Back to the old order

The smashing listing of a business networking site and the flop debut of a commodity trader send confusing signals

By Mohan Sule

Half way into the year, and the contradictions characterising 2011 seem to be becoming more pronounced. Even themes coexisting amicably have shown divergent trends as illustrated by the march of gold and silver even as base metals are correcting on concerns of consumption from China and India following tight money policies. In another indicator of its dichotomy, the market rebounds if growth data are below expectation because, the logic goes, this would slow the central bank from ramping up interest rates. Bank, automobile and real estate stocks rise, as a result, without pausing to wonder how these sectors will keep their momentum if purchasing power falters. Signs of investors adapting to this challenging environment are becoming obvious with the doubling of LinkedIn, a business networking web site, on debut and the fall of commodity trader Glencore below its offer price in the largest-ever IPO on the London Stock Exchange around the same time, marking the end of an era when a bull run bolstered stock prices across the board and a bearish phase pulled down valuations. In another contrast, the primary market in Hong Kong is booming with issuers, especially luxury retailers who are supposed to be the first to feel the effects of slowdown, lining up to list. As against this is the listless primary market in India, where issuers are opting for the quicker and efficient private placement route with bulging private equity funds. It remains to be seen if the rollout of the next phase of divestment by the Indian government brings back foreign investors, and the end of quantitative easing this month pushes US issuers to the trading ring.

Going forward, the cracks within the emerging markets could deepen as India hopes to douse the heat of inflation through normal monsoon while China faces the gloomy prospect of drought. The opening up of China in the 1980s and its entry into the World Trade Organisation in 2001 has changed the balance of power. The dot-com bust at the end of the last century contributed to the imbalance, accelerating the migration of manufacturing to China and back-office services to India. The subsequent easing of credit by the US Federal Reserve leaked to economies that had opened up, boosting global growth rates. As a result, lenders became emboldened to take on risky assets on their balance sheets. The re-allocation of resources around the globe to achieve maximum returns meant that some pockets recovered faster than the others due to the varying degrees of their reliance on the domestic and export markets and standards of control exercised by the regulators. The consequence has been a change in the complexion of economies, gradually or overnight. Exports have become the fulcrum to maintain growth for inward looking economies like China and India despite their huge domestic market even as the revival of the export-tilted US economy hinges on its real estate sector. No wonder, both India and China want to keep their currency undervalued despite being major importers of commodities.

The change in the orientation of the Indian pharmaceutical industry from the domestic market to overseas opportunities tellingly highlights this transformation. Eventually, many top Indian companies will get most of their earnings from exports or will sell out to foreign competitors. The automobile industry, too, is tipped to earn more revenue from outsourcing than sales in the home market in a few years despite the rise in domestic consumption. Tata Motors is an apt example. In fact, with companies like TCS and India Hotel Company in its fold, most of the Tata group’s sales will be from overseas businesses. The Aditya Birla group’s aggressive expansion in the commodity space also exposes it to global markets. Reliance Industries’ margin fluctuates on back of its fuel exports. Even emerging sectors like telecom are scouting abroad for growth. Bharti Airtel could soon get valuations assigned based on its earnings in the African region. As manufacturing in China slows down, confirmed by Glencore’s tame debut, a counterbalance to keep the world economy humming is sorely needed. Talks of another tech bubble emerging, therefore, are making investors across the world nervous in view of the setback to the US economy by the previous one. The success of LinkedIn and the anticipated huge valuation for Internet firms Facebook and Groupon and the downturn in commodities and commodity stocks should, on the contrary, be viewed as the imminent resurgence of the US economy on the reemergence of the knowledge industry, which was eclipsed by the commodity-based housing bubble during 2003-07. The importance of networking and bargain shopping is never felt more than in the present contradictory environment of inflation and slowdown.

Mohan Sule

India’s Abbottabads

By Mohan Sule

Wrong response to inflation, weak corporate disclosures, and silence of fund managers are testing investors’ patience

The discovery of Osama bin Laden in a military town near Pakistan’s capital has raised questions about that country’s preparedness in nabbing terrorists and detecting intrusions. Investigations will eventually reveal whether it was complicity or incompetence. Alas, our neighbour does not have proprietary stake on complacency and carelessness. If only the US Federal Reserve had noticed that cheap mortgages were fuelling asset bubbles. In India, the conspiracy to sell scarce second-generation telecom spectrum at throwaway prices to favoured companies happened in the heart of the capital, with everyone else too cynical or compromised due to compulsions of coalition politics to put an end to the looting. Similarly, there are many more Abbottabads in the country, with forces inimical to the well being of the economy lurking in the neighbourhood of policy makers and regulators, waiting to be confronted. One of the most insidious threats is inflation. Apart from the Reserve Bank of India, which scaled down the growth target for the current fiscal early this month, even finance minister Pranab Mukherjee has admitted that it would not be possible for the country to achieve 9% growth if inflation is not tamed. What he did not do was to identify the long-term contributors to the present situation excluding temporary factors such as disruption of foodgrain supplies and spurt in oil and metal prices. A constant factor for India will be the demand surge from rural areas triggered by the tilt of the present government: loan write-offs for farmers and employment schemes, which have provided liquidity to this segment.

At the same time, there is timidity to undertake painful reforms including phasing out of subsidies, taxing farm income and aggressive PSU selloffs to blunt the spending. Instead of a precision attack, like that undertaken by the US Navy Seals on bin Laden’s compound, the RBI has been enlisted for carpet bombing by ramping up interest rates. The drone attacks are inflicting damage throughout the economy already reeling from high commodity prices. The chain reaction is inducing across-the-board price spiral. Already, investors are dumping companies that are absorbing input costs for fear of losing market share. In contrast, China recently fined Unilever for trying to pass on the raw material costs to consumers. Right now, the economy needs higher capacities to cater to expanding demand so as not to affect prices adversely. The rising interest rates are sure to hinder rather than help in bolstering production. Costly money could also boost non-performing assets. The increase in provisioning by SBI in the last fiscal has raised concerns about the health of our financial services industry. If low cost of money fuels bubbles, high cost pricks them, causing pain all around as seen after the collapse of the property market in the US. Higher interest rates also attract hot money from hedge funds on the lookout for arbitrage opportunities, turning the domestic currency volatile and scaring long-term investment from pension funds.

Besides insider trading, unwillingness of companies to issue clarifications and the habit of going into denial mode before confirming the ongoing buzz are undermining the confidence of investors in the sanctity of the markets. Of the lot, the IT sector is held as a mirror to companies in traditional industries. Yet, the succession struggle in Infosys Technologies and the abrupt top-level changes at Wipro have highlighted Indian companies’ difficult transition to become transparent. Even those with substantial foreign equity stake are reluctant to open up as illustrated by the lack of clarity on the terms of the split between the Hero group and Honda Motors. Another puzzle is the silence of institutional investors even as egoistical promoters diversify into unrelated ventures, using up their cash or taking on debt. Local and foreign funds choose to remain mum or make a quick exit instead of publicly chastising these megalomaniacs. Not a single institutional investor has demanded that promoter-CEOs of listed companies linked to the allotment of second-generation spectrum withdraw from day-to-day management. Only the Norwegian partner, Telenor, suggested that the boss of its joint venture with Indian collaborator, Unitech Wireless, step aside till the probe reached its logical conclusion. Not surprisingly, the Indian promoter rebuffed this sensible suggestion. If the Apple board could sack its founder-CEO, why cannot independent directors speak out? In fact, this could win back the trust of investors in these companies. The important thing for the government, regulatory authorities, companies and institutional investors is to demonstrate that they are responsive to the needs of ordinary investors and the absence of adequate reaction is not a result of insensitivity.

Mohan Sule