, agreeing to his request.

The moral of the story is that if the thief had admitted his mistake early, the magistrate could have let him off with a milder sentence. He chose a sentence which he had no clue about, rather than opting for the clearly defined monetary fine. Also, despite suffering once, he still did not opt for the right option and suffered an avoidable twenty five lashes and twenty five more onions.

The situation of the Reserve Bank of India (RBI) is somewhat similar to the thief in the legend. It refuses to admit that it has been confused between growth and inflation for long. It also refuses to accept that in the present situation the factors driving the inflation are mostly beyond its control; and it can only manage a small part of the inflation by hurting the growth significantly and imperiling the financial stability!

Palpably, the out of turn rate hike by RBI is aimed to protect the INR. The fear of the larger outflows, as other central bankers hike rates aggressively, appears to have prompted the RBI to make a preemptive hike. The currency market though does not appear impressed by the RBI move, and INR has weakened to its lowest level ever. The outflows have continued in the equity as well as debt market, despite higher yields (bonds) and lower valuations (equity). The RBI might thus have wasted one important arrow (40bps rate hike) in its quiver.

The situation is vividly reminiscent of the current account crisis of 2012-2013. The INR witnessed violent volatility and outflows were strong in light of taper tantrums. The rate hikes at that time did not help much and we were very close to a balance of payment crisis. The RBI changed its approach in September 2014 and an imminent disaster was averted, but not without some serious damage to the financial stability and growth ecosystem.

I assume this time we will not be driven to the brink like 2013, and the crisis will be mitigated soon. For now we are eating onions only. I hope the economy will be spared whiplash and gold coins.

The Monetary Policy Committee of the Reserve Bank of India, in an unscheduled meeting on 04 March 2022, decided to hike the policy repo rate by an unconventional 40bps to 4.4%. Besides, the RBI also decided to increase the standing deposit facility (SDF) and marginal standing facility (MSF) rate by 40bps to 4.15% and 4.65% respectively. The cash reserve ratio (CRR) for the banks has also been increased by 50bps to 4.5%. This action of the RBI is not entirely surprising, given that the consumer inflation (CPI) rate in the country has been consistently running close to or over the RBI’s tolerance band for the past many months.

The decision of the RBI came a few hours after an unscheduled 25bps hike by the Royal Bank of Australia (RBA) and a few hours before the much anticipated 50bps hike by the Federal Reserve of the USA (the Fed). With this over 55 central bankers have hiked their respective policy rates in the past 10 weeks. This includes about one half of the members of G-20. Interestingly, the countries struggling with financial crises and growth like Zimbabwe (2000bps); Sri Lanka (700bps) and Pakistan (250bps) have tightened most aggressively in the past 10weeks. Besides, Australia, the commodity exporters of Africa and Americas have also hiked the rates. Russia and Singapore are the only two notable countries that have cut the policy rates since March 2022.

Evidently, inflation is the overriding concern of most central bankers at this point in time. Even the central bankers like US Federal Reserve and Reserve Bank of India which were insisting that inflation is transient, being a consequence of the temporary supply chain disruptions due to the pandemic, and could be surmounted by focusing on growth, are now according higher priority to price stability rather than growth. Both the Fed and RBI have hiked rates despite palpable slowdown in the growth in recent quarters, and consensus downward revision of the future growth forecasts. Obviously, the policy decisions lacked conviction and thus did not elicit the desired response from commodity, currency and bond markets.

The Fed itself blunted its attack on inflation by ruling out aggressive hikes of 75bps in the forthcoming policy meets. The RBI governor was conspicuously apologetic while making the announcement. It is pertinent to note that bonds and currency markets were already anticipating these hikes and had discounted some of the impact beforehand; these actions were mostly expected to have “signaling” value for the markets only. By communicating a weak signal both the fed and RBI have disappointed the markets.

RBI takes a ‘curved’ path

For the past four years, the RBI had been following a straight path. It gave top priority to economic growth, followed by financial stability and price stability in that order. The commitment to this order of priority afforded it the strength to handle the pandemic led crisis remarkably well, while aiding the government efforts to stimulate the growth. Both the RBI and the government were seen operating in perfect tandem, unlike in the preceding years when the monetary and fiscal policies were often at odds.

With this decision, the RBI seems to have deviated from the straight path to take a curvaceous road. Under the pressure to stay on or ahead of the ‘curve’, the RBI has distorted its order of priorities.

It is a common belief that most of India’s current inflation has been caused by (a) high prices of imported energy, edible oil and industrial metals; (b) higher fruits & vegetables prices due to poor weather conditions; (c) rise in food prices due to higher support prices and (d) global supply chain disruption impacting the production. There is no sign of over speculation in the domestic commodities markets. There is no sign of overheating in the housing or auto markets. The credit growth has been below normal for past three years. It is difficult to explain how, in the Indian context, a rate hike could calm down the prices, except by destroying the demand that itself is below normal. In fact only a couple of day ago, the RBI itself has forecasted that it will take 12 more years to fully recoup the losses suffered by the economy due to the pandemic.

On the negative side however, higher rates will further constrict the already tight fiscal space for the government. Higher interest expense would have to be compensated by lower spending, as in a falling growth environment hiking tax rates may not be a viable option. A stronger INR (due to higher rates) could negatively impact the exports that have been the only bright feature in the struggling Indian economy in the past two years.

…ignoring the latest empirical evidence

The most unfortunate part of this episode is that the RBI has not learned anything from history. During 2010-2014, when the economy was still struggling to overcome the effects of the global financial crisis, the RBI started hiking rates unceremoniously from 5% in March 2010 to 8% in January 2014. These hikes not only negatively impacted the recovery, but also weakened the financial system materially. The rate had to be cut by 50% to 4% in the next 6 years to stabilize the financial system and bring the economy back on the growth path. It is important to remember that the RBI was cutting rates consistently from January 2015 (except two hikes of 25bps each in June and August 2018). Only the last 40bps was cut as a pandemic stimulus in March 2020.

…and trampling on the nascent economic recovery

A 40bps higher policy rates, in conjunction with the 50bps hike in CRR and 80bps hike in the effective reverse repo (including 40bps done in April MPC meet) will definitely tighten the money market, impacting the working capital facilities and short duration personal loans. Given that we are in a lean season, the impact on the overall credit market may not be visible immediately, but the impact on growth may be felt in 2HFY23. The higher cost of capital may further delay the elusive capex recovery.

Impact for equity markets

A popular saying in the equity markets literature says, “Market stops panicking when the central bankers begin to panic”. If we go by this saying, we should be expecting a bottom in the equity markets very soon.

I am not sure if this saying will come true this time (even though I am secretly wishing for it). In my view, the markets will eventually call the bluff of central bankers and force them to revert to the straight path. Till then I expect the equity markets to stay volatile and range bound. Obviously, this market is for the swing traders to make money. For investors, it may be advisable to follow another popular market saying – “Sell in May and come back in October”.

For the past two years, I have been highlighting to the readers of this blog that almost two third of the Indian population is experiencing conditions that qualify to be termed stagflationary. Their incomes have been stagnant or declining in many cases, while their cost of living has risen materially.

The past few months have been quite trying for investors and traders in the financial and commodity markets. The markets have been jittery, and indecisive. Obviously, the market participants are becoming somber in their market outlook for the short term.

The global order is perhaps undergoing a major reset and the picture of emerging global order is incomplete. Consequently, the present global economic, geopolitical and financial conditions are quite uncertain and challenging.

As per the conventional wisdom, at this time the investors should be busy assessing the likely contours of the emerging global order, forecasting the investment opportunities and positioning themselves as per their assessments; whereas the traders should be deciphering the opportunities arising due to the transition. The shifting investors’ positioning may create opportunities for the traders in the markets.

I noted the following key trends in the markets to assess how the investors’ positioning is shifting and where traders are finding opportunities. However, I am not sure if the current market positionings are totally in consonance with the conventional wisdom. Maybe, it is early days in the transition; or the uncertainties are too much; or it’s a combination of both. Perhaps, we would know this with the benefit of hindsight only.

1.    After lagging the emerging markets for 15years, the developed markets have started to outperform in the past one year. Prima facie it may look like a case of rising risk aversion amongst global traders. But investors must be appreciating that the risk in developed markets is much more pronounced than the emerging markets. The central bankers may have exhausted the newly acquired monetary policy tools that supported the developed economies and consumers in the post Lehman era. Unwinding of unsustainable liquidity and debt may bring more developed economies to the brink than the emerging markets.

For example, in the past 5years most of the sovereign debt issued in the Euro area has been bought by the European Central Bank (ECB). The countries that infamously came to the brink during the global financial crisis (Spain, Italy, Greece etc.) have raised huge debt without demonstrating any sustainable improvement in their servicing capability. Now since the ECB is unwinding its bond buying program, next year over EUR250bn worth of sovereign debt will have to be sold to the private investors who may not be as obliging as ECB has been in the past 12years. Unsustainable debt at the time of rising rates would make these countries riskier than the emerging markets like China, India, Brazil, Korea etc.

Even the USA, is facing a stagflation like condition. Rising rates may make USD stronger and hurt the US exports, further pressurizing the growth.

2.    Most of the countries are struggling with inflation that is mostly a supply side phenomenon. However, instead of improving the global cooperation to ease the supply chain bottlenecks and stimulate investment in further capacity building, most countries have chosen to stifle the global cooperation and invest in local capacities. This will (i) prolong the present supply shortages and (ii) have far reaching implications for global trade and cooperation.

3.    Investors have not preferred the conventional safe havens like gold, CHF, US treasuries etc. in the past one year and the EM currencies have not sold out the way these used be in past instances of extreme risk aversion.

4.    Numerous experts are calling for commodity supercycle and persistent inflation. This is a clear case of mistrust in effectiveness of the central bankers, who have not only successfully averted two major disasters in the past 12years – first the global market freeze post Lehman collapse and secondly global lockdown post outbreak of pandemic. I find no reason to believe that they will fail in reining the inflation using monetary policy tools. In fact most commodity prices have shown signs of peaking after the US Fed's aggressive posturing on monetary tightening. Higher cost of carry, tighter margins and slower growth should kill the inflationary expectations in no time; particularly when most of the commodity demand could actually be speculative or in anticipation of future demand assuming the present tightness in supply to continue.

For record, the commodity heavy stock market of Brazil has been one of the worst performers in the past one month.

5.    The criticism of cryptocurrencies is weakening and their acceptance is rising by the day. Many harsh critics of cryptoes have softened their stand to conditional criticism. While the opposition to cryptoes use as currency is still strong, their role as store of value is gaining wider acceptance. Obviously, it will have implications for Gold and USD –the two most important conventional ‘store of value’ instruments.

6.    The global investors seem to be losing hope in China now. Till last year the valuation argument was very strong in favor of Chinese equities. No longer is the case. Despite 15yrs of no return, not many are arguing convincingly for Chinese equities now.

7.    The Free Trade Agreement (FTA) between the UK and India may be a positive consequence of Brexit for India. The FTA with Australia has also been signed. India has defended its bilateral trade relations with Russia despite immense global pressures in the wake of ongoing Russia-Ukraine war. Besides, the UN has not taken any significant measures to end the war.

It has to be seen whether we are entering an era of bilateralism at the expense of dissipation of multilateralism. If that be so, the role of the multilateral charters like WTO, UN, IMF etc. will have to be reassessed in the emerging global order. 

The government is making an offer for sale (OFS) for 3.5% stake in the Life Insurance Corporation of India (LIC). At Rs 902, the lower point of the price band fixed for OFS, the LIC will be valued at Rs 5.7 trn. At this valuation it will be the fifth largest publicly listed Indian entity. The OFS will yield Rs199.7bn to the government, about 30.6% of the total disinvestment target of Rs650bn fixed for FY23. The government has apparently cut the offer size from 5% announced in February 2022 to 3.5%, considering the jittery market conditions. We shall therefore see multiple follow-on offers from the government in the coming years.

If we go by the popular media narrative, the country is facing acute power crisis. Many states are witnessing scheduled power cuts of 1 to 3 hours. The headlines screaming about worsening coal shortages are scaring the users, as the already hotter summer weather is entering its peak phase in May and June. Some industrial units in the states like UP, Haryana, Delhi, Punjab, Rajasthan, Tamil Nadu and Andhra Pradesh etc., are reportedly considering production cuts, in case power situation worsens further, considering the high cost of diesel based power backup.

The government on its part has outrightly denied any power or coal crisis in the country. The concerned ministry and related officers have also assured availability of adequate coal stock.

Not surprising, the power sector has been one of the most favorite sectors with investors in the past few months. The stock prices of the power sector companies, encompassing the companies in the business of power generation, power transmission, power distribution, coal production & import, and power trading, have done materially better. In particular, stocks of the companies focusing on renewable and clean energy have performed remarkably.

Surprisingly though, the stocks of power backup companies, including generators, inverters and batteries, have done very badly in recent months despite frequent power cuts.

My understanding of the situation is as follows:

·         Presently the total installed capacity of power in India is 399.5GW. Out of this 59% (236.11GW) capacity is thermal (coal and gas based); 13% (57.5GW) is hydro; 26% (105GW) is renewable (Solar – 54GW, Wind – 40GW and Biomass – 11GW) and rest is nuclear (6.8GW).

·         In the past one decade, most of the new power generation capacities have been installed in the private sector. The addition to the nuclear capacity has been dismal despite the civil nuclear deal having been executed in 2009. The new addition to thermal power has considerably slowed in the past 4years as more and more investment is getting committed to clean sources of energy. The hydro generation capacity is also stagnant, perhaps due to environmental concerns.

·         The current daily demand for electricity is about 191.8GW, less than half of the installed capacity. The current supply is 186.6GW, resulting in about 5.2GW of shortages. Obviously it is not the paucity generation capacity which is responsible for power shortages. It is obviously the availability of fuel (coal & gas for thermal and water for hydro) that is hindering the power supply.

·         Failure in implementing reforms in the coal sector; failure in securing adequate gas supply for gas based plants; failure in securing adequate supplies for nuclear energy; are some of the primary reasons for the frequent power crisis.

·         We have committed to very ambitious clean energy targets. This definitely requires meticulous planning and execution of the transition from the legacy power generation structure. There appears to be a huge lag in managing the transition. The focus appears to have completely shifted to the 2030-2040 clean energy goals. Not enough planning seems to have been done for the transition period (2022-2030) requirements. The consumers are obviously suffering.

(All charts and Data sourced from the National Power Portal)

 

In the past one century, Drug lords in the Latin America; Italian mafia in the USA; war lords of the Africa and Arab world; Russian oligarchs; Japanese Zaibatsu; Australian media moguls etc. have perhaps been as popular with the media and entertainment industry as the intelligence agencies like CIA, KGB, Mossad and MI6. It is widely acknowledged that they did exert influence over political establishments, judiciary and financial systems in their respective jurisdictions; and many a times even beyond that.

In the post global financial crisis era, some entrepreneurs have emerged as the center of power. Historically, the large entrepreneurs have been influencing policy making, but their domain of influence was mostly limited to the policies relating to trade and finance. Geopolitics, for example, was usually not on their agenda. However, it seems to be the case, no longer. The corporate czars are now widely believed to be influencing politics, geopolitics, trade and finance, with impunity. The media and entertainment industry is obviously enamored with these new lords of the universe.

The struggle between the traditional houses of power and the emerging power centers is visible in many countries. The authoritarian regimes like China, Syria and Iran etc. have acted strictly and materially restricted the sphere of influence of the merging czars. European communities are also trying to check the growing influence of social media and other technology enabled business with pervasive influence over society and politics. Other jurisdictions like India are also trying hard to restrict the area of influence of global social media and ecommerce majors.

The acquisition of social media platform Twitter by the maverick entrepreneur Elon Musk should be seen in this context, in my view.

A significant transition in the power structure is also visible in India. I am highlighting this since I find it important from my investment strategy viewpoint.

Large business families have always enjoyed significant socio-political power in India. The families like Tata, Birla, Bajaj, Modi, Shriram, Sahu Jain, Bangur, Poddar, Singhania, Goenka, Wadia, Kilachand, Dalmia, Lal Bhai, Sarabhai, Murugappa, Thapar, Kirloskars were powerful, had political influence and made significant social contributions in the area of education, health and religion. Patriarchs from many of these families took part in the freedom struggle. However, their domain of political influence post-independence was mostly limited to the policies concerning trade and finance.

These powerful businessmen have never been known as the key drivers of consumption patterns, financial markets, foreign relations and geopolitics.

Of course the financial markets were not much developed when they reigned. The development of Indian equity markets started in true sense with FERA dilution of MNCs. It was incidentally the same time when the legendary Dhirubhai Ambani entered the public equity space. For more than one decade after the FERA dilution and Reliance IPO, the equity market was mostly dominated by MNCs like HUL, Nestle, ITC, Castrol, ACC, Cadbury, Reckitt Colman (now Benckiser) etc. Abolition of Capital Controls and permission for foreign portfolio investors to invest in the secondary market in 1991 started the journey of Indian capital markets in true sense.

Late 1990s was the era of professionally managed technology companies and private banks. For the next two decades, these businesses dominated the markets. These businesses were not particularly known for exerting any political influence or influencing the markets. The businesses, and not the person behind the business, dominated the narrative. For almost two decades, the Indian markets did not like the so-called oligarchs. Most of the post-independence oligarchs (many factions of Birla clan, Modi, Singhania, Dlamia, Sahu Jain, Lalbhai, Kilachand, Sarabhai etc.) had already diminished materially post 1991 liberalization. The remaining ones like Tata, factions of Birla, Bajaj, and emerging ones like Ambani, etc mostly underperformed the MNCs, technology and private banks.

But what has been happening since the past five years is something very new to the Indian markets. It is not the businesses, but the oligarchs who are driving the Indian markets. It does not matter what these Oligarchs do. They may be in the business of commodities (coal, copper, aluminum, steel, carbon, oil, gas etc.); technology, automobile, power, retail, financial services, food processing, textile, retailing or e-commerce etc. The market is being driven by the person behind the business, not the business itself. Valuations are being placed on the persons (Oligarchs) rather than the business. The argument is that “this person” can turn dust into gold, so paying silver for the dust is not a bad deal.

I am confused by the transformation in the market. This is something very new for me. I am not sure how this will end. Whether the dust will turn into gold; or silver will turn into dust – we would only know in hindsight. Nonetheless, I am sticking to my old methods for now – focusing on businesses and ignoring the personalities.

Besides the hydrocarbons (crude oil and natural gas), edible oil is perhaps the most critical item for Indian households, where our country is largely dependent on imports. In 2021 we imported ~US$17.5bn worth of animal & vegetable fats and oils.

Volume wise, the annual domestic consumption of edible oils is around 25 million tonnes; whereas we produce less than 12 million tonnes. Thus we rely on imports for over half our requirements, making India the third largest vegetable oil importer, behind USA and China, despite a low per capita consumption of edible oil of less than 6gms a day.

 The composition of edible oil imports is ~60% palm oil; 25% soybean oil; and 12% sunflower oil. The sources for these oils have been limited in number. We import about 95% of our palm oil requirement from Indonesia & Malaysia; and almost all sunflower oil from Russia and Ukraine.

Edible oils are a critical part of the Indian way of cooking; besides being a key raw material for fast growing personal care, detergent & soaps, processed food and chemicals. Palm oil is the most preferred cooking medium for Indians due to its chemical properties and cheaper cost. Palm oil can be stored much longer, remains stable, can be reused for frying, can be easily blended with other cooking mediums easily, and costs relatively much cheaper as compared to traditional mediums such as mustard oil, ghee, coconut oil and groundnut oil.

Edible oil therefore is an important food security issue for India that needs to be tackled on a mission basis.

Recent developments

For two months Russia has been engaged in a war with the neighboring Ukraine. This war has materially impacted trade through the Black Sea. The sunflower oil imports from these two countries have collapsed by over 50%, and dwindled further, in these two months. The war has also resulted in sharply higher hydrocarbon prices in the global markets as Russia is one of the largest exporters of crude oil and natural gas. This has resulted in increased focus on renewable sources and biofuels.

This all occurred when the Palm Oil and Soybeans oil, two largest sources of vegetable fats globally, production was suffering for 2 years due to (i) poor weather in Latin America, largets producer of soybean; and (ii) poor availability of labor due to Covid, to pick palm fruits in South East Asia. To add to this, poor weather conditions in Canada and Europe also damaged the crops of other sources like Canola.

The prices of edible oil were rising sharply for almost one year. Indonesia, the largest producer of palm oil, had tried to discourage export by increasing duties on export. To tame the high inflation and increased focus on biofuels, Indonesia announced restrictions on export of palm oil.

In February 2022, the Indonesian Government imposed an export restriction on Crude Palm Oil (CPO) and its derivatives in the form of Export Approval  to tackle the domestic shortage of cooking oil. One of the requirements to obtain a PE was the fulfillment of Domestic Market Obligation (DMO) and Domestic Price Obligation (DPO). The DMO and DPO requirement obliged exporters of any kind of CPO products to supply CPO or Refined, Bleached and Deodorized (RBD) Palm Olein domestically. Exporters were required to sell an amount equal to 30% of their planned exports to the domestic market at a predetermined price.

Last weekend, the Indonesian government sought to further tighten the export restrictions.

Obviously, it is a matter of serious concern for the Indian economy. Like hydrocarbons, the inflation in edible oil also has a second and third impact on inflation as it is a key raw material for many consumer goods and intermediate for industrial products.

The Indian government is taking steps to increase self-reliance in edible oils. But these efforts will take a long time to yield desirable results. For the next decade at least we shall remain dependent on imports. So for now, get ready to pay more for your Vada Pav and a plate of Chola Bhatura. For the poor, it’s a hard hit on their kitchen budgets; and for most of the middle classes it’s an opportunity to cut on their unhealthy fat consumption. No more Jalebi for me.