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