Trigger-happy

Interest rates, movement of oil and rupee, corporate results, divestment and state polls will influence equities

 After furiously accumulating 6,300 points in the five months to end August 2018 as against 16 months taken to travel the same distance earlier, the equity benchmark seems to be losing stamina. It shed more than 4% in over a fortnight since reaching its life-time high. The US-China impasse on trade tariffs continues. Following Turkey, Venezuela became the second emerging economy to see flight of foreign capital. The fear is of the contagion spreading to more countries. Oil prices rebounded to US$ 79 a barrel and the rupee slipped below 72 a dollar.  Bond yields have crossed 8%, indicating the central bank might have to increase interest rates for the third time after four years in its October policy meet. After the euphoria, there is a sobering realization that the 8.2% expansion in the GDP in the June 2018 quarter over a year ago might not sustain as the spurt was on a low base of 5.7% increase in the June 2017 quarter. Floods in Kerala in August, too, are likely to dent the GDP numbers of Q2 of the fiscal year ending March 2019.  What is striking, though, is the side-way movements of the market. After declining for a number of consecutive trading days, equities bounce back over the next few days, fully or partially erasing the previous losses. There are alternate bouts of selling and buying by both foreign and institutional investors. Those who prefer to sit out during the surge enter on dips. The message from the market is clear: though expensive relative to their trailing earnings, the future of Indian companies is bright. To move up to the next level, there is need for fresh triggers.   

 

 A significant cooling of crude might come after the IPO of oil producer Saudi Aramco, slated anywhere between this year and 2020, is out of the way. Saudi Arabia is pushing for a price beyond US$80 a barrel to get a good discounting for the offering in spite of the Organization of Petroleum Exporting Countries meeting the objective of draining out excess inventories after agreeing to cut output end 2016 for a year and then extending it to end 2018. A barrel had crossed US$ 140 in July 2008. A few months later many US banks collapsed. After falling in reaction to the credit crunch, crude recovered to US$ 100 in 2011 as pump-priming by the US monetary authority opened up the credit pipeline. As many smaller European countries struggled with debt default, prices started slipping in 2013 and plunged by half a year later. Hopefully, the Gulf nations would not want such a situation to repeat as the current level of cutback in output is sufficient to put their economies back on track. Alternatively, a government-induced slowdown in the world’s second-largest economy, China, can soften commodity prices and lift import-intensive economies such as India. Easing of the current account deficit will follow. The second trigger will come from the Federal Reserve if it stays put for the rest of the year, citing contradictory signals from the US economy. Consumer confidence is high but uncertainty arising from tit-for-tat trade barriers has muddied the outlook for American exports. Compensating exporters with subsidies will expand the widening fiscal deficit and derail the booming domestic economy.       

 

Stability in US interest rates will give the Reserve Bank of India flexibility to pause from its money-tightening exercise. Soft consumer prices have enabled it to let the rupee beyond 70 so as to remain competitive. Despite dipping into the reserves, there seems to be no urgency to prop it up to above 65 prevailing at the beginning of the fiscal year. The existing disparity between the interest rates in India and US is quite attractive for dollar inflow into the local capital markets. The Make-in-India campaign is an acknowledgement of the limits of relying on exports to shore up foreign exchange. Instead of higher external borrowing limit for Indian companies, opening up aviation, insurance and multi-brand retail to controlling foreign ownership will prove a powerful magnet for overseas funds. In the short term, the Q2 and Q3 performance will reveal if the resilience of Corporate India in overcoming the disruption of demonetization and implementation of GST extends to circumventing the effects of expensive inputs. Release of more dearness allowance to Central government employees and enhancing the overdraft facility to Rs 10000 for Jan Dhan account-holders should spur urban-shopping just as a normal monsoon and higher farm support prices have provoked rural-buying. Many companies’ volume-push due to reduction in GST is slated to translate into higher margins on pass-through of costs after the cooling period and improved capacity utilization. In between, the beginning of bidding for bankrupt power assets and divestment in PSU cash-guzzlers will boost investor confidence. Later, results of elections to five states will provide clues on the mood of the market.

-Mohan Sule

Strange things

Rupee weakening despite return of foreign investors, growth without discipline and promoters unwilling to let go

The snap decision of electric vehicle pioneer Elon Musk to take Telsa private and then reverse it after a few days is not the only strange thing that has happened of late. The comeback of foreign portfolio investors since July after being net sellers in four of the first six months of the current calendar year to lift the local equity market to lifetime highs is equally jolting. The BSE benchmark took half the time to amass over 2,800 points that it had accumulated in the three months to end June, gaining 27% in the next two months. Their return was despite trade tensions running high and Brent crude quoting above US$77 a barrel, triggering fears of inflation spiraling and current account deficit widening. The Federal Reserve was sending hawkish clues. The Reserve Bank of India and the Bank of England were yet to meet. The hike in their policy rates coincided with the US central bank pausing from its ramp-up cycle beginning August after raising them for seven times in three years from end 2015. The tariff agreement between US and European Union was still to be reached and signs of thaw between the world’s two largest economies to agree to talk were not visible. The buying by overseas investors continued even as there was a flight of capital from fragile Turkey after the US slapped import duty on steel exports. Not that the Indian market was cheap, with the Sensex quoting at a P/E of around 22 end June. Mid and small caps were tumbling on tighter surveillance by the market regulator. The resumption of foreign fund inflow did not offer any support to the rupee. The Indian currency continued to weaken, breaching the 71 mark, along as with those of emerging markets in reaction to the 17% plunge of the Turkish lira in a day mid August.  

More than being satisfied that India is capable of expanding in double digits, as shown by the revised GDP numbers of the UPA years, the question that investors want to ask is why 2006-07 was an exception, with growth plummeting to 6% over the next five years. Adding to the confusion if the figure of over 10% increase in output in the third year of the then regime should be taken at face value is the admission of the official compilers that there was no reliable data. Assumptions have been made. The trajectory was accompanied by 6% average CPI inflation in 2006 from 4.5% in 2005. The combined Center-states fiscal deficit had deteriorated to 23% of GDP from 15% in 2003-04, when the UPA government took office. The spending spree included 43% higher allocation to eight flagship programs over 2005-06. The target for farm credit was enhanced 15%. Importantly, cheap money from the US and Japan was sloshing around. The accelerating net external flows into India’s capital markets nearly tripled to US$20 billion in 2007-08 from the previous year. The inability to sustain the momentum thereafter is a testimony to the transitory nature in the absence of structural reforms. The asset bubbles burst in the second half of 2008. FIIs pulled out US$ 15 billion in 2008-09. In contrast, the first two years of the NDA government were marked by drought. Disruptions due to recall of high-value notes and the roll-out of the goods and services tax followed.

If the exhilarating thought of what India could have been is enough to depress investors so have certain corporate actions. Though the long-serving former boss of HDFC escaped from being ejected from the board by a whisker, the direction by foreign proxy advisors to vote for his ouster should result in introspection. No doubt even international intermediaries participating directly or indirectly in the domestic capital markets should follow standard operating procedures. Yet the firepower against them appears an attempt to divert attention from the crucial issue if the shareholders’ representatives are performing as per expectation. The scarcity of wise men to offer guidance is not a secret. What is not widely known is the number of boards they grace, raising concern of their capacity to pay full attention to the companies they are counselling. Fixed-term tenures and a gap before re-induction are ideas worth exploring. Two of the long-serving directors took the hint and quit. Hopefully, Deepak Parekh, too, will so as not to tarnish his legacy of being a role model for transparency by making way for professionals to run the mortgage lender. That owners are reluctant to let go off is not something new. What dismays is how those who preach corporate governance fall short. It took the Reserve Bank of India to nip Uday Kotak’s bypassing the spirit of reducing his stake in the private sector bank he founded by issuing preference shares instead of ordinary shares. When it comes to Indian promoters, time and again it has been demonstrated that it is selfishness rather than the interest of the small investors that guides their actions.           

-Mohan Sule