Vijay Kumar Gaba

Friday, January 20, 2023

Some notable research snippets of the week

Logistic sector (Jefferies Equity Research)

Formalisation of the logistics sector is a multi-year theme that should play out. We adjust our numbers for lower international cargo volume growth seen in 3QFY23, but believe that follow-ups to the National Logistics’ Policy (NLP), continuing GST driven organised players’ share gain, Dedicated Freight Corridor (DFC) traffic increase, Concor privatisation should play out in 2023.

NLP targets dropping logistics costs to less than 10% of GDP from the current 14-15% with initiatives including 1) Integration of Digital System (IDS) 2) Unified Logistics Interface Platform (ULIP) 3) Ease of Logistics (ELOG) and 4) Network Planning Group (NPG) and System Improvement Group (SIG). Under the IDS, thirty different systems of seven departments will be integrated and will include data of the road transport, railways, customs, aviation and commerce departments. We believe results will take time but systematically the government will reduce red tape and put in processes that ensure organised sector gains share vs the unorganised disproportionately.

Public sector banks (Motilal Oswal Investment Services)

Over the past few years, PSBs have focused on strengthening their balance sheets and consequently the GNPA/NNPA ratio for PSBs improved sharply to 6.5%/1.8% in Sep’22 from the peak of 14.6%/8.0% in FY18, respectively. PCR over similar period also improved markedly to ~72% from 45% in FY18. With the NPA cycle being largely over and no large ticket corporate accounts under stress we expect PSB’s asset quality to strengthen further over the coming quarters. Further, SMA book across top seven PSBs stands modest at 19-50bp that augurs well for incremental slippages. This will keep the credit cost benign and support overall profitability.

Margin trajectories for PSBs have revived and expanded ~8-31bp over 2QFY23 for top seven PSB’s. We, however, note that bulk of the loans for PSBs is linked to MCLR (6-12m tenure), which will drive the lagged re-pricing even as MCLR rates rise gradually. We note that against a 225bp rise in repo rate, MCLR rates across these PSBs have risen 85-100bp (barring SBIN at 130bp) thus leaving room for further expansion.

We believe that PSBs are on track to undergo complete earnings normalization, aided by lower credit costs. We expect average credit cost of top seven PSBs to moderate to 1.2% by FY25 from 3.3% over FY18–21. Overall, we forecast top seven PSBs under our coverage to report a PAT of INR1.3t in FY25 v/s a loss of INR594b in FY18. Thus, we expect 29% earnings CAGR over FY22–25 and estimate these PSBs’ RoA/RoE to improve to 0.9%/14.2% in FY25, respectively.

We note that the current RoA despite a lower treasury income forecast stands significantly lower than the average seen over FY04-13. Our current credit cost estimate too stands 14-35bp higher than the 10-year average for most banks barring BoB, BoI and SBIN. Thus, the quality of earnings also has improved which will enable PSBs to sustain ~1% RoA and possibly improve further to 1.1%-1.2%.

We continue to believe that sustained and consistent performance on delivering healthy return ratios can result in further re-rating of the stocks. We note that while the improvement in RoE’s has been encouraging, a sharp moderation in NNPA ratio has resulted in a much higher increase in ABVs. Thus, ABV for top seven PSB’s is likely to grow at 12-23% range over FY22-25E v/s 14-19% for top private banks. Valuations thus appear attractive considering the growth/profitability outlook.

WPI at 22months low (BoB Capital)

WPI inflation slipped down to 5% in Dec’22 from 5.8% in Nov’22. This was led by moderation in food (0.7% from 2.2%) and manufactured product inflation (3.4% from 3.6%). However, fuel inflation inched up (18.1% from 17.4% in Nov’22). Within food, prices of fruits and vegetables, especially tomato pulled down the prices. However, there is an uptick in cereal inflation. Improvement in rabi sowing bodes well for wheat prices. Core WPI softened to 2-year low of 3.2% in Dec’22 from 3.5% in Nov’22 owing to the dip in manufactured inflation. Going ahead, we expect further easing in WPI inflation on account of base effect in H1FY24.

Banks: New provisioning norms (Kotak Institutional Equities)

The RBI has placed a discussion paper which would ask banks to shift to Expected Credit Loss (ECL) based provisions from the current norm of building provisions after an occurrence of default. Provisions have to be built on the basis of self-designed models that capture the regulatory guidance and would have to be approved by the regulator. Banks shall measure ECL of an applicable financial instrument by classifying the loans in three stages (Stages 1, 2 and 3). It would have to look at (1) probability of default by evaluating a range of possible outcomes, (2) time-value of money, and (3) past events, current conditions and forecasts of future economic conditions. There is no timeline for the implementation, but the regulator is likely to give a (1) one-year transitioning period from the time of final implementation to place the necessary infrastructure and (2) a one-time five-year adjustment period to capture the initial cost of transmission. This would be captured through a relaxation in the CET-1 calculation.

The initial reading suggests that the RBI probably wanted banks to complete their provisions from the previous corporate NPL cycle before migrating into a new regime. We are seeing provisions come off sharply and are likely to reach historical lows that we saw in FY2004 in FY2024-25. A five-year transitioning period of the initial migration costs should make it comfortable for most banks. The previous cycle (2004-22) saw credit costs at 200 bps annually, with the cycle showing higher provisions for FY2014-20. The challenge: quality of the data is not sufficient to build these models.

A key challenge is the data that goes behind these assumptions. Estimating default probabilities or losses requires rich data sets that capture various cycles. We have had two long credit cycles in India in the past three decades. Both these cycles were characterized by large defaults in the corporate sector. The first cycle (1994-2002) was mostly with public banks, while the next cycle had the impact visible in a few large private banks. The retail cycle was probably tested once during Covid and the regulatory dispensation provided at that time masks the probable performance post default. While ECL is the best way forward, we need to acknowledge that we are also moving with less quality of data as well.

Electricals & Durables: Better days ahead after last year of pain (Axis capital)

Just when the industry was seeing a silver lining in the clouds (after multiple waves of Covid-19), the Russia-Ukraine war outbreak in Feb’22 led to global spike in commodities, which impacted margins for the sector over the last 4 quarters. The storm clouds have receded somewhat now through a mix of fall in commodity prices, price hikes, cost cutting and industry consolidation. Hence, we are more constructive on the sector given double-digit growth opportunity over next 5 years still exists.

China reopening boosts copper outlook (ING Bank)

Beijing has released a raft of policy measures in recent weeks which have increased confidence that the economy is stabilising, improving the outlook for industrial metals, including copper. For almost two decades, China’s property sector growth and the country’s rapid urbanisation have been the key driver of growth for copper demand.

China will return to “normal” growth soon as Beijing steps up support for households and businesses, Guo Shuqing, party secretary of the People’s Bank of China, told state media recently. The world’s biggest consumer of copper is expected to quickly rebound because of the country’s optimised Covid response and after its economic policies continue to take effect, Guo said.

In its most recent move, China is planning to allow some property firms to add leverage by easing borrowing caps and pushing back the grace period for meeting debt targets. The move would relax the strict “three red lines” policy which had contributed to a historic property downturn, hitting demand for industrial metals. The easing would add to a raft of policy moves issued since November to bolster the ailing property sector, which accounts for around a quarter of the country’s economy.

Credit Offtake Moderates on Base Effect, Deposit Growth Stays Slow (CARE Ratings)

· Credit offtake rose by 14.9% year on year (y-o-y), for the fortnight ended December 30, 2022. The growth has been driven by a healthy rise in NBFCs, retail credit, and working capital demand driven by inflation and capex.

· Deposits saw a slower growth at 9.2% y-o-y compared to credit growth for the fortnight ended December 30, 2022. The short-term Weighted Average Call Rate (WACR) has increased to 6.36% as of December 30, 2022, from 3.33% as of December 31, 2021. Further, deposit rates have already risen and are expected to go up even further due to rising policy rates, intense competition between banks for sourcing deposits to meet strong credit demand, widening gap credit & deposit growth, and lower liquidity in the market. Over the last couple of years, (i.e., from March 27, 2020) credit offtake has almost reached the Covid-induced lag, rising by 29.6% in absolute terms compared to 30.7% of deposit rates.

· The credit growth has continued to be in double digits and has been broad-based across the segments and is likely to remain strong in FY23. Meanwhile, this reduction would have to be monitored in the coming fortnights to determine if the credit offtake has peaked and is returning to a lower growth rate.

OMCs: Low oil and strong refining ease pain (Kotak Institutional Equities)

We believe as oil demand recovers, oil markets will get progressively tighter in 2023. We moderate our FY2023 oil price assumption to US$95/bbl (earlier US$105/bbl). We assume oil price of US$90/bbl for FY2024/2025E, and US$80/bbl for LT (earlier US$90/bbl for FY2024, US$80/bbl for LT).

OMCs: Concern on under-recoveries ease; full compensation looks unlikely With lower oil prices, strong refining margins (particularly middle distillates), and exports tax (OMCs negotiate lower refinery transfer price, and effectively pass on some marketing losses to refiners), the worries on marketing losses are now lower. Also, with weakness in gasoline cracks, OMCs now have over-recoveries on petrol. Compared to nearly Rs1.1 tn under-recoveries in 1HFY23, we estimate only ~Rs150 bn under-recoveries in 2HFY23E.

In our view, unlike the past when OMCs were near-fully compensated for fuel under-recoveries, the compensation will be much lower. As such, with petrol/diesel officially deregulated and OMCs having freedom to price, the compensation is difficult. For past LPG losses (June-2020 to June-2022), government had given one time compensation of Rs220b in 1HFY23. Recently, the media has reported that OMCs are seeking further compensation of Rs500 bn. For our forecasts, we do not assume any further compensation.

Preview of Union Budget 2023 (Axis Capital)

FY23 performance: Total receipts is likely to be higher than budget by INR 3.3 trillion due to strong nominal growth and tax buoyancy on the back of consumption recovery. However, this gain in receipts is fully spoken for via higher food and fertilizer subsidies of INR 1 trillion each. The government’s cash outgo in the recently announced supplementary grants is also ~INR 3.3 trillion. We expect fiscal deficit in FY23 to slow to 6.1% of GDP from 6.7% in FY22 and 6.4% budget target.

FY24 budget expectations: Central government’s fiscal deficit is likely to fall further to 5.7% and will be on track to achieve 4.5% of GDP by FY26. The 0.4% of GDP fiscal consolidation is supported by INR 1.5 trillion drop in food and fertilizer subsidies due to merging of food subsidy under PMGKAY with NFSA and correction in global fertilizer prices. This outcome along with modest tax buoyancy (12% YoY growth) should give the government space to target low double digit spending growth in rural development and capex.

Key expectations in the budget

· Tinkering with personal income tax slab to provide relief on real disposable income.

· Expand scope of Production Linked Incentive (PLI) schemes and green hydrogen.

· Bump-up allocation for rural development and social welfare to ensure outcomes don’t suffer due to cost inflation.

· Target double digit capex with increase in capital allocation to new DFI and special long-term loan to states for capex.

· Increase scope of asset monetization pipeline.

Thursday, January 19, 2023

Make no excuses

It was summer of the year 1997. The equity markets in India were struggling to come out of a four year long directionless phase. Though globally the technology sector had started to excite the investors, nothing much was happening in India. It was arguably the most dreary phase in the Indian stock markets in a decade.

The National Stock Exchange used to follow a weekly settlement system in those days. Under the weekly settlement system, trades done during a week beginning every Wednesday and ending on the subsequent Tuesday were clubbed together and the net result of those trades was settled in the next three days. The net funds due were paid to the clearing corporation on Wednesday. The net sold securities were delivered on Thursday. The new fund receivable and net securities purchased were received on Friday. All deliveries were in physical paper form.

A weekly settlement cycle ended on Tuesday, the 20^th of May 1997. The pay-in of funds due was made on Wednesday, the 21^st of May. The securities were delivered on Thursday 22^nd May. Everything went smoothly till 3PM, when the Bombay High Court appointed a provisional liquidator for the CRB Group, one of the prominent financial services groups at that time, which was facing problems for the past few months.

Anticipating this order, the CRB Group entities had sold a huge quantity of securities in that settlement cycle. Most notably, they had sold their entire stake in Bank of Punjab (about 5%) in that settlement. The buyers who had bought the securities sold by CRB Group had already paid in the funds on 21^st May. CRB Group had delivered the securities on 22^nd May. The provisional liquidator approached the Clearing Corporation and stock brokers and told them to hand over all share certificates delivered by CRB Group and all funds due to be paid to CRB Group. The case took about 15yrs to settle. The investors who had paid money on 21^st May 1997, received shares only in 2012-13. Luckily for them, the Bank of Punjab (BoP) was taken over by HDFC Bank in the meantime and they received HDFC Bank shares in lieu of their BoP holding.

After this incidence, two things happened in the Indian stock markets –

(a) The process of Dematerialization of securities was implemented at an accelerated pace. India actually became the first country to achieve 100% demat settlement within 3years. Incidentally India was also the first country to implement 100% screen based electronic trading of securities.

(b) The weekly settlement cycles were replaced by daily settlement cycles with a T+2 settlement schedule. Under the new system, the trades done on a particular day were settled on the third working day with simultaneous pay in of funds and securities. Though technically there was still a gap of 2hrs between pay in and pay out, the risk had substantially diminished.

A large number of young market participants who are still in their 20s may not fully appreciate how much the electronic trading and demat settlement of securities means for the Indian markets. My research in 2003-2005 had indicated that over 95% of the market participants regarded dematerialization of securities as the single most important capital market reform in India.

From the next week onward, Indian stock exchanges will move to T+1 settlement schedule for all the trades executed on the exchanges. This implies further mitigation of settlement risk and faster settlement of funds and securities. India will be the second market, after China, to implement T+1 settlement of securities’ trades. The US and Canada regulators had also passed a resolution to implement T+1 settlement last year.

T+1 settlement is a big leap towards achievement of real time gross settlement (RTGS) of securities in next few years.

Another point that is worth noting in this context is that Indians have shown remarkable capabilities and enthusiasm in adoption of technology in the past three decades. Quick and widespread adoption of electronic screen based trading, dematerialized settlement, mobile telephony, digital payments, and digital communication (e.g., healthcare, education, business and personal meetings during pandemic) are only some of the example, how even the less educated and digital illiterates have adopted the technology in their day to day life.

If a politician or policymaker cites low education level or digital illiteracy as a reason for not initiating or implementing any reform, you should know that he is either unaware of the ground realities or is making blatantly false excuses.

Wednesday, January 18, 2023

India’s external sector faces headwinds; situation manageable

The Financial Stability Report released by the RBI a few weeks ago, highlights the external sector challenges being currently faced by the Indian economy. The report however seeks to dispel the fears of any balance of payment crisis like 2013. It also assures about the adequacy of reserves to handle the present situation and stability of the INR.

External sector facing challenges

India’s merchandise trade deficit increased to a staggering US$198.3bn during April-November 2022, as compared to US$115.4bn in the corresponding previous period. Strong headwinds emanating from still elevated commodity prices, global economic slowdown, volatile capital flows and higher imports due to adverse terms of trade shock continue to exert pressure on India’s external account.

Rising oil import bill limits policy flexibility; CAD rises sharply

India’s share in global crude oil consumption increased from 3% in 2000 to 5.2% in 2021. India presently accounts for almost 20% of each barrel of incremental global crude demand. Weakness in USDINR is further amplifying the pressure on imports.

Given the structural dependence on the imported crude oil, India continues to remain a price taker in the global oil market. This limits the scope of policy manoeuvrability in managing the trade deficit. Consequently, the current account deficit has widened to a worrisome 4.4% of GDP in 2DFY23 (2.2% in 1QFY23 2.2% and 1.2% in FY22).

Net capital flows were inadequate to fund the current account deficit, resulting in depletion of forex reserves to the extent of US$30.4bn in 2QFY23. The flows improved in 3QFY23, resulting in improvement in forex reserves.

Repayments of ECBs (rise in refinancing cost, withdrawal of liquidity in global markets, improvement in domestic corporate balance sheets) also contributed negatively to the balance of payment.

External debt situation comfortable

India had an external debt of US$610.5bn at the end of 1HFY23. The short term debt (residual maturity less than one year) comprised 45% of this debt. 55.5% of the external debt was USD denominated at the end of September 2022 (53.2% at the end of FY22); while 30.2% debt is INR denominated.

As of September 2022, about US$173bn worth of ECBS were outstanding with an average maturity of 5.6yrs. About 81% of all ECBs are USD denominated.

Out of this about 50% (US$87.6bn) were the USD loans owed by the Indian private enterprises; the rest being outstanding of subsidiaries of foreign parents (US$28.5bn); INR denominated ECBs (US$15.1bn); ECB by PSUs (US$53.2bn). Out of US$87.6bn Non INR, Non FDI ECBs, about 55% is hedged while most of the balance has a natural hedge against receivables.

Given the current Forex reserve of over US$565bn, the external payment default risk is negligible; and so is the collapse risk for INR.

Tuesday, January 17, 2023

Indian Equities – A secular trend; no froth

If we cut the noise and overcome our recency bias, Indian stocks have given a decent return over the past five years; though this period had been particularly eventful. We witnessed the worst pandemic in over a century crippling the world. A variety of economic and geo-political conflicts impeded the global economy. The financial markets witnessed unprecedented liquidity deluge that led to over US$20trn bonds trading at a negative yield; followed by sharp monetary tightening. The world moved from severe deflationary conditions to sharp inflationary spikes. Central banks cut the policy rates close to zero (even below zero in some cases) and then hiked the rates at the fastest speed in five decades.

In the domestic economy, we saw macro parameters like inflation, fiscal deficit, current account deficit etc. worsening sharply. We witnessed a monetary easing and tightening cycle. Banks went through a massive credit cycle.

The benchmark Nifty50 has yielded an 11.4% CAGR over the past five year (January 2018- December 2022). IT Services (19.6% CAGR) is the only sector that has meaningfully outperformed Nifty50 over the past five years. The sectors that should have theoretically benefitted from abundant liquidity and low rates like Auto (1% CAGR) and Realty (4.5% CAGR) were actually amongst the worst performers, failing even to match bank deposit returns.

The market breadth has not been great. The broader indices like Nifty 500 (10.2% CAGR) actually underperformed the benchmark Nifty50 (11.4% CAGR). In fact Nifty Next 50, that represents the set of 50 largest stocks next to Nifty50, underperformed massively with just 6.4% CAGR. Banks (11% CAGR) and Metals (11.3% CAGR), that many might think to be massive outperformers have performed just in line with the benchmark Nifty50.

If we observe only the benchmark indices, the situation appears calm and simple. However, the story beyond benchmark indices is quite revealing. For example, consider the following facts:

Only 384 stocks (out of 1428 actively traded stocks on NSE), have outperformed the benchmark Nifty50 over the past five years.
54% stocks (770 out 1428) gave a positive return during the past five years, while 46% (658 out of 1428) yielded a negative return over the period of five years.
The top 100 stocks gained 267% to 6299% during the past 5 years. These include a variety of stocks, largecap, microcap, midcap, chemicals, textile, infra builders, power, metals, FMCG, ERD services, entertainment, NBFCs, pipes, cables, industrials, pharma, etc. The list however excludes banks, top IT services, and PSUs.
Over 270 stocks lost more than 50% of their value during these five years.

The primary idea of this analysis however is to assess two things:

1. Do we have a secular trend in the Indian equities?

2. Do we have significant pockets of froth in the markets?

The answer is:

We may have a secular trend in the Indian equities. The trend is deepening and widening of growth. A large number of sub sectors from the economy – Materials (metals, chemicals, building material, energy, textile, paper, sugar etc.); industrials; utilities (power, telecom); infra builders and owners; consumer (discretionary, durable, staples and internet); healthcare; financials (lenders, non-lenders and service providers); IT services (engineering, digital, cloud, conventional software, BPO) etc. are now participating in growth together. The market is neither sector specific nor segment (large cap, midcap etc.) This had happened briefly in the early 1990s only. This trend could actually be reflective of some structural changes in the economy per se. Of course an intensive research would be required to confirm this.

There does not appear to be froth in any pocket of the market. Though there may be cases of some individual stocks that are still in the process of normalization post the bubble burst.

The latest correction therefore could be a good opportunity to increase exposure to the Indian equities.

Friday, January 13, 2023

Some notable research snippets of the week

Capital goods and consumer durables (Nirmal Bang Institutional Equities)

In 3QFY23, the Capital Goods companies may record strong revenue growth for the Capital Goods companies (+30.3% YoY) on the back of robust order booking. In the Consumer Durables segment, demand collapsed in Nov’22 after a good Oct’22 before recovering again from mid-Dec’22. Consequently, we expect 17.3% YoY topline growth for Consumer Durables companies. For Consumer Electricals companies, we estimate 10.7% YoY topline growth, backed primarily by channel filling of non-rated fans ahead of the impending transition to new BEE norms. Also expect up-stocking of Wires & Cables by dealers and distributors as copper prices have risen by ~18% from July’22 lows.

Capital Goods and Consumer Durables companies are expected to show margin improvement as most of the companies are most likely to have exhausted high-cost inventory by mid-3QFY23. Consequently, expect a sequential improvement in aggregate EBITDA margin (+40bps). Recovery in the capex cycle, healthy order inflows and adverse impact on working capital will be keenly monitored for the Capital Goods sector.

Expect strong growth for Solar Industries (+50% YoY), which reflects better off-take from Coal India and improved realizations.

Data center capex to nudge up product demand (BOB Capital Markets)

Data centers in India are poised to add ~350MW of capacity per year till CY25 fuelled by hybrid operating models and rising internet penetration. This represents a 32% CAGR to 1.8GW over CY22-CY25, indicating a US$ 4.4bn opportunity (at Rs 350mn/MW; USDINR Rs 80).

Among the key end users of data centers are high-growth industries such as IT services, telecom and BFSI, where we can expect waves of growth led by emerging trends such as 5G penetration, digital currencies and healthcare digitization. The proposed Data Protection Bill lends further impetus to domestic data center capex given the requirement for localized data storage/processing.

Technology and infrastructure comprise ~80% of data center capex, with land forming the balance 20%. Of the total capex, 33% would be expended on power equipment (UPS, HV/MV/LV switchgears, backup generator sets) and 20% on cooling products (half of which would be for chillers).

3QFY23 preview (Elara Capital)

We expect Q3FY23E Nifty50 sales to increase 17% YoY on low base (lingering Delta COVID-19 impact) while sequentially sales is likely to be flat. As companies come off high cost inventory and overall commodities cost remains low, margin strain is likely to lessen on a sequential basis, leading to a 192bp expansion in Nifty (ex-financials) EBITDA margin, and a 123bp expansion in Nifty PAT margin to 12%. Owing to margin improvement, we expect healthier growth of 11% QoQ in overall Nifty PAT while Nifty ex-financials EBITDA is set to grow 12% QoQ. Commodities, led by metals, are expected to post the highest YoY decline on lower realization while financials, led by Banks, are likely to post a strong show on account of several tailwinds. Ex-commodities and ex-financials, we expect Nifty PAT growth of 22% YoY and 9% QoQ.

Macro normalization may lead to market buoyancy (Antique Stock Broking)

Our analysis of 20 meaningful market corrections (in excess of 10%) since 2006 suggest that growth slowdown and rising inflation are two primary reasons for market correction.

Deterioration in both growth and inflation outlook has led to sharp market correction and volatility (with three episodes of sharp market correction in excess of 10% for similar reason in the past 15 month). Consensus expects macro headwind to continue in 1HCY23, with recovery likely in 2HCY23 due to easing inflationary pressures, decline in policy rate, and lower base.

We believe that a) Most of the macro risk is priced in, unless there is a hard landing in advanced economies; and b) Market buoyancy is likely as growth may recover in 2HCY23 due to easing inflationary pressures, decline in policy rate and lower base.

We believe that overall institutional equity may strengthen in CY23 as we expect Foreign Portfolio Investors (FPI) to return in CY23 given a) Lowest FPI ownership in India since FY14; b) FPI equity outflow has never been negative for two years in a row; c) Receding macro risk in 2HCY23; d) Peaking out of Dollar index is positive for Emerging Market; and e) India to be the fastest growing large economy. We expect domestic mutual fund equity flow to persist given ~INR 2,400 bn sticky equity flow in FY24 through Systematic Investment Plan, Employee Provident Fund, and National Pension Scheme.

Our Mar-24 Nifty-50 target stands at 20,750 (19x FY25e EPS of 1094). We continue to believe that macros remain supportive for private capex cycle recovery. In this backdrop, We believe that financials (especially PSU Banks), industrials, commodities and real estate sectors have higher degree of out-performance\during 2023.

US to underperform the world (Bank of America Securities)

Buy the World: global stocks to outperform US stocks in 2023 driven by:

1. Interest Rates - US “secular growth” stocks substantially outperformed during QE/zero rates “secular stagnation”; non-US “cyclical value” stocks to outperform in backdrop of higher rates “secular stagflation”.

2. China – bull market in credit began in days following Communist Party of China (CPC) Politburo....China HY $ bond spreads halved from 2900bp on 27th Oct to 1360bp today, and speedy Zero-Covid policy exit will unleash years of precautionary savings in boost to households consumption,

3. Tech - in Q4 all tech as % US equity market was 40% vs 19% in EM, 13% in Japan, 7% in Europe; derating of tech driven by regulation, penetration, rates well underway (Big 8 stocks already down from 30% to 21% of US market), yet investor rotation out of tech sector yet to begin, hurts US more.

4. Buybacks - US stock market has enjoyed $7.5tn of stock buybacks since GFC (corporations rather than investors have powered the US stock market past 15 years - mostly tech & financials); 1% tax on buybacks now introduced (and will inevitably rise in coming years) + higher rates = less self-serving debt issuance to finance buybacks,

5. Energy - higher oil prices mean "oil exporters" e.g. US, Saudi Arabia outperform, lower oil prices mean "oil importers" e.g. Japan, China, India, Europe outperform.

6. War & the US dollar - dollar falls in '23 as geopolitical tensions ease, US domestic political tensions rise, global governments & investors diversify from reserve currency.

7. Positioning - compare $160bn US equity inflows to $107bn EU equity outflows in '22, note US hit all-time high (63%) as share of global market in 2022.

War and Peace (Credit Suisse Economics, Zoltan Pozsar)

War – in one form or another – was a theme that defined macro not only last year, but basically every year since 2019: trade war with China; the war on Covid-19; war finance to deal with lockdowns; war on inflation, as we overdid war finance; and war then spread to engulf Ukraine, finance, commodities, chips, and straits as discussed above. Monetary and fiscal responses were just that – responses to mother nature and geopolitics – and with geopolitics getting more complicated, not less, investors should remain mindful of the threat of non-linear risks in 2023.

In my previous posts, I noted that investors are not particularly well trained to deal with geopolitical risk, because for generations geopolitics didn’t matter – anyone who traded securities or ran a portfolio since the end of World War II, did so in the cocoon of a unipolar world order, under the cover of Pax Americana.

But as I argued here, the unipolar world order is being challenged, and as I argue on the front page of today’s dispatch, war has been and will likely remain a theme until the quest for world order (that is, “control”) is settled. When Henry Kissinger writes about how to avoid another world war (see here), and Niall Ferguson writes about the risk of Cold War II spilling into World War III in an op-ed on Bloomberg (see here), you know that something is definitely up...

Henry Kissinger’s year -end essay and Niall Ferguson’s new year essay are not the types of essays that you normally read alongside sell-side outlook pieces, which suggests that this ain’t your parents’ “global macro environment”, and it ain’t your grandparents’ either. We have to go way back in history for direction...

During the Great Financial Crisis (GFC), events forced us to abandon using the term “post-WWII” in the context of recessions and business cycles. Of course, that was because the GFC threatened to unleash a second Great Depression, which was a “pre-WWII” event that rendered “post-WWII” comparisons irrelevant, and turned Kindleberger’s Manias, Panics and Crashes and, via Paul McCulley, Minsky’s Stabilizing an Unstable Economy into required reading. Similarly, in light of the events of 2022, it seems prudent for investors to abandon the idea that the post-WWII world order will remain stable, or at least won’t be challenged.

Pre-WWII parallels are once again relevant, with a new reading list: Mackinder’s The Geopolitical Pivot of History, Brzezinski’s The Grand Chessboard, and Herman’s Freedom’s Forge. The last one is about two industrialists who oversaw the production of the “arsenal of democracy” that underwrote Pax Americana, which, to use Ferguson’s term, is challenged today by the “arsenal of autocracy”.

In my “war” dispatches, I stressed four themes:

1. War is inflationary.

2. War means industry.

3. War encumbers commodities.

4. War cuts new financial channels.

I now add a fifth theme:

5. War upsets all four prices of money.

For the first three prices of money (that is, par, interest, and FX) to be stable, the fourth price has to be absolutely stable. It’s simple: if the price level is stable, i.e., inflation is 2%, the Fed can “casually” manage business cycles and clean up crisis situations using QE. With stable prices, there is a fairly narrow range in which policy rates will move up or down, and hikes have a predictable pace. But if inflation is above target and off the charts, all bets are off. That’s been the story of 2022.

Thursday, January 12, 2023

NSO makes it easier for the finance minister

Last week, the National Statistical Office (NSO) released first advance estimates of the National Income for FY23. These estimates are important because the budget estimates for FY24 would be based on these estimates. The finance ministry will use these estimates to project the GDP, savings, tax revenue, expenditure and allocations for various sectors of the economy.

Some key highlights of the data released by NSO could be listed as follows:

FY23 real growth (2011-12 prices)

GDP (at 2011-12 prices) may increase by 7% to against 8.7% in FY22. This estimate is marginally higher than the RBI’s latest estimate of 6.8%.
Per capita GDP may increase by 5.8% to Rs1,13,967, in FY23, against a growth of 7.6% in FY22.
Per capita private consumption may be Rs65,237, a growth of 6.6% over FY22.
FY23 Nominal Growth (current prices)
GDP may increase by 15.4% to US$3.3trn, against 19.5% growth in FY22.
Per capita GDP may grow by 14.2% to Rs1,97,468 (US$2394), against a growth of 18.4% in FY22.
Per capita private consumption may grow by 15.1% to Rs1,18,580 (US$1437) in FY23, against a growth of 16% in FY22

FY23 Sectoral growth (2011-12 prices)

Agriculture growth may accelerate to 3.5% (FY22 – 3%)
Manufacturing growth may collapse to 1.6% (FY22 – 9.9%)
Mining growth to collapse to 2.4% (FY22 – 11.5%)
Construction growth to slow down to 9.1% (FY22 – 11.5%)
Public administration and Defence expenditure growth to slow down to 7.9% (FY22 – 12.6%)
Electricity, gas, water and other utility services growth accelerate to 9% (FY22 – 7.5%)
Trade, hotel, transport, communication etc. to grow faster at 13.7% (FY22 – 11.1%)
Financial services, professional services and real estate to grow by 6.4% (FY 22 – 4.2%)

FY23 Production growth

· Rice, cement, Oil & gas, steel, telephone subscriber, cargo at ports, air passengers, railways, exports, mining, manufactured products etc. may witness material slow down in growth.

· Commercial vehicles, passenger vehicles, bank credit may witness higher yoy growth as compared to FY22.

Key observations

The estimates are based on the data available till November 2022 and may go under significant revision when the first revised estimate for the full year will be released in May 2023. These estimates seem to assume sharp recovery in manufacturing and some slowdown in services in 2HFY23. However, it appears unlikely that the industrial growth will accelerate enough in 2HFY23 to achieve 4.5% real GDP growth in 2HFY23. The lagged impact of higher rates, tighter liquidity and slower global demand (exports) may actually be more pronounced in 2HFY23.
These estimates may however allow the government to project buoyant tax revenue in FY24, and accordingly provide for higher government spending and improved fiscal position in the union budget to be presented on 1^st February.
The NSO has projected a trade deficit of 4.6% of GDP for full year FY23 up from 2.5% in FY22. This is worrisome, as the exports are likely to slow down further in 2023 as the world struggles to avoid recession.
Real per capita private consumption expenditure of Rs65,237 read with huge income inequality indicators, is inadequate to support self-reliance of citizens and higher growth. The pressure on the government to provide basic necessities like food, housing, education, healthcare etc. will only increase going forward. This will (i) constrict investment; (ii) hinder development of quality human resources; and (iii) lead to even more socio-economic inequalities.
The good part is that buoyant growth may save the finance minister from making the unpleasant decision of hiking taxes.

Wednesday, January 11, 2023

An ethical dilemma

It's less than two weeks into the new year and I have already faced multiple instances of ethical dilemma. These instances not only tested my resolve to avoid all kinds of ethical conflicts, but also raised doubts about the health of the Indian economy and sustainability of some new age business models.

Let me first briefly describe some of these instances:

· I booked a doctor consultation for my daughter through a popular healthcare service portal. The doctor insisted that in future we should book consultation directly with the clinic instead of coming through the portal.

· I lodged a service request for our out of warranty washing machine with the concerned German Appliance company. The service engineer visited within 3hrs and repaired the fault. While leaving he handed over his private business card and requested that in future we can call him directly; and he will charge only 50% of what the company charges for a service visit.

· My wife booked a hairdresser visit from an aggregator. A young girl visited our home and did the job, While leaving she told my wife to note his personal mobile number. She said, “You can book an appointment through WhatsApp directly. It will cost you 40% less than the booking made through the aggregator.

· I booked a cab for 8hrs through an aggregator for visiting a couple of places in NCR. The driver happened to be living within 2kms of my residence. After we completed the trip, he made an offer to me, “if you need to book a taxi for longer trips, you can call me directly and I will charge you a flat Rs15/km, instead of Rs23/km you have paid today.

In all these instances, the concerned service provider mentioned that “everyone” does this. The hairdresser girl and taxi driver referred by the respective aggregators Company and Service Engineer from German company even cited some of my neighbours who have availed their offers.

All these instances obviously involve a breach of contract as well as ethical impropriety. The dilemma however is that this gives me satisfaction of helping a service provider who is being apparently exploited by the aggregator; besides of course saving me money and some effort also.

If I overcome this ethical dilemma with the argument of “exploitation of poor service provider” and decide to engage with these service providers directly, then I would need to find answers to even more pertinent questions. For example—

(a) Is the business model of most of these aggregators sustainable at all?

(b) If doctors and engineers do not care about business ethics and the sanctity of contractual obligations, how could India dream of becoming a developed economy?

(c) If the lower middle class service providers and middle class service users are both stressed enough to bypass ethics for some monetary savings, is the consumption growth story of India actually believable?

Tuesday, January 10, 2023

Save the Dev Bhoomi, for God sake

Joshimath is an important town in the Chamoli district of Uttarakhand, in the Garhwal Himalayas. It is the entry door to the sacred temple of Shri Badrinath; and also winter abode for the deity. It hosts the northern monastery (one of the four sacred Hindu monasteries established by Sri Adi Shankracharya); and a critical cantonment for the Army establishment posted to protect the northern borders with China (Tibet). It is also the gateway to famous winter sport venue Auli and several other Himalayan trekking destinations.

Over the past three decades it has evolved from a sleepy mountain village that would witness some life during the six months Char Dham pilgrimage; into a busy town bustling with activity all-round the year.

Recently, Joshimath has been in the news for the wrong reasons. About 20000 inhabitants of Joshimath are living in extreme fear as their homes have developed big cracks; and could collapse anytime. Besides, some important temples and other establishments have also become perilous.

Experts have been cautioning the authorities about the fragile ecology of the region for the past many decades. In 1976, the Mishra Committee recommended (i) restrictions be placed on heavy construction work, blasting or digging to remove boulders for road repairs and other construction; (ii) felling of trees; (iii) undertake a massive campaign to plant trees and grass; (iv) avoid agriculture on slopes; (v) construct a pucca drain system for sewage water flow and close soaking pits; (vi) To avoid percolation do not allow water to accumulate, construct drains to carry water to safer area; and (vii) fill all cracks with lime, local soil and sand.

Most of the Committee recommendations seem to have been not only ignored but blatantly violated. To make the matter worse, massive heavy construction work has been undertaken, palpably in the name of developing the area. The hydro power project in the vicinity and widening of road as part of the Char Dham all-weather road project may have inflicted serious damage to the already fragile ecology of the region.

We have seen several disasters in the past few years on the Char Dham route - Kedarnath (2013), Uttarkashi (2019) and Vishnu Prayag (2021) flash floods/landslides being the most (in)famous ones.

This year approximately 4million pilgrims undertook Char Dham Yatra during the six month period between May-November. More than 70% of these 4mn visitors may have visited the holy shrines of Badrinath, Kedarnath, Gangotri and Yamunotri in 4months (May-August), with most visiting Badrinath and Kedarnath only.

As someone who had been regularly visiting these holy shrines since childhood, I know for sure that these places are in no position to handle so many people visiting in a short span of 100 days. The ecology of Haridwar (Base camp for Char Dham Yatra) Uttarkashi (Gangotri and Yamunotri) and Chamoli (Badrinath and Kedarnath) districts has already been damaged severely in the past two decades. Several hydro projects in the area have adversely impacted the already fragile ecology of the area.

There is nothing to suggest that this fight between Nature and human greed will stop any time soon. The development planner need to assimilate that construction of development edifice which is directly in conflict with sustainability and core beliefs has to be rejected out rightly.

Unfortunately, we have not seen any policy drive to this effect despite frequent natural disasters; though many efforts to the contrary have come forth. The major road project in the Garhwal Himalaya to connect the four sacred temples in upper reaches through a wider road network is only one example of the unsustainable development.

The stated objective of the project is to make it more convenient and safer for the pilgrims to visit these sacred temples. This widening of roads has not only caused cutting of numerous trees, but is also resulting in massive increase in vehicular traffic and number of pilgrims visiting the region. This is inarguably resulting in higher pollution, massive piles of human waste & garbage, pressure on infrastructure, and massive construction of room capacities & other conveniences. This will inevitably compromise the sanctity of the place itself; and kill the sacred rivers that originate from there.

The politicians (from all parties) have unfortunately blinded the local populace with the lure of higher income and employment opportunity from rising pilgrim tourism. Unmindful construction and unpardonable exploitation of natural resources has not only endangered the ecology of the region, it has also jeopardized the sustainability of all future generations. For, this region is the source of water to more than 350million Indians.

We ought to be deeply concerned over the unmindful and unsustainable development of the hill state, known as Dev Bhoomi (abode of Gods). I have the following suggestions to offer:

Completely ban private vehicles in 50km radius of these sacred temples.
Allow only disabled and senior citizens to travel by public buses (electric vehicles) to the temples.
Accelerate the construction of ropeway projects to carry the pilgrims to the temples.
Develop the traditional pedestrian route to the temples. Encourage youth to trek upto the temples. Provide tented accommodation with bio-toilets along the way.
Regulate the number of pilgrims visiting these temples, and make it compulsory for all pilgrims to plant one tree each and pay for its maintenance for one year.
Completely ban plastic (including snacks, gutka packets etc.) in the hills.
Freeze all commercial construction in the state for 5 years.
Implement the recommendations of the Mishra committee and other such committees.
Constitute a statutory commission to regulate all the development activities in the state, including roads, power projects, and tourist flow etc.

Friday, January 6, 2023

Some notable research snippets of the week

Chemical Sector (SMIFS Limited)

Our chemical channel checks suggest that slowdown in dyes, pigments, FMCG, etc still persist in December 22 and increasing central bank rates across countries to control inflation is weighing heavily on the demand & prices of commodities chemicals. Although commodity chemical prices are witnessing a rebound from the bottom in anticipation of strong demand in the coming months and minimal channel inventory.

Despite global headwinds, India remains on a strong footing in chemicals led by increasing interest of global companies to source from India to de-risk their supply chain, increasing share of specialty chemicals in overall product mix and robust capex aligned by chemical companies to capture future growth.

Since, China is relaxing its COVID curbs hence demand is expected to remain robust, although Chinese New Year which starts from 22nd January and ends on 5th Feb 23 can be a short term demand dampener.

The trends are mixed and so the commodity and speciality chemical prices trend are not clearly indicative of its fundamentals, however, as demand kicks in post near term hiccups we expect speciality chemicals is a suitable theme to bet on in 2023 since valuations are comfortable and India is likely to increase the market share in global chemical exports.

Consumer Finance (Jefferies Equity research)

Loan growth at NBFCs accelerated in 2022 & the momentum should sustain in 2023. NIMs should dip as higher rates are fully reflected in CoF, esp. at auto NBFC & AHFCs. Asset quality and credit costs should be stable.

Strong loan growth at auto NBFCs like Chola & AHFCs should drive healthy PAT growth, despite lower NIMs. Potential bottoming of NIMs largely by 2Q FY24 can be a re-rating trigger. Top picks are Chola & Aavas; risk-reward seems unfavorable at MMFS.

IT Sector Q3FY23 Preview (Emkay Equity research)

Revenue growth momentum is likely to moderate in Q3 due to furloughs, lower number of working days, deferred spending by few clients, and increased cautiousness among clients amid macro uncertainties. We expect revenue growth of 0.8-3.7% CC QoQ for Tier-1 companies and of -0.4% to 3.4% for mid-cap companies.

Except for LTIM, EBITM is expected to expand by 20-100bps QoQ for Tier-1 companies and 20-50bps for mid-cap companies on account of flattening employee pyramid, optimization in subcontracting costs, operating efficiencies, and rupee depreciation.

Nifty IT index gained ~6% in the last 3M, largely in line with the broader market indices. Risks of recession and potential cut in FY24 revenue remain; however, margin resilience and weak rupee would limit earnings cut. We roll forward our TP to Dec-23 across our coverage universe. Our pecking order is WPRO, INFO, TECHM, HCLT, and TCS among Tier-1 players, and Zomato, MPHL, BSOFT, FSOL, and PSYS among mid-caps.

Auto sales December 2022 (Nirmal Bang Institutional Equities)

Auto OEMs in Dec’22 posted a mixed set of trends across segments. Changing customer preferences towards SUVs and shunning of entry segment cars led to a sharp disparity in volume performance.

The rising cost of ownership for entry segment PV/Car has been a major deterrent in the revival of demand in this segment. Thus, despite higher discount levels, demand for the entry segment cars remains muted. Even exports have been impacted by the adverse geopolitical situation. Overall PV industry wholesales grew by 15% YoY to 3.1 lakh units.

Companies were also looking to clear the inventory before the calendar year-end. Also, with a sharp increase in COVID cases in a few countries, OEMs have turned cautious again.

In 2Ws, overall volume declined by 8.5% YoY and 5% MoM, largely impacted by weak export markets. We expect the export markets to remain muted on account of continued stress in the global economy amid USD unavailability and high inflationary trends. In the domestic market, going forward, we expect rural demand to catch-up on the back of improving consumer sentiments and high income levels driving domestic 2W demand, partly offset by headwinds such as elevated ownership costs and consistent price hikes.

EVs continued to see greater adoption in both 2W as well as PV segments. Strong new model pipeline and elevated fuel prices will continue to drive EV sales going ahead.

Tractor sales improved by 25% YoY mainly on the back of upbeat rural sentiments besides higher discount levels. Furthermore, pre-buying ahead of the upcoming emission norms in the 50HP+ segment led to the strong YoY growth. Going forward, good progress in sowing of Rabi crops and higher MSPs will likely aid demand for tractors in the near term.

In CVs, overall volume improved by 12% YoY, led by double-digit improvement in volume posted by all major OEMs, except Tata Motors. MHCV demand continues to remain healthy, led by traction in construction and mining activities as well as pent-up replacement demand. Even Passenger Carriers continued to witness strong demand momentum. While steady freight rates continue to keep the CV demand steady, rising interest rates remain a key deterrent.

Auto Components (Kotak Securities)

We expect auto component companies under our coverage to report a 1% qoq revenue decline (17% yoy growth) due to (1) a decrease in the 2W and PV segments’ volumes, and (2) weakness in export markets, offset by (1) low single-digit growth in replacement segment (tires and batteries), and (2) higher ASPs due to price hikes during the quarter. We expect the EBITDA margin to improve 40 bps qoq, mainly due to RM tailwinds, partly offset by negative operating leverage.

Cement sector (IDBI Capital)

Our interaction with cement dealers suggests that the avg. cement price at all India level has declined by 2% MoM in Dec-22. Historically we have seen that in December prices go soft. Importantly, decline in Dec-22 has come after three consecutive months of price hikes. And thus, average cement prices on QoQ basis have improved by ~2% in Q3FY23. Post sharp decline in energy prices in Oct’22/ Nov’22; first half of Dec’22 saw an increase in energy prices, though prices are softening again in second half of Dec’22. Demand recovery is seen in Nov-22 (up 28% YoY), supported by low base and overall pick up in demand. We expect cement companies to report earnings recovery in upcoming quarters led by demand revival, price hike and lower cost.

Farm input (IIFL Securities)

Global Agri-Commodity Price Index is trending above the long-term average. Remunerative Crop prices and tight Agri-inventory positions, will keep Agrochemical and Fertiliser consumption healthy. Indian Fertiliser players will benefit from subsidy disbursements and favourable Farm policies, from the FY24 (pre-election year) budget.

According to CRISIL, Indian Agrochemicals sector is expected to grow 15-17% in FY23 and another 10-12% in FY24; thanks to tailwinds from the ‘China Plus One’ strategy of global players and key molecules going off patent. Exports are likely to grow 12-14% in FY24, driven by capex investments towards molecules going off-patent, over next two years.

From this space, exporters and companies with global presence such as UPL and Anupam Rasayan, would benefit. As reiterated in the Chemicals section, from Agchem CSM point of view, we prefer SRF over PI Industries and Navin Fluorine. We would like to remain sideways on companies having exposure to domestic market such as Bayer Cropscience and Rallis India, due to risk of Supply Chain issues on Raw Material dependence outside India and limited triggers for growth.

Insurance Sector (CARE Ratings)

The domestic non-insurance industry’s total premium grew from Rs. 1.3 lakh crore in FY17 to over Rs. 2.2 lakh crore in FY22 i.e., CAGR of nearly 11.5%.

The gross premiums of the non-life insurance industry in India are expected to grow at 13%-15% over the medium term backed by supportive regulations and economic activity. Health, which is expected to cross the Rs 1 lakh crore mark, along with motor that is envisaged to reach the Rs 85,000 crore level by FY24, would continue to constitute the primary levers of non-life insurance growth.

Nifty in Seventh heaven (Motilal Oswal)

Over the last seven years (CY16-CY22), Nifty has consecutively delivered positive returns despite a multitude of disruptions (Demonetization, GST, Covid-19, etc.) along the way.

Ø The Nifty-50 delivered a ~14% CAGR (up 2.2 times) during the period. The last such rally was seen way back in CY02-07, when the benchmark rallied for six consecutive years clocking a CAGR of 41% (up 5.6 times).

Ø Notably, even though the index was up for seven years in a row, there are only two sectors – Oil & Gas and Financials, which have delivered positive returns in all these seven years.

Ø Only two of the Nifty-50 stocks, Reliance Industries, and HDFC Bank have delivered positive returns in each of these seven years. However, none of these stocks has outperformed the benchmark in all these seven years.

Ø Four stocks have outperformed Nifty-50 in six out of seven years – Reliance Industries, Bajaj Finance, Adani Enterprises, and JSW Steel. Coal India has underperformed Nifty-50 in six out of seven years, while five stocks BPCL, Cipla, Dr Reddy’s Labs, ONGC, and Tata Motors have underperformed in five out of seven years.

Ø Within Nifty-50, Bajaj Finance and Asian Paints decline first time in CY22, after ten consecutive years of positive returns.

Thursday, January 5, 2023

USD – Has the Endgame begun?

In the US, banking panic started at regional level in 1930, with many smaller regional banks faced crisis. However, as Great Britain decided to leave the gold standard for GBP on 21 September 1931, the panic spread throughout the country. Foreigners became concerned that the US may also follow Great Britain and end gold convertibility of USD. There was a rush to convert USD into gold. The collateral was that depositors became concerned about the safety of their money and started withdrawing currency from their accounts. A global rush to convert USD into gold and an internal rush to withdraw currency from banks drained out the banking system reserves and choked the money supply – exacerbating the deflation and propagating the great depression. There was a spate of bank failures in the US during 1931-1933.

The Federal Reserve Bank of New York responded to the situation by hiking rates in October 1931, to encourage investors to deposit money in the US banks or buy US bonds. There was an immediate relief, but that did not last long. The Fed started buying bonds from the market in 1932 and hiked the rates again in February 1933. It did not help much in restoring the confidence of investors in USD. In March 1933, the Federal Reserve Board suspended the gold standard for USD; President Roosevelt announced a national bank holiday and suspended all outbound gold shipments. The provisions that allowed the holders of specific treasury bonds to convert their bonds into gold were also revoked (many commentators have implied this action to be a sovereign default by the US).

1931 was the first year in recorded history of the US when both US Treasury Bonds and US Stocks yielded negative returns in the same year. The following two years marked a watershed in the history of the US financial system.

Bretton Wood agreement of 1944, established USD as the reserve currency of the world. The agreement, inter alia, provided that all the participating nations would allow free conversion of their own currencies into USD at all times; and the US will allow conversion of USD into gold at a fixed exchange rate of USD35 per troy ounce of gold. At that time the US manufactured over half of the total global production, as most of Europe and Japan lay shattered due to WWII. Obviously no one objected to the reserve currency status of the USD.

In the next 25yrs, Germany and Japan made substantial progress. The US share in global GDP fell from 35% to 27% during 1950-1969. The US participation in the Vietnam war (1964-1970) took a significant toll on the US economy. Besides, other political efforts like “Great Society” etc., also weakened the US economy. The “reserve USD” became highly overvalued, impacting US exports and causing a sharp rise in trade deficit. The US was forced to print more USD to keep its obligation under the Bretton Wood agreement. This led to a sharp decline in the gold coverage ratio of the USD. The inflation also shot up sharply.

To stem the run on US banks, the Fed had increased its key policy rate to 9.75% by October 1969.

1969 was the second time in recorded history of the US when both US Treasury Bonds and US Stocks yielded negative returns in the same year. Two years later, in August 1971, president Nixon unilaterally abandoned USD peg to gold, hence rescinding the 27yr old Bretton Wood agreement. For other participants in the agreement, it was a virtual default on the part of the US. However, the advent of “petro dollar” a few years later sustained the reserve currency status of USD.

Presently, the USD is arguably highly overvalued. The Fed is hiking rates and reducing money supply. Inflation is high. The economy is on the verge of recession. Trade deficit is rising. Fiscal deficit is at an unsustainable level. The US share in the global economy is shrinking. Large trade partners of the US, like China, OPEC, Japan, etc. are exploring non-USD trade with other trade partners. The US is incurring huge costs in the Ukraine war. And 2022 is the third time in history when both US treasury bonds and stocks have yielded a negative return in the same year.

If history rhymes, we could see some material developments in the US and, perhaps the global, financial system. A sharp USD devaluation, replacement (or supplement) of USD with a new digital currency, end of petrodollar regime (and hence reserve status of USD) are some of the wild guesses I could make.

Wednesday, January 4, 2023

Food for thought

The Government of India has rolled out an integrated food security scheme effective from 1 January 2023. The new scheme shall remain effective till 31 December 2023. The scheme is estimated to cost the central government rupees two trillion. Under the scheme, the government would provide 5kg food grains per person to Priority Households (PHH) beneficiaries and 35 kg per household to Antyodaya Anna Yojana (AAY) beneficiaries, free of cost.

The scheme has apparently subsumed two extant food subsidy schemes of the central government, viz.,

(a) Food Subsidy to Food Corporation of India (FCI) for discharge of obligations under The National Food Security Act, 2013 (NFSA). Under this scheme Under the scheme, 5 kg food grains per person is provided to Priority Households (PHH) beneficiaries and 35 kg per household to Antyodaya Anna Yojana (AAY) beneficiaries at a subsidized rate of Rs 3 per kg for rice, Rs 2 per kg for wheat, and Rs 1 per kg for coarse grain.

(b) Food subsidy for decentralized procurement states, dealing with procurement, allocation and delivery of food grains to the states under NFSA, popularly known as the Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY) started for 9 months in April 2020 to mitigate the effect of Covid pandemic on poor and extended twice thereafter. Under this scheme beneficiaries registered under the NFSA were provided an additional 5 kg of foodgrain per month for free.

This implies that by implementing the new integrated food security scheme:

(i) The central government would save about Rs1.5 trillion on food subsidies in the calendar year 2023.

(ii) The beneficiaries registered under NFSA would get free ration for one year; though the quantity of ration available will be less.

(iii) The state governments who were claiming credit for free ration actually funded by the central government will not be able to do so.

The new scheme is thus a fiscally prudent and politically smart move by the central government. It has however evoked a variety of criticism. For example, the political opponents are criticizing the government that the very fact that over 81 crore still need subsidized or free food indicates the failure of the government's economic policies. The economic and financial market experts have criticized the government for failing in controlling subsidies. Their criticism is that the government is increasing subsidies which it will find politically inexpedient to unwind; and hence burden the future governments.

In my view, the criticism may not be fair, or, inter alia, the following reasons.

· The National Food Security Act was enacted in 2013 by the UPA government, in recognition of the fact that the fundamental right to life enshrined in Article 21 of the Constitution includes the right to live dignity that essentially includes the right to food and other basic necessities. This in fact is a globally accepted good practice for welfare states.

· The fact that 75% of the rural population and 50% of the urban population is entitled under NFSA to subsidized food does not necessarily imply that as many households cannot afford to buy food for their sustenance. This could just be a mechanism to compensate for poor minimum wage structure; faulty agriculture pricing mechanism; disproportionate indirect tax structure; and inadequate social infrastructure, especially health and education. Besides, this should be seen as a direct and effective wealth redistribution mechanism.

· Number of people availing subsidized food cannot be a good measure of poverty.

· The incumbent government has shown resolve in managing subsidies by not increasing fuel subsidy, despite political pressures, increasing fertilizer prices and imposing GST on common food items. Despite being a challenging year, the government is most likely to meet its budgeted fiscal deficit targets. Consequently, the Indian bond markets have shown remarkable stability, defying turmoil in the global bond markets.

· The restructuring of food subsidy schemes could be the first step in the direction of further rationalization of food subsidy from 2024 onwards.

Overall, in my view, NFSA, like MNREGA, is a transformative legislation. This ensures a dignified life for over 800 million people; and thus provides stability and resilience to the economy. The government’s commitment to obligations under NFSA must be commended, not criticized.