Turning of the cycle

The US and Gulf recovery will have the power to pull up emerging economies and trigger an era of high growth and inflation

By Mohan Sule

The latest policy initiative by the Reserve Bank of India evoked two kinds of reactions. Industry and investors welcomed the unanimous decision of the new Monetary Policy Committee to cut the lending rate by 0.25% to the lowest level in five years. It is unlikely that banks, groaning under the burden of bad loans, will transmit the measure as the earlier downward revisions are yet to be fully passed on to the borrowers. Yet, the step is a sentiment booster. The message is that the central bank is shifting focus to growth from the obsession with inflation, noting the sluggishness in industrial output and weakness is prices of food, metals and manufactured items. Armchair economists, meanwhile, fretted about the unwarranted adventurism. The responses from either side of the aisle have as much basis as contradiction. The decision by oil producing and exporting countries to cap output to stem the sliding crude prices poses a threat to the benign inflation environment. Recovery in rural buying post a normal southwest monsoon could be another tripping point. On the other side is the wave of low interest rates and bond-buying in ex-US developed economies. The US Federal Reserve has been displaying extreme restrain despite falling unemployment in continuing its rate hike cycle that was started December last year. China, too, is loosening its monetary policy to bolster capacity utilization. The depreciation of the yuan means   emerging markets have to weaken their currencies to stay competitive. The plunge in the value of the pound against the dollar following the Brexit poll is another challenge for Indian exporters. The rupee has been gaining of late due to the inflow of foreign portfolio and direct investment. The success of the Make-in-India campaign hinges on a soft currency.

Apart from the slump in economic indicators capturing output and prices, an important reason why the RBI could not have taken a pause in paring rates is the momentum of the US recovery that makes a second rate hike in a year by the Fed increasingly inevitable. Post December, there is a possibility of net outflow of foreign portfolio investment. India’s comfortable reserves could deplete rapidly if capital flight were to gather momentum and oil prices rule higher than the levels in 2015.  The glut in food grains is likely to result in pressure on the government for  higher support prices to farmers. All these developments will strain the balance sheet of the government and fuel inflation, complicating any move to ease interest rates further. Balancing the adverse effect of the Fed’s action will be the bounce-back of the Chinese economy. China is the largest exporter to the US. A healthy American market is bound to revive the appetite for commodities. If not the US due to its sufficiency in energy on the back of the domestic shale gas industry, Chinese consumption will lend support to fossil fuels. The revival in spending by Gulf countries on back of higher crude prices will be a powerful booster dose for India’s services and merchandise exports.

The reluctance of the market to break from its range-bound movement indicates that the coming Fed rate action has been factored by equities. As such, there might not be a plunge of the magnitude that would take stocks to the post-September 2008 level. Some industries seem to have priced in the recovery of the Indian economy post southwest monsoon of 2016. These are mainly the consumption sectors such as automobiles, apparels and housing-related products, whose purchases had been differed due to the two years of drought. Some others, primarily in the core and infrastructure space, will benefit from low base on private sector investment. In fact, booming US and Chinese economies will do more to wipe out Indian banks’ bad loan problem than any amount of relaxation in income recognition norms. Discretionary sectors might continue to report flat margins as the rise in demand could be accompanied by a spurt in the cost of raw materials. A muscular dollar will push up exports to the US and at the same time ensure that the Fed ramps up its discount rate in driblets and the exuberance in commodity prices is capped. If foreign funds maintain the inflow momentum to buy cheap Indian assets, a strengthening rupee, essential to keep a lid on inflation, is likely to blunt the salutary effect on the margins. Revival of IPOs in the US might see a repeat of history, with profit booked going to emerging economies. So much so that some countries might have to impose capital controls. Investors will have to reconcile that the era of cheap money might be coming to an end by the second half of the next fiscal due to increase in risk-taking in the US, India and China. As such, higher Fed rates and oil prices could be the liquidity injection by the US and the Gulf region to pull up global economies.

Going for a ride

Promoter and institutional offloading is a concern for secondary market investors but does not seem so in the primary market

By Mohan Sule

The success of the Rs 6000-crore IPO of ICICI Prudential Life Insurance Company, the biggest primary market offering since Coal India’s Rs 15000-crore share-sale in 2010, proves two things. The slowdown in the loan growth of banks is not due to lack of investment opportunities but because of risk aversion. Second, the atmosphere of gloom of the past four years is dispersing. The optimism is captured by the multiple times subscription and surging small and mid caps this fiscal. A booming primary market tends to suck out liquidity from the secondary market. China had to suspend IPOs to halt the plunge in stocks last year. The Rs 11700-crore issue by Reliance Power early 2008 was blamed for the subsequent crash in prices though the run-up to the collapse of Lehman Brothers later in the year could have been the contributor. Currently, there are no signs of any adverse impact of the resurgence in issuance on the cash market. Volatility has been in tandem with the mixed signs from the US Federal Reserve and the oil exporting countries to cap output. The indecisiveness in movements is also an outcome of the entry and departure of investors with differing views on the course of the global and Indian economies. Such a fluctuation should actually frighten issuers. On the contrary, it is being considered an opportune time to strike as equities are not displaying a noticeable trend either way. Any decline due to profit-booking results in attractive valuations, enticing investors.

The present state of flux is attracting two types of investors. The first considers the primary market to provide better returns in a shorter span compared with the slow trot of quality listed paper. Most issues are recording gains on debut despite charging premium comparable with established competitors in the belief that the acceleration in the growth of the economy is not if but when. The Securities and Exchange of Board of India has taken steps to create a secure environment for subscribers and issuers. The period for listing of securities has been reduced, thereby freeing funds, and transparency enhanced by insistence on elaborate disclosures by companies. The other class of investors prefers the book-building price band over the off-balancing spurt and fall of stocks at recurrent but unspecified intervals. With traditional industries bogged down by excess capacities and leveraged balance sheets, many entrants are from nascent sectors, whose potential at once excites and scares. Valuations become a concern for start-ups from emerging areas such as insurance and e-commerce as there are hardly any peers for comparison. These enterprises are capital-guzzlers. The tepid listing of ICIC Pru seems to confirm the view.

Another discomforting fact is that many offerings are primarily routes for private domestic and foreign investors to exit or for promoters to cash in partially. Secondary market investors scrutinize the increase and decrease in promoters’ control as well as local and overseas funds’ holdings every quarter to validate or churn their portfolio. A change in stake by either categories triggers introspection and investigation.A decline, reflecting doubt about operational performance, corporate governance or industry outlook, is a cause of concern. Not much time is spent brooding why big-ticket investors want to leave through a public issue. It is assumed that their support is no longer required as the entity is ready to stand on its own and they are looking for decent rewards for providing backing when it was most needed. The venture might need to scale up for which resources have to come from the capital markets. Besides, they will be replaced by institutional investors who will be keeping a watch. Yet it is a point worth pondering. First, hedge funds and mutual funds are not for the long haul. Second, if the future of the company is bright, why not stay put? No wonder, many ordinary investors get the feeling that they are being taken for a ride by clever investment bankers. The systematic marginalization of the small investors despite their quota standing increased at 35% over the years means heavy bookings by foreign funds can create an illusion of huge demand. Sebi’s measures such as barring cancellation of interest evinced during book building have eliminated to a large extent frivolous and rigged bidding. Still the question haunts. With the vigor back, it is time for the market regulator to revise the allotment cap for ordinary investors to 50% of the size to ensure that the offerings are priced moderately and the over-subscription genuinely captures the enthusiasm for the issuer.

Predator v disruptor

Pricing is a temporary advantage to gain market share and not a change that transforms consumer habits

By Mohan Sule

The giddy reaction to Reliance Industries’s foray into telecom pivoted around how the predatory pricing of voice (nil) and data (huge discount to prevailing market rates) would cause turbulence in the industry. Forecasts ranged from tariffs tumbling across the board to consolidation among players. There is no price war in evidence so far nor has the valuations of the top tier rivals plunged though Reliance Communications and Aircel have agreed to merge. The episode, nonetheless, has brought the focus back on what causes the market to change complexion irrefutably. Are these gradual or sudden? The dominance of Apple in the handset space is not due to its competitive pricing. Yet makers of cheaper models were unable to keep up. Steve Jobs created a mobile computer-cum-camera that was aesthetically appealing. Technology that enhances users’ experience can trigger turmoil in a historical model depending on supply-side advantage as illustrated by the gaining popularity of taxi apps. They have shaken up the way we choose to travel by empowering passengers, upending the prevalent practice of taking up the service being offered. The first takeout is that transformation in market dynamics depends on how effectively evolution is captured for the convenience of the customer. Some of the e-tailers are absorbing this important lesson the hard way. The initial proposition of getting orders at the doorsteps quickly has deteriorated into free-for-all price discounts, taking a toll on the delivery timeline. Though a virtue, scale alone cannot rupture the fabric. Looking back, there is realization that the Internet by itself would not have had the force to bring about an upheaval if not for the blooming of online payment modes just as plastic money is believed to have spurred consumption.

The government’s thrust on niche channels to transfer money is an efficient use of the digital platform to widen and deepen the reach of banks.The aim is to eliminate the informal system that charges huge interest rates and plug leakages of subsidies. In fact, the netting of the non-banked will be the first step in doing business with big banks. The primary market for equities and bonds is a supplementary route for companies to raise risk capital and not a substitute for borrowing from banks. Importantly, traditional banks are adopting technology to make transactions for customers simple and speedier. Computing did not erase the need for maintaining accounts but eliminated manual book keeping. The second observation is that disruption has to alter the contours of the industry and should not merely be a flyover to reduce discomfort. Till becoming a member of the World Trade Organization, Indian pharmaceutical producers could get away by making copycat products by reverse engineering. Now, they have to wait till the patent expires to manufacture generics. Their market has expanded across the globe as patients in rich nations switch to cheaper versions of the expensive medicines that they were prescribed due to the reluctance of the developer to bring down prices.

Automobiles is another sector that is projected to see turmoil in the coming days. Electric and self-driven cars are thought to bust traditional auto companies as outsiders are taking the lead. Pricing and safety, however, will determine mass acceptance. Even legacy manufacturers can foray into the arena by modifying their existing platforms. A fallout might a plunge in oil prices and the possibility of the comeback of fossil-fuel-run vehicles as they become affordable. If this happens, the current uncertainty might turn into much ado about nothing. Investors in FMCG stocks are in a flux as personal-care products with Indian flavor are catching fancy. It is too early to say if this is a fad that will fade over time. Going by the recent quarter results, the urban-oriented fast food sector seems to be going out of fashion. This means its popularity was a manifestation of increased purchasing power rather than a displacement of entrenched habits such as the increasing use of cell phone to capture images. The third conclusion, therefore, is that though shedding of the skin will be a recurring phenomenon, the process will be life-altering only if there is no going back to the old lifestyle. Showing signs of giveaway is the way media are being consumed, with handsets streaming entertainment on demand. Not surprisingly, the market is turning to predictable industries such as oil and refineries, power, construction, logistics, cement and housing related products for comfort.