Climate change

The year of scanty monsoon to incessant out-of-season rains and thrifty giveaways giving way to generous public payout

By Mohan Sule

It took many years of persuasion, prevarication and procrastination for the world to realize the dangers climate change posed for the survival of the human race. But, for India, 2015 was a year of sudden transformation, of paradoxes and contrasts. It took just days for the crescendo of infallibility and invincibility to crash into a pit of despair and dejection. If the high point was the feeling of smugness to see the world’s most powerful man braving smog and a drizzle to catch the Republic Day parade in the capital, the low point was the bounce-back into the political arena of a crusader from bureaucracy, one of the three strands choking the common man in their tentacles of quid pro quo. Not surprisingly, the market, too, took no time to come back to reality after reaching the zenith as the euphoria of India finally cutting the umbilical cord of giveaways to farmers and friendly capitalists got punctured by the second consecutive deficient southwest monsoon. Ironically, it poured and how in some coastal belts even as many parched states continued their tryst with famine and farmers’ suicides. The trepidation in waiting for the most powerful woman on earth to act outdid the plot line of a Hitchcock movie in its twisted suspense even as foreign equity and debt investors suffered a spell of vertigo. Nonetheless, foreign direct investment made a beeline on spotting of opportunities in insurance and defense and Make in India even as China collapsed under the weight of excess capacities and unbridled speculation in the primary market. If there was unanimity on the cause — excessive leverage — of the euro region’s recession, there was no such agreement on why India’s growth engine had lost steam. The reasons ranged from those with substance (the slow pace of reforms) to bogus (failure to build consensus with a recalcitrant opposition focused single-mindedly on stalling legislation to trip the economy).

The confusion was evident elsewhere, too. The ghost of Hamlet haunted the Fed as it wrestled with the dilemma to raise rates or not to without upending the emerging markets and so also our own central banker: tame food inflation or boost industrial output. Banks, though, shrugged off the benevolence, obsessed as they were in cleaning up their balance sheets, marked with years of generosity to customers with closeness to the movers and shakers as collateral. Squeezing margins, falling demand and spiralling food prices were not the ingredients to boost the spirits, despite plunging commodity prices proving to be a silver lining. The promise of operational autonomy in lending was as enchanting as a rainbow. In fact, the hard times exposed the unpalatable underbelly. In spite of rapid urbanization, villages held the key to savings and consumption. No wonder, financial inclusion became a buzzword, with attractive acronyms coined to capture the essence. Transfer of subsidy benefit and deduction of pension and accident cover premium were believed to be the recipe to bite into the banking habit. A welcome sign was the thrift on display, ranging from selling natural resources through bidding to reluctance in waiving loans and ramping up a minimal the minimum support price for crops. Yet, there was splash of indulgence. The hefty increments recommended by pay commissions transformed government and PSUs as sought-after employers as evident from the clamor to expand reservation quotas.

The Bihar polls demonstrated that getting the mathematics of caste and community equation right mattered more than the combustible composition of a corruption-free society. If the results underlined the limits of brand power and the downside of brand dilution, they also reinforced the adage of what it means to win the battle but to lose the war. It was triumph of parochialism (Bihari v Bahari), viewed as a legitimate concern when practiced by one set of players but not by others (presidential campaign in the US). Hypocrisy was perhaps the most enduring takeout of the year. For the sullen opposition, the idea of pulling India by the bootstraps came to imply sabka saath, ek family ka vikas. The indefatigable salesman, logging flier miles to make friends for India, was ridiculed for being an NRI and enthralling a constituency that was not going to vote. A 56-day sabbatical to mysterious lands, however, was considered necessary for reinvention and rejuvenation. Unwittingly, the argument exposed the chinks in the intolerant debate. The existential fear stemmed from the attack on holy cows of cronyism and appeasement of entrenched interests and the emergence of voices that were hitherto suppressed. There was shock and awe that many might actually like and share a new growth trajectory based on market intervention rather than the state-knows-best trickle-down economics. The climate in India surely underwent a change in 2015.

Factoring in the Fed

Increase in interest rates by the US central bank will eliminate uncertainty and correct stock prices that have outpaced earnings

by Mohan Sule

The question is not if but when. After seven years of keeping interest rates near zero, the US Federal Reserve is preparing to gradually ramp up the cost of money. Inflation is moving up, house prices hardening and jobless claims falling. So there is every chance that the US central bank might muster courage and take the plunge. The possibility of such an eventuality has been in circulation even before its October meet, when it put off the decision. The blowout in China and the recession-like conditions in the euro region weighed on just as the fragility of the US economic recovery, spurring speculation that the Fed might even postpone the rate hike to 2016. The uncertainty about its moves seems to be tapering, with near 80% of international money managers in a recent poll ascertaining that December might be the month signalling a U-turn of the monetary policy. Yet, going by past experience, the bounce-back of the domestic economy might not be the only factor to contribute to such a reversal in stance. The poor health of the euro region and Japan along with volatility in the emerging markets in anticipation of such a step is likely to be factored in. Besides, a sudden rush of fund inflows from different corners of the globe has the potential to fuel inflation faster than that might be desired by the Fed. The already strong dollar will become mightier still, jeopardizing American exports. The result will be the reverse of what happened pre-global financial crisis: cheap dollars and yen flooded emerging markets in search of better yields. The fear of formation of asset bubbles forced central banks of these countries to ramp up interest rates, thereby disturbing the equilibrium necessary for long-term money to flow around the globe smoothly.

Despite apprehensions about the potential of the undercurrents to capsize the emerging markets’ currencies, the increase in US interest rates will be a welcome development for many reasons. First, it will be an unambiguous affirmation about the recovery of the US. Second, a booming America has the force to pull China’s and other emerging markets out of the rut. Before China became the pivot to the world, the global economy was US-centric. The country was the largest exporter and importer. The double-digit growth of the mainland was mainly due to American businesses’ quest to keep prices of output low. This was done by shifting manufacturing to China and back-office services to India. With domestic consumption low due to high savings, China suffered as the US went into a tailspin after the credit crunch. Third, tech companies have emerged as one of the significant sources of foreign exchange earnings. A weak rupee will be an attractive proposition for US clients while placing orders, propelling the sector’s growth and hiring. Fourth, the domino effect will increase China’s consumption of commodities, helping economies of metal and oil producers such as Brazil and Russia to recover from the slump. The euro region, whose health is increasingly linked to that of China, will be able to rapidly climb out of recession. Fifth, dumping of China’s cheap goods into India and other emerging economies will slow down, boosting domestic producers. Local sourcing will be important for infrastructure spending. In the process, commodity prices will not remain untouched. Blunting the implications of a ballooning import bill will be robust exports.

Oil producers have kept their output intact despite declining prices to neutralize the threat from shale gas. With this mind, it is unlikely that they will take advantage of increasing consumption to ramp up prices to unrealistic levels to profit from the situation. For one, it will provide support to the comatose US shale gas industry. Second, the global economy could once again slide into recession. The response of the stock markets in emerging market is not expected to be dramatic. Many have factored in the imminent increase in US rates. Corporate India’s earnings have not kept pace with prices and further correction, if any, due to acceleration in foreign fund outflows will provide an opportunity to enter quality stocks at reasonable valuations. IPO pricing, too, will get moderated, leaving scope for appreciation post listing as local big-ticket and small investors are more finicky about getting big bang for their bucks. Importantly, domestic institutions are buying even at the current level, spotting growth potential going ahead and perhaps in the belief that any decline from the current level might be short-lived. Against this backdrop, investors should hope that the Fed begins its course correction sooner than later.

Safe and sound

The response to recent IPOs indicates that optimism about the future overwhelms the affirmative steps by the regulator

By Mohan Sule

The importance of foreign investors in the capital markets has been drilled into Indian investors’ collective conscience. Their presence in a stock is taken as a stamp of confidence in the corporate governance practices and outlook. They are known to prefer companies with liquidity on the trading floor. However, there is a downside, too. Just as they enter a stock with a big bang, their exit can play havoc with the valuations. Their departure is not necessarily linked to domestic issues and is often influenced by global events over which the local government and companies have no sway. Many of the foreign investors in India are pension funds or insurance companies, which can take exposure only to counters that meet the parameters laid out in their investment objectives. Most of them buy only index constituents. Many select scrips that are available in the derivatives segment so as to hedge their cash market positions. As a result, the price earnings ratios of quality stocks spurt so as to go beyond the reach of the ordinary investor. Deserving mid caps capable of delivering stupendous capital gains are ignored either due to the modest outstanding shares or because of the inability of these investors to breach their mandates. To ensure that the inflows of foreign funds are spread out across the board, it is necessary that companies expand their capital. An economic climate that holds the promise of increase in consumption can embolden enterprises to undertake fund-raising. It is at a delicate juncture when the economy is at the crossroads of bottoming out and bouncing back that the vacuum of retail investors is realized.


As small investors take small bites, the advance in prices might not be as sharp but then volatility is also low. Many of them hold their investments for several years and are happy with regular dividend payment, allowing companies the flexibility to plan for the long term without being bogged down by quarterly targets. Also, decisions are based on domestic considerations and company-specific events rather than second guessing the actions of the central banks around the world. Despite the global financial turmoil post 2008 liquidity crunch, China’s equity market did not panic like other emerging markets with large foreign institutional presence as retail investors constitute a majority of the investing community. It is not that our policy makers are not aware of the positive impact of the small investors on the equity market. Market regulator Securities and Exchange Board of India keeps on tinkering with guidelines to address the problems faced by the marginalized investors. These have included recalibrating the proportionate allotment of shares, increasing retail quotas, discount on the offer price, shorter listing period, debiting of subscription only on allotment, ban on withdrawal of bids by institutional investors, buyback of new shares by promoters and increasing the investment limit. There is also a move to direct companies to declare their dividend policies. Yet the revisions in various regulations were not followed by a spurt in retail participation.

There is a point up to which a safety net can work. Investors want transparency from companies and swift and visible penal action against errant promoters from Sebi. At the same time, it is wrong to create an environment that encourages small investors to believe that there are no risks and only gains. Mutual funds, unfortunately, unleashed this sort of hype and eventually became victims of investor disillusionment. There are already murmurs about the poor returns generated by equity schemes over the past year. Debt funds, too, have betrayed the trust by investing in low-quality, high-yielding paper to prop up NAVs. The response to two recent IPOs from the services sector indicates that investors know a value proposition. Both were richly priced. One flopped on listing as the scope for a high-end outlet was seen limited despite the rapid urbanization. At the same time, the premise that there is an untapped market waiting to be connected cost-effectively saw demand outstripping supply on the debut of the second stock. The conclusion is that, apart from a secure atmosphere being a basic requirement, optimism about the direction of the company going ahead is more important. If retail investors do not come into the market in droves, the fault is not because Sebi is lacking the will to enforce discipline. Confidence in the economy at large and the role of the issuer in the scheme of things are the pivots. The market is willing to pay a premium to companies that have survived and prospered even in tough times. That explains why some stocks fly high and some get grounded.

A chill in the air

The September 2015 quarter results trends confirm what was feared but also throw up some surprises

By Mohan Sule


To latch on to multi baggers, investors have to catch on trends early so as to enter a stock at modest valuations. At the macro level, inflation, deficits, trade imbalance, usage of particular goods and services and port and rail traffic among others give an idea about the state of the economy. At the micro level, expenditure undertaken for organic and inorganic expansion, mode of financing the capital and new launches reveal the optimism or pessimism of a company. The market’s perception is evident in the discounting assigned to the stock. Volumes traded, open interest in the derivatives market and volatility on the trading floor are other signals about the soundness or hollowness about the rosy picture painted by the management. Companies are in the business of making profit for their shareholders. To achieve this, they have to create trust among their consumers for their brands and products and services. This comes about by serving quality on a consistent basis at affordable prices. More is the demand-supply imbalance, higher is the scope for healthy margins. The implication is that companies have to keep on innovating to be among the first off the block. Else, they have to produce copycat products with superior technology. Automobile companies and cell phone makers have used this proposition to their advantage. The basic requirement for the premise to work is for consumers to have purchasing power to look beyond their essential requirement. Here, too, demand for workforce should be more than supply to create a situation of rising disposable income to climb up the value chain.

There is no better gauge to determine the ground-level impact of the economic environment than to examine the financial performance of companies. What the results reveal should be used by the government to re-calibrate the applications of its post-May 2014 policies. The inference from the July-September 2015 quarter is that a deficient south-west monsoon for the second consecutive year is making its adverse impact felt. The volatility in financial numbers of a large number of sectors including FMCG, automobiles, cement, paints and pesticides and makers of rural-dominant products and services confirms the rural distress. Some have managed to keep afloat with lackluster numbers, while a few others’ margins have taken a hit. Low base and price cuts have aided many. This leads to the second conclusion. The results could have been worse had not the slump in consumption balanced by falling commodity prices. The crash in crude oil prices has benefited not only oil marketing companies and refiners but also those using crude-based derivatives as raw materials and intermediates including plastic goods makers. The decline in commodity prices is a byproduct of global slowdown. The twin effects have been slump in project exports to oil-exporting countries and dumping of cheap goods. Also feeling the heat are the tech sector as clients seek better pricing and the domestic metals industry that could have otherwise bounced back quicker by the demand that is set to be generated by the Made-in-India initiative.

The opportunity presented by Digital India to penetrate the hinterland remains to be tapped by telecom services providers, who are facing the joint attack of stiffer regulations and diminishing share of the voice revenue stream. Better connectivity poses a challenge to capitalize on data, which has not deterred e-commerce properties. The diversion of traffic from brick-and-mortar retailers to digital markets have translated into better performance by logistics and courier firms, buzzing about delivering consignments. Two-wheelers and commercial vehicles, not surprisingly, are witnessing the beginning of achche din. The gradual revival of the power and road sectors has boosted freight movement. Capital goods makers, too, seem to be perking up as government investment is percolating to the grassroots. Hopefully, the increased infrastructure spending and lower interest rates should provide solace to public sector banks, continuing to be preoccupied with bad loans. The agile NBFCs, meanwhile, seem to have quickly occupied the slot of the small borrower’s preferred choice for consumer loans and so also microfinance institutions. The spurt in sanctions and disbursement by mortgage lenders catering to the mid-income group underscores the latent demand for affordable homes. Travelers are taking the bait of discounts offered by airlines and stuffing bag and baggage. The global economic gloom has not spoiled the appetite to have fun. The increase in footfalls at multiplexes, setting the cash registers jingling, proves that show business remains the opium of masses.

The last-mile challenges

A New Deal is required to tackle the ground-level problems posed by reforms

By Mohan Sule

The global economic gloom has not clouded the silver lining: the fastest-growing economy in the world. Fiscal and current account deficits are deflating largely on lower commodity prices and declining subsidies. Government investment in infrastructure is gathering pace. Interest rates are moving south. FDI is coming in fast and furious as the world is looking at India anew. Natural resources are getting auctioned. Many government departments and outfits are undertaking open bidding. PSU divestments started with a bang. The IPO market is reviving. Make in India to export to the world appears an attractive proposition with a weak rupee. Digital India is an ideal alternative to pass around infrastructure bumps. Smart Cities and Housing for All will be powerful boosters for job creation. The Jan Dhan Yojna is a smashing success in enlisting the unbanked. Mudra Bank and small finance banks are expected to fill the gap left by big banks in catering to the small borrowers. The social security schemes including pension and insurance are steps towards financial inclusion. Foreign portfolio investment outflow has slowed down as the US Federal Reserve is unlikely to increase interest rates this calendar and on second look at domestic valuations. In short, all the ingredients are in place for India to take off. Yet there is concern that despite the good intentions, the country could trip. Last-mile connectivity might pose a problem. Some of the legacy issues look insurmountable, frustrating policy makers in finding a solution. The choice is between tough decisions and letting the problem fester at the cost of the health of the economy.

Supply of coal and gas to power plants has improved and so also power generation capacity. Private sector is participating in the transmission and distribution sector. The hitch is the state electricity boards. They are unable to sell power to residential users at a cost plus basis. Cheap power is the poll plank of most political parties to win elections. Resultantly, SEBs cannot pay in full to generators and T&D companies. The situation has deteriorated to an extent that, despite adequate power, users are not getting uninterrupted supply. SEBs have turned to public sector banks to tide over the cash crunch. Their exposure comprises two-thirds of the Rs 450000-crore power sector loan portfolio of PSBs. Interest payment constitutes nearly 25% of the power cost. In 2002, a Rs 40000-crore package by the Central government mandated a deficit reduction timeframe. More than a decade later, Rs 200000 crore more were sanctioned for their restructuring, with the Central government taking on 50% of the liabilities. The remaining debt was to be converted into bonds to PSBs at less than 9% interest rate. In return, SEBs had to increase tariff. The average hike was a measly 14%. As the new Reserve Bank of India norms stipulate banks to make 15% provision for even restructured loans, any more credit from the PSBs in unlikely. Also, there is rampant corruption in SEBs. Inflating of cost is common.

The second tripping point is the telecom sector, with call drops becoming a recurring nuisance. The industry, the second largest after China by subscribers, is becoming a victim of its own success, with demand outstripping the spectrum available. There are more than five lakh towers in India, half of what are required. Services such as 3G or 4G require higher frequencies (above 2,100 MHz), which means more numbers. Metros and tier 1 cities do not have them in sufficient quantity. There is reluctance to share the infrastructure. Civic bodies do not have uniform standards for granting permission. The government has allowed trading of spectrum at a price pegged at the latest auction to tide over the shortage. Unless telecom connectivity is put on par with water and power supply, things are unlikely to improve and Digital India and Smart Cities might remain wishful thinking. The third obstacle is the health of banks. Non-performing assets do not allow them to focus on the future. Most of the bad loans are beyond repair. Unfortunately, these are to industries such as infrastructure that have to start spending to boost the economy. Capital infusion by government is a short-term solution. The Indradhanush reforms giving operational freedom will take a few years to show results. The fourth speed breaker is the conflict between MNCs and domestic players. In the power sector, most of the capital goods orders issued by PSUs have been snapped by MNCs and Chinese firms at rock-bottom prices. This plays to the advantage of the buyer but sounds the death knell for listed local players. Tackling these tough challenges means demolishing the status quo and giving India a New Deal.

Better late

Had Raghuram Rajan not done what he had to do, the central bank would have faced a crisis of confidence

By Mohan Sule

Has India’s financial markets got its version of James Bond when the Reserve Bank of India boss announced, “I am Raghuram Rajan and do what I have to”, and slashed the lending rate by 50 basis points (bps) late September? Finally, it appeared, the governor had come on board of the finance minister’s mission of aiming for growth. Investors, fed on a near zero-calorie diet by US Feral Reserve’s previous governor Ben Bernanke, however, did not appear impressed. Equities closed the day with just 0.63% gain. The clue was in plain sight: the market had discounted a benevolent money regime in spite of Rajan resisting a rate reduction for nearly a quarter since his last adventure and springing a surprise with a cut that was 25 bps more than expected. He waited for Fed chair Janet Yellen to reveal her cards (making jokers of pundits predicting her to start the cycle of rate increases from September), for the southwest monsoon to end and threats from maverick politicians to convince himself that the virtue of cautiousness could become a crisis of confidence in the central bank. That India might have been saved from tipping into recession is borne by the fact that the RBI has downgraded the growth and inflation targets for the current fiscal by 0.2% points. The downward revision indicates slump in demand going ahead despite softer rates.

Against the backdrop of the ex-US developed regions undertaking liquidity injection to boost inflation, a vital indicator of growth, the governor’s focus on controlling inflation would have been viewed indulgently if the domestic economy was sprinting. India’s projected expansion for the current year is notable considering China’s slowdown but tepid if not for the lower base of the past years. A deficient monsoon last year and moderate increase in the purchase price of crops have tamed food inflation, which contributed just 0.41% to headline inflation in April-July as against 2% a year ago. The change in the peg for the base rate to the consumer price index (with more food items) has raised the bar for policy action. WPI-based inflation dipped further and continued to be in the negative zone for the 10th straight month and the all-India general CPI inflation was nearly flat in August. The last lending rate cut of 25 bps had not pushed up inflation but was not having the desired salutary effect on manufacturing either. The cumulative output of eight core industries was down to 2.2% in April to August 2015 from 5.6% growth a year ago. Accounting for the overall CPI in August, the real rate of interest at 3.50% was too high for a listless economy. Viewed against the negative WPI inflation, it should have been near zero. The flight of foreign capital in anticipation of the hike in Fed rates in September 2015 hit a two-year high in August. Yet it is likely that the outflow will taper going ahead as a strong dollar has been largely factored by the market.

The third reason was the improvement in India’s macro picture but for the wrong reasons. The balance of payments surplus rose slightly in the June 2015 quarter from a year ago but had eased from the previous quarter. The current account deficit was down to 1.2% of GDP from 1.6% in the June 2014 quarter but had increased from 0.2% in the March 2015 quarter. Low commodity prices were improving the government’s balance sheet but not booting up industrial activity significantly. Due to higher domestic interest rates, external debt rose1.8% end June 2015 over end March 2015 as outstanding NRI deposits more than doubled from a year ago and low-cost overseas commercial borrowings increased. The volatile financial markets resulted in spurt in demand deposits in the current fiscal till early August as against a slide a year ago. The fourth factor was the government’s performance. Credit is up slightly so far in the fiscal. GDP expanded 7% in the June 2015 quarter, higher than the 6.7% growth inherited by Modi. Importantly, the uptick has come despite low inflation. Exports continue to be down but seemed to have bottomed out as the pace of the decline was the lowest in eight months in July. Fiscal deficit at 8.84% of GDP in the June 2015 quarter from 9.99% a year ago was due to the success of PSU divestment, auction of natural resources and control over subsidies. Total receipts were up 20.59% in the quarter over a year ago. Against this backdrop, the RBI could no longer pass on the task of accelerating growth to the government. The fifth reason was China’s depreciation of the yuan to spur its slowing economy. The rupee had to weaken in relation to stay competitive in international markets. The window of opportunity would be available till December, when the Fed is said to finally embark on boosting interest rates in small doses. As such, Rajan had to do what he did without much ado.

The guest list

Instead of meeting captains of industry, the prime minister should have heard from some ground-level troops to fix the economy

By Mohan Sule

The ritual of the policy makers from prime minister downwards meeting corporate bosses every time the economy goes into a tailspin is familiar and frustrating. The conclusions drawn from the few hours of interaction with the who’s who of the government are also predictable. The ministers kick the ball into the businessmen’s court. The manufacturers and financiers plead for more fiscal and monetary sops. It is puzzling why Prime Minister Narendra Modi, who rode to power promising a break from the past, should carry on with this legacy of a thoroughly discredited regime. Though there was a sprinkling of public sector presence, the gathering was dominated by big private sector players. Many of them could have been the poster boys of crony capitalism, enriching themselves by cornering lucrative commodity prospecting rights. One is allegedly involved in the coal block allotment scam and another blamed by the government of under-performing to get higher prices for the output. A banker is grappling with mounting bad loans due to interference from power brokers and so also a peer because of aggressively chasing market share. Another emerging industry czar with political ties is believed to have under-reported revenues to avoid levies. The head of a diversified conglomerate makes a toxic product as well as a food item that is of late under the scanner of the regulator.

The old guard of India Inc is known to get policies tailored to protect them from competition, out-of-turn favors and easy access to the PMO and the finance ministry. It is used to bagging licenses not for any skill set but because of the proximity to the movers and shakers in the capital. Loans were obtained without adequate collateral and risk assessment following phone calls from bureaucrats, secure in the knowledge that any execution risk will be taken care of by visiting the relevant ministers. Auctioning of natural resources, instructions to banks to give credit based on commercial viability, cracking down on makers of spurious products and directing influential visitors to the concerned officials instead of the finance or prime minister have not helped the Modi government in winning any popularity sweepstakes with Corporate India. In fact, a patriarch got miffed because his fund-raising proposal did not get any preferential treatment. Many are heard grumbling, anonymously, in the media of not getting to meet the prime minister to sound him out on troubling issues specific to their projects. After operating in such a comfort zone, no wonder industry is muttering about cheap Chinese imports and sluggish rural market. The subtle message is that the government should continue routing doles through the Mahatma Gandhi National Rural Employment Guarantee scheme and increase the minimum support price for crops to bring prosperity to the hinterland, hurt by poor monsoon, to lift sales instead of declaring that it is ready to set up factories to provide jobs to the next generation of those farmers willing to give up their land for a stake in future prosperity.

What should the prime minister have done instead? Often he has professed his belief that it is the medium- and small-scale units that drive employment in India. To test his proposition, he should have invited tier 2 and tier 3 entrepreneurs. For example, the boss of the newest private sector bank and a new-age insurer could have elaborated on the potential of financial services to marry technology and human resources. The founder of a corporate healthcare chain could have focused on the paucity of skilled workers including doctors, support staff and lab technicians. A publisher of educational tools would have been a symbol of the parallel system that is catering to thousands of students outside the mainstream. One of the MPs from the prime minister’s own party could have revealed the potential of the entertainment industry as a revenue generator as well as a magnet for employment in front and back of camera. The potential of processed food, as any of the promoters graduating from the unorganized sector to builders of brand for the domestic and export markets would have told, still remains to be tapped. A food supermarket entrepreneur would have been appropriate to note the linkages between better prices for farmers, cheaper products for consumers and training of unskilled labor. A budget hotelier would have reminded that domestic tourism, too, is a crucial contributor to the GDP. A first-generation airline owner could have dissected the reasons why a once emerging sector had gone out of favor with investors and how it is a supplier of jobs ranging from flight service to maintenance engineers. To win the war against poverty and unemployment, there is need for foot soldiers rather than generals.

Money goes round

The strength or weakness of the currency rather than government policies will determine the direction of the market

By Mohan Sule

There is broad agreement among investors that the launch pad of the missiles that torpedoed global stock markets on Black Monday 24 August and Black Tuesday a week later was based in China: a sluggish economy, overheated stock market and devaluation of the currency to remain competitive. However, the contributors responsible for plunging China into a crisis vary. Some blame the overcapacity in its manufacturing sector, a supplier to the world. Others point to the very high savings rate, resulting in a skewed growth of the economy, with investment overshadowing consumption. Whatever may be the factors that led to the meltdown of equities around the globe, some trends are visible from the fallout. The first is not to depend on one market. India’s tech sector suffered due to the slump in demand from the US, its main consumer. Exporters of metals and crude oil to China such as Russia and Brazil are facing the prospect of recession. Investors give better discounting to companies with a diversified product portfolio and user base over those who sell to a few clients and geographies. The second realization is that reliance on exports has a downside, too. The ride is smooth as long as the economies of the importing countries are healthy. The slowdown in the US and recession in many parts of the euro region translated into lower consumption of Made-in-China goods. The third fallout is the acknowledgement that while outsourcing is a great idea to retain flexibility to adapt to changing market moods, the price is importing the customer’s travails. The ripples of the credit crunch in the US post September 2008 were felt across continents. India had to offer fiscal sops on faltering consumption by the growing middle class, riding on the tech and financial services boom fueled by foreign money.

Yet for companies and countries exports signify strength, a stamp of acceptance of the quality of their products and services. The bottom lines of companies, particularly those in economies with weak currency, get an edge over peers. No country is self-reliant and even fully integrated companies have to depend on outside suppliers. The fourth lesson is despite the integration of global economies due to outsourcing and the global stock market rout stemming from China’s problems now and the US mortgage market turmoil earlier, the world is not flat. China’s woes have erupted even as the US economy is recovering and set for its first interest rate hike after the financial crisis. Emerging markets are worried about the outflow of foreign funds. The euro zone has a common currency and a common central bank setting a common monetary policy. The result should be uniformity in prosperity or despair. Germany is thriving but Iceland, Ireland and Greece went bankrupt. If a union formed to allow free flow of financial and human capital, goods and services has failed to be the model for a common market, how can a loosely interconnected global economy dotted by countries with disparate growth systems?

China has embarked on cheap money to prop up the confidence of its consumers and investors. Japan, too, began injecting liquidity even after the Fed stopped its bond-buying program. As a result, the US dollar is getting stronger and other currencies weaker in relation. As if to underscore their unique identities, their decline is not to the same degree. The extent of fall of a currency is in proportion to its economy’s dependence or lack of it on the American and Chinese markets. China had to further depreciate the yuan so as not lose its export edge to those whose currencies had tumbled steeply. The use of currency to retain preeminence leads to the fifth outcome. Monetary policies are the newest weapons in the armory of countries to stake their place in the global economy. RBI governor Raghuram Rajan has warned of currency wars as the rupee slid to the 67 level. The inescapable conclusion is liquidity will determine the direction of the market rather than fiscal policies, which are many times anticipated and discounted by the market ahead of their implementation. The hike in foreign investors’ cap in insurance to 49% was hyped as the most vital reform for India in the post-liberalization era. Subsequently, the revision in the land acquisition law and the passage of the goods and service tax amendment are being touted as the ultimate frontiers to be conquered. In the heat and dust, the market forgot how it sulked for days when increase in FDI limit in multi-brand retail, said to have the potential to open up our economy to a tsunami of foreign exchange, was shot down. Now the focus is back on Fed and RBI rate cuts. This is the sixth takeaway. The market will keep on shifting its goal posts to justify bubble valuations or pathetic discounting.

The action begins

Government v Nestle is an opportunity to shine a light on the regulation of safety standards

By Mohan Sule

The progress of the Union government's class action suit against Nestle India will be keenly watched for many reasons. The legal step will be the first of its kind since the introduction of the concept in the Companies Act, 2013. It could be a test case for similar strikes going ahead. India might soon have its own ambulance chasers, the breed of lawyers ready to spring into action by encouraging users to take on the services provider or the manufacturer responsible for any deficiency. Second is the curiosity to observe the defendant's ability to bounce back post penalty. The damage has been quantified at Rs 640crore (as against Rs 1185 crore net profit made in the year ended December 2014) in the Maggi noodle case. How the figure was arrived is not clear. In many health-related cases, the side-effects take years to manifest. Juries in the US are known to award multi-million-dollar compensation. Cigarette maker Philip Morris was directed in 2006 to pay US$10 billion to plaintiffs. The third will be to assess the impact on investments. The target is an MNC with a long presence in India. As it is India is known to be a tough market to crack. Besides red tape, users are price conscious. Patent infringement is common. Fear of harassment from multiple levels of the state machinery responsible for oversight for any perceived deviation scares off scarce capital. The procedure, therefore, comes at a delicate juncture. India is well positioned to attract investors disillusioned with China. The echoes are still reverberating of the din arising from taxing (US$ 2.5 billion) the capital gains made during the transfer of Hongkong-based Hutchison Telecommunications International's 67% stake in its telecom services joint with Essar to Vodafone's Netherlands subsidiary for US$1.2 1 billion in 2007 and the minimum alternate tax levied on foreign investors retrospectively.

Yet there is a need to display firmness to demonstrate that the Indian market cannot be taken for granted. The resolve gave birth to amendments in regulation to tax capital gains made outside India on transfer of assets in India. Providing the medium of class-action suit is an acknowledgement of the helplessness of consumers in India. The forerunner was the formation of statutory bodies to oversee various markets. The Reserve Bank of India is the banking industry's ombudsman and the Securities and Exchange Board of India of the capital markets. Sebi has of late started the practice of consent decree. Companies under investigation agree to pay a fine without admitting to wrongdoing, thereby preventing years of costly litigation. The Telecom Regulatory Authority of India, the Insurance Regulatory and Development Authority and the Central Electricity Regulatory Commission have been created to monitor niche markets. The Competition Commission of India scotches unfair trade practices. It has penalized many companies including cement makers for cartelization and rigging prices. In the US, the Department of Justice is known to have cracked down on many powerful companies including Microsoft, resulting in a settlement in July 1994, with the software maker agreeing not to tie its products to the sale of Windows.

An antitrust lawsuit blocked AT&T's proposed US $39-billion acquisition of T-Mobile that would have substantially reduced competition for mobile wireless telecommunications services across the US, resulting in higher prices, poorer quality services and fewer choices and innovative products. BP agreed to pay US$ 18.7 billion to settle federal and state claims arising from the 2010 oil spill, the biggest pollution penalty in the US. The European Union is toying on how to tame the all-pervasive Google to create a space for other search engines. An interesting inference is that many companies in legal tangle for their negligence and arrogance are leaders in their market and have enriched shareholders. Most have eventually settled with the litigants to focus on their businesses. The bottom line is that class action suits need not necessarily mean the end of the road for a company. The US Food and Drug Administration routinely blocks shipments from Indian facilities. Serious players take steps to bring their production plants in line with international standards and do not spurn the market instead. Nestle can use the opportunity to shine a light on the substandard government testing facilities in India. The Union minister for food processing has admitted that the inspector raj is resulting in rotting of food grains in warehouses. As the drama is played out in the court, the producers, consumers, the market and the government will get to know how to set right the many wrongs to tap the potential of the industry to the fullest.

No free lunch

By Mohan Sule

Controls on the flow of capital to protect the domestic financial market are effective in the short term but result in prolonged volatility

Investors take into account many factors while entering a market. These include quality of stocks, market share, future potential, taxation regime and political stability. The most important is liquidity. Stock exchanges use two methods to meet the criterion. The obvious is to make the listing procedure stable and transparent. By laying down norms, exchanges segregate companies based on what sort of audience they want to attract. Some of the world’s biggest companies are traded on the NYSE. Tech companies opt to list on Nasdaq. The BSE has a separate platform for small and medium enterprises. The specialized set of companies attracts investors aware of the risk-reward equation. Stocks included in indices and the derivatives segment ensures a large number of participants. At each stage, picking stocks for special treatment implies wielding of control to retain the characteristic of a market. The process also means there is nothing like unfettered access to a stock or market. Circuit breakers are safety nets to prevent a blowout. In India, for instance, shareholders’ nod is required to determine the extent to which foreign investors can buy into a stock. The Securities and Exchange Board of India insists that market intermediaries know their clients. Premature withdrawal of fixed deposits invites penalties. Some equity and debt funds slap exit loads for redemption within a certain timeframe. A differential tax rate regime for long- and short- term capital gains is another hurdle.

Investors, too, understand the limitations. The problem arises when the regulators and the state machinery intervene to prop up or suppress the market. The two most recent examples of imposition of obstacles to change the course of the market are China and Greece. Worried about a bubble, China tightened the margin requirement to borrow to trade. The kneejerk reaction to the backlash that ensued was to reduce interest rates, ban IPOs, and order state institutions to buy shares from the secondary market. The meltdown has been contained, for now. The question is: for how long? The economy has to revert to double-digit growth for the Shanghai stock exchange to sustain once the artificial support is withdrawn. The curtain has still not fallen on the comic-farcical Greek drama. The shutdown of banks, then caps on deposits withdrawals and the five-week halt to trading did contain capital flight. The steepest fall of the stock market in a decade on opening indicates that the inevitable merely got postponed. Past experience suggests that economies hampering free flow of funds enter a period of ups and downs. After the debt crisis of early 1980s, the thriving Latin American economies had to struggle for more than two decades before the commodity boom of the early 2000s lifted them out of the rut. The growth of the Tigers of South-East Asia slowed down after the currency crisis of the late 1990s. The common thread is the intervention by their central banks to regulate the passage of capital. As the US Federal Reserve started buying bonds and kept interest rates near zero, cheap money found its way into the emerging markets of Asia and Latin America in the second half of 2009.

In response, Brazil levied tax on the purchase of financial assets by foreigners and Taiwan restricted overseas investors from buying time deposits. Indonesia implemented a one-month minimum holding period for certain securities. South Korea placed limits on currency forward positions. Mexico, Peru, Colombia, South Africa, Russia and Poland, too, tightened capital controls. India’s central bank was praised for keeping domestic institutions on a tight leash. Despite the obstacles, investors chase markets offering higher yields. Yet here is an undercurrent of concern. Most of the flow is from unstable sources such as hedge funds and arbitrageurs, who aim for absolute returns and not beating the benchmarks. Their participation, necessary for liquidity, increases volatility. The special investigative team probing the problem of black money created panic in the market recently when it noted the use of loosely-monitored participatory notes as one of the conduits. China’s stock market collapsed after easing entry to foreign investors recently. India’s shallow market has ensured that foreign investors have to take exposure to index and large stocks traded in the F&O segment. Amid the turbulence, one country stands out for not clamping down on the market even at the height of global credit squeeze. Inflows into the US, particularly from China with ambitions of the renminbi becoming the global currency despite rigorously calibrating the flow of overseas funds, continued due to the confidence that there would be no hindrance in taking out capital. So is it any surprise that the dollar remained firm against all other currencies even post September 2008?

The helpline

By Mohan Sule

Use forex reserves to buy bad loans of PSU banks so as to profit from low commodity prices and US recovery

Global financial markets took one step forward and two backwards last fortnight. Even as the Greece blowout was being contained, China’s stocks melted and there were indications that the US interest rates were set to rise. The dollar strengthened and commodities collapsed. So there is a strange spectacle of the US economy regaining health even as rest of the world is struggling. As a major consumer of commodities, India’s current account deficit will narrow further. Cheap metals will boost a host of industries including refineries, power distributors, capital goods, automobiles, consumer durables, paper and packaging, paints and FMCG. The margins of tech, pharmaceuticals, garments, jewellery and other services exporters might expand A weak rupee should be an incentive for global manufacturers to set up base in India to export. What could be a better booster dose for the prime minister’s Make in India project? The problem is that the Indian rupee’s depreciation against the dollar is on the lower side compared with those of other emerging economies including Russia and Brazil. Due to the scare about China slowdown, foreign investors have not completely abandoned India. The market is huge and so also the scope for reforms. Their presence is keeping the rupee range-bound. The other not-so-obvious explanation is the covert role of the Reserve Bank of India. A steep depreciation will leave little room for reduction in lending rates. The fall in oil prices will be somewhat blunted, frustrating the government’s efforts to reduce fuel subsidy. Besides good southwest monsoon, low prices of petroleum products are necessary to keep inflation in check.

The currency is not the only worry that is complicating India’s efforts to profit from the current scenario. A low interest rate regime at a time US bond yields are stiffening is similar to opening the stable doors for foreign investors to bolt. Pre-2008, it was the carry-trades (borrowing in cheap yen to invest in economies with high returns) that kept the stock market buoyant. Those expecting the RBI to embark on an aggressive cycle of rate cuts will have to contend with disappointment. More than the domestic economy, future action on access to money is likely to be calibrated with that of the Fed. As the cooling of food inflation will not be the only motivator for the central bank to cut rates, there will be no immediate easing of the troubles of infra companies and banks. The short-term solution will be capital infusion into banks and fund-raising by leveraged companies depending on investors’ sagacity to overlook the present problems for a long-term vision. Overseas acquisitions to expand might slow down as borrowing costs rise in the US. The impact of the miscalculation of those who had issued foreign currency convertible bonds to finance overseas acquisitions is still being absorbed by the shareholders. The bearish phase post 2008 meant that investors preferred redemption over conversion into equity.

The RBI has limited flexibility to ignite growth by keeping the cost of money low, balance the currency so as to not hurt importers and exporters and sustain foreign inflows. Besides, banks’ balance sheets are hindering the pass-through of interest rate cuts to customers. Unless the problem of bad loans is solved, softer interest rates will remain on paper. The tapering of supply of capital from overseas and domestic sources can stall the economy. Liquidity is essential to drive investment, direct or portfolio. The challenge will be to sustain and accelerate inflows from both to meet the capital expenditure requirement of the public and private sector during this difficult juncture till global markets adjust to the decoupling of the US and rest of world. The central bank had foreign exchange reserves of US $ 353.33 billion mid July. It can set up a special purpose vehicle to buy out at least 50% of the US$435-billion bad loans of PSU banks, leaving sufficient cushion to step into the market during volatility. The depletion of dollars will be at best temporary as these will get bulked up by export revenue from a healthy US market. Banks will get a breather to pass on base rate cuts and should write off at least a quarter of the remaining sour assets. In the process, they will become attractive to investors to contribute to their capital. The move will provide the much-needed propellant to lift the economy, without straining government finances, and hold the attention of foreign investors set to flee to the US. The SPV can sell the bad loans in small tranches at a discount to the face value to vulture funds and institutional investors. These investors can redeem them after an appropriate gap from the issuing bank or convert into equity of the borrower, thus gaining a voice in the future of the company.

Striking similarities

Sebi and investment banks have to ensure that the imminent IPO boom does not degenerate into doom as in China

By Mohan Sule
The primary market is a parasite. It survives by feeding on the secondary market. A euphoric Shanghai stock market spun off a share-sale deluge. No sooner did the Chinese controllers stepped in to cap the runaway prices by hiking margins than listed equities began displaying withdrawal symptoms, plunging 30% from the peaks. So much so that financial institutions and brokers had to pledge to step up buying. Issuers were banned from raising capital to shore up the secondary market. China’s secondary market may well hold due to all the public display of affection but will IPOs? India is on the cusp of a primary market recovery. It will be the beneficiary of any disappointment of foreign investors with Shanghai. Yet, China’s experience of boom and projected doom has raised concerns. There are striking parallels. Chinese stocks have run ahead based on the belief that double-digit growth will be the norm. A slowing economy, therefore, can pull down high-flying stocks. Hence, the desperate attempts by the authorities to cool the heated equity market. Indian shares started spurting even before the May 2014 Lok Sabha elections on projections of the rise of Narendra Modi. His stint as the chief minister of Gujarat had established his reformist credentials. Also, the low base of the last two years meant heady growth going ahead. The turn in sentiments propelled the market to cross the 30,000 level. Just like China, India has plenty of room to grow. The potential of both remains untapped due to different reasons.

The deceleration in the grinding of its manufacturing facilities, triggered by the fall in property prices, is slowing China’s growth. The glacial pace of India’s reforms is lagging behind the galloping valuations. A common area of worry is the banking industry. China’s is dogged by dodgy account keeping, hiding the true state of its bad loans. Loose lending has contributed to bubbly stocks. India’s banks, too, are weighed down by non-performing assets, immobilizing their capability to lend to new clients. If the Chinese IPO boom is the beginning of the end of the China’s growth story, is India too destined to burn out before taking off? The composition of investors is a rough indicator to determine the state of a market. Ordinary investors fuelled the Chinese primary market. Indian retail investors are returning to the ring, primarily through mutual funds. On many occasions domestic institutions have bought equities even when foreign investors were selling. The downside is that the small investors responsible for holding up the market through mutual funds might book profit in the secondary market and turn their attention to new offerings. The Securities and Exchange Board of India has shortened the listing period from the close of issue by nearly half to six days. The prospect of bumper profit in a short time span can prompt diversion of funds from listed stocks. No wonder, a frothy primary market is viewed as the last phase of a bull-run. The equity market went bust shortly after the mega offer by Reliance Power in January 2008.

The other danger is the absence of capital appreciation due to high-value offerings. There is at least a probability of gains being recycled into newer offerings. Under-subscription due to richly-priced issues or listing at a discount to the offer price has the malevolent power to destroy the primary market and, in turn, the secondary market. Many issues will be offering exit route to early-stage investors, who would want good returns on their investments. More will be from companies aiming to deleverage. With banks going slow on lending due to money locked up in bad loans or entertaining only those with good credit score, there will be no surprise if those requiring capital will be from risky but promising segments. Small and mid caps will be the most vulnerable to mood swings as money flows in and out of the secondary market, depending on the size and attractiveness of the issue in the primary market. The market regulator has gone out of its way to ensure a smooth ride for small investors by introducing concepts such as retail discounts, anchor investors, market-making and buyback as safety net. With the memory of the roller-coaster ride of Chinese stocks still fresh, Sebi has to nip in the bud any signs of irrational exuberance and become vigilant in vetting the issues. There should be zero tolerance for non-disclosures by becoming visible in cracking down on those who flout rules. Investment banks have to cap the greed of issuers by nudging them to price their shares modestly so that they can be long-term players rather than flashes in the dark.

What to do with banks

Time to junk the concept of universal banking and turn to niche banking to ring-fence risks

By Mohan Sule
One of the stumbling blocks to the revival of the Indian economy is the poor health of public sector banks, which own more than 72% of the assets and 77% of the deposits of the industry. Not surprisingly, the finance minister has to keep reiterating the government's intention to infuse fresh capital into PSU banks. This is to restore confidence in the system, which is apparently to serve the small saver but has been twisted and bent to cater to crony capitalists. The banking industry has been the problem child not only of India but of the global economy, going back to the Great Depression. The Glass-Steagall Act was passed in the US in 1933 to limit commercial banks' securities activities, clearing the way to demarcate savings and lending institutions and investment banks. The idea was to protect the risk-averse depositors from the leveraging associated with dealing in securities. The scope to make big profit from accepting funds at lower rates and lending at higher rates is limited. Expanding physical presence to garner a big share of the market requires huge capital. In contrast, there are bumper gains to be made from advisory services and dabbling in the debt and equity markets on a relatively lower base. The M&A wave in the US in the 1990s saw commercial banks acquiring stake or tying up with securities firm for that much-needed bump to the bottom line. The Gramm-Leach-Bliley Act of 1999 repealed the provisions restricting affiliations between banks and securities firms, sowing the seeds for the blowout of the too-big-to-fail banks in 2007-2008 as exotic derivatives were deployed to top the league tables, ignoring capital adequacy.

The subsequent forced merger by the government of weak and strong financial organizations has resulted in a handful of institutions dominating the US's banking space. Though capital requirement has been enhanced and proprietary trading scrapped, prospects of a systemic failure have increased due to the small numbers. In India, PSU banks replicate efforts, manpower and capital to expand into each other's territory to chase customers. Their bottom lines are influenced by income derived from non-banking activities. Their assets are prone to turn sour because credit sanctions are not always commercial transactions. Mergers can create a few capable banks with scale. The issue is if the alliance should be based on balance sheet strengths and weaknesses or geographical presence to achiever wider reach. Core banking is making brick-and-mortar existence redundant. Interestingly, this leads to two crucial questions. Should banks be viewed as FMCG companies, vying for attention on the basis of brand loyalty acquired through superior service? Or are banks going to become e-commerce entities delivering the basic needs efficiently? FMCG stocks are favored for consistent payouts, while Internet startups are enjoying huge valuations despite making losses because of the potential. Banks combine the best and the worst of both.

Just as the FMCG sector is no longer viewed as evergreen due to dependence on monsoon to drive rural growth as the urban market has flattened out, PSU banks are burdened with the cost of reaching out to the lowest denominator. Like e-retailers who are prone to categorize themselves as tech companies rather than slot themselves with retailers in the real world enjoying poor discounting, banks are embracing technology for the ease of doing business and increased penetration. Unlike cyber malls, however, their valuations factor in the non-performing assets rather than the huge unbanked population as India urbanizes. The second dilemma is if India should go back to the era of institutional lenders confined to corporate clients rather than encourage universal banks. The regulatory framework for banks operating in various niches will differ. Investors will be able to pick stocks in the sector suiting their profile. The discounting due to the thin margins earned by attracting and lending money will be mediocre compared with those for bottom lines supported by trading income. Yet as the business of savings banks will pivot on the credit track record of retail borrowers, they will be viewed stable and safe. Investment banks will focus on maximizing treasury opportunities and big-ticket players will be specialists in devising innovative ways of raising capital, thereby rewarding risk-takers. VC and PE funds are meeting the needs of startups. Microfinance and SME lending institutions can take care of the small borrowers. The proposed Mudra Bank is aimed at the unorganized sector. Thus, clubbing banks as per the markets they cater to, with different capital requirement, will lead to better monitoring and containment of risks.

The 2-minute lessons

What the Maggi fiasco of bans and stock withdrawal reveals about Nestle’s strengths and weaknesses

By Mohan Sule

Every crisis teaches a lesson to the stakeholders, and the Maggi storm is no different. The first is makers of consumer products have to be prepared for a far severe backlash than business-to-business enterprises. Larger the size of the market, more does the echo reverberates. Many top-notch pharmaceutical companies have had their shipments from sub-standard production facilities suspended by the US regulator. Apart from a short-term reaction in the stock market, their domestic image hardly took a knock. Nestle had to face consumers’ as well as shareholders’ ire. This leads to the second lesson. Companies spend a lot on building brands, particularly in markets where entry barriers are low and competition is on the basis of price. Therefore, a breach of trust is hard to bridge: You, too? Investors who had propelled a north-based developer into the largest market cap player in the segment, leading to its inclusion in benchmark indices, felt let down on learning of material non-disclosures in its red herring prospectus. The third lesson is positioning. As long as Maggi remained a convenience food to be cooked quickly, it was looked at indulgently despite the widespread knowledge, at least among adults, that its basic contents contributed nearly nil nutrition. No sooner did it shift the focus to being a healthy alternative for children, it attracted scrutiny, leading to its downfall. Real estate players who forayed into the 2G telecom space have still to recover from the debacle.

Can Maggi win back users’ confidence? Going by the experience of Cadbury, which too faced quality issues, the exercise should not be difficult. A company with an established brand finds it easier to get up after a fall is the fourth lesson. At the same time, there is a danger for a brand operating in a buyer’s market sliding as consumers have other choices. The FMCG sector is a classic example of fierce loyalty to brands and fleeting from one brand to another in many segments of the personal-care category. The fifth lesson is that a track record determines how fast a company can emerge out of a blowout. Nestle has been in India for many years. It has had no run-ins with regulators till the recent episode. The result is that though the Maggi brand has taken a knock, the company has not suffered irreparable damage. The sixth lesson is that even low beta stocks can turn volatile. Nestle lost more than 9% in a single trading session and shed 11% in the fortnight since the snowballing of the content controversy early June. Yet, the stock is more than 25% away from its 52-week low and is still expensive. The market is optimistic of a bounce-back in earnings after a few quarters as the other brands in the basket are holding on. Despite sticking to the basics, the company did not allow any single food item to dominate, which has proved to be a bulwark against the Maggi backlash. Too much reliance on blockbusters can be counterproductive when they face a downturn is the seventh lesson. Core competency can boost as well as drag down bottom lines. Following the 2008 global financial crisis, the tech sector is expanding into Europe. L&T has forayed into the residential segment of the construction market after the slump in the infrastructure space due to the pre-2014 policy paralysis. To de-risk from its bread-and-butter business of cigarettes, ITC is now into food products and hospitality.

The eighth lesson is that tangible assets help a company to fall back during a storm. From small savings, Sahara has diversified into hotels and real estate, which will help its boss to post bail to get out of jail. Nestle has visible presence. There is no danger of the company vanishing like many others after the bust of the IPO boom late 1990s. The reaction of the capital market watchdog was to delist erring companies. Banning a product from the market or a company from the stock exchange should not be a kneejerk reaction is the ninth lesson. Here, the Securities and Exchange Board of India’s insistence on full disclosures by companies raising capital should be the template. Cigarettes are sold with a warning about health hazards. Similarly, consumables should display the ingredients and their nutritional values. Deviation from the stated composition should be the trigger for crackdown. Automobile companies are known to recall models after discovery of faulty mechanism. The return is the reinforcement of consumer bonding. Nestle, too, has recalled Maggi from the shelves. Where it slipped was in its sluggish response. Though the company kept the communication channels with the stock exchanges open, filing regular updates, it was slow in addressing the concerns of the consumers. The tenth lesson is that MNCs, as a rule, are transparent but are not necessarily sensitive to the sensibilities of the local markets in which they operate.

Changing complexion

Three transformations that investors will have to prepare for as the market undergoes another evolution

By Mohan Sule
The way of doing business has gone a dramatic change since last May. Transparency and rule-based governance are the buzz words. Natural resources are being auctioned. There are no phone calls or chits from the PMO or extra-constitutional authorities to bank CEOs to grant loans to cronies. Company bosses and lobbyists no longer have to make frequent trips to New Delhi with suitcases to tweak policies to suit them. The transformation is welcome and is another pointer that India is slowly graduating to a demand-based market from a supply-controlled economy. Investors have to prepare for the next phase in the evolution, where a company’s value will be determined by cost-efficiency and competitive policies rather than due to the monopoly status acquired by bagging licences based on proximity to the policy makers. The rise and fall of Naveen Jindal’s JSP should be an apt illustration and so also the wealth creation by the Adanis through acquisitions. Instead of SBI, the group is scouting finance from Russian and Chinese banks for its Australian mining project. The earlier stages saw the scrapping of the Controller of Capital Issues, which was vested with powers to decide not only the entry but also the size and price of the offering. The opening up resulted in a flood of fixed-price issues from the established to the shady. To solve the problem of hefty premium, the power of deciding pricing has been transferred to the market through book building. Another difference is the motive of the IPOs. Initially, they were to raise funds for expansion. Now shares are listed to allow early stage incubators to exit. The issue of expensive offerings, thus, continues.

The next stage is crucial. It can either propel the stock market’s wealth or discharge the third shock. The first was the period when fishery and aqua culture growers and timeshare promoters ripped investors, followed by the bursting of the dot-com bubble blown by eyeballs. Two types of issues will dominate. The first, of course, will be from the infrastructure sectors as stalled projects spurt to life. The not-so-pleasant past experience with these companies in the frontline of benefiting or losing due to government’s wise or whimsical policies might prompt caution. The second lot will be emerging companies, predominantly from the services sector. This is natural. The share of the services sector in a developed economy overwhelms manufacturing and agriculture. Pinning down valuations will be difficult due to their unique business models. Investors grappled with a similar dilemma when fast-food chains and telephony- and web-based aggregators of information ranging from general to wannabe brides and grooms and jobs entered the market. Is the valuation expensive based on trailing 12 months or cheap discounting the enormous forward earning potential? Lately, theme parks have sought funds and going forward there could be those setting up digital platforms to exchange used goods, sell furniture or find suitable houses not to exclude e-supermarkets. Should the market compare them with tech companies? Many of them may not even have comparable brick-and-mortar peers. More than these wonders, perhaps below-the-radar back-office and last-mile services providers are likely to be the winners, just as our tech companies remained immune from the crash of Internet companies.

The second challenge for investors will be to spot when a generational change takes place. Usually, the recast of indices is a good guide to notice the shift. Despite the first-mover advantage, Nokia and Blackberry have lost market share to the disruptive Apple. Traditional business houses have been shaken to the core by the net revolution, which has flattened the globe. Not surprisingly, they are in the forefront of the campaign to discourage zero rate arrangements between Internet service providers and e-commerce companies. The worry is that an agile upstart can neutralize the high-entry barrier in the real world by diverting traffic to its site by tying up with an ISP. Investors are already in the midst of the third wave of change. As the government pulls out from the business of running businesses, monetary rather than fiscal policies are having a far greater impact on the market. The US Federal Reserve’s moves are closely monitored. China’s softening of interest rates created ripples and so also liquidity injection by the European Central Bank to pull the euro zone out of recession. The policies to control the flow and the cost of money will affect the health of the market more than the budget as tax rates become stable and the government runs a system without many shocks to attract investors. Just as the Fed chairman is the most powerful person in the world, the Reserve Bank of India governor will be the man to watch out for.

Clash of conventions

Is volatility good? Can you trust promoters pledging their shares? Do cash-rich companies need investors?

By Mohan Sule

Stocks have been volatile of late, rising and falling with the flow of news. A sudden development interrupts consecutive days of unilateral direction of the market. On some other occasions, equities plunge or surge with equal ferocity on alternate trading sessions or even intra day. Events influencing investing are not necessarily confined to India. Stalling of key bills in the Rajya Sabha pulls down the market and so also improvement in US jobs data, sparking fears of US Federal Reserve sticking to its course of hiking interest rates from June. Similarly, cut in lending rates by China’s central bank casts a gloom on worries that the move will increase consumption of commodities by the largest manufacturer in the world and thereby boost prices as well as on concerns that the issue of retrospective collection of minimum alternative tax will drag on in courts. Besides the softening of the position of Greece on payment of debt instalments, putting on block a couple more PSUs for stake-sale and reworking the urea subsidy mechanism to kick start fertilizer production induce optimism. In short, the market is jumping from one issue to another without letting the resolution of earlier problems to percolate. This is because valuations have raced so much ahead, taking for granted that the NDA government will be bombarding the economy by one reform after another. Earlier, the delay by parliament in approving increase in FDI in the insurance sector to 49% was painted as the ultimate reform on which the well being of the economy hinged. Now it appears that the passage of the amended Land Acquisition Bill is the final frontier for India to conquer.

It should be evident by now that the Narendra Modi government wants to take one step at a time, covering its tracks even if it means delays, so it cannot be accused of carrying out reforms at the behest of certain sections of industry or to appease some other segment. In the process, however, it is the retail investor who is left wondering if the market flux is here to stay or temporary. Yet, realization in emerging that volatility may not be bad after all. For every foreign institutional investor fed up with the dodgy interpretation of tax rules in India, there might be a mutual fund familiar with the grinding speed with which the bureaucracy functions but still believes in the India growth story. The wild fluctuations are more likely to be a clash of opposing views rather than a reflection of a shallow market. The correction and recovery ensure valuations do not enter bubble territory or a downturn. A secular trend is more dangerous as it exemplifies unwarranted pessimism or irrational exuberance. The severe market gyrations should lead to rethinking of the vanilla concept of bull and bear phases. The other is of pledging of shares by promoters, which triggers a reflex ` sell’ action by investors, conjecturing all sorts of dark scenarios ranging from extravagant lifestyle of the owners to mismanagement.

Not all companies operate in ever-green sectors such as FMCG, pharmaceuticals and tech. A developing country needs capital-intensive industries. These companies have lots of debt, low promoter holding and ongoing capital expenditure. Shares are mortgaged to fulfil promoters’ contribution or to buy more shares to retain controlling interest after equity dilution. Better a promoter who publicly pledges his shares and invites focus on his company than who liquidates his holding in trickles and dribbles while the going is good. An extreme view is that it is only a matter of time before such inefficient promoters are dislodged in favour of an agile management. Another traditional position is being threatened in the face-off between companies preferring to keep investors happy with liberal dividends and those that are undertaking expansion and diversification for capital appreciation. Investor activists demand cash-rich companies to go for buybacks or increase the dividend rate and, in the process, further boost their valuations. The problem is that the perceived tax-free status of dividends despite the dividend distribution tax attracts risk-averse investors to dividend-yielding scrips over taxable fixed deposits or growth stocks. The fear is that acquisitions will result in leveraging of the balance sheet and sometimes turn out to be bad fits. Capacity expansion can go horribly wrong if anticipated demand does not materialise or there is disruption in the market. Yet, dividend yield too varies depending on the mood of the market. Just as interest rates recede, premium on companies with generous payouts also shoots up in a bull run. So if equity investing is providing risk capital, why chase overvalued companies not in need of cash?

Well done!

After a decade of pessimism, Prime Minister Narendra Modi has instilled optimism that India will have a better future

By Mohan Sule
When is the right time to assess a government's performance? Immediately after swearing in? After 100 days? Six months? Most new governments around the world enjoy a 100-day honeymoon. Unfortunately, the Narendra Modi government has been not shown any such courtesy. Precipitating the problem was the mess he inherited: policy paralysis, mounting bad loans of banks and a huge subsidy bill. Initially, surging consumer prices were the focus of the attack. Later, parliament proceedings were disrupted on the issue of return of black money. Now it is the alleged anti-agrarian bias of the government that has become the rallying point. The flirting from issue to issue is due to the lack of stickiness of any. With wholesale inflation below zero and consumer inflation below the 6% comfort level targeted for the current fiscal by the Reserve Bank of India, price rise is no longer an emotive topic. Unaccounted money resonates during times of economic hardships and not when the stock markets are buoyant. Scaling down of the rural employment guarantee scheme and the minimum support price are being blamed for farmers' woes caused by unseasonal rains. This is a 180-degree reversal from attributing the deployment of funds to dole out wages for digging holes for widening the fiscal deficit and causing rural inflation. A moderate increase in MSP against the background of plentiful of crop was praised for capping food inflation, which is allowing the RBI to begin its rate cut cycle. Currency volatility affecting imports as well exports and preoccupation with shedding debt and high-cost inventory contracted when oil prices were high are responsible for the corporate sector yet to see achche din.

As it completes a year in office, the Modi government should have reasons to feel satisfied. The increase in FDI in the insurance sector to 49% has become a reality. The initiation of e-auction to sell mines will mean that henceforth natural resources will never ever be assigned arbitrarily. There were concerns that the high price to secure mines and spectrum will result in pass-through of costs. In the present circumstances, however, transparent allocation of resources is the best possible way. The cost-benefit equation will get sorted over in the coming years, with players keeping their bids reasonable. Besides these visible reforms, behind-the-scenes triggers have been pulled. Many projects got stalled after the 2G spectrum allocation scandal followed by the cancellation by the Supreme Court of the coal blocks allocated since 1993.Promoters, too, did not display any urgency because of the global economic slump. Some projects were starved off coal and other critical inputs such as natural gas. Environmental clearances are coming without any `tax'. The high price of natural gas approved by the previous government was revised to offer a modest increase. Pooling of domestic and imported LNG will even out prices. Taking advantage of falling crude prices, diesel was deregulated. The appeal by the prime minister to the well-off to give up their subsidized LPG cylinders is Kennedysque: Ask what you can do for the country.

Bankers now can sanction loans based on commercial viability. There is consensus among multilateral and credit rating agencies that India is the growth story to watch out for. The upward revision in the outlook for the country from junk status on improving macro indicators will lower the cost of overseas borrowings. Make-in-India and Digital India have the capacity to stimulate the economy. Foreign investors are being treated on par with ordinary tax payers, whose previous seven years' tax returns can be opened for scrutiny. The Jan DhanYojna is set to be a game-changer in the goal of financial inclusion. The amendment to the land acquisition bill is a result of the prime minister's experience as Gujarat chief minister when activists stalled the Narmada dam. The mark of a leader is being firm in his convictions unlike the Gandhi scion who pandered to every section and sub-segment of the society on the eve of Lok Sabha elections. By labeling the NDA government as suit-boot ki sarkar, the Congress leader who aspires to be the next prime minister humiliated the aspiring India and the migrants who come to cities to better their and the next generation's standard of living. Mikhail Gorbachev’s perestroika triggered the fall of the Berlin Wall, freeing former Communist bloc countries from the tyranny of the Soviet Union. The heir to the dynasty of former prime ministers, who kept the animal spirits of two generations of its citizens shackled, perhaps anticipates that Modi will occupy a place in history for freeing India from cronyism, corruption and feudalism after P V Narasimha Rao in 1991 freed India from the licence raj regime.

Bogus outrage

Attempts to create a level playing field can have limited success going by the experience in the stock market

By Mohan Sule
The trigger for the outrage was innocuous. An Internet service provider offered zero rates to users clicking on the app of an e-tailer. Instead, the merchant paid the ISP for not counting the usage of data by the visitors. Competitors contended the agreement gave an unfair advantage to the trader. A grim scenario was painted of ISPs blocking sites on behalf of government or slowing access to those of smaller players who are unable to afford this extra cost. The argument is that as gatekeepers to the Internet, ISPs have to be neutral in providing access to the net and not help divert traffic to certain sites by providing exclusive lanes to speed up download. The proposition is compelling. Imagine, for instance, a hospital charging differential rates for the same treatment, depending on the economic status of the patients. Civic services like supply of water are billed as per usage and not the purchasing power of the user. Power bills and telecom tariffs are generated as per consumption. Yet, leveling the field is easier said than done. Applicants to private educational institutions can jump the queue by paying donations, disregarding scholastic achievements. Corporate hospitals hike fees to ensure that their resources are not comprised by heavy demand or to enlist specialists. Multiplexes price tickets depending on the popularity of films and screening slots. Credit card issuers routinely offer discounts for visiting certain retail outlets or fine dining restaurants. Brands woo super markets and even mom-and-pop outlets with higher margins for better display and push. This means unless some sort of discrimination is practiced, it will be impossible for many organizations set up to make profit to justify their existence.

The Securities and Exchange Board of India’s experiments to flatten the playing ground for issuers and subscribers have produced more misses than hits. The stock market regulator has strengthened norms against insider trading by enlarging the definition of who fits the bill. Deliberations of board meeting have to be conveyed to stock exchanges within minutes. Transcripts of analysts’ meets have to be posted on the company’s web site for symmetrical dissemination of information. The efforts to protect minority shareholders have been matched by easing of resource-raising. As long as they make full disclosures, companies do not need permission of any authority to list on stock exchanges. This has opened the floodgates for even dubious promoters, many of whom have subsequently vanished from the scene. On complaints about the cost of floating shares to the public and for staying listed, Sebi carved out quotas for institutional investors, throwing in a carrot of retail discount. Shares can be placed with qualified institutional investors, bypassing the small investors. Book building gives big-ticket investors influence to determine pricing as they are informally polled to find the appetite for the offer. Grading of public issues indirectly helped established companies and so will the move to cap the commission of mutual fund distributors, an avenue for small players to gain visibility.

In the debate on net neutrality, a crucial issue has been lost sight of: except for sites put up by governments and multilateral institutions, everyone is out to make money or peddle influence. B2B presence is to gain access to a wider market and B2C properties eliminate the cost of building a brick-and-mortar set-up. Blogs eventually hope to self-sustain through ads. Free content is giving way to paid subscription to meet costs if not to etch out a profit. If there is still an echo of the disastrous eyeball parameter to assign valuations to dot-coms without any cash flows reverberating across the net, it is due to startups, many put up by con artistes out to snag venture capital or private equity. The shrill follow-the-herd cries for net neutrality should recognize that telecom companies have to pay for spectrum. They are answerable to their shareholders. The choice for them is between increasing voice and data tariffs and exploring other options to lighten the pricing burden to stay competitive. Internet retailers, on the other hand, are hobbled by server breakdowns in their quest to expand market share. The result is an arrangement beneficial to all the stakeholders. It is a pity that Flipkart buckled under pressure and backed out of the zero rate plan of Bharti Airtel, which though has stayed firm in going ahead with the program. No doubt, a company has to operate in an ethical environment. But surrendering to populism at the cost of the bottom line reveals to the shareholders where its priorities are. Hopefully, investors will not forget this when the e-commerce pioneer in India comes out with an IPO.

In the crossfire

Currency crosswinds due to liquidity injection and withdrawal and differing interest rate policies are complicating stock selection

By Mohan Sule
Those who were disappointed that the Union Budget 2015-16 did not produce a Big Bang will find plenty of fodder in the new fiscal to stock up the cannon. The moot question is whether the explosions will light up the landscape or trigger a bush fire. The era of a market throwing up only gainers, with all the stocks across the spectrum turning gold, during a bull phase is perhaps past us. This is because of crosscurrents of monetary policies as each region struggles to tailor the environment to suit local requirement. Even as the US Federal Reserve phased out its bond-buying and is poised to increase interest rates on signs of a recovering economy, the European Central Bank has embarked on a euro1-trillion liquidity infusion to revive confidence in the euro region. China, too, is expected to follow Japan’s example of loose money policy to stem the slowing of its GDP growth. India is on the path of low interest rates and massive infrastructure spending. Unfortunately, the fallout is not confined to the borders. The ripples are felt across the globe in differing magnitude. A prominent casualty of the declining consumption of energy by the euro zone and China is crude oil, which slide below US$50 a barrel at one point. Instead of cheering, most developed countries are worried how to stop the spiral of disinflation. The fallout is a slippery gold, a comfort investment to fend off inflation.

Withdrawal of foreign funds from the emerging markets when yields on US bonds become more attractive than dollar returns from equities could be a blessing as stocks cool down and the rupee weakens. For the Reserve Bank of India, however, this is a recipe for disaster: how to shore up the currency and at the same time keep interest rates low to keep the liquidity tap open. A strong dollar is a prominent manifestation of the complex global scenario. Nothing seems to soften the Teflon currency, even fears of recession in its home market. On the contrary, signs of uncertainty boost the greenback for its safe haven status. The mighty dollar is neutralizing the slide in oil prices for emerging markets. The net result is that neither fuel prices have fallen to the level they should have nor are the wobbly export markets bringing relief. Not surprisingly, the RBI is under increasing pressure to reduce interest rates and thereby let the rupee depreciate further to provide the winning edge to Indian exporters. The prevailing uncertainty has not dampened global markets, which are hitting highs in the belief that the problems in different corners of the world are not insurmountable. After the success of the US Fed, pump-priming is viewed as a solution to all economic ills. This is in contrast to the view last century, when distressed borrowers were bluntly told by multilateral institutions to tighten their belts. The rebellion by Greece and the cold caught by markets around the world subsequently has reconfirmed the premise that the penalty for splurging is injecting more money rather than imposition of fiscal discipline though it was living beyond means that was responsible for the mess in the euro zone.

If the inflows from the US slow down, the floodgates of the euro zone have been thrown open. If China is no longer attractive, there is India, despite no noticeable ground level change in the ease of doing business. The drumbeats heralding the country as the next financial hotspot has already begun, with the ADB and the IMF joining the chorus of various foreign brokers and rating agencies in revising up the growth forecast. Yet no one has been able to assert with any degree of finality that not only foreign money will stay but the inflows will continue in spite of the ramping up of interest rates by the US. As a result, tech stocks roar every time a Fed official reiterates sticking to its roadmap of hiking interest rates from June and falter on weak US job data. In the same way, banks and auto shares’ fortunes fluctuate with the unpredictable consumer price index as the RBI takes one slow step at a time to slash domestic rates. Evergreen FMCG scrips are no longer oases, wilting and blooming with the monsoon’s mood. Pharmaceutical stocks’ health depends on US regulatory approvals and crackdowns. Power and capital goods counters with plenty of potential are yet to share the enthusiasm for Make-in-India due to the overbearing public sector’s influence on their orders and bottom lines but cement companies, projected to be the beneficiaries of government-sponsored low-cost housing and infrastructure projects, race ahead of earnings. No wonder the market is looking like a game of Russian roulette more and more.

Breaking away

Lessons from the ex-PM's summons, the land bill, the Sebi-Sat spat on DLF and the resistance to the FTIL-NSEL merger

By Mohan Sule

Out-of-season rains is one of the banes a farmer faces in his long journey from tilling his field to reaping the crops and selling them to the government or private distributors. Yet the disruption in pattern underscores the importance of rules, be they made by nature or man. The heat generated over the summons to Manmohan Singh by a Central Bureau of Investigation court in the coal allotment scam demonstrates India's reluctance to break from the past of differential treatment to the rulers and the ruled. Congress president Sonia Gandhi marched to his residence to announce that the entire world knows of the former prime minister's honesty and integrity. The argument offered in his support is that he did not make any money from the process. In the earlier age of innocence, railway ministers were known to resign, owning up moral responsibility for any major train accidents on their watch. Home ministers have been shunted out for terrorist attacks or due to law-and-order situation spinning out of control during their tenure. If bureaucrats can be questioned and a minister and a beneficiary who happened to be a member of parliament could be sent to jail for their roles in the second-generation spectrum allotment case, then surely a former head of the government can appear before a judge. The opportunity should be used by Singh to clear the air if he assigned coal blocks because of his belief in the end use or he was helpless because someone even more powerful than him had a say in the arbitrary allotment.


The outrage instead should be reserved for the action of those who have tried to influence the due course of law by applying covert populist pressure. Thankfully, our judiciary is made of sterner stuff as seen from the woes of Subrata Roy, who was in the habit of issuing full-page ads in the newspapers in response to the Supreme Court's summons in the case filed by the Securities and Exchange Board of India for misappropriating more than Rs 30000 crore of investors' funds. His attempts to try his case in the court of public opinion flopped. The Sahara kingdom provides employment to thousands of people and sponsors sporting events. That, as the firmness of the SC has shown, should not be the criteria for leniently dealing with a law-breaker. Even after a year in jail and employing the best legal eagles, the boss has not been able to raise Rs 10000 crore for bail. The rallying of opposition to the land acquisition bill is similarly an attempt to mislead: it is not so much to ensure fair compensation to farmers as to try to protect Rahul Gandhi's ownership of the Act. As per the consensus of chief ministers, including those ruled by Congress, the law in its present form is not practical. The prime minister noted the fact during the bill's introduction in the budget session of the parliament. Instead of modifying a harebrained legislation, propaganda that the bill is anti-farmer has been whipped out despite spelling out the kind of projects including defense and infrastructure projects in the public sector and education institutions and hospitals in the private sector for which the consent of the land owner will not be acquired, while maintaining the level of compensation.


Along with a country’s development, the level of urbanization increases. Those in agricultural jobs shift to manufacturing because the number of hands required to farm fall due to genetic modification, mechanization and improvement in yield on deployment of pesticides. Many farmers are keen to switch to another profession as their land's productivity decreases over the years. Breakup of families means fragmentation of the land parcel. Not all members might want to continue with farming. The most convincing argument against allowing status quo is that no investment has come in due to this shabby legislation. In the same wayy, there is an urgent need to change the mechanics to resolve regulatory tussles in the capital markets. Sebi banned DLF from issuance of capital for three years for inadequate disclosures in the IPO document seven years ago. The Securities Appellate Tribunal found the punishment harsh. This is not the first time that Sat has overturned the market regulator. This back and forth should be increasingly replaced by consent decrees. The promoters save face but pay monetary fines. Banning fund raising can scotch genuine attempts to turn around the company just as delisting blocks investors' exit route. The disclosure of payment of penalty in the offer document should alert investors as should the fact that a major portion of the revenue of the flagship is derived from a subsidiary with opaque business practices. If the shareholders of the parent can partake in the good times, surely they should be willing to make good the Rs 5600-crore hole in the balance sheet of a wholly-owned subsidiary. The division over the FTIL-NSEL merger should prompt investors to pay attention to consolidated accounts, which provide a window to corporate governance and how revenues are earned or siphoned off.