The RBI’s cautious stance on interest rates has set back India’s recovery timetable
By Mohan Sule
The market is sensitive. At all times it looks for clues to determine future trends. Savvy stock pickers are alert to developments around the globe. A bumper wheat crop translates into soft prices, benefiting companies packaging foods. The rebuilding efforts following natural disasters lead to higher usage of metals and cement. A growing economy would be a copious consumer of fast food and talk time as well as decorative and industrial paints. Nowhere is thinking on the feet so essential than while tracking the yield curve. Supply and cost of money is vital to keep the wheels of the economy moving. Due to global integration, intervention by a central bank anywhere could have a positive impact at home but reverberate adversely elsewhere. Not surprisingly, central bankers are under round-the-clock scrutiny of the market. More subtle is their speech, more is the anxiety to uncover the nuances. However, of late, the statements are becoming ambiguous and open-ended. They seem to rely on historical data than act in anticipation of certain events. This is similar to treating a patient after falling sick rather than taking preventive action to ward off the illness. The US Federal Reserve, for example, has been repeating it will keep interest rates as low as possible till the need arises. The worry about the sustainability of the recovery of the domestic economy comes out clearly. The fall in oil prices will slow down or even stall the pace of growth of inflation to the targeted level of 2% by June to trigger a spike in interest rates. In the emerging markets, however, the pronouncement has been greeted with relief as dollar inflows in search of better yields will continue. But, for exporters, the volatility in the US economy is a cause of concern.
There is comfort that the Fed has spelt out its roadmap to raise interest rates. In that sense there is certainty about its action. However, the helplessness in charting the trajectory of growth and inflation due to confluence of international events is evident. The concern about the unpredictable undercurrents in the global economy is also on display in the actions of our central bank. It unexpectedly cut the lending rate by 25 basis points a couple of weeks before a scheduled policy meet after the wholesale price index slumped to near zero and consumer price index touched the 5% level in December. The market saw the action as the beginning of the rate-cut cycle. Yet, the Reserve Bank of India did not act at its sixth bimonthly review of the monetary policy early February. Instead it reiterated the old message that further easing of monetary policy would depend on data about disinflationary pressures. Also, the quality of fiscal consolidation as well as easing supply constraints of key inputs such as power, land, minerals and infrastructure would be key factors in determining future course. The first condition is understandable in view of the budget to be presented a few weeks later. What is puzzling is the second caveat. Infrastructure modernization is always a work in progress and has long gestation. Does this mean that, unless these two important criteria are met, the central bank will continue to tinker with reserve requirements of cash and government bond holdings?
Reading between the lines it is clear that the RBI has put the onus of economic revival on the government. Nonetheless, it has revealed why it decided to pause in carrying out further rate reduction. Banks have not passed on the earlier cut to customers. Their priority is cleaning up the balance sheet. Many have had to make higher provisions as some loans are beyond recovery. Another reason for the cautious stance was the looming hike in interest rates by the Fed, which could see tapering of inflow of foreign portfolio funds. Hence, the frenetic rush to build up the foreign currency chest. The market is not convinced. It believes rate cuts would enable hard-pressed borrowers to repay some of their loans. This would free funds of banks for lending. By lowering the statutory liquidity requirement of banks, the central bank seems to have acknowledged this problem. Whether banks will feel embolden to lend to infrastructure projects again when they are busy tackling their previous sour loans to this sector is debatable. Instead, another 50-bp cut in the lending rate might have prompted them to pass on at least some of the relief to new clients and at the same restructure a portion of the existing bad loans at softer rates to steadily chip at the mountain of non-performing assets. Improvement in market sentiment due to increase in consumption as a result could have attracted foreign investors. Buoyant equities would have fetched PSUs lined up for divestment better valuations, helping to bridge the fiscal deficit. By its timidity, the RBI has set back India’s recovery timetable.
Thursday, February 26, 2015
Thursday, February 12, 2015
Tale of 2 companies
The out-of-form TCS and HUL reveal the urgency of better deliveries by the central bank and the government
By Mohan Sule
At first glance, they do not even resemble chalk and cheese. One is an Indian company that is becoming transnational. The other is the Indian outfit of a multinational company. One has a dominant presence in an emerging sector, offering back-office tech solutions, while the other is an old warhorse persuading buyers to upgrade their lifestyles by consuming its products. TCS is known as a leading outsourcing supplier; HUL has outsourced most of its manufacturing to local enterprises. The fortunes of one swing with the movement of currency, while volatility in crude oil prices boost or cut the input costs of the other. Yet there are similarities in their operations. Both apparently run businesses that are called defensive by market folks. Banks need their ATMs to function even during a bear phase just as ordinary folks have to brush their teeth and bath irrespective of an economic downturn. Both are constituents of the broad market indices of the NSE and the BSE. They are run by professional managers. In quest of growth, both are rapidly expanding their footprints across geographies: one overseas, another at home. Of late, the two companies are increasingly changing their complexions to become cyclical plays. A slowdown in its export markets affects the prospects of one, while poor monsoon and high inflation result in resistance for the products of the other. With the economies across the globe getting tightly integrated, both encounter a bull and bust phase at the same time. Also, the foreign exchange market and the oil market are increasingly getting linked. Fall in oil prices bolsters the economies of the developed countries, the main market of TCS, as well as the domestic economy, the domain of HUL. At the same time, the local currency appreciates on good growth prospects, hurting the revenue of exporters. A strong currency encourages imports and intensifies competition in the domestic market.
The December 2014 quarter amplified the woes of TCS and HUL as both got caught in the crosscurrents of the global and local economies. Loss of consumer confidence was the major reason for the slowdown of the US and the Indian economies for the better part of 2014. However, the causes of the manifestation were different. US buyers had become risk averse after the collapse of home prices, while Indian users saw their disposable income shrink after spending on costly food items. TCS’s revenue was near flat over the September 2014 quarter and HUL’s volume growth slipped to 3% over the year. The software major had last recorded such a performance five years ago and the FMCG giant two quarters ago. HUL had to focus on volume rather than on pricing to drive even this tepid growth, while the highest attrition rate in six fiscals kept TCS afloat. The software services provider blamed the holiday season for the lackluster show. The consumer staples maker, which could increase its margin by a percentage point solely due to fall in price of an important input, attributed the late onset of winter and intense competition for the personal-care category nearly halving sales. Both the companies find themselves at a crossroads. Their markets have become price conscious after the turmoil in their economies.
The poor form of the two leaders in their categories, one a play on the export market and another on the domestic market, reflects the state of the economy. The Reserve Bank of India will have to accelerate its rate-cut cycle. This will encourage consumer spending and discourage short-term foreign investors from parking their funds in the country for higher yields. The upward pressure on the Indian currency will ease and give breathing space to the central bank instead of being overwhelmed by the dollar deluge, necessitating a mopping up operation to maintain the rupee’s competitiveness, which could trigger inflation. The delicate nature of recovery will reign in the finance minister from tampering with personal or capital gains taxes in the coming budget. With the rural market losing its growth momentum after deficient rainfall, there will have to be determined efforts to bring investment into these areas. The rural employment guarantee scheme has been modified to funnel money only into productive assets. The haste in passing the land acquisition ordinance now appears appropriate. If the PSU divestment program succeeds and a good amount of money collected from the telecom spectrum auction, there will scope for reduction in personal taxes. Falling oil prices have provided room to clean up the country’s balance sheet. The recent price correction could be an opportunity for investors to take a fresh look at these companies, which have the scale to claw back their way to leadership roles.
By Mohan Sule
At first glance, they do not even resemble chalk and cheese. One is an Indian company that is becoming transnational. The other is the Indian outfit of a multinational company. One has a dominant presence in an emerging sector, offering back-office tech solutions, while the other is an old warhorse persuading buyers to upgrade their lifestyles by consuming its products. TCS is known as a leading outsourcing supplier; HUL has outsourced most of its manufacturing to local enterprises. The fortunes of one swing with the movement of currency, while volatility in crude oil prices boost or cut the input costs of the other. Yet there are similarities in their operations. Both apparently run businesses that are called defensive by market folks. Banks need their ATMs to function even during a bear phase just as ordinary folks have to brush their teeth and bath irrespective of an economic downturn. Both are constituents of the broad market indices of the NSE and the BSE. They are run by professional managers. In quest of growth, both are rapidly expanding their footprints across geographies: one overseas, another at home. Of late, the two companies are increasingly changing their complexions to become cyclical plays. A slowdown in its export markets affects the prospects of one, while poor monsoon and high inflation result in resistance for the products of the other. With the economies across the globe getting tightly integrated, both encounter a bull and bust phase at the same time. Also, the foreign exchange market and the oil market are increasingly getting linked. Fall in oil prices bolsters the economies of the developed countries, the main market of TCS, as well as the domestic economy, the domain of HUL. At the same time, the local currency appreciates on good growth prospects, hurting the revenue of exporters. A strong currency encourages imports and intensifies competition in the domestic market.
The December 2014 quarter amplified the woes of TCS and HUL as both got caught in the crosscurrents of the global and local economies. Loss of consumer confidence was the major reason for the slowdown of the US and the Indian economies for the better part of 2014. However, the causes of the manifestation were different. US buyers had become risk averse after the collapse of home prices, while Indian users saw their disposable income shrink after spending on costly food items. TCS’s revenue was near flat over the September 2014 quarter and HUL’s volume growth slipped to 3% over the year. The software major had last recorded such a performance five years ago and the FMCG giant two quarters ago. HUL had to focus on volume rather than on pricing to drive even this tepid growth, while the highest attrition rate in six fiscals kept TCS afloat. The software services provider blamed the holiday season for the lackluster show. The consumer staples maker, which could increase its margin by a percentage point solely due to fall in price of an important input, attributed the late onset of winter and intense competition for the personal-care category nearly halving sales. Both the companies find themselves at a crossroads. Their markets have become price conscious after the turmoil in their economies.
The poor form of the two leaders in their categories, one a play on the export market and another on the domestic market, reflects the state of the economy. The Reserve Bank of India will have to accelerate its rate-cut cycle. This will encourage consumer spending and discourage short-term foreign investors from parking their funds in the country for higher yields. The upward pressure on the Indian currency will ease and give breathing space to the central bank instead of being overwhelmed by the dollar deluge, necessitating a mopping up operation to maintain the rupee’s competitiveness, which could trigger inflation. The delicate nature of recovery will reign in the finance minister from tampering with personal or capital gains taxes in the coming budget. With the rural market losing its growth momentum after deficient rainfall, there will have to be determined efforts to bring investment into these areas. The rural employment guarantee scheme has been modified to funnel money only into productive assets. The haste in passing the land acquisition ordinance now appears appropriate. If the PSU divestment program succeeds and a good amount of money collected from the telecom spectrum auction, there will scope for reduction in personal taxes. Falling oil prices have provided room to clean up the country’s balance sheet. The recent price correction could be an opportunity for investors to take a fresh look at these companies, which have the scale to claw back their way to leadership roles.
Saturday, February 7, 2015
Changing lanes
To counter the possibility of slowing foreign inflows, the focus has to shift to boosting consumption to justify the rich equity valuations
By Mohan Sule
Is consumption going to replace liquidity-driven investment as the pivot for the economy to spin? Symptoms of the change in the mood of the market became noticeable after the equity market crash on 6 January 2014. Overriding the fears of the US Federal Reserve raising interest rates following the 5% growth of the US economy in the third quarter of last calendar was oil’s fall from grace. It pointed to the slowing of the world economy, particularly China, and triggered worries about what it meant for oil producing countries. Remittances from NRIs in the Gulf region form nearly 6% of India’s foreign exchange inflows. The contagion effect of the slowdown in consumption of oil could be as devastating as the 2008 meltdown of the financial markets, when credit dried up as lenders saddled with exotic derivatives, composed of home mortgages of varying degrees of default risks, were left with worthless securities on their balance sheets. The withdrawal of liquidity decelerated the growth engines around the world. The conclusion was that however attractive an economy, it needed inflow of cash to keep its wheels turning. Low interest rates in the US after the dotcom bubble bust at the turn of this century allowed investors to borrow cheap and stash the funds in high-interest rate emerging economies. Quantitative easing or the bond-buying program of the Fed following the collapse of some too-big-to-fail banks injected liquidity in the market when traditional avenues of borrowings had closed down.
The market did sulk after the announcement of the gradual phasing out of the QE programs. However, the Fed’s vow to keep rates near zero till the US economy was on an irreversible path of growth blunted concerns of credit turning scarce. Money poured into assets with the potential to beat inflation in the local economies and low interest rates in the developed world. In India and China, the flow was mainly into stocks and property. As a result, Shanghai and Mumbai were among the best performing markets in the emerging economies in 2014. Due to the Reserve Bank of India tightening lending norms to developers, the property market may not have a crash-landing like it is feared will happen in China, infamous for its financial institutions’ dodgy book keeping. The dangers of investment-led growth, without the backing of consumption, are now becoming evident in both the countries, which share the common trait of high savings rate. In India, manufacturing growth is lagging as reforms are yet to percolate to the grassroots. China is facing a slump as domestic consumption is unable to fill the gap created by the comatose exports markets. India’s wholesale inflation, majorly comprising the manufacturing sector, is down to zero, while retail inflation is sliding as the specter of drought and famine has receded despite deficient southwest and northeast monsoon.
Consumption falls when prices of goods and services increase at a pace faster than economic growth. Interest rates are hiked to cool inflation. The artificial barriers on supply results in underutilization of capacity, created during the boom period. Lowering of interest rates should indicate that the economy is not in a good shape and it needs liquidity injection. Instead, investors view the development favorably for stemming the outflow from equities. It is considered positive for sectors whose top line depends on borrowings by consumers. Hence, the beginning of the softening of interest rates sends a strong message that the central bank wants consumption to increase. Both China and India seem to be on the same page on this issue. After consistently ramping up interest rates, China’s central bank executed a U-turn in November. Another round of reduction is due anytime now. The RBI, too, has signaled its readiness to begin its cycle of rate cuts from this year. An important player in determining the cost of money is the government, which comes to the market to meet its expenditure needs. The success of the current phase of PSU divestment, therefore, is important as it will remove the presence of the elephant from the room. Even the forthcoming telecom spectrum auction is receiving attention for its ability to improve the country’s balance sheet. However, bagging licenses at reasonable rates is the key to ensure competition, so vital to increase usage. The government’s idea of allowing consumers to choose their power suppliers will be a step up the pyramid, the bottom being the unleashing of competition in the consumer staples and discretionary space. Improved consumption will moderate valuations of heated stocks, enabling more investors to enter and better price discovery. For all these reasons, investors should go out to eat, play and buy.
By Mohan Sule
Is consumption going to replace liquidity-driven investment as the pivot for the economy to spin? Symptoms of the change in the mood of the market became noticeable after the equity market crash on 6 January 2014. Overriding the fears of the US Federal Reserve raising interest rates following the 5% growth of the US economy in the third quarter of last calendar was oil’s fall from grace. It pointed to the slowing of the world economy, particularly China, and triggered worries about what it meant for oil producing countries. Remittances from NRIs in the Gulf region form nearly 6% of India’s foreign exchange inflows. The contagion effect of the slowdown in consumption of oil could be as devastating as the 2008 meltdown of the financial markets, when credit dried up as lenders saddled with exotic derivatives, composed of home mortgages of varying degrees of default risks, were left with worthless securities on their balance sheets. The withdrawal of liquidity decelerated the growth engines around the world. The conclusion was that however attractive an economy, it needed inflow of cash to keep its wheels turning. Low interest rates in the US after the dotcom bubble bust at the turn of this century allowed investors to borrow cheap and stash the funds in high-interest rate emerging economies. Quantitative easing or the bond-buying program of the Fed following the collapse of some too-big-to-fail banks injected liquidity in the market when traditional avenues of borrowings had closed down.
The market did sulk after the announcement of the gradual phasing out of the QE programs. However, the Fed’s vow to keep rates near zero till the US economy was on an irreversible path of growth blunted concerns of credit turning scarce. Money poured into assets with the potential to beat inflation in the local economies and low interest rates in the developed world. In India and China, the flow was mainly into stocks and property. As a result, Shanghai and Mumbai were among the best performing markets in the emerging economies in 2014. Due to the Reserve Bank of India tightening lending norms to developers, the property market may not have a crash-landing like it is feared will happen in China, infamous for its financial institutions’ dodgy book keeping. The dangers of investment-led growth, without the backing of consumption, are now becoming evident in both the countries, which share the common trait of high savings rate. In India, manufacturing growth is lagging as reforms are yet to percolate to the grassroots. China is facing a slump as domestic consumption is unable to fill the gap created by the comatose exports markets. India’s wholesale inflation, majorly comprising the manufacturing sector, is down to zero, while retail inflation is sliding as the specter of drought and famine has receded despite deficient southwest and northeast monsoon.
Consumption falls when prices of goods and services increase at a pace faster than economic growth. Interest rates are hiked to cool inflation. The artificial barriers on supply results in underutilization of capacity, created during the boom period. Lowering of interest rates should indicate that the economy is not in a good shape and it needs liquidity injection. Instead, investors view the development favorably for stemming the outflow from equities. It is considered positive for sectors whose top line depends on borrowings by consumers. Hence, the beginning of the softening of interest rates sends a strong message that the central bank wants consumption to increase. Both China and India seem to be on the same page on this issue. After consistently ramping up interest rates, China’s central bank executed a U-turn in November. Another round of reduction is due anytime now. The RBI, too, has signaled its readiness to begin its cycle of rate cuts from this year. An important player in determining the cost of money is the government, which comes to the market to meet its expenditure needs. The success of the current phase of PSU divestment, therefore, is important as it will remove the presence of the elephant from the room. Even the forthcoming telecom spectrum auction is receiving attention for its ability to improve the country’s balance sheet. However, bagging licenses at reasonable rates is the key to ensure competition, so vital to increase usage. The government’s idea of allowing consumers to choose their power suppliers will be a step up the pyramid, the bottom being the unleashing of competition in the consumer staples and discretionary space. Improved consumption will moderate valuations of heated stocks, enabling more investors to enter and better price discovery. For all these reasons, investors should go out to eat, play and buy.
Subscribe to:
Comments (Atom)