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

ECONOMIC ACCELERATION & DECELERATION IMPACT IS LONG TERM

As chickens are coming home to roost in the Junk Bond Markets in the US the threat of a contagion impact across asset classes is now increasing. The fall in crude oil prices was welcomed as a positive development as till now it has created a massive $ 2 Trillion of savings for the global economy by putting extra money in the pockets of consumers. However as I had mentioned earlier a fall is very good but a crash will always have some negative side effects. We see those side affects play out now in the Junk Bond Market in the USA.

Out of a total of $ 1.3 trillion of Junk bonds raised over the last few years nearly $ 550 billion has been by oil exploration and related service providers to the US Shale gas investment cycle. This cycle has created a huge impetus to parts of the US economy and helped the US reduce dependence on imported oil significantly. However the crash in price of US Crude to levels of $ 58 which is lower than the average breakeven level of Shale Oil of $65 has the potential of triggering off a crisis. Some level of sell off has started again and the ripples of that are being felt across the entire asset value chain.

On one hand we have the “Junk Bond” markets and on the other hand we have the market of Bonds that are priced AAA when they possibly should be valued Junk. When the US Federal Reserve started its cycles of Quantitative Easing it was actually successful in bringing long term rates down while bringing short term rates around the policy rates. On the gross basis the US FED is sitting on significant mark to market profits at this stage. How it will behave in the future is a matter of debate. However the bigger risk comes from the Euro Zone where countries like Italy and Spain (Lets not talk Portugal, Greece etc) today borrow at interest rates which are lower than the rate at which AAA borrowers can borrow. This is despite no structural improvements in their economies and recessionary economies. The ECB is moving on its new asset buy program at a time when the prices of those assets are already distorted much beyond fundamental. No one was willing to lend to these countries at 7% plus two years back and now they are borrowing at 2% for 10 year money.  The probability of the ECB ending up with huge losses on its Balance Sheet is extremely high as it accelerates its new Asset Buy program. Financial Markets now used to continuous doses of drugs are unable to fathom the risk that lies ahead.

Credit Market risks do not only flow from the US and European Markets. There is this case of borrowings of Oil Export Revenue dependant economies where the probability of default in some cases in increasing. Last week the probability of default of Venezuela went upto as high as 93%.

The Sovereign Wealth Funds of large Oil exporting countries have also been huge providers of capital across the world. As Oil prices collapse, export revenues reduce and the Budgets move into Deficit most of these countries at this stage could stare at actually removing liquidity from Global Equity and Bond assets from a scenario where their flows continuously increased over the last 10 years.

The risk of implosion of Chinese Wealth Management products that are extremely opaque has been talked off over the last 2-3 years. However defaults in China have been muted and have not been of any systematic risk till date. However these things come to fore much more as Economic Activity slows which results in an increase in Non Performing Assets. It is now a reality that Chinese Growth is going to slow. The impact this has on Chinese Local Government Debt as well as other opaque wealth products will need to be seen going forward.

IN CONCLUSION

In conclusion we have seen that Equity Markets have reached all time highs across markets in the month of November. We have seen a selloff in Emerging Market currencies start a few months back. A vast majority of EM currencies are now at multi year lows. The Equity Markets of some of the commodity dependant EM’s have also sold off significantly. With an improving US growth outlook and probability of rate increases going forward we could see a further strength in the US Dollar and sell off in EM currencies. This has happened at a time when growth has been faltering everywhere but the US. On top of this we now have issues that have come up in the Credit Markets which have the potential to create huge volatility and potentially a global market selloff.

While long term potential remains high in India the short term risks are high and growing. It should play out over the next few weeks. 

In the first part of the article I had illustrated the issues facing the Indian Economy. Now I come to solutions that are critical both for the short run as well as the long run.

Growth and only growth is the fix to India’s Fiscal Deficit problem in the long run. Now besides creating an enabling environment for private sector investments there are a few things that the government can do to revive growth in the near term.

-Focus on Urban Infrastructure projects-Urban infrastructure projects are easier to execute, especially projects like metros, overhead road and rail networks, water and waste water projects etc. An initial focus on these could contribute strongly to investment revival.

For example metro projects in 20 cities would involve a layout of Rs 200000 Crores. These projects do not face problems related to land acquisition

The DMIC involves an investment of $90 billion over the course of the project. It has been in the making for nearly 6 years now and lot of the plans and land acquisitions in a number of states are also through. Taking up project awards on the various parcels of this project will be extremely beneficial as it will create a huge amount of investments as well as job creation.

 

-Railway and Road projects-The boom in the last cycle started from the NHAI projects. Road projects are hugely positive for the economy as they generate large employment, & require lot of inputs & machinery. The economy around the project sites also gets a boost with increased demand for a number of products. The slowdown in this sector is easier to reverse as collection of user charges has not been an issue with roads till date.Easier exit norms post completion of project combined with proper evaluation of bids can attract lot of PE money. A combination of EPC & PPP with relaxation of Environmental norms will lead to a rapid revival of investments. An award of 8000-9000 kms of projects per annum will lead to an investment cycle of Rs 100,000 per annum.

Railways have been the most neglected sector of the Indian Economy. Huge investments can take place and start at a rapid pace by means of up gradation of stations, trains as well as on new tracks. This might require a greater support for the government in the short run. However the multiplier impact of this on the economy will be huge.

—  Agriculture supply chains- In good times supply constraints have not been worked on especially in the case of agricultural produce where it is an estimate of many that nearly 33% of the perishable produce gets destroyed. This is valued at Rs 200000 Crores. There is need to set up food processing units, modern cold storages as well as transportation networks. The total storage capacity in the country currently is just 300 lakh tonnes. Estimates indicate a requirement of another 370 lakh tonnes requiring an investment of Rs 120000 Cr by 2016-17.     It is unlikely that the wary private sector will come in without government support or tax benefits in this segment.  Government needs to move fast on this as this is one key facet of supply side reforms for bringing down inflation in the long term. This will set the tone for Round 2 of Rural Growth & Prosperity which started off with the inefficient NREGA scheme

-Relaxed environmental norms in the short run- Forest and Environment clearances take the maximum time need to move with a deadline. Most countries that have developed till a particular point of time have had relaxed environmental norms. However we seem to be moving towards one of the most stringent norms even at low development level of the economy. Another five years of somewhat relaxed environmental norms is not going to kill the country. This time frame can be used to streamline processes and guideline.  This needs to be accompanied by time bound project clearances.

I have illustrated some steps that should be the first steps to revive the economy. Consumption demand will take time to kick in. Awarding projects and implementing their execution is key. In the near term government needs to spend in Viability Gap Funding, Equity Funding or Funding private sector projects by the means of long term soft loans. Once the revival starts it can be self sustaining for a long time.

WHAT AILS THE INDIAN ECONOMY (PART 1) 

The Indian Economy has gone through one of the toughest periods since the beginning of the Millennium over the last three years. With the ushering in of the new government there has been a rejuvenation of hope which is reflected in Consumer and Corporate confidence. However this has not translated into actual economic activity till date. This is somewhat strange in the context of the fact that normally strong consumer confidence does translate into higher consumption spending. However this has not happened till now. Investment activity also continues to be on the slow lane as the NDA government grapples with trying to fix the system for smoother execution of projects.  Let’s look at some aspects of the economy now

Poor Consumption – Consumption held on quite well even during the time when the economy was in absolute doldrums. However despite a strong recovery in consumer sentiment there has been no pick up in consumption. A large number of companies actually believe that consumption of their products is worse than last year. So what explains this? In my view there are 3 major factors

-High inflation of the past- Indian’s have had to go through a phase of unprecedented inflation over the last 3-4 years. Even though we can be happy at seeing a figure of 5.52% for the CPI as the latest print the fact of the matter is that CPI has gone up in absolute terms by nearly 40% since the beginning of 2011. Most people have had to reduce savings and cut corners in order to keep up with their lifestyles. The inflation has been worse for the Lower and Middle class owning to the fact that Food Inflation in the same time period has been greater than the overall CPI by 5-10%. This has also happened at a time when economic activity has been slow and as such the increase in incomes has been muted across the board. In such a situation it is very difficult for people to suddenly start spending more even though they might be feeling better. On the one hand their overall savings have reduced which need to be built up and on the other hand a better sentiment has not yet translated into better incomes for people at large. Inflation on the services side of the economy has also been very high. As such lower inflation in the near term will go more into saving than spending.

-Falling rural incomes- The rural consumption story has been strong over the last few years as the multiple impact of MNERGA and huge increase in Minimum Support Prices for various agricultural products led to strong rural incomes. Incomes were also supported by high prices of various agricultural cash crops like Sugarcane, Rubber etc. As such, although rural inflation was also high it was counterbalance by high rural incomes. However this does not hold any longer. Spending under various rural employment schemes has been curtailed now. Moreover agricultural commodity prices have come down substantially from the highs of 2013 and on top of that MSP increases have been muted this year. Agricultural production is also down due to the erratic monsoons. Under the circumstances rural consumption is coming under pressure.

-Inflationary expectations are still high- Normally after a period of very high inflation there is a general belief that inflation will remain high for a prolonged period of time. The same is the case in the inverse.  As such, although prices might be coming down the expectations in the minds of people still continue to be high and this makes them save more than spend.  Although people do see a brighter future they would rather wait for it to come rather than spend in its expectation.

Poor Investment Cycle- In a recent survey of corporate it was revealed that nearly 54% of companies are still operating at a capacity utilization that is below 75%. More than 20% operate below 50%. Only a single digit of companies is operating near a figure that exceeds 90%. Now this creates a situation where even after the economy starts showing some traction and growth picks up there is unlikely to be a huge Corporate Investment boom in the near term. Any large corporate capital expenditure cycle will take at least 2 years to kick in.  In this situation the key is to see what will lead to an industrial revival.

-Misplaced focus on Fiscal Deficit- As the demand revival kicks in we will start seeing better figures on the IIP, however this will be in the absence of any huge corporate capital expenditure. 6-12 months from now the companies will start planning expansions and the real impact of this pending will be seen 1-18 months down the line. Under the circumstances the government needs to step in to revive demand. However the Finance Ministry in continuation of the UPA tradition is focussed on an artificial fix of the Fiscal Deficit. A reduction in Fiscal Deficit by reducing economic growth is a vicious cycle which is difficult to come out of. The Finance Ministry needs to stop pleasing rating agencies and foreign brokerage economists and get back to getting the economy on track. They also need to come out with realistic estimates of numbers. For example figures that came out this week show an amazing divergence between reality and what has been projected just three months back. Indirect tax increase for the first seven months has been just 5.6% against a projected 25.8% leaving a huge gap of Rs 50,000 Cr in government finances. If crude oil prices had not fallen the Fiscal Deficit would have easily crossed 5% this year.

Growth and only growth is the fix to India’s Fiscal Deficit problem in the long run.

THE MIRAGE OF LOW INFLATION

Even as reported CPI and WPI figures are coming down and the reported inflation is collapsing the key thing to analyze is whether you and me are actually feeling the impact of low inflation or is this just a mirage reflected in reported figures and the actual picture is something else. The fact is that actual inflation in India is much, much higher than what these figures reflect.

In order to make my point I recently analyzed the construction cost of a new house. My friend is constructing his house in Chandigarh. I had done a similar construction for my parents 5 years back.  The facts of the inflation in house construction 2009 Vs 2014 lie as follows

Cost of Labour per day  Rs 250 Vs Rs 600

Cost of Sand per truck  Rs 10000 Vs Rs 400 (whopping increase due to mining ban, everything in the hands of the sand mafia now who are minting money)

Cost of Bajri per truck  Rs 10000 Vs Rs 1500 (whopping due to ban on crushers etc so again mafia at work)

Cost of Bricks per brick Rs 6.75 Vs Rs 3

On the other hand the cost of the material which finds a place in the Wholesale Price index i.e Cement and Steel is up by hardly 25% over a period of five years.  What the above mentioned figures actually reflect is the fact that the cost of construction is significantly higher than what the official figures would reflect.  After taking into all of the above the cost of constructing the house of a similar size is in the region of Rs 1 Crores as against Rs 40 lakhs that I spent in 2009, i.e. the inflation is actually 150% over a 5 year period.

The above example was just one to show that the actual inflation is much higher than what figures reflect. Now if we come to the day to day living of people, although the price of petrol and diesel have come down and are likely to come down further for the common public who use public transport in the form of buses or railways or use taxis or autos the prices continue to move up. Railways did not increase ticket prices for years and as such the adjustment towards higher ticket costs is likely to continue. Taxi and Auto fares have been rising in double digits and the cost of Bus Travel has behaved similarly.

In terms of power i.e. electricity costs for consumers the story is similar. Most distribution companies have failed to cut losses despite huge investments. They continue to make losses and burden the public with higher electricity tarrifs every year. The last two years have seen an average increase of nearly 20% and despite lower fuel costs we are unlikely to see lower costs for us anytime soon. Infact on an all India basis a double digit increase is expected next year too.

Food price inflation to a great extent tends to be better captured in official statistics. There has been no movement on the supply side on the Agriculture front. No new investments seem to be coming up to reduce pre and post harvest losses, storage etc.  The low inflation figures that we see today are just due to the base impact where prices were very high last year. Food prices are prone to supply shocks and the per capita consumption of products like milk, eggs, pulses and vegetables is only likely to grow in India. Fruit price continue to be high and the inflation in these is in double digits. It is not that nothing good is happening in agriculture. Basmati rice and Cotton are big success stories. However much more needs to be done.

The biggest inflation is seen on the services side. Besides transportation the cost of every service has increased at a pace much higher than the reported CPI. You need to yourself see the increase cost that you have to pay for a haircut, healthcare, various public services or to hire a cook or a driver. Do we actually believe that the cost increase in these is near the current CPI of around 5.5% or the average CPI over the last 5 years of 9-10%. The fact is that even 10% is an underestimation of the cost increase of all of these.

All this is not to say that inflation has been muted in a lot of manufactured products. However these products do not form a part of day to day living of the general public. Prices in India tend to go up faster, however are very sticky on the way down. Even when wholesale prices crack retail prices are sticky. The fight against inflation still has a long way to go. 

I am presenting my long term market outlook via this presentation. The long term bull story for India is very strong although markets might run ahead of themselves in the short run.

The Indian Economy is likely to see a Structural Transformation which will create huge wealth for Long Term Investors. Attaching the presentation as reference.

With the significant fall in commodity prices over the last 2-3 months and its resultant impact on both CPI and WPI expectations have grown that RBI will cut policy rates in the December policy. These expectations have also grown with the dismal growth numbers coming out of the Indian economy where growth seems to be faltering and the IIP for the second quarter  likely  to show virtually no growth. The fall in agricultural product prices, especially issues related to cash crops like Sugarcane, Rubber etc as well as a lower increase in MSP’s this year is also likely to put Rural growth under pressure in the near term.

The results season till now also has been quite moderate, more towards disappointing with results across the board coming in below expectations or just about meeting expectations. The only silver lining is that with the decline in input prices margins have held up and could see some uptick going forward.

RBI action is likely to be on the SLR front rather than a cut in the policy rates. Raghuram Rajan has repeatedly said that Monetary Policy is directional and once a step is taken towards easing, stopping or reversing that will be extremely catastrophic from angle of  the credibility of the Central Bank. The second major point that RBI has said is that the current decline in inflation is largely due to the decline in global commodity prices and the base affect of last year, where vegetable price inflation had shot up between June to November last year. As the low base wears off we could again see an uptick in inflation. Foodgrain production has been low this year due to the erratic monsoon and prices of several key vegetables like Potato, Pulses , Dry Fruits as well as Fruits remain strongly elevated. Although we have not seen any spike in food prices, on an overall basis there hasn’t been much decline too. Overall the supply side response from the Domestic angle is still a long way off.

The other major factors which will keep the RBI wary in the near term is the fact that it is difficult to say whether the fall in crude prices is durable and will last given that there are countries like Libya which could see a sudden stop in production any time. The RBI has also warned on unhedged Forex exposures both related to Capital as well as by importers. Strong capital flows and not an improvement in the Trade Deficit has kept the INR stable at a time where we have seen most Emerging Market currencies fall 8-20%. A strong US Dollar combined with lower yields in India and a weakening currency could lead to sudden capital outflows especially from the Debt markets.

Banks have continued their rent seeking behaviour. Deposit rates have come down and liquidity eased significantly. The cost of funds for banks have come down due to this. However despite extremely slack credit growth banks in India refuse to cut lending rates inorder to boost lending. Net Interest Margins in India for banks are among the highest in the world with some Private Sector Banks reporting margins as high as 5%. This needs to come down.  I still remember at the time when RBI was cutting policy rates a couple of years back, banks refused to cut rates citing tight liquidity. Today liquidity is very easy, so why not cut rates? This requires no action from RBI’s side.

It is clear that the next action of RBI will be that of cutting rates. The question is just of timing. Will it start in 3 months or six months? My guess is that if global commodities remain weak for the next 3-4 months we could see the rate cuts being front ended in the year 2015. However a spike would postpone the action. However the possibility of a cut in SLR has increased substantially. On one hand it releases funds that banks can potentially lend into the economy, secondly it will reduce the downward pressure on Govt bond yields which have been falling to RBI’s discomfort. The cut in SLR could also be of a significant magnitude. Repo rate cut should be ruled out for now.

MARKETS

I had expected the markets to correct from the 7900 levels mainly due to the expected upmove in the US Dollar as well as increasing risks of a global stock market correction. We did see a correction in global markets and most EM’s also corrected 8-15% from the top. However the positivity due to the new government combined with falling commodity prices has continued to keep the Indian markets buoyant and after a shallow correction the markets have moved up sharply.

So does this mean that we abandon the view. I find it so weird that just because markets move up people expect me to become bullish. Anyone who knows me knows I am the biggest long term India bull. However we cannot ignore short term factors. Results largely have been disappointing, FM Arun jaitley has himself accepted lately that revival is a long haul and Global risks remain. Just because BOJ and ECB have announced money printing the risks have not moderated. Current markets reflect Euphoric conditions where the belief that markets will not correct is so high that I can see that in response to my cautious views on Twitter and FB.  This is reflected in the way global markets moved after BOJ announced an additional QE of $ 90 billion over one year and Global Market Capitalisation went up by $1.5 Trillion.

Any correction will provide potential entry points at justifiable valuations. The kind of stocks that will do the best  in 2015 will also be different from stocks that did well this year. However I will talk of that more towards the end of the year.

My view has been a 10% cut from the top. Earlier that was at 7100-7200 for the Nifty. Now it could be 7400-7500.

I turned sceptical on the markets around 6-8 weeks back as the USD rally started in a big way and it became apparent that the Global Growth scenario wasn’t looking as good as it seemed in the middle of the year. Since then most global markets have corrected by 10-15% from the top. The US markets have held on relatively well with a fall of just 8% from the top and now trade around 5% below their top as economic data continued to be strong out the the US.

The normal assumption that plays out is that the linkages between financial markets tend to be extremely high in the short run while the long run performance depends on relative Economic Growth as well as future prospects and earnings. The Indian markets in that sense have held on very well despite poor economic growth numbers and a relatively subdued start to the earnings season for the 2nd quarter.

The two big reasons are

Rapidly falling inflation – Inflation has come down sharply over the last two months largely driven by the crash in global commodity prices and a lower food price spike relative to previous years during the July-October time period. Given the global growth outlook this scenario might hold out and help RBI in its inflation fight over the next few months. Supply side measures on the domestic side are still awaited.

Economic growth in the domestic economy has slowed very sharply and this by itself has created a disinflationary cycle. However we actually need faster growth and low inflation. RBI also seems to be watching out for how inflation behaves as the economy revives and might not cut rates in the very short run.

Growing strength of the Central Govt – The Modi Government has started taking aggressive decisions to revive in the economy over the last few days. Diesel deregulation was aided by the nearly $ 30 fall in crude prices from the peak. Measures have also been taken over the last two days on getting the Coal segment on track. The State Govt elections have also strengthened the hands of the Government.

However a greater economic revival will require industrial activity to pick up and Infrastructural projects to get going. Most industrialists are of the view that without the change in the Land Acquisition Law it might be difficult in the short run. Economic growth has slowed very rapidly with growth likely to be 4.5-5% for the first 3 quarters of this year.

The Global growth outlook is also moderating which puts pressure on commodity producers as well as exporters. Export oriented companies have done very well in the stock markets over the last one year. However this might not hold in the next six months. Now the further upmove in the markets has to be driven by Capital Goods and Financial sector stocks.

IN CONCLUSION

Without writing too much my view at this stage is that the longer term outlook for India is becoming Brighter and Brighter. However I still believe that it is difficult to escape global linkages in the short run.  I turned negative on the markets around the 7900 Nifty level. After several ups and downs we are at the still level. As a BULL I would like the markets to do well but given my past experience I would be naive to believe that India can be a standout market in the entire world. This has never happened in the past.

In my view the Global Stock Market correction is still not over. One more round of correction is still likely. Lets see how it plays out.

As people say “There is always a first time”. I personally wouldn’t bet on it though.

I have overall been a supporter of Raghuram Rajan since the time he was appointed as RBI governor. My view has always been that we need someone who understands economics well and can look into the future to formulate policies as RBI governor instead of ex Bureaucrats that we have traditionally got. RBI’s thinking and actions have been a refreshing change over the last one year.

The overall policy stance on building defences for the INR last year, the change in focus to CPI, keeping liquidity relatively easy while targeting short term rates around policy rates, clearer communication etc have been extremely good steps from the RBI. The RBI has also removed tail risks for the INR by getting rid of their forward dollar delivery commitments and now holds a net long position in the forward markets. I have also argued that RBI’s inflation focus of getting CPI down to 6% is infact the best thing for bond investors as sustained low inflation will lead to a sustained bond rally.

However the INR policy in the near term has been a cause of concern. INR appreciation led by capital flows was the bane of the INR post 2007. I have argued in the past that we should have a weak INR policy till the time the CAD comes below 0.5% of GDP. The rupee should appreciate due to structural factors and not cyclical ones.

The fall in commodity prices, especially crude oil will save the country nearly $ 15 billion this year and also help reduce the Fiscal Deficit by reducing subsidies. However this is a stroke of luck and not due to any structural move by the Government or in the economy. The reduction in CAD in the USA is structural as they are now producing nearly 50% of their requirement of Oil & Gas. However India’s import dependence has actually gone up as production as continuously declined. On top of that we have increase imports of Coal, Edible Oils, and Electronics etc.  What if the crude oil prices spike up again going forward due to any reason? The entire Trade Deficit reduction and Subsidy reduction argument will no longer hold then.

India has got nearly Rs 120000 Cr inflows into Debt and Rs 80000 Cr into Equities this year.  However the overall build-up of reserves since the beginning of this year has been just around $ 20 billion i.e. just around the amount which has flowed in as Debt inflows. Forex reserves were $ 295 billion at the end of Dec 2013 and are $ 315 bn now.

The government is taking more time than was initially anticipated to bring about structural changes in the economy. This was always supposed to be a time consuming thing however expectations were that a start would be made sooner than later. However we do see some delays there. In such a scenario allowing a strong rupee builds up risks for the economy.

The INR has appreciated by nearly 5% against a broad basket of currencies since the beginning of August while holding steady against the USD.  This includes advanced economy currencies like the Euro and the Yen where it has been in the magnitude of 5-6%. Most EM currencies have fallen by nearly 5-10% against the USD in the same time period. In the absence of any structural improvements in India’s external balance of trade this is extremely risky. This could lead to a cooling off of exports and a pickup in imports going forward as imports become cheaper and India loses the relative currency advantage in exports. Textile, chemical and auto ancillary exporters a big story in the stock markets could lose competitive advantage.  The other major factor to consider is also that one of the major reasons for the reduction in the trade deficit has been the restrictions that have been put on import of Gold. Finally these restrictions are artificial and will not last forever. As prices of Gold come down and the restrictions are eased we are likely to see gold imports pick up again.

A strong INR also has the impact of keeping imported prices low and inflation lower than what it would have been in the case if INR was 4-5% weaker.  The other big factor playing out these days is that due to a high forward premium of Rs 4.5-4.8 for USDINR most exporters are hedging their receivables while importers are going unhedged as the hedging cost seems too high to them. This is now building up another risk factor in a scenario where a reversal in capital flows could create a short term downside in the INR and hit the unhedged importers in a big way, which would then run to hedge and create more downside for the INR.

In conclusion I believe that the RBI should use relative INR strength to build reserves rather than keep the INR at levels which are not economically sustainable. Forex reserves could be $ 20 billion higher if this strategy is employed. Till CAD is sustainably under control and inflation much lower than current levels there is no case for a strong INR.

 

MY ARTICLE IN THE HINDU BUSINESS LINE TODAY

Stocks markets worldwide have been on a runaway up move for the last several months. We have seen some intermittent corrections, but those have been shallow and of a very short duration. Although I am quite bullish on the markets over the Long Term the near term picture does not look encouraging. The risks to the markets are predominantly global and somewhat local. Some risks that I see playing out are as follows
(CONTINUE READING ON THE LINK)

Multiple challenges to galloping markets | Business Linehttp://www.thehindubusinessline.com/features/investment-world/market-watch/multiple-challenges-to-galloping-markets/article6367123.ece

In recent days we have seen the Competition Commission of India (CCI) either starting investigation or imposing fines on companies in several industries with respect to potentially cartelization. We have seen fines impose on Cement and Auto Companies along with some Real Estate companies. However much more needs to be done.

The issue of inflation and inflation control has taken centre stage in India over the last several years. Despite extremely tight monetary policy as well as stagnating to weak global commodity prices inflation has not come into control. Small period of low inflation have been followed by long periods of high inflation. In the strong growth era of the period 2004-2007 one could have argued that high demand and lagging supplies could explain higher inflation. However the last two years have seen an absolute demand collapse in the domestic economy and as such it is not demand pull that is responsible for higher inflation. The obvious reasons of the social sector dole outs of the outgoing UPA government, high Fiscal Deficits and a weak INR combined with persistently high food inflation are the logical explanations for high inflation, however strong cartels that operate within the economy are also responsible for the persistently high inflation. Some examples of these cartels are as follows-

The Real Estate/politician nexus cartel- The real estate cartel is one of the worst in the country. The entire real estate industry operates under a shadow of extremely opaque operating structures, payoffs to politicians and local bodies, restrictive supply regimes which create artificial shortages etc. There is also an extremely regressive taxation structure related to both the sale and purchase of property where the registration charges and stamp duties are extremely high and force people to understate the value of the transaction as well as on the capital gains front where taxes are high and force people to understate the value of the transaction. Given high transaction costs and opaque approval structures Real Estate which constitutes the maximum allocation of savings among Indians (recent estimates put HNI allocation to real estate at 43% of savings) is poorly regulated. The Real Estate Regulation bill has still not been approved and implemented. As such lack of transparency and extreme political patronage has made real estate extremely expensive in most parts of India. The rental value of residential property ranges between 2-3% in most parts of India and 3-5% on commercial property. These returns are obviously not viable given the interest rate regime in India and reflect a negative carry. One of the flats that we owned in Mumbai started off giving us a pre tax rental yield of 7% in the year 2007, this fell to just 2.5% in the year 2012 as property prices rose and rentals fell. This is when we decided to sell it off.

Better regulation, ease of purchase and sale as well as better transparency will reduce the cost of homes for millions of Indians who cannot afford it today.

The Cement Cartel- This is one of the most open cartels in India. I still remember that couple of year’s back I was sitting in the office of the MD of a large south based Cement Company when he got a call from one of his subordinates. The entire summary of the conversation was about how one of the other companies was increasing supplies despite their arrangement and was insisting on a higher quota. The openness with which this conversation was on really surprised me. Since then I have not invested into this sector.

Cement has been plagued with huge oversupply across the country, especially in South India. Demand has been weak and cost pressures have been high due to rising coal and fuel costs. Logistics costs have also risen due to rising diesel prices. However despite all of this we have seen huge stability in the EBDITA per tonne of most cement companies. Cement prices have fallen in some periods of time; however they have bounced back as fast. This has been despite large capacity additions and poor demand. Supply restrictions, pricing discipline is a well understood principle of this industry at this stage. If it had not been for this cement prices would have been much lower than they are today.

THE Tyre Cartel- Tyre oligopoly and pricing arrangements in this industry was a case study that we studies in our Management Schools nearly two decades ago. The same thing has made an appearance over the last couple of years. The Tyre lobby first got Chinese imports restricted and virtually stopped by putting some certification requirements on those tyre imports. As such Bus and Truck tyres which had seen a huge influx of Chinese tyres which had taken away more than 10% of the replacement market suddenly saw their exit. This was also the time when most tyre companies had embarked on a program of significant expansion expecting strong demand driven by strong economic growth. However as growth collapsed the demand for tyres also collapsed. On top of this the industry has been aided by the severe fall in input costs where rubber prices are off nearly 50% from their peak levels seen more than two years back.

Despite low capacity utilization, low input costs and poor demand the tyre prices in the market have held up, mostly due to some pricing arrangement. But for this prices would have been much lower.

The Power Cartel- The power sector cartel is largely a state owned one and not that of the private sector. Extremely poor inefficiency, large scale power theft and transmission losses combined with unfavourable power purchase arrangements from power producers makes us pay nearly 30-100% more than what we should actually be paying. The open sourcing and common carrier principle as envisaged under the Electricity Act is nothing but a joke. The power costs that household consumers and industry pays continues to rise despite the peak power deficit in the country now being just around 3% from a peak of nearly 15% a few years back. The power price on the electricity exchanges have collapsed to just around Rs 3 per unit & sometimes even below that. However despite that consumers are forced to pay higher and higher every passing year. The unbundling of most power utilities into generating and transmitting utilities happened several years back in most states. Despite that and despite investing billions into the supposed improvement of transmission systems power losses have not reduced in most states. As prices have risen the incentive for power theft has increased more and more.

There is need for implementation of the Electricity Act in letter and spirit. The supposedly independent power regulators need to act on the behest of consumers and stop approving tariff hikes every year without efficiency gains. Overall power tariffs in India should peak out and actually fall going forward instead of rising if these inefficient state cartels are broken.

The Agri Cartel- I will not go into details of the extent of losses of farm produce post production in India as this issue has been talked of and discussed enough in the past. The key is that despite increasing production every year, improving farm productivity and huge buffer stocks with the government food inflation has been very high in India over the last 5 years. One reason for this has been the continuous increase in support prices under UPA. However the bigger reason also has been the rampant food grain purchase by the government which then lets it rot and degrade instead of selling it to consumers at reasonable prices. The government has made no major move to improve the agri supply chain or break the cartels which operate under APMC acts. Food product inflation can only be controlled if the mark up from the production stage to the retail sale point moderates. However there are so many layers in the entire agri chain that this mark up has only increased over the last few years.

Then new government will have to work on this front strongly to control the CPI which has a weightage to food of 57% for rural CPI and 43% in Urban CPI.

Overall several cartels operate in India which keeps prices higher than what they should be. I might not have covered all the Cartels as many more might exist. A proper control and operation of the Competition Commission of India along with strong punitive action by the government will help moderate prices and control inflation.