SANDIP SABHARWAL
Stocks,shares, finance, money, profit and the economy

I had become negative on the markets at the start of the 4th quarter of 2014. The reasons were not any long term negatives related to India but mainly because of the fact that the markets had run ahead of fundamentals, the expectations were  too high, the new government had just taken over and the mess that UPA had created required 12-18 months to resolve and the uncompetitive INR was making Indian export uncompetitive and this was a drag on the earnings of many export oriented companies.  The global risks were also being underestimated.

At the beginning of the year my view was that the first half of the year will be tough for the markets.  However as things would play out the second half would be much better. As I write we are almost flat for the year till date.

As we look forward the things look much more benign.  The green shoots of recovery are now evident with a slow increase in the reported Industrial Production data. This recovery is likely to gain steam going forward and I expect that from the month of September we should see reported IIP figures moving up to high single digits. This will be contributed by many factors which include

  • A pick up in consumer demand with lower inflation and lower interest rates boosting consumer sentiments and demand for both consumer durables and non durables.
  • A nascent recovery in the investment cycle as the impact of the start of many infrastructure projects as well as some amount of corporate capital expenditure will start getting reflected in reported figures
  • With the INR giving up some of its appreciation and uncompetitive move against other currencies we will see some pick up in exports

The services side of the economy will also start showing traction as a strong fiscal position of the government will push government expenditure which will have a multiplier affect. A better fiscal position due to better revenue collections will also reduce the impact of crowding out due to excessive government borrowings and will improve market liquidity and make more money available for the private sector.

The other big factor that will boost the economy will be the clear control on inflation that has come through now. The Consumer inflation is unlikely to pick up and given the excellent start to the monsoon season there will be less tendency for middlemen to jack up prices in the expectations of a poor agricultural production. Lower inflation always has a virtuous cycle impact on the economy. Not only will it give space to the RBI to cut rates further it will also improve consumer sentiments which have been depressed for a long time.

The other factor then to consider is then the impact of global factors where we are facing two issues today

  • An expected increase in interest rates by the US Federal Reserve. This is a huge bogey in my view. The increase in rates is not due to the formation of a commodity or financial bubble but due to an improvement in economic growth prospects and better employment. It will be supportive of equities and not negative. I will write in detail on this issue separately.
  • The Greek issue. This issue can have a sudden and sharp impact on markets. However it is unlikely to have any meaningful impact on global markets due to two factors. The first is that the current market capitalization of Greece is just $ 20 billion and as such no major losses are likely for equity investors out of Greece. The second is the total debt of $ 324 billion of Greece, which is huge but almost entirely held by the Europeans themselves and the IMF. There is unlikely to be any long term impact of the same on either the Indian economy or the stock markets.

IN CONCLUSION  I would say that the probability is very high that the worst of the markets is already behind us. My expectation of a bottom around 7900-8000 for the Nifty seems to be playing out. There was always a probability of a slip to 7700 levels however this seems to be a lower probability event now. I am a buyer in the markets now. The second half should be decent

We are now 5 months into 2015 and the Indian Markets have gone up by just around 1.5% in these 5 months in INR terms and are almost flat in US Dollar terms. This, I accept is somewhat better than the scenario I initially thought would play out. However we still have one month to go in the first half of the year which I expected to be tough for the markets as on a broad basis the performance was running well ahead of fundamentals. June could be an interesting month given that we seem to be at the cusp of a global stock market correction and it might be difficult for Indian markets to perform in light of that. However any global sell off is likely to be short-lived as long as the Greek crisis is contained.

The results season has almost come to an end. This was by far one of the worst results season that I have seen in many years. Technology sector companies faced margin headwinds and growth jitters and as such most underperformed expectations. Auto company results were mixed but on a broad basis in line with reduced expectations. Telecom companies outperformed expectations. Most PSU banks reported horrific results with continued pressure on the balance sheet while Private sector banks reported healthy numbers and balance sheet. Industrials showed improved margins and some companies did surprisingly well. Most consumer companies saw a significant slowdown in growth in Sales, however due to lower input costs most showed better margins. On the whole the results season saw more downgrades than upgrades of future earnings.

On the mid cap side of the markets the picture was the same. Some companies that did well were handsomely rewarded with strong stock price moves, however on the whole it was not a great performance. Too many mid caps that are fancied are trading at valuations that are not justifiable by any valuation parameter. On the other hand we do have value picks that are not fancied and as such provide investment opportunities.

I am confident on a good second half performance by Indian Markets; however the month of June could face issues related to

  • A global stock market correction which could impact funds flow. As it is Foreign Investors have been significant sellers in the month of May
  • A peaking of the Greek crisis, before the solution is found. We have seen this play out several times over the last 5 years where brinkmanship takes the shape of last minute resolutions
  • A less than satisfactory progress of the Monsoons which could create short term growth and inflation concerns while having not much of a long term impact

The second half performance of the Indian Markets is likely to be driven by improved macro’s in terms of improving investments and growth numbers starting September 2015 as well as directional moderation of inflation irrespective of a possible spike due to higher food prices if the monsoons fail.  The impact of various government actions on growth will start becoming visible between September 2015 and March 2016.

We have now seen a period of nearly one year when the markets on a point to point basis have not moved up much. As such a silent time wise correction has been on. However results of companies have also disappointed on the downside thus prolonging this entire sideways to corrective move. As I have written earlier, if Rajan cuts rates and moves on improving liquidity on 2nd June we could bottom out more near the lows of 8000 seen on the Nifty, however just a 25 basis point cut might disappoint the markets where expectations are too high and this could create a further 3-5% downside.

In conclusion I believe that we are now at the last stages of a time wise and value wise correction in the Indian markets. The lows seen over the next few weeks are likely to be the lows for the year 2015 and the second half of the year should see decent returns which could be in the form of low double digit gains from the bottom that is made.

I had written about my prognosis for the economy and the stock markets on the 20th of April via my note “The Juggernaut is rolling”. The thesis for the same remains and over the last few days we have seen the stock markets sell off quite a lot. The Nifty and Sensex have now reached levels that were seen in September 2014. As such we have not only had a selloff of 10% from the top but have also had a time wise correction of around 8-9 months. This was my thesis to start with. The markets had run way ahead of fundamentals and it is difficult to predict markets over short periods of time where momentum has a greater impact, however over the medium to long term markets are and will always be slaves of earnings.

The results season till date has been mixed. A lot of companies are still to report, however a large number of Technology stocks have reported and the earnings and outlook is not exciting with the companies facing challenges related to currency moves as well as pricing pressures. Their businesses are in the midst of a churn which should eventually settle down. Besides this telecom stocks have reported and here the outlook is decent. Results of a majority of high flying mid caps have been muted or just about met lofty expectations. There also are indications of significant inventory build-up in some companies that recently reported, like Kajaria Ceramics and Exide Industries. On the auto side Maruti reported very good numbers and as I write this article their April numbers have also come out which are very strong. Banking sector results have been surprisingly resilient and reflected in the near term outperformance of the Bank Nifty. Cement company results have been disappointing. Most capital goods, pharmaceuticals and consumer companies are still to report.

Overall, as expected the results are nothing to write home about.
The markets have also come under pressure due to the continuous offer for sale by either promoters or by strategic holders and we saw sales from Infosys, HCL Tech and a huge sale in Sun Pharma by the erstwhile owner of Ranbaxy. Besides this there have been other big sales too. All of this has had a technical impact on the markets where lot of the funds have got absorbed in these sales. Indian markets became the darling of global investors post the formation of the new government at the centre and India became a huge overweight in most global portfolios. We are now seeing a correction of the same with increased allocations to China, Russia, and Brazil etc. Growth has not picked up as expected by most trend following investors (it was never going to) and on top of that we again have chaos created by the Finance Ministry and IT Department on MAT taxation, retrospective demands etc which has had an impact on sentiments. A lot of noise is also being made out of possibly bad monsoons. Unseasonal rains have impacted rural demand in the short run, however these rains could help retain soil moisture and come to the aid of farmers in case of deficient monsoons.
However all of these things are what would eventually create the much required correction in the markets. Stock market participants and experts always find a reason for the correction after the correction has happened. The important thing is to see it with a perspective of the future.

Consumer inflation is unlikely to pick up- Monsoons or not I do not see consumer inflation pick up in any big way. Historically food inflation is driven by MSP increases and not by rains, unless and until they are really bad. Global food stocks are at historically high levels and at 25% of global production as against a normal level of 15%, Edible oil prices are subdued and Global Dairy product prices have crashed nearly 60% over the last one year. Real Estate and housing inflation is totally absent and with low input prices and slow demand there are unlikely to be any major price increases by companies across the board and we could actually see discounts. Crude prices are still half of what they were a year back despite the recent rally. Major spikes here are also unlikely. Overall CPI will remain muted and RBI will cut rates further which will drive economic growth.

MARKET OUTLOOK
Growth revival is now around the corner and it’s a matter of a few months. There are positive triggers for the markets like the passage of the GST bill which should be taken very positively by the markets. The Land Bill is difficult to call and we need to see which way it goes. Some sort of global correction seems to be building up across the developed world markets like the US, Europe and Japan. It is possible that the heavily overbought Chinese markets could also sell off sharply in a short period of time. This will impact global fund flows and Indian markets in the very short term.

However I believe that these things will play out over the next two weeks. Indian markets do not have much downside from here and my base case view is that the markets should bottom out around the 7900 levels. This level will be a good entry level irrespective of the case even if we see a further selloff in the markets. Any correction below this level will be very temporary and a one or two days phenomenon.

Panic is around the corner and it will be the time to BUY and play the Indian markets as the “JUGGERNAUT FINALLY STARTS ROLLING”

Sugar is one industry and sugarcane one crop which should ideally be beneficial to both farmers and sugar mills. Sugarcane is a cash crop which is very durable, requires low upkeep and relatively less prone to the vagaries of weather. In case of sugar mills it is a business where the risk of what they are buying is low, by-products are profitable and ongoing investment requirements are low. However continuous political interference in the way the industry operates has bought it to a situation where it is on the verge of financial collapse, especially in the state of Uttar Pradesh.

Typically farm support is given to several crops in India in the form of Minimum Support Prices (MSP) i.e. the price at which government agencies would buy the produce from the farmer if he is unable to sell at a higher price in the market. The calculation of MSP derives itself from the Cost of Products determined by the Commission on Agricultural Costs and Prices (CACP) which determines the MSP from their analysis of various input costs and a minimum profit for the farmer. This has worked well in commodities like Wheat, Rice, Cotton, Pulses etc.  The MSP is determined by the Central Government. The government agencies will normally buy part of the produce at the MSP and the rest of the produce is sold in the market at market prices.

Sugarcane is one agricultural commodity where the government agencies do not procure anything i.e. the government does not put any of its own money on it. However the government comes out with a Statutory Minimum Price (SMP) or Fair and Remunerative Price (FRP). Given below is the movement in the same over the last few years

Sugar Season SMP (` per quintal) Basic Recovery Level
2005-06 79.50 9%
2006-07 80.25 9%
2007-08 81.18 9%
2008-09 81.18 9%
2009-10 (FRP) 129.84 9.5%
2010-11 (FRP) 139.12 9.5%
2011-12 (FRP) 145.00 9.5%
2012-13(FRP) 170.00 9.5%
2013-14(FRP) 210.00 9.5%

 

As is clearly visible politics has entered into the FRP calculations from 2009-10 and the FRP has gone up at a CAGR of 21% over the last 5 years.  Only in the current year the increase is just to Rs 220.Even if we assume a cost increase of 10% every year this is way higher than what pure economics would determine. In the meantime global sugar prices have fallen 60% since 2011.

On top of this the State Governments came up with their farmer appeasement measure called State Advised Price (SAP) which has been 20-40% higher than FRP.

In the initial phase of the introduction of FRP and SAP the sugar mills adapted as their by-products like ethanol and power were profitable and the lower profits from sugar were compensated. However as sugar prices crashed over the last two years this has not been possible and compromised the financial viability of the entire industry. It is absurd for State Governments to ask private mills to pay a price higher than what is viable for a final product where the pricing is market determined and there is no Support Price. Private enterprises are being made to subsidise the vote bank politics of State Governments.

THE SOLUTIONS

  1. The solution to the problem has been well documented as per the report of the Rangarajan Committee which proposed linking sugarcane pricing to the final product price and also some benefits from the by-products. Pure politics has prevented its implementation.
  2. The direct conversion of sugarcane juice to alcohol is still not allowed in a majority of states. This should have been implemented, this way in surplus sugar years more of alcohol would be produced and vice versa and take care of the demand supply balance. Forcing sugar mills to make alcohol only out of the by-product Molasses is hurting the industry.
  3. The Ethanol Blending program has been a still born one. Despite law mandating a 5% blending only around 0.6% has been implemented till date. Oil companies should be made to comply with the law by the book or pay a fine for non compliance.
  4. If a state government advises a SAP then it should also be willing to buy sugar from the mills at cost or production plus a base profit.

These are the durable solutions. Others like increasing import duties, giving export subsidy; buffer stocks etc can only be stop gap measures which do not resolve the structural issues.

Farmer arrears have already reached Rs 19000 crores and due to the artificially high SAP’s farmers have moved more and more towards sugarcane which has led to excess a record production of nearly 27 million tonnes this year. This has further pressured sugar prices at a time when global sugar prices are at multi year lows.  Most sugar companies are making huge losses and are unable to repay their bank loans. It’s a vicious circle which needs to be broken at the earliest.

As we enter into the 11th month of the new government, the initial feeling of Euphoria is giving way to some despondency and a feeling that nothing much has changed and there is no move forward.  While it is true that there are elements of policy as well as implementation that could have moved faster the fact is also that a lot has been done and the impact of the same will be seen on the ground over the next 3-6 months.

An economy is like a huge boulder, when it is moving in momentum it moves smoothly and without friction. However when it has been bought to a standstill, like what happened during the UPA regime then it is difficult to move it initially, however after an initial impetus has been provided then gaining further speed is relatively easier. I do believe that the government has moved on several directions and the impact of the same will be seen in terms of growth going forward.

Reasons for a slow pickup initially are as follows

Consumer growth is subdued- Consumer demand has continued to be subdued despite inflation coming off and there being a feel good factor. The reason for this is simple. We had a period of nearly 5 years when Consumer Inflation was more than 10%. This was also a period when economic growth was slowing down. In such a situation most people used their surpluses to consume. Consumer demand continued to be strong even when inflation and interest rates were high in the initial period and cooled off subsequently. Similarly even when inflation has come down and there is a huge stimulus due to lower crude oil prices the pickup in consumption demand will take time as people need to be more confident of the sustainability of the move. Salary growth has lagged inflation over the last few years and this is now having a delayed impact. Rural demand has also been hit due to poor weather and low agricultural commodity prices.

Investment demand pickup is low- Most companies today have excess capacity driven by a long period of below par growth. The only thing that can contribute towards a pick up in investment demand is the infrastructure sector. Given the issues around the Land Bill as well as various issues plaguing stuck infrastructure projects is has taken time to get things off the ground. However now we see activity in several sectors especially roads.  A lot of projects stuck due to regulatory issues have also got cleared. As the investment cycle starts we will see capacity utilizations across the board go up and the virtuous cycle will eventually lead to corporate capital expenditure pick up. We could have seen some faster movement in this segment, however nevertheless there is decent traction now and the impact should be seen in the second half of the year.

Banks are wary of lending and interest rates have been slow to come down- Inflation and inflationary pressures have come down substantially over the last one year. Some of it has been due to the crash in global commodity prices and the rest due to subdued demand in the economy as well as a high base of agricultural commodity prices in the previous year. Despite ample liquidity and RBI rate cuts banks have been slow to pass on interest rate cuts mainly driven by the poor state of their balance sheets. Private Sector banks have benefited due to the poor asset quality of PSU Banks and have been able to expand their Net Interest Margins. However the passthrough  is happening now. Contrary to fears about a potential spike up in Consumer inflation due to unseasonal rains it is unlikely to happen as extended cool weather as well as soil moisture will lead to higher summer vegetable production. Monsoons are the joker in the pack and we need to see which way they go. However lending rates are likely to maintain a downward trajectory for the foreseeable future. The worst of bank asset quality will also be seen in the current results season. This will set the tone for better transmission and an impetus to growth going forward.

Overvalued rupee has hit exports- An overvalued INR driven by optimism around India’s growth revival as well as an improved Current Account Deficit has hit exports big time. High interest rates relative to global rates combined with the overvalued rupee has made Indian Exports uncompetitive. This has hit the growth in the external sector.

The way forward

In my view a combination of the steps that the government has taken legislatively combined with the impetus on boosting investments will start showing in growth numbers in the second half of this year. As inflation remains low and interest rates trend down we will see that translating into greater consumer as well as investment demand.  Exports on the other hand will continue to be an area of concern.

The progress of the Land Acquisition Bill will be interesting to watch. I see it similar to Manmohan Singh’s conviction on the India-US Nuclear deal for which he staked a lot. PM Modi seems to be taking a similar stance on the Land Bill. A success here will be very positive. The other key bill is the GST Bill which could actually pass through much more peacefully.

The Bureaucracy is still slow to move as the amendments to the draconian provisions of the Prevention of Corruption Act are still be passed by parliament. This has been in limbo for several years now. Most people underestimate the impact of this on decision making given that several bureaucrats have been pulled up and charged despite no personal benefits over the last few years.

Taking into account the lead factor of 12-18 months I see a strong revival in the economy panning out just a few months from now. This will translate into higher earnings growth for corporate India and give a boost to stock market performance.  The markets have remained in a range for the last 6-7 months and are now more or less at the same levels at which they were in September 2014. That was also the time I had become somewhat wary about the way the markets were getting delinked to the economy. The current corrective move should provide a good opportunity to get into the markets to ride a better second half.

The Elephant has started moving, there is acceleration ahead.

We are at the end of the first quarter of 2015 and it has played out more or less like I thought it should. The NIFTY went up by around 2.5% this quarter. After an initial up move during the month of January the markets cooled off significantly. This was driven by reality of a slow economy and low earnings growth setting into the market.  This has been despite very strong global cues where we have seen most European Markets rise 15% plus and a strong performance by the US and Chinese markets. India to that extent has been an underperforming market. However if we take into account the fact that the INR actually appreciated in a quarter when most currencies sold off big time against the US Dollar in USD terms the performance of the India markets is not as bad.

The current quarter saw outperformance from Telecom, Infrastructure, select Auto and private sector banking stocks. A vast majority of PSU Banking stocks sold off sharply this quarter with the likes of PNB, BOB, Union Bank etc down 30-40%.

Markets look decently poised at this stage. Although there are chances of a further downside of a few percentage points the longer term outlook now looks better with low oil and commodity prices sustaining. The global risks also have moderated with ECB QE and the fears of Greek Exit from Euro zone getting built into the system. However, an actual exit if it happens will create volatility for sure. The Government could finally move ahead with legislative action during this quarter and we have also seen economic activity start in some segments of the economy, although a broad based recovery is still lacking. The Global economy is also slow but no longer decelerating, which is a welcome change from last year.

The pulls on inflation at this point of time are downwards on the commodity and manufacturing side, while food inflation could rear its head up again due to unseasonal rains and if monsoons are below par again. However this is not the base case scenario. The entire benefit of oil price and the follow through fall in prices of oil derivative products is yet to play out and will keep overall inflation low. Iran’s deal with the world powers and easing of sanctions on that country will keep the oil supply strong and prices low for the foreseeable future.

The April Quarter should finally see the impact of RBI easing flowing into the economy. RBI should most likely ease liquidity in some way going forward so that the economy benefits from the interest rate cuts. The government was also holding on to cash in order to meet the 4.1% Fiscal Deficit target (as government accounts are on a cash basis). We should now see significant liquidity release due to Government spending into the system.

The current results season is unlikely to be exciting and we could see specific pressure in PSU Bank results as there will be no trading gains and increased NPA recognition. However now one can be reasonably sure that we are at the peak of the NPA problem and from here we should see a phase of sustained recovery.

The year 2015 will be challenging as I pointed out during the beginning of the year, however there is a realistic possibility that the upside from the markets could play out much stronger in the second half of 2015. I will keep on monitoring and writing on that going forward. We will also identify ideas accordingly.

For the absolute short term RBI’s monetary policy on the 7th of April is quite crucial. RBI needs to take steps for rate cuts to percolate down into the system. Lack of any such measures could create a short term downside.

The next leg of the market up move is likely to be led by Capital Goods, Infrastructure, Banks and Telecom companies. Besides this stock specific opportunities on the mid cap side will be there for sure.

 

The last few weeks have reinforced the rate cycle assumptions that low global interest rates are here to stay longer and to that extent give a greater opportunity to RBI and the Indian Government to replug and accelerate the economy.

Low inflation globally has pushed Global Central banks in the developed world towards more and more easing. The US FED stopped pumping in liquidity into the global economy last year. However the multiplier effect of the same is still playing out. We all know that the Bank of Japan is also pumping in huge liquidity and the ECB has stepped in from this month. The impact of ECB bond buying (money printing) on global flows can be quite significant as unlike the money printing by the US FED, the ECB is starting at a time when bond yields across the Eurozone are at all time lows by a wide margin. Also with negative bond yields across the short end cycle playing out in many countries of Eurozone as well as Japan the likelihood on money flow out from these economies into high yielding Emerging Market assets is only increasing.

The US FED has also indicated slower rate increases in its last meeting.  The most important thing this time is that the cheap money that is sloshing around has not been used to pump up commodity prices given the growing surplus across commodities. Some part of the liquidity, especially in the US has gone towards a higher credit growth and lot of this money is flowing into global equity markets as well as global bonds.

From an Indian perspective the extended rate cycle is good in more ways than one.  When the US FED did its initial Quantitative Easing (QE1 & QE2) a lot of the liquidity went into speculation in commodities and pushed up inflation in India. However this is not happening now as growth is anaemic in most parts of the world and we also have a Chinese economy that is slowing rapidly. As such the tables have turned and the negatives of excessive liquidity have been nullified from an Indian perspective. As a result we have seen huge money flow into Indian Equity and Bond markets.

The opportunity is there today to attract huge FDI into India. Some part of this will flow in as primary equity into Indian Companies, however a lot more can come in via Private Equity, REITS, Annuity based infrastructure projects etc. The government in the recent past has shown some urgency in pushing economic growth. More needs to be done to get in sustainable long term FDI.

The impact of the collapse in crude oil prices is yet to flow into the Indian economy. The direct benefit is $ 40-50 billion i.e. equal to a 2-3% push to the domestic economy. On the other hand exports are suffering due to an uncompetitive rupee which has been stable at a time of carnage in global EM currencies. Although the RBI has the opportunity to accumulate Forex and push in INR liquidity into the market it does not seem to be doing that. RBI’s easing cycle has had little impact in terms of lending rates of banks. This can serve the dual purpose of inducing some INR weakness and also increasing system liquidity which will lead to lower lending rates. Being happy at a lower Current Account Deficit just due to a collapse in crude oil prices does not reflect long term vision. Exports need to move up and sustain the lower CAD. Make in India also becomes tougher with an overvalued currency as imports are much cheaper. As the economy revives and imports increase we could see the CAD move up again.

Overall lower global rates for an extended period of time give the opportunity to RBI to ease more. We should see further moves by the RBI in April which will push banks to reduce lending rates. The front loading of rate cuts is likely to play out strongly.

MARKETS

Stock Markets have corrected 6-7% from the top. Another 5-6% should take out the froth from the markets and create better investment opportunities. This could take the markets down to levels seen at the beginning of 2015 and would meet my expectations at the beginning of the year that the first 4-5 months of the year are unlikely to see any significant returns. However as things seem at this point of time the second half could be better than what I initially visualized. Will update more on this later as the correction plays out.

Raghuram Rajans last interest rate action has taken a lot of people by surprise. The jury is still out on whether the rate cut 40 days before the scheduled policy and at a time when the Union Budget was inflationary in general was called for.

As I seen things the main reason for the cut seems to be the fact that RBI now believes that the slow pace of the economy is unlikely to lead to a pickup in inflationary pressures in the near term. Moreover low global commodity prices are assumed to be here for a medium to long term. Although Rajan did speak about the quality of Fiscal Consolidation the logic for the same is just not there. In my personal opinion more money in the hands of States is more inflationary as States tend to be more profligate than the Centre. The other concern in the back of the mind of Rajan seems to be the strength of the INR. Since August last year the movement in EM currencies has been as follows

Brazil Real – down 30%

Turkish Lira- 20%

SA Rand-12%

Indonesian Rupiah-12%

Mexico Peso-16%

INR-3%

Besides this developed market currencies like Euro and JPY have also depreciated significantly against the INR. This is impacting our export competitiveness in a big way and lower rate differentials might lead to some fall in the value of the INR.

Now when I say that Rajan needs to cut on 7th April I am following his own logic where he believes that the economy is in slowdown, there is excess capacity and there is need to front load the impetus given to the economy. NPA strapped banks have refused to pass on the rate cuts to borrowers. However come April and improved liquidity we should see rate cuts percolate down.

In order to make monetary policy more effective now RBI need to cut again on 7th April. This will push a nearly 50 basis point cut into the economy at one shot. This will have a twofold impact.

  1. It will improve the balance sheets of debt laden corporate and improve their debt servicing ability. There are a large number of companies that have good operational performance, however tight liquidity and high interest rates have impacted their performance. These companies will see an immediate improvement in their profitability.
  2. It will make lot of new projects and investments more viable as rates come down by nearly half a percentage points. It will give a definite impetus to capital formation all across. Right from infrastructure to corporate capex as well as demand for housing loans, home sales etc.

The other strategy that RBI can follow if it actually wants rates to move down is to improve liquidity by OMO’s where it buys government bonds from the markets and releases liquidity. This will have an immediate impact of bringing market rates down. However it does not seem to be inclined to do so right now.

RBI’s thinking seems to be that core inflation is well under control and unlikely to come up in the near term. Fuel inflation will also remain subdued although food is another matter given the fact that seasonal reduction in prices has been lower this time and summers could see some sort of spike.

IN CONCLUSION

In conclusion the time for half baked measures is over in my view. Either RBI needs to follow its own logic and drive rates down enough so that it leads to a real improvement in economic performance or else its recent measures might come to nought. It needs to front load and then it can give itself a 4 to 6 month break before responding further to incoming data at that stage.

Markets seem to have got all the positive news it was looking for in the near term. The corrective move that has started can be sharp and swift. It will provide the base for a stronger move later in the year. PSU Financials as well as Technology stocks look most vulnerable at this stage. A decent sized correction will give good opportunities to pick up stocks in a year which is likely to be a stock pickers market.

As the budget speech started and Part I of the speech wound down I actually thought that it was Mr Chidambaram speaking and not Mr Jaitley. However Part 2 did wave me up from the slumber and increased the rating of the budget substantially.

THE GOOD

First of all the thing that pleased me the most. The rule for establishing where the permanent residence of a Fund lies will no longer be dependent on where the Fund Manager sits. This absurd rule had forced many Fund Managers managing investments into India to sit in Singapore, Hong Kong, Dubai, London etc. Now if the Fund Manager is in India it will not establish permanent residence and the taxation of Foreign Funds. This makes the life of Fund Managers like me who never wanted to move out of India easy and creates more opportunities. Now there is no longer any need to sit at high cost destinations away from on ground research to invest into India.

Also in line with changes to improve funds flow into India were the proposals to treat taxation of Real Estate Investment Trusts (REITS) at par with equity and allow pass through status. The other major change was with reference to taxation of Alternative Investment Funds (AIFs) where again there will be pass-through and moreover foreign funds can now invest into AIFs which will improve funds flow into these funds and provide greater opportunities for Foreign Investors investing into India.

The other positive announcement was the strong action of the government on Black Money where holding black money abroad and holding Benami properties in India now will become a criminal offence imprisonable with sentences upto 10 years. The government has shown its sincere intention to control black money generation and this will eventually lead to greater flows into Equities, Bank Deposits and Insurance.

Tax breaks on savings have also been increased with a further limit of Rs 50000 being allowed into the New Pension Scheme as a tax exempt investment.

The postponement of GAAR by two years and its implementation from 1st of April 2017 and will also be applicable prospectively on investments made after that date. This improves lot of tax ambiguity. There are also moves to reduce taxation on royalty payouts by domestic arms of MNCs.

The GDP growth next year is projected to be in the range of 8-8.5% which looks realistic as per the new series.  The proposed legislation on reducing red tape for setting up new establishments by formulating regulations to follow and not take approvals from various authorities is a big positive.

Combining FDI and FII into one single category of FPI is also positive as it reduces monitoring requirements, an artificial distinction between good and bad foreign money and simplification.

I do not want to get into each and every step but just focus on main points.

THE BAD

 

The negative impact of the budget is in terms of the increase in Excise duties as well as the substantial 2% increase in service tax which will be highly inflationary. On top of that there has been hardly any move on addressing structural issues which impact inflation especially food inflation. I am afraid that this will make food inflation raise its ugly head sometime in the near future. When the finance minister said that problem of inflation has been addressed structurally it is simply not true. You just got lucky due to the commodity price collapse. Brent crude prices have already moved up from $ 46 to $ 63 now and might see levels of $ 70 during the month of March driven by reduced OPEC output, disruption in Libya production as well as short covering.

There have been no major steps taken to improve the balance sheet of PSU Banks.  The contribution towards PSU Bank recap at Rs 7940 Cr is a joke. Given their balance sheets they need at least Rs 30000-50000 Cr this year.

The disinvestment target is too steep at Rs 69500 Cr when the achievement for this year is just Rs 26000 Cr, although the move to undertake strategic sale of loss making PSU’s is positive.

Although a long term direction has been given on reducing the Corporate Tax rate in the current year it has actually gone up. This is ridiculous given the slowdown in the economy. We need lower taxes now not at a time when the economy is roaring.

There is also no clarity on final GST rates which could create some volatility for the economy as 1st April 2016 approaches.

Overall there have been lot of announcements however no substantive steps to improve the growth of the economy in the near term.  At a time when we are undergoing growth slowdown this is a negative.

IN CONCLUSION

In conclusion I would say that the budget is directional good but does little to provide near term economic stimulus or momentum. The probability that in light of poor corporate performance and a likely bottoming of inflationary downswing that the markets will move substantially higher from the current levels is extremely low. The markets need to consolidate and possibly give up some gains over the next few weeks and months.  Can markets rise from here? Sure they can on momentum but will find it difficult to sustain. The attention will now shift from making the Ordinances into law via the parliament.

As I conclude the article new is coming in that Petrol and Diesel prices have gone up by Rs 3 per litre. The best of deflation is behind us; don’t bet on lower rates in the near term to drive the markets.

The action from here on will be stock specific where there is still potential of generating huge alpha.

BUDGET AND THE MARKETS, REALLY?

The annual season of pre-budget expectations and discussions around how this budget is going to be trend setting for the Indian Markets and the Indian Economy have been buzzing for the last few weeks now. After having watched Budgets being presented as I have been working in the field of investments for the last  20 years now there are two things that I can conclusively say-

  1. The impact of the Budget speech on the markets is vastly exaggerated.
  2. The trends in the markets are long term in nature and the Budget is an annual event. Normally events in a trend never have the ability to change the trend

That said, a vast majority of traders, Rating Agencies, brokerages etc give a lot of importance to the event. We can say that the annual Budget exercise could have been very important when we were living in a closed environment and India was a closed economy. Now that the economy is open and most of the products can be freely imported and exported and there is very little to do on the indirect tax front the Budget should be treated as just one factor among many. Just to take a recent example, the first budget speech of the current Finance Minister in July last year was considered to be a letdown with not too many takeaways. However did it impact the long term direction of the markets? It did not. Infact in the last 20 years the markets have fallen 11 times in the month following the Budget and risen 9 times.  

So does this indicate that the Budgets were good only 9 times in the last 20 years or were bad 11 times?  Moreover 6 times out of the 11 times it was negative the markets gave a significant positive return for the full year.

Now what should we conclude from this data. I believe that the Budget in India has become an annual exercise where the government of the day puts out its agenda and thinking for the economy. There are a lot of things said in the Budget speech which are supposed to be followed up and done by various ministries who work independent of the Finance Ministry. Implementation of the things spelt out by the government, the growth rate of the economy, inflation, interest rates, and global factors i.e. all the standard factors have a much bigger impact on the performance of the markets than the Budget.

There should ideally be no change in investment strategy because of the Budget. The trends in the economic growth cycle as well as stock market moves are long term in nature. Negatively perceived events create correction in Bull Markets and positively perceived ones corrective up moves in Bear Markets. Ultimately markets are slaves of earnings and if economic growth is strong and earnings beat expectations markets tend to do well.  These days there is another major factor that affects the performance of stock markets globally and that is the Quantitative Easing programmes of various central banks. With economy growth anaemic globally most of this money is flowing into bonds and equities and this event has become more important than any other for the performance of global equities in the near term.

Near term market outlook seems more dependent on Global factors related to the movement in Oil prices, the crisis in Greece and Russia as well as the expected pace of tightening by the US FED. My view at the beginning of the year was that the first half of the year 2015 is tricky for the markets and we should see a better performance in the second half. I still believe that we need to be cautious till April/May by which time we should have clarity on lot of things.

In conclusion trade or invest based on the Budget at your peril. It is unlikely to impact long term stock market returns in any way.