The company 2019 kept

How Corporate India’s moments of pride, greed, envy, lust, gluttony, wrath and sloth played out in the year that was

Self-interest prevailed unashamedly and unambiguously in the year that was.  India walked away from the Regional Cooperation Economic Partnership with Asia-Pacific nations to protect domestic farmers and industry from a flood of cheap imports. Survival superseded consensus. The surgical strike on corporate tax by eight percentage points propelled India into the competitive league despite some dissent of cash handout being a better incentive to propel consumption and investment. Strike-back replaced compromise. Energy producers, staring at bankruptcy due to state power distributors’ reluctance to pay, took the lenders to court for clubbing them with other sectors to determine their solvency.  Self-preservation overrode commitment. Auditors and financial heads of several companies preferred to quit rather than acquiesce to dodgy numbers. Nationalism co-existed with political correctness. As capital of Rs 70000 crore was being infused into non-performing public sector banks, the Reserve Bank of India was pulling them up for under-reporting of their bad loans. The wealth destruction accompanying the auto sector’s painful transition to new emission norm to face the challenge of climate change was met with resigned acceptance by investors even as the contention that the plunge in sales was also due to buyers’ resistance to the ramp-up of retail prices gained some traction. With survival at stake, companies adopted desperate strategies to stay relevant. Telecom players grappled with issues such as the duration of the ring-tone and if the originator of calls should pay any fee to the receiving service provider. The drying up of liquidity following the collapse of IL&FS late 2018 torpedoed the transmission of the central bank’s rate cuts, with NBFCs mopping up funds above the benchmark. 

Pride suffered a blow. The fastest-growing economy was toppled from the pedestal by small economies in the neighborhood. The smugness that foreign investors have little option but to invest in India was busted when the first budget of the re-elected government hiked the surcharge on the tax on the super rich. The decision of a committee that the RBI should hand out a bigger payout to the treasury deteriorated into a contest of greed versus prudence. The access to funds was viewed as a lazy option to expend on fiscally damaging but socially relevant programs without taking the difficult road to grow revenues. On the other side of the coin was relief that the government’s market presence would be curtailed, leaving room for private borrowers. The wrath of the lenders, who refused to grant more roll-over of their repayment schedules, grounded a full-service air-carrier on the promoter’s reluctance to cede control. Among the receiving end of investors’ ire were mutual funds signing standstill agreements with borrowers unable to service their debt and the market watchdog for absolving fund managers by allowing separation of toxic paper to protect the NAV. The gluttony of two promoters of hitherto thriving enterprises in the banking and media space to add to the top line by pledging their shares dragged down their stocks and eventually led to their departure from their ventures nurtured from scratch.

IPOs, good and mediocre, got bumper subscriptions, capturing the lust for quick gains. Who was the suitor and who was wooed was a topic of speculation following Saudi Aramco agreeing to take up to 20% stake in RIL: the Saudi government-owned oil explorer had to justify to subscribers of its IPO the intended US$2-trillion valuation, at a time of down-trending crude prices, with additional income streams. The Indian oil-to-retail conglomerate needed to pare debt to raise more resources to drive the telecom business, a potential cash-cow. In contrast, the other marriage of convenience was forced than voluntary. Ten PSU banks were merged into four to make them attractive to prospective suitors. Envious of its unique entrepreneurial model, a construction conglomerate launched a hostile bid for a tech solutions provider that was rocked by stake-sale by one of its cash-strapped promoters to service the debt of his floundering quick-service restaurant chain.  Angry whistle-blowers played no small part in the regulator refusing its nod to a housing financier to merge with a legacy private bank and knocking down the valuations of an IT solutions provider and a drug maker, two heavyweights of the headline marker. How sloth can result in miscalculation was illustrated by telecom services providers who threatened to close down when asked to pay their share of under-reported revenues to the government instead of cutting flab and admitting that their business model of relying on voice calls at the expense of data had misfired. Indeed, the mainline indices hitting record highs even as mid and small caps languished as 2019 came to an end told a tale of a year that was disruptive yet riveting.    

 -Mohan Sule

What the market knows

The stock-surge that is discounting the lag effect can be torpedoed by richly-valued IPOs and governance issues

Mainline indices galloped amid evidence tumbling out of the economic slowdown worsening. An optimistic outlook might have justified the surge. That is not so. Global and domestic institutions seem to be in a race to slash growth forecasts. The divergence in the market’s behavior from ground realities should ideally be a cause of concern. It is not for two reasons. First, the market is aware of the lag effect. The inflow of foreign funds, fattened on the profit skimmed from the US markets recording new lifetime-peaks, has benefited mainly large and mid-cap biggies. The liquidity that will come from booking capital gains will percolate to small caps. As such, there is scope for front-line stocks to let off steam without causing an all-round collapse. Second, the underlying stress is providing a trigger to restructure the economy. The reduction in the base corporate tax rate to 22% has placed India among the most competitive countries to attract FDI. The big-bang reform is comparable to the opening up of closed sectors to private investment by the cash-strapped Narasimha Rao government in the early 1990s and setting up of a divestment ministry by the Atal Bihari Vajpayee government in September 2001 following the dot-com bubble burst at the turn of 2000. Now the Narendra Modi government might be giving up control of banks and withdrawing from the oil and gas sector. Unlike rating agencies basing their projection on past performance, the market is discounting the path the Modi government is going to travel to make India a US$5-trillion economy. Standard & Poor’s seems to have read the signals correctly. It sees India outperforming its peers going ahead.

The market recognizes that some companies can outperform the country. Reliance Industries is hitting new highs irrespective of gloomy macro indicators. The Bajaj financial services twins are in a fine fettle even as the NBFC space is struggling. IPOs of IRCTC, India Mart InterMesh, CBS Bank and Ujjivan Small Finance Bank got good response despite risk-aversion. The market is sensitive of the collateral damage caused by governance issues. The IL&FS default has had a cascading impact on lenders including companies, banks, NBFCs and mutual funds. Heavily-leveraged DHFL has become the first financial services firm to undergo the resolution process. Promoters of Yes Bank and Zee had to shed stake and management control. The issue of divergence in reporting of bad loans turned off investors from private banks. The market’s distaste for small caps lingers more than a year after the auditor of Manpasand Beverages quit, setting off a chain of resignations. In a throwback to Satyam Computer Services’ accounting scandal, the board of CG Power and Industrial Solutions confessed of manipulations by its head. The market fears whistle-blowers for the wealth destruction they inflict. The recovery of Infosys, Indiabulls Housing Finance and Sun Pharmaceuticals has not fully made up for the value erosion caused by allegations of malpractices. The market is watching how the issue of misuse of client funds by stock broker Karvy is handled by the regulators as such scams can put off investors for a long time as happened after broker Ketan Parekh was found in 2001 to have manipulated prices of 20 stocks. The market knows that the standstill agreements executed by mutual funds, allowing borrowers to roll over their repayment and quarantining such paper, have resulted in loss of confidence in debt funds.

The market is aware that the frenzy in the primary market can result in a stampede to exit if a richly-valued IPO disappoints. Reliance Power debuted in February 2008 at a 17% discount and never ever crossed the offer price. It accelerated the meltdown of the primary and secondary markets that was gathering speed as the housing mortgage market in the US was coming under increasing strain. The market has realized that the world is flat. The over year-long US and China trade-tariff tiff and the tortuous course that Britain is taking to exit from the EU are overhangs on the direction of the global economy. Central banks have to track the Federal Reserve’s moves to determine their policies. Would the Reserve Bank of India have taken a pause if the Fed had not hinted that it would not undertake any more rate cuts next year? At the same time, the market has now understood that inter-connectivity and supply-chain links are fragile. The US has demonstrated that an inward-looking economy can triumph over free trade. Not surprisingly, India’s rejection of the Regional Comprehensive Economic Partnership, covering the Asia-Pacific region, did not create any ripples in the market.

-Mohan Sule

Never say never again

No matter your attitude or mood, stocks have the capability to surprise you by their turnarounds

Every rally and pullback amazes and stuns. Stocks dismissed with contempt spring back and those viewed with awe stumble. Two recent instances confirm that investors should never, never say never again. A few days after the market welcomed its impressive quarterly results, Infosys dragged down the mainline indices by slipping 16% in two days following a whistle-blower’s complaint of financial irregularities. The IT bellwether is up about 9% since Chairman Nandan Nilekani asserted to the NSE that such a possibility is remote due to fail-proof safeguards. Rating downgrades and resignation of three independent directors were the beginning of Yes Bank’s travails. The Reserve Bank of India in October 2018 refused to give the founder-CEO an extension beyond March 2019. The new-gen private bank’s slide thereafter spilled into the open the top manager’s leveraged position. It shed more than 90% before the promoter divested most of his stake but nearly doubled from its low after an NRI agreed to pump in US$ 1.2 billion. The automobile industry captures the dilemma if the worst is over or there is still more pain for a sector. The pile-up of inventory and the resultant production cuts by manufacturers are turnoffs for slowing the growth momentum. Low prices are viewed as an opportunity by the contrarians because the disruption due to the transition to BS VI norms from April 2020 is expected to last for a couple of quarters more before a refurbished industry is ready to roar. Backers of PSUs for the comfort of controlling government stake are in a better place today. Savvy investors recognized that the acknowledgement of bad loans, creation of an insolvency vehicle and consolidation are carefully calibrated steps to the eventual privatization of nationalized banks. The recent Supreme Court judgement that creditors take precedence over operational facilitators in bankruptcy proceedings has fortified those who believed in these lenders. The Nifty PSU Bank index has appreciated 7.6 % from end August, when Rs 70000-crore capital was loaded upfront.

Discerning observers who understood Aramco’s buy of RIL’s 20% stake as a forerunner to the opening up of the oil and gas sector would have felt justified after the government put its entire stake in BPCL on the block. Debt-laden Vodafone Idea and Bharti Airtel were written off after a price war and the Supreme Court’s demand to pay backdated revenues. The  decision to differ the installments payable for buying spectrum in the next round for two fiscal years and principal competitor RelianceJio’s plan to start levying tariffs on voice calls rekindled hope of a second coming. At the same time, a sudden adverse turn by counters that have been creating wealth year after year can shake up complacency. Graphite makers capitalized on China’s clampdown on polluting industries and recovery of user industry steel. Graphite India returned 1,401% and HEG 2,808% in the 20 months till August 2018.The over 80% plunge in Graphite India’s net profit in the latest quarter was a shock but not a surprise as the US-China trade war sparked more than a year ago dampened demand. In fact, HEG had started showing signs of stress in the June 2019 quarter, with the bottom line sliding 70%. The removal of the anti-dumping duty on Chinese imports was a double whammy. Both have shed nearly 70% in 15 months.

 Buying into a company that has been unstoppable so far is as much a gamble as trying to catch a falling star. There is no knowing when overvaluation will burst the bubble or when the bottom will be reached. For Titan, with P/E of about 72, growth-driver gold turned into an obstacle as prices pierced the resistance level. The jeweler has declined 15%, while the mainline index has inclined 3.5% in the past month. Those sticking with ICICI Bank amid mounting bad assets and the Videocon loan scandal might feel vindicated as it has gained about 80% in the near 14 months following the installation of a new CEO and MD. Faith imposed in Indiabulls Housing Finance on its proposed merger with Laxmi Vilas Bank might seem misplaced now as the deal did not get the regulatory nod despite the group divesting most of its real estate assets. It has given up 80% in the ensuing six months. The confidence in Zee, on the other hand, might be bearing fruit as the overhang of pledged shares is disappearing, with the promoters offloading most of their holdings to pay their loan obligations. The many divesting from the NBFC space wholesale after the collapse of IL&FS in September 2018 might be stumped at the resilience of Bajaj Finance, amassing 90% on its October 2018 low even as peers are struggling. To modify the soundtrack of an old James Bond movie, no matter your attitude or your mood, the stock will surprise you.

-Mohan Sule

A nod to risk-takers

Policy makers are recognizing that the shareholders can no longer be ignored to favor consumers

There is an 80-pound gorilla in the room and the policy makers are finally acknowledging its presence after a bruising price war and an imminent auction of the next-generation airwaves. A committee of bureaucrats will decide how to revive a once-emerging sector gasping for breath. Judicial interventions, policy muddles and cut-throat competition have contracted the marketplace to three universal telecom services providers. What needs to be determined is if the sector is so critical to the economy that there is a need for a life-support system. After all, aviation is none the worse for the wear and tear after passing through an identically tumultuous phase. Many fly-by-night operators folded or sold out just like in the telecom space. If budget carriers IndiGo and SpiceJet shone a light on the flawed business model of full-service carriers Kingfisher Airlines and Jet Airways, eventually resulting in their grounding, free voice calls and low data offered by RelianceJio  since September 2016 and slashing by over half the fee paid by the call-generating teleco in October 2017 hastened Idea Cellular’s merger with a stronger and dominant partner Vodafone India in August 2018 and the shift in Bharti Airtel’s focus on Africa to hedge the domestic margins. If the first-come-first-served process adopted in awarding licences for 2G spectrum distorted the field, so will providing a breather to ailing participants to pay the discovered price in the 5G spectrum auction, because they have to share more revenues with government as per the recent SC ruling, interfere with market forces. Lenders did not roll over Jet Airways’ debt on losing hope of recovery but due to doubts of eventual de-leveraging without the promoters diluting their stake for capital infusion and ceding management control.

Unlike automobile makers facing a slump in demand across the board due to transition to a stricter pollution emission standard and global slowdown, telecom services providers’ woes do not stem from faltering usage. The market has in fact exploded, with the mobile subscribers using the GSM platform expanding more than 90% in the three years till end 2018. Their problems have similarities as well as differences with those of airlines. Low tariffs as against surging overheads bind the two sectors. Idea Cellular dipped into red in FY 2018 for the first time since its IPO 11 years ago as revenue growth faltered and operating profit dipped. Though the consolidated loss of Vodafone Idea has stabilized at the Rs 4870-crore level in the June 2019 quarter from a peak of Rs 5005 crore in the December 2018 quarter, its equity and debt papers have turned into junk. Standalone Bharti Airtel made a loss in the December 2017 quarter for the first time since its IPO in 2002.  If high Central and state taxes, going up to 40%, on volatile aviation turbine fuel are weighing down airlines, backbreaking bidding for circles are draining telecom players. Barti Airel paid nearly half its standalone revenues and double its net profit and Idea Cellular over 30% of its standalone revenues and three times its profit in FY 2016 to bag spectrum at the last auction in October 2016. Vodafone Idea’s consolidated debt stood at Rs 1.18 lakh crore and Bharti Airtel’s Rs 1.08 lakh crore end March 2019.

It will be tempting to view RelianceJio’s eventual consolidation to monopoly status as inevitable. That need not be so. Green shoots are visible. The 16% slide in the average revenue per user in the year to the December 2018 quarter indicates the beginning of the slowing of RelianceJio’s momentum. Incremental additions on the largest base of over 330 million subscribers end June 2019 will not be necessarily accompanied by higher margins. In contrast, Bharti and Vodfone are showing signs of bottoming out, recording a slight improvement in the revenue provided by an average user. RelianceJio has started imposing a nominal six paise per minute for calls from October to put pressure on Trai to totally abolish interconnect usage levy. The players are undertaking financial engineering to reduce leverage. Bharti Airtel is merging its tower arm and its tower joint venture with Vodfaone. To become debt-free to raise Rs 20000 crore for investment in the telecom business, RIL is transferring its fibre and tower business to an investment trust and equity investment in RelianceJio to a wholly owned digital subsidiary. What these developments signify is that the attention is now shifting from the consumers to the shareholders who contribute the risk capital. Making available goods and services at the lowest price is possible as long as investors’ pain threshold is not crossed. The political leadership has understood that the beast needs to be tamed without subduing the animal spirits.

-Mohan Sule

Click and bait

The strategy to entice investors with underpriced IPOs to offer richly-valued FPOs going ahead can backfire

What the slashing of the corporate tax did to the secondary market, the IRCTC IPO has done to the primary market. The cloud of pessimism has given way to giddy euphoria. If the flight of foreign investors slowed down in the aftermath of India’s transit to a competitive economy with a 22% peak base rate, the more-than-100-times subscription and over cent-per-cent listing gain, a rare feat for a PSU, dispelled the myth of a liquidity crunch. Overseas and local investors’ appetite for Indian paper was amid, or despite, a flurry of downward revision of growth projections by domestic and global institutions for the current and the next fiscal year. The market is sentimental but practical. The Indian Railways’ catering and online booking provider and tour operator was sought after not only for its monopoly but also for its impressive core performance. Such debuts are rare. The last one that was greeted with a similarly rapturous reception was in 2017. Since then, the enthusiasm has partially evaporated save for exceptions such as IndiaMart InterMesh, a B2B e-commerce platform that was 36% oversubscribed, opened at 34% over the offer price and has returned 48% in the four months since then. Leadership position of a company is a strong motivator for investors to part with their money. The concern is sustainability.

The rise and fall of MTNL is a chilling reminder of how fortunes of in-favour themes can deteriorate on changes in the composition of the market and government neglect. The IPO of BSNL, the government-controlled supplier of telecom services, except to Mumbai and Delhi, did not materialize. Instead MTNL will become a listed subsidiary of BSNL in a mega merger. VSNL was a crown jewel before it was completely absorbed by the Tatas in February 2008, six years after buying a 45% stake. The stock has shed half of its value at the current market price. Air India’s descent accelerated after the sky was thrown open. The problem once again was cannibalization of the business by new-age operators and indifference of policy makers. Slowly but surely IR is being dismantled. Private players can operate freight and some passenger routes. What needs to be seen is if the latest success story will consolidate and continue to create wealth for the shareholders like Avenue Supermarts or fizzle out like Astron Paper and Board Mill and Career Point, among the few whose collection exceeded 100 times the issue size.  When the operator of offline retailer D-Mart entered the market, doubts were raised about its dated business model despite its conservative approach to cash management. Digital marketplaces were gaining popularity. Departing from the favorable view of businesses with asset-light model, the market found virtue in owned outlets in prime residential localities, a hedge in a worst-case scenario. Justifying the confidence, the grocer has appreciated 85% in over 32 months.  The diluted EPS has expanded 74% in four years. In contrast, struggling Flipkart was bought lock-stock-and-barrel by Walmart. Amazon has to be satisfied with 51% multi-brand FDI cap.

That the stunning performance of Avenue Supermarts and IRCTC will encourage sound companies to raise capital even in a hostile market will be a welcome outcome. What is not is the unease about discovery. Book-building is undertaken to assess demand from long-term institutional investors, who balance the past with the outlook. The process aims to eliminate over- or under-pricing. A manageable contribution sees securities getting credited in the demat accounts of most participants. The modest payoff on debut attracts new investors. There is no hurry to tap the market. It is puzzling how investment bankers could be so horribly out of tune with the mood on the street in determining the offer band. Besides undermining the proportionate allotment model, the exercise has turned into a lottery for speculators looking to book quick profit. A lower valuation restricts capital expenditure or debt clearance, affecting growth plans. The recipe to entice investors with a discount to come out with richly-valued FPOs going ahead can go wrong if earnings do not keep pace with the enlarged base. The Astrom Paper and Board Mill IPO mopped up more than 240 times the issue size. The 58% opening advance end 2017 has slumped to about 15%. In retrospect, the cautious approach of Avenue Supermarkets seems justified. The promoters were diluting their stake to stay listed through issue of new shares. The premium was accrued to the company for de-leveraging. The railway ministry has short-charged tax payers funding the enterprise by agreeing for below-par collection. The government will get the entire proceedings of the divestment. Benefits to IRCTC, if any, going ahead are uncertain if does not turn into another MTNL in the meantime.  

-Mohan Sule

Out of control

Cooperative banks should be converted into small finance banks and brought under the supervision of the RBI

Even as the flow of credit to the economy is being eased, the pipeline is springing unexpected but not surprising leaks. The Rs 6500-crore gap in the books of Punjab and Maharashtra Cooperative Bank has overshadowed recent moves to nurse public sector banks to become fit to lend. The attraction of fewer strong institutions to meet the demands of a growing economy will be nullified if investors panic.  The latest cooperative bank to be in trouble created fictitious accounts to give nearly 73% of its lending surplus to a single borrower. Regulations are as good as their implementation. What the implosion underlines is that collusion between cunning customers and corrupt officials is not specific to any category. Broker Ketan Parekh triggered the collapse of the Madhavpura Mercantile Cooperative Bank and the new-age Global Trust Bank, later merged with Oriental Bank of Commerce, by using his access to their treasuries to manipulate stocks.  Punjab National Bank’s board was not aware of the misuse of letters of undertaking by Nirav Modi for overseas transfers from a single branch in Mumbai.  PMC Bank kept quiet despite HDIL not servicing the loans for many years. Auditors of these banks were either careless or collaborators. That these small but systemically important outfits have escaped from being taken over by the government even half a century after nationalization speaks of the powers that have come to control them. The Reserve Bank of India governor has said discussions are on with the Central government to reform the sector. The stage for cosmetic tinkering is over.

The cooperative movement started in the early 1950s, when banks were controlled by large industrial groups. The principle of each member being a stakeholder and a potential borrower was to ensure prudent practices and disciplined repayment. The 0.5% to 1% point higher interest offered by this category compared with government-owned banks, while not unusual in a competitive era after freeing of rates, should have resulted in a scrutiny of their practices. Excluding cooperative banks from exchanging high-value currency notes in November-December 2016 provides hints of the monetary authority’s unease. The PMC management admitted to siphoning of funds by the HDIL group after the board and auditor had approved the annual report and expressed satisfaction with the financial strength. Clearly, the dual-regulatory regime is not working. The RBI supervises their banking function. It does not have the power to constitute, supersede or liquidate the boards or remove directors. Registration, management and audit are by the registrar of cooperative societies.  A committee appointed by the central bank in 2015 had recommended converting multi-state urban cooperative banks with Rs 20000 crore of business into scheduled commercial banks. Even the very few that qualified did not show any enthusiasm. The recently issued norms for on-tap licensing of small finance banks should be modified to envelope these shaky edifices.  In the meantime, these entities should be barred from taking exposure to the corporate sector and instead limited to financing consumer goods, automobiles and gold. Treasury operations should be restricted to inter-bank transactions.  

A rapid crisis action team needs to be deployed to fire-fight a run on banks.  Clamp-down on withdrawals, though necessary to gauge the damage to the balance sheet, can prove counter-productive. Loss of confidence can set off a chain reaction of flight of deposits, undermining the foundation of even stable banks. The first step even before investigation starts into the causes and extend of rot is to ensure liquidity. A centralized contingency fund, with each bank contributing a percentage of its liabilities by subscribing to RBI's lending-rate-linked bonds issued by the task force, can provide support to troubled lenders. They can draw from the pool to return at least the principal if not the accumulated interest of worried savers. It will eliminate an important source of irritant: right now only up to Rs 1 lakh is insured and guaranteed by the deposit-taker. It is likely that housing societies, trusts and other non-profit organizations will be examining safer options. Most will opt for nationalized banks. Mutual funds should woo these risk-averse investors to money market schemes that invest in government securities. Redemption is assured. The entire subscription is available along with modest gains. The tax outgo, too, compares favorably with bank fixed deposits: as per the tax slab up to 36 months. The rate lowers to 20% with indexation benefit beyond that. There is no TDS applicable, unlike on bank fixed deposits if interest income crosses Rs 40000 in the year. Instead of trying to patch up the leakage after each eruption, the RBI’s focus should be on how to replace the pipeline to avoid any disruptions in future.

-Mohan Sule

Sting in the tail

Get set for migration of established companies with new business ideas to the low-tax regime for start-ups

The equity market finally got the trigger it was waiting for in the unexpected deep rate cut to 22% from 30% in the base corporate tax and scrapping of the surcharge on long-term capital gains for the super rich, capping nearly a month-and-a-half of monetary and fiscal stimulus in driblets. The Nifty gained 7.7% in two days, its best performance till date. If previous high-decibel actions including the recall of high-value notes in November 2016 and implementation of the universal goods and service tax from July 2017 and real estate regulations from May 2016 did not produce such a big impact, it was because their outcome was never meant to be visible in the short term. Their intention was to change entrenched habits to effect a transformation. The benefit of the latest fiscal reform to level the field with other competitive economies could be captured just like when the Reserve Bank of India slashed the lending rate to a nine-year low and kept provisioning at 5.5% of the balance sheet, instead of the earlier 6.8%,  to hand out to the treasury Rs 1.76 lakh crore of surplus. The market’s relief following the government deciding to front-load Rs 70000 crore into public sector banks was much more noticeable than the reaction to easing NBFCs’ access to liquidity, opening coal mining and contract manufacturing to 100% foreign direct investment and relaxing local sourcing norms for single-brand retail to an average of five years instead of every year.

The spurt in stock prices factored in higher earnings growth. If so, mid and small caps, too, should have bounced back when the eligibility for 25% corporate tax was hiked to include those with turnover of Rs 400 crore from Rs 250 crore in July, covering over 99% of all companies. Yet, the relaxation did not lift the market mood as many of the intended beneficiaries had opted for exemptions or the lower minimum alternate tax, now brought down to 15%, from 18.5%, of book profit plus surcharge and cess. Several were grappling with the execution of GST. A few would be disclosing more taxable income to avail of the input tax credit. That the latest tax bonanza is applicable across the board is a welcome realization that concessions should encourage risk-taking. Limiting them to size and nature of business distorts the marketplace. Booming orders from original equipment manufacturers can do more to encourage formalization of the unorganized support system relied on for outsourcing than preferential treatment. The indirect tax regime is already transiting to two-three slabs. Large, mid and small caps have gained in tandem, based on the premise that the savings in tax outgo will be used to expand capacity and product portfolio, diversify into new markets, revive consumption, clear debt, increase dividends or issue bonus. Even in the crowd, companies with no or negligible leverage populating certain sectors got more attention. Banks turned into favorites in the belief they would have more cash to lend and their borrowers would be in a better position to service their loans.

 Worries about fiscal deficit ballooning on tax revenues declining Rs 1.45 lakh crore without a rollback in government expenditure took a back seat because of the central bank’s bumper dividend and consolidation and capital infusion expected to spur a PSB turnaround. Higher payouts will improve the dividend distribution tax mop-up. The reluctance to reduce GST from 28% on automobiles sends a message that the sector’s woes stem from structural issues. The thrust on housing for all and infrastructure does merit a lenient view of cement. If the sector failed to get any sympathy it speaks of the doubts of pass-through of any benefit due to the tendency of the players to flock together. The stunningly low 15% tax rate on new companies setting up manufacturing between 1 October 2019 and 31 March 2023 is the sting in the tail. In the giddy euphoria of imagining an exodus of foreign investors from China to India, what has failed to get traction is the possibility of legacy companies taking advantage of the eight percentage point arbitrage in the tax rate to stay ahead.  When the cap on foreign direct investment limit was removed in many non-core industries, MNCs saw more drawbacks in compliance than upsides of raising capital from the Indian market to stay listed.  Those that were hobbled by the high price thrown up by the reverse book-building process to go private shied from new launches. Some set up new units to make value-added products. If Indian promoters turn copy cats, the shareholders hoping for bumper wealth creation going ahead will be disappointed. After enjoying a short-lived spike in valuations, investors will face a choice of a stagnant future or starting afresh.  

-Mohan Sule

Mr Cool

Small investors keep faith even as the central bank shies of deep cuts, companies default and mutual funds favor borrowers

A crisis tests the will and resolve of policy makers, companies and investors. The first responder is the central bank. How it calibrates the flow and cost of money contributes significantly to the transition to recovery. Its task is becoming increasingly difficult and complex. Following the anemic growth of 6.6% on an average and consumer price index at around 2.5% in CY 2017, slashing the repo rate from the 6% level should have been an automatic response if not for oil crossing US$50 to US$70 in CY 2018, fueling fears of inflation, which had been tamed by the farm output glut, breaking free. GDP growth might not have sunk to a 25-quarter low in the three months ended June 2019 if borrowers could have had money cheap. The Reserve Bank of India’s diffidence was a reaction to the Federal Reserve embarking end December 2015 on hiking lending rates for three years after a decade to cool the heating US economy.  Despite the cautious approach, foreign investors dumped Indian stocks for most part of CY 2018 and CY 2019 to head back home to ride on the booming equity market or to park funds in safe haven gold. US-China trade tension and uncertainty over Britain’s exit from the common European market mellowed the Fed into taking a pause and then paring the discount rate twice by 25 basis points in CY 2019 so far. The move emboldened its Indian counterpart to top its four rate cuts in the year by slicing off a quixotic 35 bps. A hefty dividend using a new benchmark was transferred to the treasury. It signaled its determination to become the fulcrum of the efforts to persuade the economy to pick up speed. At the same time, the hesitation to execute a neat half a percentage cut indicated the bravado might be a one-off instance There is now renewed pressure to follow People’s Bank of China’s aggressive chopping up of the cash to advances requirement so that the rupee can weaken to stay in competition with the yuan. A slump in manufacturing does favor such a posture. The hitch is that any steep trimming might accelerate the outflow of foreign funds as there will not be any more softening by the Fed till end CY 2020 on a strong labor market and incipient inflationary pressure.

If the RBI’s dilemma is how far to go without appearing to be adventurous as well as to remain stubbornly conservative,  the finance ministry appears unable to make  up its mind if the slowdown is cyclical or structural. Credit lines have been opened to HFCs and NBFCs and affordable housing projects. Certain sensitive but safe-from-controversy sectors can have full foreign ownership. Local-sourcing irritation of single-brand retail has been addressed but the multi-brand retail space still remains out of bounds, signalling that the loss of momentum is being attributed to bottlenecks in supplies rather than stemming from lack of consumption. The merger of and capital infusion into public sector banks implies divestment of government stake will be selective rather than across the board.  If the monetary and fiscal authorities are darting between daring and dithering, the corporate sector is a picture of capitulation and confidence. Instead of introspecting about excess capacity and resorting to price hikes to boost the margins, auto makers are seeking concessions to shake off sluggish sales. Companies relying on leverage and preferring to pledge shares to entertain unrelated activities instead of diluting stake are facing the prospect of letting go control to tide over debt defaults. Meanwhile, mutual funds, after taking exposure to unlisted and junk paper to boost NAVs, are siding with borrowers by signing standstill agreements and postponing redemption.

At the other end, biscuit makers are pushing premium products.Personal-care leaders are passing on lower GST rates to push the top line. Brick-and-mortar retailers are opening branches. Cinema operators putting up screens in tier 2 and 3 cities. The order books of infrastructure and capital goods players are bulging. IT solutions providers are making the most of a resurgent US economy and a weak rupee. The surviving airlines are registering record profit and price wars in telecom services are tapering. Promoters are monetizing their holdings to pay off loans as chances of ever-greening are turning slim. Auditors are opting to quit than accede to window-dressing. In the process, balance sheets are becoming cleaner, governance standards improving and raising working and project finance from the market getting easier. In the dust, the small investor stands out for his refusal to succumb to scare-mongering.  IPOs from companies with solid business model are getting oversubscribed and listing with a premium. Inflows into equity mutual funds are steady and into debt funds surging, a testimony to the domestic investor’s faith in the India growth story unlike the fickle foreign investors.

-Mohan Sule

Lingering taste

The 2008 liquidity crisis led to quantitative easing in the US and fiscal recklessness in India

An economic slump, however uncomfortable, offers a welcome window to retrospect, reassess and review policies and regulations. The response leaves a lingering taste, good or bad. The thread binding the capital outflow of the late 1990s, the credit crunch of CY 2008 and the global slowdown in CY 2019 is risk aversion of foreign investors. The Asian Tigers kept interest rates high to attract overseas funds. The money trail turned cold when the US started increasing lending rates to curb inflationary pressures. The exit of hot money knocked down the value of currencies across emerging economies. Russia defaulted on short-term liabilities. The rouble, freed from restrictions, lost two-thirds of its value. The contagion spread to Latin American, which had deployed the same tools as the South East Asian peers to attract dollars. The IMF prescribed spending cuts, hiking taxes and privatisation. The region got caught in a vicious cycle of bailouts and debt defaults. The US financial crisis was a rude reminder that asset prices are volatile. The reaction to it marked a departure from the usual practice of tightening the flow of money to mend the side-effects of conspicuous consumption. Instead, a contrarian approach of making more money available more cheaply has become a playbook to be copied by monetary authorities around the world. Tarp or the troubled asset relief program was accompanied by near-zero lending rates. Buying of government and mortgage-backed securities was referred to as quantitative easing.

In the process, the Federal Reserve’s balance sheet expanded from less than US$900 billion before September 2008, when Lehman Brothers collapsed under the weight of its cocktail of home-loan paper of varying credit-worthiness, to US$4.3 trillion by October 2017, when the process of liquidation of the holdings commenced. It also started the practice of forward guidance on interest rates to alert borrowers about the longevity of the current regime so that they could expedite or put off implementing their investment plan. The unmistakable message is that risk-taking, essential for growth, has to be accompanied by a safety net. Developing economies responded to the crisis by ramping up expenditure. China’s four- trillion yuan outlay for CY 2009 and CY 2010 comprised 14% of the GDP in CY 2008. India’s central bank, which had been increasing the cash reserve ratio and interest rates to fight inflation, reversed its course from October 2008 by loosening CRR five times in four months. The statutory liquidity ratio, governing banks’ holding of government securities, was sliced 100 bps.  About Rs 25000 crore was released to finance a farm waiver scheme. The first stimulus package in December 2008 earmarked Rs 30700-crore spending and brought down excise duty by 4%. Additional Rs 1100 crore was provided to refund duties paid on inputs by exporters. The second in January 2009 centered on Rs 30000-crore tax-free bonds to fund projects worth Rs 75000 crore. Commercial vehicles got 50% depreciation. The limit on FII investment in rupee-denominated corporate bonds was hiked to US$ 15 billion from US$8 billion. The third helpline in January 2009 resulted in revenue loss of Rs 29100 crore. Central excise duty was slashed by another 2% and the earlier 4% reduction extended.  Service tax was also pared by two percentage points to 10%.  

The recovery of GDP from 6.7% in FY 2009 to 8.6% and 9.3% in the next two years came with a hefty price tag. Annual consumer inflation tripled to nearly 15% in CY 2009 from two years ago and remained at 11% three years later. The current account deficit to GDP doubled to 4.8% in the three years to FY 2012. The fiscal deficit to GDP stood at 6.46% in FY 2009 and hovered at about 6% two years later. If the UPA government’s treatment to insulate India from the global financial crisis was characterized by fiscal recklessness, the approach of the Reserve Bank of India and the NDA 2 government to the slowing economy due to US-China trade tariffs is marked by fiscal conservatism. The lending rate, at 5.4%, remains higher than the annual CPI of 3.15% in July. The emphasis is on ease of doing business by foreign and Indian investors and flow of credit to vulnerable sectors. Foreign investors can undertake coal mining and contract manufacturing without permission. Consolidation in the banking space will achieve scale. The monetary, fiscal and structural changes are without succumbing to populism of out-of-turn cuts in GST and personal and corporate tax. The nuanced approach spells confidence rather than panic.

-Mohan Sule

    

Friends in need

The RIL-Aramco deal could be the forerunner to further reforms in the PSU refining space

The world’s largest company by profit joining hands with India’s largest company by profit is an event that celebrates scale. The convergence of interest conveys interesting insights about the two partners. Saudi Arabian Oil Company and Reliance Industries are headed by ambitious inheritors. Both are seeking validation from the retail segment. Mohammed bin Salman, the titular head, is firming up plans to take the state-run explorer public. After offering cheapest data downloads in the world, Mukesh Ambani wants to list Reliance Jio in five years.  The effective ruler of the desert kingdom and India’s richest man want to hedge the downside risk of their flagships by looking at other markets. They have tasted blood. A bond offering by Aramaco mopped up US$ 12 billion in April. Besides the US$ 15-billion investment in the oils-and-chemicals business, UK-based BP will pump in Rs 7000 crore to buy a 49% stake in a joint venture with RIL to run a network of retail pumping stations and enter the aviation fuel business. Global investors’ embrace of the crown prince indicates that the overhang of the murder of a dissident journalist last year is fading. Becoming the world’s largest telecom services provider by subscribers has busted the belief that the Ambani family’s success was restricted to the B2B marketplace. Saudi Arabia’s latest overseas investment will expand its downstream footprints and entice investors with the prospect of the declining revenues getting a boost. Assured annual supply of 25 million tonnes of crude oil will insulate RIL from geo-political shocks.

The teaming up is not only because of the opportunities. There are compulsions, too. The fiscal deficit of Saudi Arabai is expected to nearly double than that estimated for the current calendar year as earnings from export of energy falter. The IMF has projected a threshold of US$ 80 a barrel for the world’s largest oil producer to stay afloat. Though doubled since the beginning of 2016, prices have halved in the last eight years as recessionary conditions prevail in the euro region and China’s slowdown looks set to become a trend rather a blip as trade tension with the US is expected to linger well into end 2020, when Donald Trump faces re-election. The slight acquisition premium compared with international peers gets Aramco an operational refiner, thereby circumventing the obstacles created by environmentalists to the US$44-billion proposed green-field partnership with Abu Dhabi National Oil Company in Maharashtra’s Ratnagiri district. High leverage is hampering RIL’s hunger for cash to deploy into emerging areas to compensate for the sluggish growth of the petroleum business as the world shifts from fossil fuels to electric vehicles. Cash EPS is down 40% and the operating profit margins of the group have contracted 226 basis points over three years. The gross refining margins were at an 18-quarter low end June 2019. Net cash-flow from operations halved in the latest financial year over a year ago. Outstanding liabilities of nearly Rs 3 lakh crore are more than double the cash reserves, with most of it going to fuel Reliance Jio’s run. The stock surged 10% in a day on the reckoning that the recent capital infusion will wipe out RIL’s debt by next fiscal year, leaving room for enhanced payouts and borrowings.

Going beyond how the collaboration will help repair the balance sheets of the two companies, the larger message is about the outlook of the global and domestic economy. That Dhirubhai Ambani’s heir is willing to part a chunky stake for the first time to a foreign competitor in the promoter-driven indigenous conglomerate is a reiteration of the recent trend of Indian companies collaborating with or surrendering to external competition. Home-grown Flipkart has been snapped by Walmart, while Idea Cellular has joined hands with Vodafone. It confirms the diminishing role of oil as a lubricant of the global economy. The world’s most valuable company is not a decades-old US onshore or offshore prospector but a relatively young New Economy player. The short-term benefits for India will be narrowing of the current account deficit and stabilizing of the rupee when the dollars flow in. The era of arbitrarily tinkering with central and states taxes on petroleum products to meet expenditure requirement is probably on its last leg as foreign investors will seek stability to avoid disrupting their growth trajectory. India might even be willing to hike the 49% FDI ceiling in processing and marketing PSUs on the road to withdrawal of subsidy support. Freeing the entire value chain from price controls will be the next logical step. If there are any winners or losers of the recent tie-up will depend on how quickly the stakeholders adapt to the changing times.  

-Mohan Sule

Firm but flexible

The concern of the market on some budget proposals can be addressed by learning from the phase-out of PNs

The stock market is supposed to capture local and overseas political shocks and surprises, over and under currents of domestic and global economies, stress and buoyancy in corporate earnings and accidents and incidents in making policies and regulations. Many times equities exhibit irrational exuberance that defies ground reality and underwhelming sluggishness despite optimistic indicators. That there are two views on the direction of the market makes trading exciting and rewarding, uncertain and risky. Hate it or love it but it is hard to ignore it. Three days after the presentation of the budget, when the market mood had turned distinctly dark, Union Finance Minister Nirmala Sitharaman told corporate bigwigs that she does not let the market affect her. In 1992, then Union Finance Minister Manmohan Singh had famously proclaimed that he does not lose sleep over the market. Shortly thereafter the surging stocks tumbled on revelation of manipulators siphoning off funds from banks to rig prices. In contrast, US President Donald Trump makes no secret of his desire for a booming market. Besides exploring the possibility of firing the chair, his own appointee, he has criticised the Federal Reserve for raising the cost of money too soon too often. The tendency is for government to point to the market’s strength as a vindication of the management of the economy but shift the blame to the central bank when the tide is not favourable.  P Chidambaram was not on talking terms with Y V Reddy and shared strained ties with D Subbarao, the two governors he dealt with during his stints as finance minister. 

Paring of lending rates usually points to a pessimistic view on the economy. It is an acknowledgement that the purse strings have to be loosened for consumers to borrow and spend. Yet equities spurt on any hint of a softer rate regime. US indices reached historic highs towards end July in anticipation of the Fed undertaking its first rate cut since the financial meltdown of September 2008 on projections of global trade war tensions shaving off growth after maintaining since late last year that there was no reason to intervene throughout 2019. No sooner did it act, stocks tumbled. More than the action, the disappointment was in the change in the outlook  from accommodative, suggesting an openness to react to any distress signal, to neutral, scotching any room for more snipping in the rest of the year. So here was a situation of the market sulking because the economy is showing resilience. In India, something similar seemed to have happened. The Union Budget for 2019-20 reduced the fiscal deficit target to 3.3% of the GDP, down from 3.4% projected in the interim budget presented in February 2019. Such a scenario should have been ideally very satisfying to investors. There was reiteration of partial or complete divestment from select PSUs and aligning of the FPI limit in stocks to the FDI ceiling of the sector.  Pumping Rs 70000 crore into banks to enable them to start lending, spending Rs 100 lakh crore on infrastructure over the next five years and reducing the corporate tax from peak 30% to 25% on companies with up to Rs 400 crore turnover, thereby covering more than 99% of the corporate sector, have the characteristics of a fiscal stimulus. The market chose to ignore them and obsessed over the higher surcharge on the super rich. Other irritants were the prospect of supply of more paper as companies move to maintain a minimum 35% public float from 25% and 20% tax on buybacks to bring them on par with dividends.  

The question that arises is if monetary or fiscal policies drive the market. Interest rates have been trimmed four times in the current calendar year to encourage private investment and consumption without much success. How much longer the cycle has to continue for risk-taking to make a comeback is uncertain. The goal post keeps shifting. From NBFCs’ liquidity crunch to regulatory overhang on the auto sector, the current crisis of confidence is being attributed to the higher effective tax on foreign investors structured as trusts. Trading had to be halted when Sebi in October 2007 curbed investment by foreign investors through participatory notes. Eventually, a window of 18 months was provided to wind up exposure through PNs, then comprising half of all foreign investment in the Indian market. The share came down to 16% in three years and is now 4% as reporting was made more stringent from 2012 and taking of naked positions in F&O through these instruments banned in September 2017. To resolve the current impasse, the finance minister needs to be firm but flexible to accommodate the concerns without losing sight of meeting the revenue targets.

-Mohan Sule

Irrational concerns

Misplaced fear of the higher surcharge on the super rich, overseas borrowings and increase in the free float of listed non-PSUs

Every budget stirs passion for a variety of reasons. These include runaway spending, increase or decrease in allocation to social programs, and taxing of the middle class. The Union Budget for 2019-20 has all the ingredients to make it appear wholesome. There is commitment to ease of living. The thrust on digitalization will make the tax collection process anonymous and transparent. To move towards Housing for All by 2022, the interest payment on loans for affordable housing eligible for deduction has been enhanced. There is nod to reforms. These include a higher target for disinvestment of PSUs, with many intended for outright sale. The 51% controlling stake in non-financial PSUs will be clubbed with that of government entities, thereby clearing the way for dilution of direct government stake. Consolidation of PSUs in related sectors will lead to effective utilization of capital. Treating foreign portfolio investment on par with FDI ceiling for the sector will open up more investment opportunities. If at all the recent budget merited scepticism, it is for lacking details of achieving the targets. A committee will determine the road map to mop up Rs 100 lakh crore needed for infrastructure-building over the next five years.  There is no clarity on how Uday, a scheme assisting the transition of state power distributors to health that has received lukewarm response, and power generators and tariffs can be reformed without prompt and fair payment by end users. The subsidy for food is higher than in the previous year.  It would have been still more had the Food Corporation of India not been enlisted to raise resources. Instead, the firepower has been directed at three proposals that ideally should have been embraced for their salutary impact on revenue collection and liquidity.

The two-tier hike in surcharge on taxable income above Rs 2 crore will affect only a small portion of the tax base. The suggested scary outcomes range from fleeing of the heeled to warmer climes to drying up of private investment. Crippling taxes do crimp entrepreneurship but are not the only obstacles to boosting productivity. Stability in policy-making, with no retrospective shocks, and a transparent mechanism to address grievances and enforce the law has not received adequate attention. Ramping up the effective tax rate on high earners will hurt professional managers. Most of the business class lives on  dividend income, paying 10% tax if the cash-flow exceeds Rs 10 lakh a year, from the companies they have promoted or invested in. They pay as little as 10% long-term capital gains tax if a stake-sale is undertaken.  Portfolio managers earning fixed or variable fees will end up with a lower tax of 25% up to turnover of Rs 400 crore if they convert into corporates, a move that will help shine a light on the sources of their funds.    

Opposition to the Central government’s intent to borrow from overseas markets is based on the conjecture of adverse exchange rates giving rise to the possibility of debt default. The situation will not arise if the funds are used to create assets rather than finance the deficit. The shrinking of the government’s presence in the domestic debt market will result in availability of capital at softer rates to small and medium companies without access to dollars and crowded out by large peers. The current time of falling yields is opportune to supplement the chest of forex reserves as a hedge against outflow of foreign portfolio investors on the prospect of rising yields back home. It will keep the current account deficit in check and insulate the country’s currency from volatility headwinds. In the run-up to any sovereign debt issuance, India’s balance sheet will come under heightened scrutiny, encouraging fiscal discipline. An upgrade in sovereign rating will lift well managed local companies. Hopefully, the confidence of servicing dollar-denominated debt will reignite the debate on capital account convertibility for wider acceptance of the rupee as a global currency, eliminating the need to issue sovereign debt in future. The liquidity provided by 35% minimum public holding in listed non-PSU companies will improve price discovery. Mutual funds and foreign investors, worried about price fluctuation due to their entry or exit, will feel comfortable owning such stocks. Increased institutional presence will lead to better governance. The higher free-float will increase the weight of Indian companies in various emerging market indices. Cash from offer for sale or issue of new shares can be utilized to undertake organic or inorganic expansion to bump up earnings. The three propositions in the budget do not appear to be offhand. They seem to have been formulated after much thought. Like most other initiatives of the Modi government, their impact will be felt over time.  

-Mohan Sule

The right notes

The Union Budget 2019-20 keeps sight on achieving growth, generating resources and easing living

The Modi 2.0 government’s first budget continued the relentless focus on repairing and refurbishing the economic model by chipping away the deadwood (pushing for the replacement of Pan with Aadhar and clubbing the multiple labour laws into four broad codes) and applying varnishing where the lustre had faded (improving Uday and infusing Rs 70000 crore to recapitalize public sector banks weakened by provisioning for bad loans). India is to be propelled into a US$ 5-trillion economy without disturbing the fiscal balance and crimping on capital expenditure unlike last year, when inter-PSU sales had to be organized to meet the 3.5% fiscal deficit target. With the middle class (up to Rs 5 lakh of taxable income out of the net on utilizing appropriate savings instruments) and the farmers (Rs 2000 cash transfer every quarter) taken care of by the interim budget, mobilization of resources, the crisis in the financial services sector and ease of living took centre stage. A national gas, water and highway grid, coming after the last-mile delivery of sanitation, houses and power, signals that the animal spirits of the people can be unleashed if they have access to basic amenities.  A committee will suggest how to mop up Rs 100 lakh crore of low-cost capital over the next five years to build infrastructure. Besides the message of managing currency volatility, the unexpected decision to offer sovereign debt implies confidence of earning investment-grade rating going ahead so as to lower borrowing costs. Inviting private partners to bring in some of the Rs 50-lakh-crore investment required between FY 2018 and FY 2030 is a public acknowledgement that running railways is a business. Fully foreign-owned airlines, animation studios and insurers are likely. Making electronic parts in India will get tax incentives. Aligning the foreign portfolio investment ceiling with the sector cap rather than restricting it to 24% across the board, too, will accelerate dollar inflows .Stocks will get better discounting. More companies will have dispersed shareholding.   

The credit crunch in the financial services sector has resulted in a slump in consumption. The government’s move to guarantee up to 10% loss for the first six months on buying up to Rs one lakh crore of securitized assets of sound NBFCs will embolden banks to open up the liquidity tap. Besides strategic sale to meet the Rs 1.05-lakh-crore divestment target, CPSEs will hike public presence to at least 25% of the share capital. Minimum government control of 51% will now be relaxed to include holdings of other government entities and foreign shareholding of PSUs in the emerging market index will be synchronized with the sector limit to make them attractive. Exchange traded funds investing in CPSEs are to be put on par with ELSS to make them popular with retail investors. The peak tax rate has been reduced to 25% on companies with turnover up to Rs 400 crore from Rs 250 crore. Interest outgo up to Rs 3.50 lakh on mortgages to finance residences up to Rs 45 lakh will be eligible for deduction. Capital gain on sale of residential house will be exempted if invested in start-ups by March 2021.

Three proposals in the harmlessly optimistic vision document provoked the market. Petrol products did not absorb the volatility in international crude prices for the near two-month duration of the Lok Sabha polls. Half of the two-tier higher levy of Re 1 each per liter on petrol and diesel will hopefully go to compensate the PSU oil market companies’ losses. The other half will contribute to the national highway network. The move signals a soft outlook for petro products and another nudge along with the Rs 1.5-lakh relief on servicing of loans to buy e-vehicles. The concern of supply overhang knocking down valuations of non-government companies to maintain the new 35% threshold for free float is misplaced as the outcome will be better price discovery. Reverse book-building by MNCs to delist will be an opportunity for decent capital appreciation. The 20% tax on buybacks by listed companies plugs the loophole to avoid the dividend distribution tax and levels the field in choosing one of the two options to reward the shareholders. No-charge digital payment for establishments with over Rs 50-crore turnover, pre-filled IT forms and simplified quarterly GST returns for businesses with less than Rs 5 crore of sales, scrapping scrutiny of sources of funds and share premium charged by new ventures making regular disclosures and between 3% and 7% effective increase in tax rate on the super rich. The budget has paved the way for more rate cuts.

 -Mohan Sule

Withdrawal pangs

The turmoil due to liquidity and governance issues is contributing to shrinking the basket of investible stocks

There are two ways of looking at the current turbulence in the Indian equity market. Companies with over decades of experience are facing the prospect of either disappearing or turning into shells. The situation can be wholeheartedly embraced as a much-needed detoxification to cleanse the system. Many in the center of the storm are not particularly known for their governance. More often the aggressive push to multiply earnings was through reckless borrowing for expansion and diversification, causing asset-liability mismatch and serial ratings downgrades.  Not that there was much of a choice. Financial services, aviation, media and entertainment, real estate and telecom are capital-guzzlers. A power generator recently exited from a city-specific distribution and asset management.  A stretched media conglomerate is in the cable business, makes laminate packaging and runs an amusement park. Now most of the stressed companies are exploring dilution of ownership in favor of strategic investors to remain in the game. An earlier display of maturity to let go would have prevented destruction of shareholder wealth. The downside is risk aversion. Companies might choose sluggish growth and returning of cash as dividends or through buybacks over undertaking capital expenditure based on assumption of future market size. Already investors are withdrawing from certain sectors that have not lived up to their earlier promises.

Telecom has become a graveyard due to the policy flip-flops, regulatory uncertainties and pricing wars. The space has shrunk to three players in a battle for supremacy and survival. The outcome is not fat margins but cannibalization. There is no clarity on the outlook even as India prepares to enter the 5G era. Only those with an appetite for adventure will undertake the roller-coaster ride with the two no-frills listed airlines remaining in the fray with more routes to fly after yet another player hit an air pocket. PSU and private banks are taking turns to be in and out of fashion based on trends of capital infusion and missteps on governance. Till recently the poster boys of how banks should be, NBFCs’ fall from grace has been swift and cruel on realization that these traders of funds are not even adept at balancing their books. Caught in the crossfire are real estate developers: they cannot deleverage unless their lenders extend credit for their stalled projects. The FMCG category is facing an identity crisis as it transforms to a cyclical depending on monsoon from being an evergreen defensive. Similar is the fate of pharmaceutical producers. Rather than being a balm in volatile times, they are transmitting stress of intensifying competition in generics in the developed countries and periodic inspection crackdown by overseas health agencies. Cement makers get strength only when they hunt as packs of price-manipulating hounds, dependent as they are on production and market locations.

The usually reliable two-wheeler and car makers have lost the kick to turn in heady returns as they grapple with climate-conscious warriors. How many of them will be able to travel the road to electrification is a question to which there is no easy answer. Improved road connectivity and a uniform indirect tax regime were supposed to put commercial vehicles in the fast lane. Weighing them down is too much debt taken to accumulate capacity. Power generators should ideally be fighting state distributors to pay their bills promptly.  Instead they were litigating to postpone getting auctioned for not servicing their loans. Catering to a global powerhouse in the making should be lifting valuations of oil explorers and refiners only if round-the-clock elections did not hinder their ability for a cost pass-through. Tech solutions providers were knights in shining armor for providing capital gains in a transparent manner till it became apparent as they struggled to transit to a digital economy that their gear is rusting and the troops are conveyor-belt operators. The choice is between backing high-risk ventures of first-generation promoters for rapid multi-fold appreciation and sluggish growth of established giants commanding discounting based on their brute market share. The  global footprints of those enjoying the advantage of cheap labor and operating in low-tech or polluting industries are not going to last forever. Indian investors are paying ridiculously high valuations for efficiency of capital utilization rather than for innovations. Harmonizing national ambition with regional aspirations (NaRa) is the slogan coined by the Modi 2.0 government. The investing community needs companies with global ambitions using the springboard of local aspirations (GaLa) by offering products and services that might not be essential but are indispensable in the New Economy.

-Mohan Sule

Crack the whip

It is time to order some healthy private banks and financiers to divide the assets and liabilities of IL&FS among themselves

That the equity market is forward-looking is now an accepted wisdom. Outlook overwhelms a stock’s present or past, however glorious or bleak. Headline indices scaled new highs after GDP data put India’s growth at a five-year low of 6.8% in the fiscal year ended March 2019 and intensifying trade wars threatened to derail the world economy. Instead of causing concern, the distress signal was greeted with relief due to the assumption that interest rates are bound to soften to promote consumption. Subsequently, the Reserve Bank of India cut the lending rate by a quarter percentage point and the US Federal Reserve has hinted that, instead of a hands-off policy for 2019, it will wield the scissor. Encouraging growth figures, on the other hand, create panic on fear the central bank will become hawkish to keep the resultant inflation in check. The message from the market is clear: policy makers have to ensure ease of liquidity at all times. The wish is based on the response to past crises. The out-of-the-box solution to pull the US economy out of the housing bubble burst of 2008 due to low-cost mortgages was making available more cheap money. In India, banks and mutual funds starved NBFCs of funds after the debt default by IL&FS. The RBI’s two auctions to release rupees by buying dollars have not squashed the clamor for pumping more cash into the system. 

Entry into the banking space is after vigorous scrutiny of the governance and financial track record of the promoters. In comparison, anyone with sufficient capital to meet the minimum requirement can start a shadow bank. If there are solid financing vehicles set up by corporate groups to push their products, there are also many entrepreneurial-backed ventures that are vulnerable to changes in regulations and market tastes. Instead of reliance on retail deposits that require investment in infrastructure and branding, bulk funds are on tap from institutional lenders in search of higher yields in a short span. If rollover of loans to crony capitalists without proper due diligence was the cause of grief for banks dependent on small savers, NBFCs’ woes are due to seeking resources from wholesale financiers for the short term to deploy them for a longer duration with buyers of consumer durables. Their survival problem is a horrible reminder of the plight of the ordinary investor in income instruments. Banks will return only up to Rs 1 lakh of the money surrendered for fixed returns. Mutual funds cannot even guarantee the principal. Regulations on capital adequacy and exposure norms framed to withstand headwinds are often found to be inadequate. Players grapple with the conflicting obligation of keeping customers in search of cheap loans and the shareholders looking for high capital gains satisfied.  Investment-grade paper offers poor yields. The search for lucrative assets has led to shares of unlisted companies and infrastructure projects promoted by government. If the upside is fat margins, the downside is the absence of a secondary market for exit.

 The reflex action of monitoring agencies faced with a blowout is to clamp down. The RBI has ordered NBFCs to set aside more emergency capital. The sensible move is to avoid defaults and curb panic in the market. The collateral damage is less money to lend. A better approach is to encourage a shake-up. Consolidation will weed out weak outfits. The global financial meltdown was used by the US Treasury department to browbeat too-big-too-fail financial institutions to merge. The Fed, on its part, turned on the credit pipeline to avoid recession. India is in a better position. The slowing economy has not spurred talk of recession despite the Indian central bank’s revision of its outlook for interest rate to accommodating from neutral led to the tanking of the stock market.  The monetary authority is awaiting a committee to suggest how to meet the fund requirement of non-bank players. This is inadequate. The March 2019 quarter numbers of companies and sales of automobiles in the first two months of the new fiscal year have created urgency for proactive measures. It should supplement its recent action by slashing the benchmark rate to the 5% level, considering the projection for consumer price inflation is around 3% for H1 of FY 2019, and complement it by reducing the mandatory cash-keeping requirement by at least 50 basis points. The salvaging of IL&FS is taking too long, with no end in sight. Sitting out any longer for resolution is not an option anymore. The finance ministry should order healthy private banks and some sound NBFCs to divide the lender’s assets and liabilities in return for plum PSU accounts and making them the financiers of choice for government employees. The time to dangle a carrot is over. Now bring out the stick.

-Mohan Sule

Jewels in the crown

PSU banks are important for the government’s social outreach program to be indiscriminately disposed of

Ever since British Prime Minister Margaret Thatcher opened up the London financial markets on 27 October 1986, there is a tendency to slot reforms. Big-bang modifications are sought to demolish entrenched practices in contrast to incremental revisions unveiled one step at a time. The aim of the two approaches is the same: to make the system efficient. A sudden recast can overwhelm stakeholders who have to adapt to the new environment without any transition period. The outcome might not be visible immediately but casualties are in plain sight, raising doubt about the exercise. Both demonetization and the goods and services tax are expected to widen the tax base though high-value notes were scrapped overnight and uniform indirect tax slabs were launched after years of preparation and false starts. What was evident in the short term was the discomfort experienced during the transformation. The introduction of electronic trading and settlement was a major inflection point for investors. The process was undertaken in small doses. Dematerialization of large caps was followed by mid and small caps. The lower valuations attached to physical shares accelerated the push to digital format. Nonetheless, it took 22 years since its introduction to enter a completely paperless regime from end December 2018.The annual budget exercise too is used to plug loopholes and launch initiatives. With a few exceptions, such as in 1991, when the economy was opened across the board, the announcements are not clubbed with measures that irrevocably change the way business is done. Investors tend to separate the run-up and the period after the change as different eras. 

Despite undertaking four major disruptions including making the real estate sector transparent and accountable and passing the bankruptcy law, the appraisal of Narendra Modi’s track record invariably features the sluggish pace of the privatization program. Comparisons are made with the NDA-1 government’s aggressive thrust, when a dedicated ministry was set up to fast-track partial or complete withdrawal from PSUs. Diluting holdings in banks and oil explorers and refiners despite facing resistance are cited as the resolve of the AB Vajpayee government in getting out of running companies. In contrast, the first tenure of the NDA-2 government was marked by PSUs buying shares of other PSUs. Offers for sale to retail and institutional investors were in bits and pieces. Now, 35 profitable and loss-making Central enterprises have been identified for outright disposal despite the bizarre outcome of strategic sale during the previous NDA rule. A hospitality property was resold by the acquirer for a higher price. Another is again on the block. The three hotels of the ITDC group barely managed to scrape through. There were no takers for 51% share capital of Fertilizers and Chemicals Travancore despite the lure of dual pricing and higher subsidy. It took 16 years for the Tatas to get permission to monetize the land that it had bagged with the 25% equity in VSNL in 2002. The failure to get any bidders for over three-fourth holding in Air India due to its Rs 33000-crore debt is a rude reminder that PSU assets are not exciting buyers. It is now clear that the enthusiasm of the disinvestment drive 20 years ago cannot be replicated.

What has changed?  The subsequent UPA- 1 and -2 governments did not build up the momentum by giving operational freedom to even those PSUs that are listed. Petrol prices were de-regulated in 2012 after a committee’s recommendation a decade earlier.  It took another seven years to free diesel. Fuels, however, continue to remain outside GST, enabling the Central and state governments to revise taxes as per political expediency. Phone-banking ensured credit lines to cronies. The pile-up of NPAs turned off investors from PSU banks. Remedies such as recovering bad loans through bankruptcy proceedings, insulating appointments of top officials and business decisions from political interference and capital infusion are making them attractive. Merger of associates with SBI and among three government-owned lenders is leading to consolidation in the space. The use of banks for last-mile transmission of many welfare schemes had triggered a clamor for the government to retreat on concerns that Mudra loans to set up micro enterprises have the potential to turn sour. The din subsided on revelations of governance missteps at some private banks. As Gujarat chief minister, Modi turned around salvageable state organizations by assigning bureaucrats instead of politicians to run them. That the Nifty PSU Bank index has outperformed the Nifty and the Nifty Bank index since the last two phases of the Lok Sabha polls captures the market’s optimism about their return to health rather than ceding of government control.

-Mohan Sule