Divergence to convergence

Law makers and regulators are getting on the same page for ease of doing business without bothering about the bill

 21 September 2020

Ever since the US Federal Reserve shifted its gaze last month from inflation-targeting to job-creation, the role of policy makers and market monitors has come into focus. Before the pandemic, there was no confusion on what was expected of governments and various regulators. Elected representatives making laws that turned their nations into welfare states or were so restrictive so to stifle entrepreneurship had to face the backlash of higher purchasing spends and low growth. The problem is that the terms of most democratic governments range from four to five years. The scope to inflict damage due to recklessness or timidity is extensive, requiring painful adjustments by the next regime. Regulators balanced populism and conservatism by calibrating policies that tightened or eased rules. Central banks tinkered with the flow and cost of money to discourage exuberance or encourage consumption, while keeping food and non-food output affordable. Efforts of the securities monitors were to create a level-playing field for issuers and investors. Competition regulators nipped predatory pricing and unfair sales practices to ensure users had a choice. With such clear-cut spaces to operate, there should be no recession, runaway retail prices and speculative bets. Each segment should have a handful of operators enjoying similar share of the market. Insider trading, stock-rigging and accounts fudging should be the rarest of rare cases. Unfortunately, textbook rules do not account for changes in technology and tastes. The IMF and World Bank prescription of belt-tightening for government excesses has become outdated. Now the template is more liquidity to boost consumption.

The pandemic has blurred the boundaries between the functions of legislators and gatekeepers. Ideally, they are supposed to work at cross-purpose without paralyzing the system. If the government adopted loose fiscal habits of cash infusion, soft taxes and high expenditure to support the distressed economy, the monetary authority was expected to make funds dearer to nip any bubbles in the making. Right now, both the arms are working in tandem to make available low-cost loans. In fact, the Fed has strayed from its mandate to boldly trespass into a domain that is not in its charter. It will keep the tap of cheap credit turned on for as long as it takes to achieve saturation employment and retail demand to outstrip supply by 2%. The Reserve Bank of India is in no mood to bump up the real negative interest rates for fear of stalling economic recovery. After the Rs 50000-crore targeted refinancing in May, NBFCs were offered another Rs10000 crore in August. Servicing of term loans was suspended for six months, an action best suited for politicians. Easing of asset classification was permitted to offset provisioning for covid-19 defaults. A one-time restructuring of loans outstanding before the medical emergency is set to be followed by sector-specific prescriptions.  Priority sector lending norms have been tweaked to include education and social infrastructure. Flow to credit-starved districts will earn incentives.

 

The capital market watchdog turned endearing from brusque. Preferential issues at higher of the volume-weighted average price over 12 weeks or two weeks cleared the way for cash-starved Corporate India to tap into the US and India stimulus. Scaling down the minimum market cap of public holding in a rights issue to Rs 100 crore from Rs 250 crore, threshold for subscription to 75% from 90%  and prior listing to 18 months from three years have provided flexibility to promoters to increase their exposure to support their companies. Doing away filing of draft offer for rights issues up to Rs 25 crore is to help small enterprises. The roll-back of the gap between buybacks to six months from one year opens the exit route for the shareholders.  Side-pocketing of stressed assets can be done the moment a proposal for debt recast is received by the fund house, thereby stemming the erosion of NAVs and redemption pressure. The clampdown on multi-cap funds and end-of-the-day margin in the cash segment plugs another loophole for manipulation. Instead of lazy investing of concentrating on large caps, fund managers need to take exposure evenly across different categories of stocks or allow investor migration. Brokers can no longer misuse shares pledged for rampant intra-day trading as each transaction has to be accompanied by adequate backup. What needs to be seen is who is going to pick the tab for the ballooning bad loans and loss of price discovery coming as accompaniments in the feel-good feast.

 

-Mohan Sule 

 

New beginnings

 

Emergence of strong companies on clearing of regulatory overhang, capital-raising and restructuring

 7 September 2020

 

The June 2020 quarter sharpened Corporate India’s fault lines by separating companies into three categories. Essential services providers did not have to shut down. Nevertheless, volumes and the margins contracted on a sudden slump in demand, with export-oriented pharmaceutical producers and tech solutions providers being the exceptions. In the middle were a majority, with no output in April and a gradual recovery from May to about 80% capacity utilization by June. Some of them put up a decent show by restricting the fall in the margins due to soft input costs and dip in fixed overheads on reduced operations. Rural consumption partially compensated the absence of urban buyers. The worst of the lot were those who had to bear the full weight of social distancing and included malls, multiplexes, airlines and tourism- related services. A common thread binding all is the focus on survival rather than growth. Capital expenditure is the casualty as cash is stocked up.

Going beyond the headline numbers, three trends became visible, reaffirming the assumption that a downturn is the time for new beginnings. First is the clearing of the overhang of past issues that had spilled over from the pre-covid-19 period. The pullback of Yes Bank from the brink is a stunning example of how a crisis can be converted into an opportunity by taking advantage of the cheap liquidity looking for deployment. The risk-takers, the clutch of public and private lenders pooling in Rs 10000 crore by subscribing to the shares at Rs 10 mid-March, had made a notional profit of 50% on their investment in five months, giving an annualized return of 120% when real interest rates are negative. Besides returning to profitability after reporting losses in the past three quarters, Q1 showed sequential improvement in operating parameters. Customers repaid almost 50% of their overdue position, enabling repayment of 35% of the Rs 50000 crore borrowed from the Reserve Bank of India. Credit ratings on foreign and Indian currency borrowings have been bumped up. The regulator’s nod for a new top boss of HDFC Bank and Bandhan Bank coming out of restrictions on branch opening since September 2018 after promoters brought down their stake by half to around 21% contributed to the rerating of the banking sector that got a further boost after the central bank allowed one-time restructuring of  loans outstanding  in March. The turnaround in sentiment was also an extension of the record Rs 56500-crore capital-dilution by Yes Bank, ICICI Bank, HDFC and Axis Bank as India was unlocking. IT, real estate, auto and pharma players, too, are tapping the equity and debt markets. Shares are being offered at a discount to the current prices, off their yearly highs, leaving scope for appreciation once spends on growth resume. Sovereign funds besides venture capitalists are taking exposure. The exercise offers clues to the shape of the issuer. Private placement indicates the support price for the stock. Retail investors through FPOs can enter at levels lower than those of institutional investors. Rights issues usually imply lukewarm reception from new investors. At the same time, they demonstrate promoters’ commitment. Debt implies short-term need for money. Several companies are accessing credit at a coupon of around 8%, implying real borrowing cost of 1% considering consumer price inflation is a tad below 7%.

 

Change in ownership is another offshoot of any churn in the market.  The amalgamation of 10 public sector banks into four from 1 April, at hindsight, preempted what would have been inevitable in the post-pandemic era. The merger between ICICI Lombard General Insurance Company and Bharti Axa General Insurance Company is a forerunner to the consolidation in the financial services segment, just like in the telecom space, where only three participants remain. A shakedown in the distressed realty sector will leave only companies enjoying investor confidence. The Embassy group’s friendly takeover of Indiabulls Real Estate was not surprising. A 10% equity stake was divested to the new promoter last year as part of the effort of the troubled group to clean up the balance sheet in the run-up for  approval to combine the financial services arm with Laxmi Vilas Bank that is now not happening. Economic turmoil is the right time for unwieldy conglomerates to become lean. The hiving of the non-airport businesses by GMR Infrastructure was in response for pure play to assign proper discounting. Privatization and connectivity in the civil aviation sector is one of the thrust areas of the Modi government. Investors can, thus, look forward to a fitter Corporate India readying to take off.

 -Mohan Sule