To let go or not

The only silver lining in the global economy needs an RBI boss capable of innovative solutions to support growth

By Mohan Sule

The battle lines are drawn. On one side are market participants and companies. They feel the Reserve Bank of India has been too miserly in reducing interest rates. The asset quality review ordered by the central bank has compounded the problem. Over the last two quarters, public sector banks have been aggressively making provisions for hopeless loans. The exercise is likely to continue till the end of this fiscal. On the other side are economists and foreign fund managers who feel cleaning up of banks’ balance sheets is a precursor to reducing government’s stake to make the behemoths nimble. Critics want the RBI governor to be more aggressive in cutting the cost of money, while supporters view the cautious approach as enhancing India’s credibility in the financial markets. Unwittingly, both schools seem to converge on the issue of the importance of the monetary authority in steering the economy of the country. Implicit in their disagreement is the consensus that the growth trajectory hinges on the action or inaction of the central bank. The outcome should not surprise those who have witnessed the boom and bust of the global financial markets in the last decade. Pumping of liquidity and wielding of the scissors by the US Federal Reserve, European Central Bank, Bank of Japan and, of late, the People’s Bank of China are keenly watched by global markets to decide their bets on currencies, interest rate and commodity futures. The central banks are no longer mere regulators of the financial markets. They are monitors, correcting the missteps of governments.

No wonder, the market has come to vest in central bank bosses mythical powers. Opinion is consolidating that governors can do no wrong. They are the gatekeepers of the economy, the steady hands on the wheels of ships sailing in turbulent waters. Would the world have slipped into a second global depression if the Fed’s Ben Bernanke had not kept interest rates near bottom and embarked on bond-buying program for more than half-dozen years to boost the US economy? What if Mario Draghi of the ECB had paused injecting liquidity to pull out the euro region from recession? Should the BoJ be credited with saving the economy by keeping interest rates negative to encourage spending? These measures are discussed and debated because they go against the conventional wisdom. Till the 1980s, the International Monetary Fund’s remedy for countries with reckless consumption was to tighten belts by slashing subsidies, devaluing currency and opening up the economy. The austerity measures resulted in social unrest in many countries, undermining the textbook prescription. The 180-degree turnaround in the approach to debt is spurred perhaps by the decade-long depression that cuts in spending resulted in the 1930s. The pump-priming of the economy as a solution to avoid slowdown also shifted the primacy of shaping the economy to the central banks from the government. More than reforms, liquidity is becoming crucial to keep the markets ticking. As such, central banks that prefer to stick to theoretical solutions tend to stand out. To some they are models of rectitude in a feckless market, while to others they are anachronistic dinosaurs that should have extinct during the evolution that followed September 2008.

It does not require great intellect to decipher the position Raghuram Rajan will embrace to tackle economic crises. Initially, the obsession was with inflation due to deficient southwest monsoon. The benchmark was changed from wholesale price index that had dipped into negative due to decline in usage of industrial goods to consumer price index to factor in prices of agricultural output. Corporate India would have faced far more difficult times if global commodity prices too had not declined in tandem due to slowdown in China, allowing pass-through of lower prices. After a gradual and steady reduction in rates, any further cuts were linked to government discipline in spending and borrowing. The budget for the current fiscal demonstrated the government’s resolve to stick to fiscal deficit target by slashing subsidies and preventing leakages. The outflow of foreign portfolio investment has been blunted by the gush of foreign direct investment due to the Make-in-India initiative, thereby avoiding major damage to the currency. Though the rupee is off from the bottom, the weakness has neutralized the benefit of soft crude prices. In the meantime, inflation has started to look up, the fallout of two successive years of scanty rainfall. The answer to the question if a country that is the only beacon of hope in the gloomy global environment should practice traditional economics or break away to chart a unique path to complement growth should determine if R3 should get a second term. 

The disruptors

Quick and sudden changes in trends mean investors have to constantly monitor their portfolio to weed out dated securities

By Mohan Sule

Is the best over for the world’s most valuable company? For the first time, shipments of Apple’s bestselling iPhones declined in April 2016.  This has given rise to speculation that the era of smart phones might be coming to an end just as laptops killed desk tops. IBM lost its leadership position in the personal hardware space and had to sell off the PC division to China’s Lenevo. Intel, the world’s dominant chip maker, is slashing thousands of jobs as its focus shifts to making chips for smart phones and other emerging applications. The rapidly changing scenario should not come as a surprise as evolution is the basic characteristic of a dynamic economy. Landlines ceded space to cell phones, horse carriages to motor cars, fossil fuel-run cars to electric-driven. Soon drivers will become redundant as more and more Silicon Valley firms eye this frontier, with Google taking the lead. Till recently investors were confronted with deaths of brands and obsolescence of products due to value addition. Nokia, at the top of the mobile handset market, had to eventually sell itself to Microsoft but not before its CEO likened its state to a burning ship. The intensity of the flux is the sharpest in the tech sector. The pharmaceutical sector, too, sees new discoveries. Yet, prevalent medicines do not go out of fashion. Instead they become cheaper due to the rush to make generics.  The consumption sector brings out newer and sleeker versions by modifying the basic structure to replace products that have had their run. Banking will remain true to its core strength of lending and borrowing though the transmission channels will become more pervasive and the structure of loans more complex.  Automation of production is displacing unskilled workers on the shop floor. Banks are diverting spending on technology rather than on swanky branches.  Even as emerging companies are maturing, new entrants are creating slots not imagined a few years ago. Facebook has become a money-making machine despite the medium to access it is slated to report flattish growth.

Investors grumble how difficult it is to foresee these changes. This is not a new complaint. Very rarely have companies that have started with a specific object have retained their original complexion. Those that anticipated changes in consumption behavior due to new technology or climbed up the value chain managed to survive and thrive. Many countries are investing in shale gas and solar energy as a cheap substitute as well as to insulate against fluctuation in prices and supply of oil.  Sugar manufacturers are looking at bio fuel as diversification to insure against the effects of shortages and surplus output and regulations. Usage of plastic, particularly in automobiles, is reducing dependence on metals just as aluminium was seen as a lighter and better option than steel. Online shopping is the biggest threat to brick-and-mortar retailers. The business model of investing in real estate and distribution network has crumbled. Many have latched on to the platforms of e-tailers, while a few who cater to price-conscious consumers have lobbied with the government to change the rules so as to discourage deep discounts: now digital malls cannot have a say in the pricing of the products on display. This will be at the most a temporary respite.

Besides shopping, investors have had a close brush with the ongoing transformation while trading. Dematerialization of physical shares has paved the way to online transactions, giving investors control in executing their decisions without any chances of miscommunication and misappropriation. Brokers, too, have adopted and adapted to the changes smoothly. What they would have to spend on spreading penetration is now expended on establishing a digital presence. The other area where consumers have experienced first-hand how disruptions are threatening age-old businesses is the FMCG sector. From craving for foreign brands during the pre-liberalization era to discovering the merits of local ingredients and remedies, the buying pattern of Indians has turned a full circle. It is not the first time that smug MNCs have been attacked by a home-grown upstart. The emergence and success of many Indian entrepreneurs who are rubbing shoulders with foreign players with me-too products at cheaper prices and attracting equivalent market capitalization are a testimony to the fact. Investors, too, are discovering the potentials of SMEs that are showing gumption by coming into the market with richly valued IPOs and getting enthusiastic response.  No doubt many of them have been backed by venture capitalists and private equity investors from the US. The difference is that the big bets are on domestic brands that service the tier 2 and tier 3 population.   

Clash of conventions

The recurring volatility in the market is but a reflection of opposing viewpoints about the same trigger

By Mohan Sule

Besides the question whether volatility is here to stay, another issue frustrating investors is the ability of an event that triggers a stock to spurt to cause a sell-off on another occasion. In fact, the different interpretations of corporate actions or policy initiatives are partly responsible for the constant state of fluctuation of the market. Liquidity injection by central banks is supposed to be an extreme measure to poke the economy from its slumber. The step, ironically, cheers the market, anticipating the flow of cheap money. The moment Bank of Japan paused in its efforts to pump money into the system to boost inflation, global markets shuddered instead of taking it as an indicator of the country’s improving health. Doubts about the sustainability of the US economy spur a wave of buying of emerging markets assets. A vibrant American economy, in fact, is beneficial to exporters as they can take advantage of the weak home currencies. The continuing release of the euros in the system by the European Central Bank buoy equities fattened on cheap liquid diet, shrugging off the reality of the region’s fragility. The negative interest rates offered by BoJ are seen unavoidable to encourage spending despite the potency of the move to sow doubts about the future. The current spell of turmoil in the market should temper the bullish or bearish streak of investors: cycles are going to be short and snappy as evident from the turnaround in the prices of oil and other commodities.

The ongoing results season has been marked with roller-coaster moments, once against testifying to the risk of the unexpected reaction to an expected development. The outcome of two banks reducing interest rates is contrasting: there is liquidation in the shares of a profit-making new generation private sector bank but buying of a big PSU lender saddled with huge bad assets. The market obviously feared squeezing of the margins of the private bank known for judicious lending. On the contrary, investors probably viewed the rate cut by the PSU as being an opportunity to its borrowers for refinancing. The normal reaction of investors to disappointing numbers should be to head for the exit as prices might have run ahead in anticipation of a good score card. The downward revision in valuations due to an out-of-line blip, however, can make a sound stock with an optimistic outlook seem a value buy. No wonder stocks of two two-wheeler companies exhibited symptoms entirely in tandem with their past performance but shares of a software giant became eligible to enter due to a temporary setback. The contradictory perception of the market to capital-raising by companies, too, is another enigma for investors. The exercise by profitable companies is taken as a sign of confidence of growing the market share. Another set of companies receives thumbs down as the funds are required to retire debt. Some might feel repairing of balance sheet is a positive development that necessitates a re-rating as it displays the resolve to become lean and fit. Higher provisioning by banks is painful in the short term but considered a necessary surgery. Ironically, PSU banks fitting the category were embraced but not a private sector bank.

In the same way, divesting of non-core assets by a company gets a warm reception by the market, without pondering as to why these businesses were acquired in the first place if not for the pressure of big investors to use the cash in a meaningful way to expand presence. Investors who had earlier applauded a company’s move to integrate, foray into new geographies, expand product portfolio or diversify to protect flagship business become impatient for the management to streamline operations and products. Pledging of shares or paring of stake by promoters is considered as a last resort to stay solvent or loss of confidence in their business. That there are buyers for or lenders against the shares, however, can be construed as the paper being investment-grade. Buybacks also generate conflicting emotions. Companies willing to purchase shares from the open market are often cash-rich, implying a solid footing in the industry. As equity investing looks ahead rather than back, there is also disappointment that the management has not found suitable avenues to earn good returns. Some investors might prefer to stay invested, satisfied with the cash-generation capability, while many others might not want to hold an ill-liquid stock of a company with no idea of what to do going ahead. The market needs investors with opposing investment strategies to create liquidity. But do investors need a market that initially welcomed the plunge in crude prices and is now enthusiastically talking about bottoming out and recovery due to rising commodities?